Let the Tea partiers read ‘Lords of Finance.’ I thoroughly concur with Clive. The politicians should understand that what matters today the most is continuation of growth. Deficits can help slow or stop a downward spiral of negative growth. If the growth rate is maintained to an ideal 3% or a shade more, deficits shall be harmless, the percentage of Federal budget required to pay for interest on Federal debt may well stay below 10% in five years.
It is the interest on the Federal debt that worries most of these politicians, yet they fail to see the relationship between growth and deficits. We know that if the growth rate of the GDP drops to -2.5% the percent of Federal budget required to pay the interest on Federal debt would increase in 3 years to 15% and in five years to around 20%. That is what will ensure the bankruptcy of a nation; it is the cash flow that dictates a nation’s viability and the cash flow of a nation is its ability to grow and produce jobs and be productive.
Many politicians are attracted to 'one liner political symbolism' and don’t see the real economy behind the numbers. Notwithstanding 8 plus percent joblessness, the good news is that the real economy is now creating private sector jobs; the growth is in the formative stage. That is one thing that should be kept going. When a crisis looms, the injection of funds to shore up failing banks should come sooner rather than later and in sufficient quantity to capitalize the banks and allow them to begin lending. When Adam Smith's "invisible hand" goes arthritic, Maynard Keynes is there to take over the heavy lifting.
In September 2, 2010, Chairman of the Federal Reserve Ben Bernanke was asked by the Financial Crisis Inquiry Commission what books or academic papers he would recommend to understand the financial crisis of 2007–2010. The only book that Bernanke recommended was Lords of Finance by Liaquat Ahamed. Today’s policy makers like Bernanke have learned from these dreadful mistakes of the past 100 years, but they still have more to do to restore economic strength and bring down joblessness. Lords of Finance helps to educate, as it entertains, on how back in the 1920s and 1930s enormous power was wielded by a quartet of central bankers. Bernanke was in likewise a tough spot, comparable to the ‘global warming’ predicament. By the time one can agree on a deal where everyone agrees, it's much too late.
In Bernanke's view he should have acted much earlier, but if he had acted later, we would have seen Depression 2.0. The book describes how it took a non-economist, a man with an incisive mind and clear intuition, President Franklin Delano Roosevelt, to realize that what the world needed was inflation, not further measures that would only compound deflation.
Let's look at what happened in the case of Weimer Republic where tyranny and subjugation in shape of Nazism raised its ugly tentacles.
September 1928 - 650,000 unemployed
September 1929 - 1,320,000 unemployed
September 1930 - 3,000,000 unemployed
September 1931 - 4,350,000 unemployed
September 1932 - 5,102,000 unemployed
January 1933 - 6,100,000 unemployed
A meltdown of 'real economy' that will lead to negative growth will only be caused by lack of credit and liquidity. We have similar simmering political problems in the world in the shape of extremism and nationalism today. In the face of economic impairment of societies these ugly tendencies can become global inclination. Protectionism can lead to economic wars as frustrations expand; in these circumstances we need to take lessons from history and be proactive.
Warren Buffet explained the genesis of 2008-9 crisis in layman terms in his shareholders letter on 28th, Feb 2009.
1. "Borrowers who shouldn't have borrowed being financed by lenders who shouldn't have lent."
2. It's not just whom you sleep with, but also whom they are sleeping with.
Global wealth destruction from $65 trillion to $25 trillion in 2008-9 needed creation of cash to avoid mass insolvency. With the benefit of hindsight one can appreciate the size of wealth destruction of such unprecedented nature. A cool 40-trillion-dollars were wiped out in market capitalisation in 2008-9. That was surely an overreaction from jittery markets. Valuations just disappeared into thin air overnight, yet the loans secured by these valuations still existed without corresponding discounts.
Had it not been the foresight of Bernanke and Co, politicians would have dithered and failed miserably to provide the system with the supports that were imperative. Today most of the assets on US books are saleable and have a positive net worth; so has the economy turned around.
Quantitative easing provided some relief, although called 'printing money,' without it, the effect of a huge wipe-out of wealth would have been far dangerous for the global economy. The liquidity provided by QE2 avoided the return of 1930's era. Economic studies have indicated that just the 1930 downturn spread worldwide by the rigidities of the Gold Standard, it was suspending gold convertibility (or devaluing the currency in gold terms) that did most to make recovery possible. Devaluation of currency in real terms may have happened now too but without this course the turnaround would be impossible.
Roosevelt introduced the Emergency Banking Act which, with subsequent actions, brought a sharp end to the banking crisis, clearly visible in the data. At the same time, gold convertibility was suspended and a "crawling peg" of the dollar to gold instituted, moving the price of gold from $20.67/oz. in March to $35/oz. by the following January. There is very widespread agreement among economists that both steps were crucial and powerful in turning the Depression around. The capital of the banks in this crisis too was wiped off, and the banks needed liquidity and the Federal support of the banker of last resort so that the money markets could function. Without drastic actions the banks would have had to close shop. In absence of liquidity the bank securities were not liquid; these were assets that are backed by mortgage securities but discounted as if these will never ever be paid, however most of us were still paying our bills.
The governments needed to create a system that would lead to buy these assets temporarily and take them off market. That created some liquidity and semblance of order and restored confidence in the system. Politicians should not become followers of instant gratification. The crisis that has just passed will return with all its ferocity if correct policy decisions are sacrificed at the political altar of scoring points. The contemporary history of recent crisis is so important to know and Clive Crook has rightly highlighted the risks associated with this careless attitude of some members of the Congress.