On September 15, 2008, the bankruptcy of the United States investment bank Lehman Brothers and the collapse of AIG, the world's largest insurance company, triggered the 2008 Global Financial Crisis. The end result was a global recession, which cost the world tens of trillions of dollars and rendered 30 million people unemployed. In addition, the crisis doubled the national debt of the United States. In our senior seminar final project, we plan to explore the relevant theories provided by economists Karl Marx, Minsky and George Berkeley on the financial crisis.
On September 15, 2008, the bankruptcy of the United States investment bank Lehman Brothers and the collapse of AIG, the world's largest insurance company, triggered the 2008 Global Financial Crisis. The end result was a global recession, which cost the world tens of trillions of dollars and rendered 30 million people unemployed. In addition, the crisis doubled the national debt of the United States. In our senior seminar final project, we plan to explore the relevant theories provided by economists Karl Marx, Hyman Minsky and George Berkeley on the financial crisis.
Following the theories, we will also examine the empirical evidence from the Great Depression and the recession in the 70s as well as the current financial crisis. The Marxists think recessions are imbedded in the capitalism system and business cycles are the direct result of profit maximizing actions in the market. Karl Marx developed the major theory of business cycle, which draws heavily from J.S. Mill. As a post Keynesian economist, Minsky explained the fragility of the financial system is a feature of a Capitalist system. In particular, an integrated international financial market only increases the instability of individual economy.
Following the Marx and Minsky theories, we will examine the empirical evidence from the Great Depression and the recession in the 70s as well as the current financial crisis. The Marxists think recessions are imbedded in the capitalism system and business cycles are the direct result of profit maximizing actions in the market. Karl Marx developed the major theory of business cycle, which draws heavily from J.S. Mill. As a post Keynesian economist, Minsky explained the fragility of the financial system is a feature of a Capitalist system. In particular, an integrated international financial market only increases the instability of individual economy.
Within the Berkeley approach, we will examine human motivation, Berkeley's functions of a bank, regulatory monitoring, separation of powers, transparency, elimination of conflicts of interest, speculation and economic crisis and artificial appetites. Furthermore, we will apply these sections of analysis to Wall Street.
The solution Marx proposes is to overthrow the capitalist government by revolutions. The working class should redistribute means of production to workers. The problem of overproduction will then be solved because workers make more sensible production decisions than firm owners. Marx also calls for an international alliance of workers. In the long term, economic crisis will not happen again if working class rules the world.
The solution Marx proposes is to overthrow the capitalist government by revolutions. The working class should redistribute means of production to workers. The problem of overproduction will then be solved because workers make more sensible production decisions than firm owners. Marx also calls for an international alliance of workers. In the long term, economic crisis will not happen again if working class rules the world.
== Section II:Minsky ==
== Section II: Minsky ==
[[File:Hyman Minsky.jpg|right|frame|Hyman Minsky (September 23, 1919 – October 24, 1996)]]
[[File:Hyman Minsky.jpg|right|frame|Hyman Minsky (September 23, 1919 – October 24, 1996)]]
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== Section III: George Berkeley ==
== Section III: George Berkeley ==
This section can now be found on the moodle course
[[File:George Berkeley.jpg|right|frame|George Berkeley (March 12, 1685 - January 14, 1753)]]
'''References'''
George Berkeley had already developed a sophisticated analysis of financial crises by the 1730s. His policy recommendations still have much to teach us today as we come to grips with the current financial crisis. Berkeley’s work combines his insights about human sociality and his knowledge of real-world banking successes and failures with his concern for the public. Berkley’s theory on human behavior and his theories of economic development: consistent framework for understanding 18th century style financial crises that provides concrete policy conclusions. His multi-faceted argument mainly draws on two works: "The Querist" and "The National Bank Plan".
'''Berkeley's Approach to Money, Credit, and Debit'''
Berkeley worked along the lines of the "Theory of the Second Best" and argued that his beloved country of Ireland ought to make the best of a difficult situation. He judged policy in terms of the "Greatest Happiness of the Majority", which entailed the well-being of all of the people, not just a select few. To promote economic prosperity, the majority ought to be made better off (Queries 20, 107, 351, 352, and 353).
