Tuesday, September 8, 2009

Never Trust Experts

The New York Times columnist and liberal economist Paul Krugman had a deeply misleading article in the New York Times Magazine last Sunday, titled "How Did Economists Get It So Wrong?"

Misleading? Well, he represents that economists, especially the neoclassical kind, believe in a rational model of the economy, and were taken by surprise when the credit system collapsed a year ago. There's an argument between "freshwater" economists in the heartland and "saltwater" economists on the coasts as to what, if anything macroeconomics could or should do about regulating the economy.

I'll have more to say on Krugman's argument later. But let us at least start with this.

All economists are experts that want to influence government policy. And they all seem to believe in some sort of rational bureaucratic model of economic policy. They want to be the political advisers of whom Lord Salisbury said: "Never trust experts."

That's because experts are people on the fringes of political power who want their pet theories implemented by the politicians. They aren't really principals with ownership and responsibilities. They are just bit players who would do anything for a starring role.

Since the advent of big government, say at the turn of the twentieth century, the big economic problem has been how to deal with the dreadful distortions that governments routinely impose upon national economies. The monetarism of Milton Friedman is one attempt to deal with the problem. The Keynesianism of liberal economists is another.

But both approaches are grossly simplistic, and really fail to deal with the central problem.

The problem is that politicians and special interests are eternally trying to game the economic system for their benefit. In the 1920s politicians were trying to game the system to deal with the distortions created by the Great War and the reparations imposed upon Germany. And in the United States there were people trying to gun the economy to increase home affordability.

Of course, all this meddling produced all kinds of unexpected results. And in addition, when the economy turned south in 1929, the newly created Federal Reserve Board wasn't up to the job and didn't really know what to do. Why be surprised. The nation's de-facto central banker, J.P. Morgan, had been replaced by political hacks. So the Fed temporized, as political hacks will do--and allowed a ton of banks to fail.

In the 1990s the economy was naturally boomed by a remarkable technical revolution. But it was also being boomed by a vast increase in credit for home mortgages driven by the government-sponsored Fannie Mae and Freddie Mac.

We now know that Fannie Mae and Freddie Mac were disasters waiting to happen. But the economists didn't seem to think so. Not at the time. I remember being troubled by the housing boom, but I didn't realize the exact mechanism: the sub-prime loans that were driven by political mandates on the banks. And I didn't think that the Fed would let a major bank like Lehman Brothers fail.

The point is that the silly intramural quarrels over monetarism and Keynesianism rather miss the point when you've generated $5 trillion in Fannie/Freddie mortgages that completely overwhelm the market operations of the Federal Reserve Board. I didn't read too many academic economists putting their fingers on this problem. But I remember wondering why the Monetary Base was going up so slowly in the mod 2000s when it was clear that credit was booming.

My argument is that this argument between monetarists and Keynesians is what President Obama would call a "false choice." The problem is that government is trying to game the economic system all the time and that makes it very difficult for markets to provide a clear signal to investors.

We need a lot less gaming, a lot less leverage and a lot more equity in the markets. And that should start with government. It's got to stop favoring special interests with cheap credit.

No comments:

Post a Comment