The world faces crisis of finance, not a crisis of capitalism. As protestors gather to denounce capitalism on the occasion of the G20 summit in London, it is worth remembering that free markets and free trade are not to blame for the current economic mess. The real culprit has been skewed finance. This distortion has operated on four levels.
First, there has been an imbalance in world trade, with giant surpluses in China matched by deficits in the US, the UK and elsewhere. That allowed borrowers to rack up huge debts. It was not a natural phenomenon of the free market. It was at least partly the result of China’s decision to keep the renminbi’s value artificially low.
Second, there has been the US habit of bailing out the financial system whenever it hit trouble. Investors used to talk about the “Greenspan put” in recognition of the fact that the former boss of the US Federal Reserve could always be relied upon to squirt money on the markets at the first sign of trouble. This, again, distorted the free market. It both numbed investors’ fear, causing them to take excessive risks, and added cheap credit in the West to the liquidity pouring in from the East.
Third, there was the inherent distortion in having financial institutions that are considered “too big to fail”. Banks sailed too close to the wind because they knew the authorities could almost always be relied upon to bail them out. The antidote to having institutions that are “too big to fail” is either to cut them down to size so they can fail safely or to regulate them more tightly. But, in recent years, banks got bigger and were deregulated.
Fourth, there were the “heads-I-win-tails-you-lose” incentive plans for the financiers themselves. If their bets paid off, they stood to become multi-millionaires. If they lost a packet, shareholders and ultimately taxpayers were left to pick up the tab. Some culprits have even been able to walk away with fat bonuses and enhanced pensions. This, again, is not the free market.It is an asymmetry that turned finance into a casino.
So the G20 protestors should blame distortions rather than the free market. And the G20 leaders should aim to fix those distortions so the world never again has to face this mayhem.