Berkeley believed that "the credit of the public funds" was "a mine of gold" (Query 233) and that a national bank is "the true philosopher's stone in a State" (Query 459). He advised that a public bank would help mine the gold of the public funds for the promotion of wealth and indsutry among the lower people" by "facilitating and quickening the circulation of power to supply wants" (Query 480).
For Berkeley, money is a circulating medium based on credit: “all circulation…is like a circulation of credit, whatever medium (metal or paper) is employed…” (Query 426). Additionally, Berkeley believed that money should not have any instrinsic value whatsoever. He explains that ”The true idea of money is that of a ticket or counter” (Query 23) What is real wealth then? It is not the token money but rather it is the “power to command the industry of others”, that is “real wealth” and money is merely “tickets or tokens for conveying and recording such power” (Query 35). A country is made wealthy by “the industry of its inhabitants…they prove to inexhaustible funds of real wealth…” (Query 40) Land itself is not wealth. (Query 38) It is the” industry of the people” that makes wealth possible (Query 38). A number of queries emphasize that it takes human labor and industry to generate wealth. Thus, money is seen as an aid to and not a substitute for human effort.
[[File:The Querist.jpg|right|frame|Berkeley's "The Querist"]]
'''Human Motivation'''
Berkeley realizes that the human actor must be involved and so he attempts to set incentives to separate functions as to minimize malfeasance. He does not rest his economic arguments on the assumption of benevolent agents. Thus, he proposes that the government and legislature is the ultimate overseer of the bank. However, Berkeley also sees human agents as flawed. Hence, he provides checks and balances in his bank plan and seeks the improvement of politicians (a number of queries call for those with influence and power to improve themselves). Within his writings, there are numerous examples of the fallible human actor and instructions on their self-improvement (he was a Bishop after all). Berkeley is also not blinded by the actions of self-interested and fallible politicians who ultimately oversee the bank which final authority emanates. Thus, he suggests checks and balances to try to get the incentives right, believing that the human actors will need the disciplining effects of an open and transparent system of governance.
'''Functions of Banks and Commonly Accepted Aspects of Regulation'''
Berkeley’s writings demonstrate an awareness of what have become the commonly recognized economic functions of banks (a testament to how far ahead he was compared to the time period in which he lived in). For Berkeley, banks receive deposits and ought to create loans to promote industry. Hence, banks act as financial intermediaries helping to channel savings from borrowers by moving funds from “lenders” (the depositors of the bank) to borrowers. Berkeley’s public bank would help coordinate lending with sound borrowers and would encourage “manufacturers of several kinds, which are not likely to be set on foot and carried on to perfection without great stock, public encouragement, general regulations and the concurrence of many hands”(Query 226). As Berkeley argues, his public bank will be better able to enforce agreements and vet good and bad risks. Back by the power of the state and with legislative oversight, a public bank would be better able to reduce the problems of asymmetric information (adverse selection and moral hazard) which might otherwise mean that fewer loans would take place.
'''Berkeley's Rules of Sound Banking to Avert Financial Crisis'''
1.) Restrictions on Entry. Not just anyone should own or operate a bank: “too much power in the hands of private men…gives handle to monopolies, stock jobbing, and destructive schemes.” (Query 216)
2.) Disclosure and Transparency to help prevent fraud: subscriptions, shares, dividends, and stock jobbing. The opacity (transparency) of financial activities has played a role in the current financial crisis. “The secrecy of private banks” is “the very thing that renders them so hazardous” (Query 45) Policy goal ought to be promotion of industry.
3.) Regulatory Monitoring: “Those things that are subject to the most general inspection are the least subject to abuse.” (Query 56) Proper regulation and supervision allowing for regular and routine inspection by the state.
4.) Banks and Investment firms ought not to be overseeing their own regulation. Through vigorous lobbying, the financial industry has played a large role in the helping to reduce regulation: “But, whether a private interest be not generally supported or pursued with more zeal than a public.” (Query 28)
5.) Structure to ensure that private interests are aligned with the public interest.
