Sunday, 9 August 2009

The Queen`s Question

9th August 2009
The Malta Independent on Sunday

“Why did no one see the crisis coming?” Queen Elizabeth is reported to have asked one economic practitioner during a public audience.

The question in its simplicity challenges the basis on which economic doctrine was built since Margaret Thatcher and Ronald Reagan threw Keynesian doctrine in the garbage bag and focused economic thinking on the merit of the market’s ability to resolve all problems and lead to sustainable economic growth.

The Queen seems to have a habit of asking the right question in the most simplistic way. During the last London G20 photo session when Prime Minister Berlusconi was calling President Obama from some distance away, the Queen turned and asked all around her “Why has he got to be so loud?” Recent events exposed how, in spite of mani pulite, Italian politics is still dominated by string-pulling favours including procurement of escort girls and the promotion of such beauties to front line political roles. They have shown that Berlusconi is loud in more ways than the most obvious sense.

Still, the question as to why no one saw the crisis coming is a question that has been asked by many. How is it possible that practically in the time it takes to bat an eye-lid, the world economic scenario could change from one of ebullience into one of extreme gloom and uncertainty? How is it possible that a world, which one year ago was living with record oil prices fuelled by demand as a result of strong economic growth, could so suddenly turn into crisis where the world financial system would have collapsed were it not for very extreme measures taken by governments, which involved the recapitalisation of large banks and the orchestration of enormous stimulus fiscal packages, to keep the economy from falling into a depression?

In putting such a question, the Queen made an implicit assumption that, however, is unsustained by historical facts. In asking how no economist had seen the crisis coming, the Queen was expressing her belief in the false claims made by modern economists that economics has predictive properties setting it aside from other social sciences and putting it closer to the natural sciences that can make precise forecasts, such as when the next eclipse of the sun is due, or when Venus will be closest to earth.

This time last year I wrote a piece about futurology, economics for the next 50 years, for a local media agency company that was celebrating its 50th anniversary since inception. This is how I started my contribution:

“Economists are generally better at explaining why yesterday’s prediction about today were not realised than in making accurate forecasts about tomorrow. That is a health warning readers would do well to bear in mind.”

This is not to say that in any way I claim any merit for foreseeing the crisis, or at least the acute extent of it. Far from it! It is just that I was underlining the predictive limitations of economics in spite of all the sophisticated mathematical models that lead many modern economists to believe in their predictive powers.

Indeed, very few economists did actually foresee the crisis. Among them, Dr Doom Nouriel Roubini and Black Swan Nassim N Taleb risk being accused, in the fullness of time, of being permanent bears that, like the dysfunctional clock, show the right time twice a day. George Magnus, chief economist of UBS, was more accurate, as it was he alone, in the first quarter of 2007, who explained the risk of the housing problem in the US leading to what is technically known as the Minsky Moment, i.e. the situation where liquidity dries up as the banks start distrusting each other because of their exposure to an asset which has gone bad.

But even these ‘special ones’ never really predicted that the fallout of the US housing crisis could be so big as to cause a worldwide financial crisis leading to the most severe post-war recession.

The point is that rather than a natural science, economics is not different from other social sciences. Indeed, J M Keynes, whose teachings are again becoming fashionable following failure of the doctrine that the markets can take care of themselves, had said, “economics is a moral and not a natural science”. More recently, George Soros, the hedge fund manager par excellence, has been building up the philosophy of reflexivity in his various publications, explaining that human behaviour impacts economics, which in itself influences human behaviour through the concepts of greed and fear, the animal spirits that were first explained by Keynes.

Capturing such reflexivities through mathematical models in an attempt to render economics as a natural science is an illusion.

The reason why no one really saw the crisis coming is that disequilibria were building up gradually over such a long period of time that humans made the false assumption that we could live with these disequilibria as a state of normality forever. We believed we could have the inverted logic where the poor peasants of China were financing the excess consumption of the rich US consumer and that this could go on forever, as the excess consumption was helping the Chinese peasant to find a more remunerative and stable job in the cities.

Such artificialities can last a long time but not forever. At some point in time, like the straw that broke the camel’s back, the whole system will implode. But until it does, most of us are tricked into a state of artificial normality. That’s why, Your Majesty, no one saw the crisis coming. Because human weakness makes you see what you want to see and not the reality hidden beneath the surface. Because while the party is going on, regulators, politicians and their economists find it so difficult to take away the punchbowl because if they try to do so, they will be punished by the party revellers who vote in the democratic process. That’s why they say every country gets the government it deserves.

No comments:

Post a Comment