THE free market fundamentalists are in denial. They are demanding increasingly large doses of government intervention in failed financial markets to restore sound market fundamentals.
It is a bit like asking the devil to save God according to Henry Lieu, chairman of a New York private investment group writing recently in the online magazine, The Asian Times.
The fundamentalist ideological inconsistency is shameless. The implications are more serious if the problem has been misdiagnosed. There is a big question still to be resolved: is the crisis the result of a temporary liquidity problem or is it the result of systemic insolvency?
The crisis itself has built up over decades in part because the response of central bankers to any downturn has been to ensure plenty of liquidity to avoid the risk of a major depression.
This was the lesson that central bankers learned from the Great Depression. Despite their public disavowal of Keynesian economics, they understood that pro-cyclical policies to tighten money supply would increase the amplitude of any downturn in the business cycle.
In Australia, the 1931 Premiers Plan involving a 10% cut in wages led to an even larger cut in prices. Those who held their jobs and had no debts did well out of the Depression. All the burden fell on the 30% of unemployed people and their families. But the plan achieved the main objective of its architects — protecting the interest of the London bondholders.
But the other half of the lesson, that the banks should be kept under tight regulatory control to ensure they played their subordinate role to facilitate the functioning of the "real" economy was forgotten after the generation that experienced the Depression and World War II retired in the 197os.
The iron law of financial deregulation is that competition to increase market share leads to self-destruction because the only way banks can increase market share at the expense of their competitors is by lowering lending standards.
Australia experienced this after financial deregulation in the early 1980s. The increase in the number of banks led to a collapse in lending standards as the banks competed for the dubious multibillion dollar business of the paper entrepreneurs such as Alan Bond and Robert Holmes a Court.
The major product of the period was $20 billion in non-performing loans, the November '87 sharemarket crash, the transfer of many of Australia's finest assets into the hands of foreigners and the response of the monetary authorities in the form of a huge injection of debt/liquidity that financed the subsequent property boom and led to the "recession we had to have" in 1989.
Now the systemic problem is more deep seated. In Australia the problem of household debt has been ameliorated so far by the continuation of the housing bubble. The bubble has burst in Britain and the because of their housing glut.
But the housing bubble is arguably bigger in Australia than Britain and the US and it is reasonable to expect the bust will be proportionately bigger when it comes.
In Australia, the systemic risk to financial markets has been fuelled by capital gains concessions and negative gearing, squeezing first-home buyers out of the market.
Wage earners have no choice but to see their savings flow mainly into domestic and foreign financial markets that are mainly vehicles for speculation rather than productive investment.
The amount going into public infrastructure is inadequate and infrastructure priorities are being distorted by the public-private partnership industry, which is controlled by the financial engineers whose financial "products" have been the major factor in creating the financial crisis that is still threatening to lead to a 1930s-style debt/deflation depression. Continued…