6.) Policy should enhance actual and perceived security to provide for stability. Not only the physical makeup, construction and layout of the bank.
7.) Restrictions on Assets and Activities: There should be a wall of separation between Banks and firms that engage in risky investments (Query 106). “A means of idleness and gaming, instead of a motive and help to industry” (Query 229), circulating without industry (Query 250), “subscriptions, shares, dividends, and stock jobbing” (Query 246).
8.) Separation of Powers: separate powers for directors, auditing inspectors and governing bodies that have oversight over the bank managers and the directors of the bank (Query 111). Separate bodies choose directors (Query 230), are not part of the legislature which would help to oversee the bank. Directors would “be subject to the audit and visitation of a standing committee of both houses” (Query 231). To prevent conflicts of interest and power to be accrued the “committee of inspectors should…be changes every two years, one-half going out, and the another coming in by ballot” (Query 232).
9.) Adequate Ready Cash Reserves on Hand to promote stability in banking system and lessen risk of default.
10.) Deposit Insurance and lender of last resort (LOLR): Berkeley’s public bank had the full backing of the legislature and the public.
11.) Money need not have intrinsic value or be “a commodity, a standard, a measure, or a pledge” (Query 23). Indeed, “the true idea of money…is that of a ticker or counter” (Query 23).
12.) Berkeley warned about “permitting all persons to take out what bills they pleased, upon the mortgage of lands” (Query 215).
13.) Conducting monetary policy is another important aspect of banking. Banks play such an important role in the money supply creation process. Berkeley also recognized this important role with his emphasis on preventing inflation from becoming too great. KEPP INFLATION IN CHECK. Berkeley cautioned that there must exist limits on the creation of notes and he suggests some guides to policy making, pointing to inflation and asset price inflation especially of land prices and mortgages. Emphasized that policy makers ought to keep an eye on land prices and to avoid the formation of bubbles. Making the prevention of asset bubbles a policy goal and explicitly pointing to relevant asset prices (ie. land for his day). He sees a monetary goal allowing for slow increase in prices over time, keeping an eye on inflation and the rise in the price of lands. Monetary Policy is a trial and error procedure where “the quantum of notes ought…to bear proportion to the public demand” (Query 245). “Too small a proportion of money would…hurt the landed man, and too great a proportion the monied man” (Query 245). In these queries, Berkeley points to the crises that came about because of failure to limit the number of notes issued.
14.) Monetary policy ought to help meet the financing needs of business (Query 134) and to provide for stable prices (Query 123).
'''Regulatory Monitoring'''
According to Berkeley, regulatory monitoring is crucial reasoning "those things that are subject to the most general inspection are the least subject to abuse” (Query 56). Not only that but he also sees that there is a scope for mutual monitoring to help ensure that the incentives of the directors are aligned with those of the bank. He argues that “managers, officers, cashiers” ought to be the “servants of the public, acting by orders and limited by rules of the legislature” (Query 124). Under Berkley’s plan, “the managers and officers of a national bank…are in effect as little trusted, have as little power, are as much limited by rules, and as liable to inspection” as “cashiers and clerks of private banks” (Query 90). Unlike a private bank, the national bank does not depend “on the credit, or wisdom, or honesty of private men” (Query 91). Rather, it depends “on the public, which is the sole proprietor and director thereof, and as such obliged to support it” (Query 91).
Queries 124-136 discuss the issues of structure, monitoring, and security. Berkeley provides detailed rules governing when and how often inspections take place, who will make up the body of inspectors, the role of legislature, the importance of duplicate books kept in separate locations, and even the very material used for the buildings of the public treasuries. These rules are designed to prevent conflicts of interest, to promote mutual monitoring, to provide public show of security and to promote transparency. All of these work together to provide a stable banking system.
Queries 117, 118, and 119-123 describe the structure and funding of the bank. “The sole proprietor of such bank…is the public, and the sole director the legislature” (Query 123). Hence, the public is the lender of last resort. This is also repeated in the national bank plan: “A Bank, whereof of the Publick makes all the Profit, and therefore makes good all Deficiencies, must be most secure.” And under section X, “THAT as the Publick be alone the Banker, or sole Proprietor of this Bank; the Profits whereof shall be accounted for in Parliament, and applied under the Direction of the Legislature, to the promoting of publick Works and Manufactures.” Oversight by the state, would provide assurances to the solvency and fitness of a private bank (Query 48).
'''Separation of Powers'''
Berkeley devised rules to help establish separate powers with respect to the directors, auditing inspectors and governing bodies that have oversight over the banking managers and the directors of the bank.The Banks of England and Scotland, Berkeley observed, were “attended with great inconveniences” because they ”lodged too much power in the hands of private men…giving handle for monopolies, stock-jobbing and destructive schemes”(Query 216). “A BANK wherein there are no Sharers, would be free from all the Evils of Stock-jobbing. A Bank, whereof the Publick makes all the Profit, and therefore makes good all Deficiencies, must be more secure (The National Bank Plan). Again, “the evil effects which…have attended paper-money and credit in Europe…[sprang] from subscriptions, shares, dividends, and stock-jobbing” (Query 246). Hence, under Berkeley’s plan, “Managers of the bank” were to be “excluded…from a share in the legislature” (Query 224).
Directors were to be chosen by separate bodies: “national bank, [was to be] under direction of certain persons, one-third whereof to be named by the Government, and one-third by each House of Parliament” (Query 230). The directors of the bank ought not to also be part of the legislature, which would help to oversee the bank. Directors would “be subject to the audit and visitation of a standing committee of both Houses” (Query 231). To prevent conflicts of interest and power to be accrued the “committee of inspectors should…be changed every two years, one-half going out, and another coming in by ballot” (Query 232).
'''Transparency'''
"The opacity of financial activities, the inability to judge the true risk of complicated assets has played a role in the current financial crisis." (McPhail and Rashid 12)
Berkeley foresaw that “secrecy” played a key role enabling fraud to take place, providing the wrong incentives for the directors of the bank. Proponents of private banks argued that secrecy would be reduced with a national bank but as Berkeley argued, openness was an argument for having a national bank(Query 44).
- Indeed, “the secrecy of private banks” is “the very thing that renders them so hazardous” (Query 45)?
- The better the inspection procedures, the less likely that there will be abuses (Query 56) and greater oversight, there would have been fewer financial collapses (Query 45).
While Berkeley did not believe that government officials were selfless or that government action was not without its concerns, he wished to refute the opposite error: believing that private decision making, when mediated by market exchange, cannot produce results inferior to those bought about by enlightened government action. Berkeley saw the financial sector plagued by market failure. He found it “very hard to suppose all sense, honesty, and public spirit were in the keeping of only a few private men, and the public was not fit to be trusted” (Query 26). Or given to the secrecy “whether there can be any security in an estate of land when the demands upon it are unknown” (Query 38)?
'''Elimination of Conflicts of Interest'''
Berkeley warned about private concerns that put their self-interest before that of the public. The success of a public bank would come at their expense hence their “zeal” to support their own interests over that of the public’s (Query 28). Indeed, “whether though a scheme be never so evidently practicable and useful to the public, yet, if conceived to interfere with a private interest, it be not forthwith with in danger of appearing doubtful, difficult, and impracticable” (Query 40) or that “Whether, for private ends, it may not be sometimes expedient to object novelty to things that have been often tried, difficulty to the plainest things, and hazard to the safest” (Query 57)?
Numerous queries defend the public bank against private interests. Berkeley asks: “How, why, by what means, or for what end, should it become an instrument of oppression” (Query 37) Is it the public not to be trusted but “a few private men” are to be trusted (Query 26)? Is it “not ridiculous to suppose a legislature should be afraid to trust itself” (Query 27) given that “the legislative body hath not already sufficient power to hurt, if they may be supposed capable of it, and whether a bank would give them any new power” (Query 41)? Why would the public “defraud itself” (Query 42)? Is it reasonable to believe that the legislature wishes “its own destruction” (Query 43)?
For Berkeley, it is not reasonable to “expect wise and punctual dealing” in a private bank which “depends on secrecy” rather than a transparent public bank “regulated and inspected by Parliament” (Query 33).
'''Speculation and Economic Crisis'''
Berkeley was a student of economic crises and wrote a number of queries precisely on that topic (ex. the Mississippi bubble and South Sea Company scheme. Berkeley argues that the rules governing the banks that played a role in encouraging and promoting bubbles were simply not up to the task to avoid the outcome. He was keen to argue that fractional reserve banking need not lead to bubbles. Instead, he sought to show that banks can be set up so as to help provide the liquidity and credit that the economy requires to function smoothly.
Remarkably, Berkeley realized that asset price inflation could help to bring about a banking sector crash. Commenting on the situation in America, he noted that “over-rating their lands” (Query 247) or land speculation and the over assessment of the value of the lands (what was seen in the real estate bubbles in Japan, the United States, and various other countries) are caused by fraud and incentives that help to encourage speculation. Commenting on “the ill effects of such a bank as Mr. Law proposed for Scotland", Berkeley warned about “permitting all persons to take out what bills they pleased, upon the mortgage of lands” (Query 215). Berkeley realized that this speculation had nothing inherently to do with the institution of banking, paper money, or credit but rather that it had to do with the incentives that actors faced and the occurrence of outright fraud. Berkeley argued that fraud takes place in the form of “legislators breaking their own rule in favour of themselves, thus sacrificing the public to their private benefit” (Query 247).
Berkeley had an endogenous account of how a bubble can arise. Queries 304 -317 lay out the mechanism that he saw at work in the various failed schemes. Berkeley linked his notion of the infinite artificial appetites (Query 304), which can, in the presence of wrong incentives such as those found in the Mississippi Scheme and failed schemes in England and France, take control. Under those conditions, speculation would endogenously arise.
'''Artificial Appetites'''
Berkley argues that artificial appetites can give rise to financial instability because of the increased willingness of financial advisors to engage in riskier and riskier behavior, or as he calls: Berkeley’s “madness”.
Berkeley’s theory of human sociality also comes into play when assessing the financial crisis from a Berkleyan perspective. Berkeley often employed medical terms when diagnosing the ills of the social body. He asked: “whether it is not natural to wish for a benevolent physician” (Query 344)? When making an analogy between the physical bodies and the social body, Berkeley notes that “passions and motions” can obstruct the social body and that like the human body, the health of the social body cannot be achieved without the health of the parts. Berkeley notes that these “obstructions” can interfere with our natural fellow feeling and that “private passions and motions of the soul do often obstruct the operation of that benevolent uniting instinct implanted in human nature”.
The Querist details how in the economic sphere “obstructions” can lead individuals to a focus on private interest to the expense of the public interest. Berkeley counsels that these obstructions, which are the result of the artificial appetites, the vanities, and the passions, etc., either need to be redirected into more socially useful pursuits or, if need be, they need to be curtailed by state action. Berkeley explicitly recognizes “speculation and other forms of passing money from hand to hand without industry” as obstructions to the social body.
Berkeley argues that legislators ought to know “how to guide men’s humours and passions”(Query 346). They have a special role to play as “the soul or will of the community, which is the prime mover that governs and directs the whole” (Query 590).
Berkeley combines his theory of artificial appetites and obstructions with his argument that “industry causeth a country to flourish” and makes it wealthy not on the mere accumulation of gold and silver (Queries 560, 561 and 562). Berkeley equates gold and silver to a “drug” when it does not promote industry.
Berkeley sees that these artificial appetites are given full play in a speculative frenzy where it is the mere pursuit of riches, gold, silver and money without aim to promote industry: “Whether the ruinous effects of Mississippi, South Sea, and such schemes were not owing to an abuse of paper money or credit, in making it a means of idleness and gaming, instead of a motive to help industry” (Query 229).
Buchholz, Todd G. New Ideas from Dead Economists. N.p.: A Plume Book, n.d. Print.
'''Applying Berkeley's Analysis to Wallstreet'''
Dymski, Gary, and Robert Pollin. New Perspectives in Monetary Macroeconomics. N.p.: The University of Michigan Press., n.d. Print.
[[File:Wall-Street.jpg|right|frame]]
Mandel, Ernest. "Karl Marx." Marx's Theory of Crises. N.p., n.d. Web. 8 May 2011. <http://www.marxists.org/archive/mandel/19xx/marx/ch09.htm>.
The role of the enormous "appetites" of Wall Street investors have not gone noticed. The "casino-like" behavior of financial markets has spilled over into the lives of the investors themselves. The growth of the super yacht club, the indulgence in prostitution and heavy drug use, the pursuit of lavish liefstyles are what Berkeley would label as "aritifical appetites". Berkeley argued that artificial appetites (especially those fueled by money and power) were infinite while natural appetites are limited.
"MINSKY ON THE REREGULATION AND RESTRUCTURING OF THE FINANCIAL SYSTEM." Levy Economics Institute. N.p., n.d. Web. 8 May 2011. <http://www.levyinstitute.org/>.
Given the behavior of the Wall Street class that helped bring about the financial crisis, Berkeley may well have counseled that "when the root yieldeth insufficient nourishment men, top the tree to make the lower branches thrive" (Query 158).
Minsky, Hyman P. Stabilizing a Unstable Economy. New Haven: Yale University Press, n.d. Print.
'
Skouse Mark. The Making of Modern Economics: the Lives and Ideas of the Great Thinkers. 2nd ed. Armonk : n.p., n.d. Print.
Latest revision as of 19:27, 8 May 2011
Introduction: Minsky, Marxist and Berkeley
On September 15, 2008, the bankruptcy of the United States investment bank Lehman Brothers and the collapse of AIG, the world's largest insurance company, triggered the 2008 Global Financial Crisis. The end result was a global recession, which cost the world tens of trillions of dollars and rendered 30 million people unemployed. In addition, the crisis doubled the national debt of the United States. In our senior seminar final project, we plan to explore the relevant theories provided by economists Karl Marx, Hyman Minsky and George Berkeley on the financial crisis.
Following the Marx and Minsky theories, we will examine the empirical evidence from the Great Depression and the recession in the 70s as well as the current financial crisis. The Marxists think recessions are imbedded in the capitalism system and business cycles are the direct result of profit maximizing actions in the market. Karl Marx developed the major theory of business cycle, which draws heavily from J.S. Mill. As a post Keynesian economist, Minsky explained the fragility of the financial system is a feature of a Capitalist system. In particular, an integrated international financial market only increases the instability of individual economy.
Within the Berkeley approach, we will examine human motivation, Berkeley's functions of a bank, regulatory monitoring, separation of powers, transparency, elimination of conflicts of interest, speculation and economic crisis and artificial appetites. Furthermore, we will apply these sections of analysis to Wall Street.
The Inside Job (2010)
Section I Marxist
Karl Marx (May 5, 1818 – March 18, 1883)
Inspired by Mill and Ricardo, Marx argues that profits of firms in a Capitalist market have a tendency to fall as competition increases. As a result, firms will experience a boom-bust cycle, which could become an economic recession. The primary assumptions Marx make includes labor exploitation, falling profit rates and finally the innate crises of Capitalism.
Ricardo and Mill’s Inspiration
The Marxist theory follows the tradition of Ricardo and J.S.Mill. The Ricardian theory of distribution explains that “wages and profits vary inversely, prices were determined by labor costs, and long-run wages will fall to subsistence levels” (126, Skousen). The initial idea that is later developed into the labor exploitation and surplus theory. Mill expands the labor theory to a discussion of Socialism which inspired Marx’s ideas. Ricardo and Mill were the first intellectuals to employ the concept of classes to analyze economies. This class view of society greatly influenced Marx’s economics theories. In particular, Mill questioned the legitimacy of private ownership and advocates three types of socialism: Utopian Socialism, Revolutionary Socialism and Fascist Socialism (128, Skousen). Marx continued the tradition of Revolutionary socialism by calling for violent abolishment of private ownership.
Labor Exploitation
According to Marx, the value of products are determined by the amount of hours workers spend to produce and machines are forms of working hours stored in metals (Buchholz,130). He also insists that labor is the only determinant of product value. In an ideal system, the prices of products should always be equivalent to the labor wages. However, in a Capitalist society, owners of the firms make profits by deriving “surplus values” from workers who live on small wages (Buchholz, 131). This process is called labor exploitation by Marx. In order to demonstrate the surplus value, he invented a formula: P=s/(v+c) in which P is profit, s is surplus value, v is variable capital and c is constant capital (152,Buchholz). According to this formula, profit derived from production is directly related to surplus value, or exploitation. He also comments on women and child labor as an extreme example of exploiting surplus value.
Falling Profits and Accumulation of Capital
He further explains the technology advancement such as replacements of machinery in a way benefit the exploiters, as they will need fewer workers for the same production process. However, according to the surplus formula, P=s/(v+c), an increase in machinery will drive down profits. Big firms stay in business due to their larger scale of production whereas small businesses fail. More workers will become unemployed from small firms. In addition, competitions among producers will coerce producers to substitute workers for newer equipment and result in larger unemployment rate. A direct consequence of such unemployment is that people now have less purchasing power for more goods produced due to the lack of substantial income. Economic instability thus results from the surpluses of output.
The Crisis Cycle
The natural tendency of expansion in output is the real driving force to economic downturns. Thus Marxist believes crises are buried in the root of Capitalism.
“lowering costs, falling profits monopolistic power, under consumption, massive unemployment of the proletariat class---all these conditions lead to more extensive and more destructive crises and depressions for the capitalistic system.” (153, Skousen)
Unaware of profit-seeking activities will lead to economic downturns, firms will continue to fall into the same cycle as they expand. Crisis cycles will inevitably occur as the Capitalistic system functions. A credit cycle occurs in accordance with the business cycle. Businesses expansions increase credit demand. In a capitalist system, this will allow temporary increase in services and producst sold. As a result, the economy will experience a boom. However, as the debts will eventually have to be paid back, artificial surplus values added could become a potential credit crisis (1,Mandel).
Marxist Solution
The solution Marx proposes is to overthrow the capitalist government by revolutions. The working class should redistribute means of production to workers. The problem of overproduction will then be solved because workers make more sensible production decisions than firm owners. Marx also calls for an international alliance of workers. In the long term, economic crisis will not happen again if working class rules the world.
Section II: Minsky
Hyman Minsky (September 23, 1919 – October 24, 1996)
Section II Minsky’s Theory
Minsky’s idea concerns the fragility of the financial system at the national level and the international level. He explains the tendency of firms in both financial and non-financial sectors to take greater risks in liabilities as businesses expand. At the international level, the interdependence of economies largely increases the instability of the international financial system because of international lending activities. Governments and central banks therefore must play a supervising role and act as “lender of the last resort”. Following Keynes’s countercyclical theory, Minsky strongly advocates government regulation in times of financial crisis. Empirical data shows an example of successful government intervention in 1970s. Similar conclusion can be drawn from the current crisis.
Minsky’s approach to domestic fragility
Minsky’s theory includes two aspects: the increasingly fragile nature of the financial system and the importance of authorities to counter the fragility. In chapter nine of his Stabilizing the Unstable Economy, he pointed out the main reason for different economic behaviors are “financial practices and the structure of financial commitments change” (197,Minsky). He also compares the post-war economic stability, a result of financial conservation and the instability in the 1970s and 1980s, a direct consequence of profit-seeking activities in the economy. The profit-driven economy will also impact the financial structure through merge, acquisition and other restructuring activities. The financial market, driven by profits, is open to innovative financial activities such as inventions of financial products, techniques and strategies. A successful financial activity, as he points out, will inevitably be imitated by the market without considering the risks. The financial market will be thus run by the most risk-taking groups. To counter risky financial activities, Minsky thinks that the central banks and governments should play a critical role in overseeing financial activities.
The Instability of the International Financial System
Minsky is particularly concerned with internationalization of the financial market. On one hand, he states the inevitability of integration because of the increasing economic interdependence among countries. On the other hand, Minsky is critical about this tendency of a connected international financial system. A domestic economy will be affected by foreign originated shocks. As lending decisions are made by domestic executives with limited access to foreign borrowers’ credit history, international transactions might be riskier than domestic financial activities. Moreover, the domestic economy experiences more “disturbances and mistakes that have their origin in foreign but connected systems.”(150, Pollin) The integrated instability is also dependent upon relative sizes of economies. For example, the international system will be sensitive the U.S. domestic economic activities than a smaller country.
Empirical evidence
Minsky is a strong advocate for Big Government in times of instability. In his Stabilizing an Unstable Economy, he drew the economic data from the 1973-1975 recession to illustrate the effectiveness of government intervention which eventually prevented another Great Depression. The 1973-75 recession underwent two phases: the first four quarters of mild economic downturn and the drastic drop in the last two quarters (Minskky, 15). During the first phase, uncertainty made it more difficult to make decisions in the short term. In particular, businesses shifted investment preferences to “large immediate financial gains that can be made by being right on the swings over the more lasting and secure gains”(Minsky,17). The change in investment behaviors in turn aggravated the recession in the following period.
To counter the recession, the government increased federal deficits to “affected income, sustained private financial commitments and improved the composition of portfolios” (Minsky,19). In addition to aggressive fiscal policy, the Fed also acted as lender of last resort to encourage refinancing activities. The Big Government actions were perceived to be effective in various aspects such as the income and employment effect, budget effect and portfolio effect during the recession. Being the most direct influence, the increase in government spending on goods and services; budget effect creates more sectoral surplus; the portfolio effect reflects the financial instruments change in both the private and public sectors.
The Minsky Moment and Reform
According to Paul McCulley, an economist and fund manager at Pacific Investment Management Co. the world's largest bond-fund manager "we are in the midst of a Minsky moment, bordering on a Minsky meltdown." (Lahart,Wall Street Journal) A Minsky moment refers to a time when borrowers have to sell of their good debts to pay off excessive loans, which often follows by cash flow problems. The current crisis starting from 2007 is described as such a moment. Although Minsky did not live to see it happen, he proposed a constructive reform to the current financial system.
According to traditional economic theories, financial risks can be reduced by pooling among large integrated financial institutions (11, Bard Levy Institute of Economics working paper). The mainstream financial reform is based on two ideas: regulations should help financial institutions better manage their risks and the means to force them into bankruptcy (11, Bard Levy Institute of Economics working paper). In contrast to the traditional effort to prevent risk-taking activities, Minky thinks crisis is imbedded in the operations of the financial system and it is therefore impossible to prevent financial disruption. Reforms should focus on the operations. Instead of “too big to fail”, he is in favor of allowing banks to fail without public assistance. In other words, banks will naturally reconstitute into bigger banks to retain good liabilities. He also mentioned a structural change in the profit-generating model for many financial institutions. In particular, instead of limiting financial rewards from risk-taking activities, Minsky advocates a shift from short-term profit seeking of financial products to profit generation from long-term assets and commission fees (12, Bard Levy Institute of Economics working paper). Financial institutions thus will not have the incentives to take excessive risks but maintain financial stability for their long-term benefit. Minsky proposed a fundamental solution to alter the fatality of the current financial system by changing the motivations of financial institutions. In the long term, banks will be more responsible for their lending activities.
Section III: George Berkeley
This section can now be found on the moodle course
References
Buchholz, Todd G. New Ideas from Dead Economists. N.p.: A Plume Book, n.d. Print.
Dymski, Gary, and Robert Pollin. New Perspectives in Monetary Macroeconomics. N.p.: The University of Michigan Press., n.d. Print.
"MINSKY ON THE REREGULATION AND RESTRUCTURING OF THE FINANCIAL SYSTEM." Levy Economics Institute. N.p., n.d. Web. 8 May 2011. <http://www.levyinstitute.org/>.
Minsky, Hyman P. Stabilizing a Unstable Economy. New Haven: Yale University Press, n.d. Print.
Skouse Mark. The Making of Modern Economics: the Lives and Ideas of the Great Thinkers. 2nd ed. Armonk : n.p., n.d. Print.
