Getting out of this crisis involves identifying who was right and who was wrong. We have had little accountability so far. The Rubinites are back in charge and we can only hope (and pray) that they have changed, because they were destructively wrong before. Phil Gramm is wounded by his silly statements during the presidential campaign ("Nation of whiners"). And it is hard to identify anything that Paulson and the Bushies did right. Accountability really should go further. Where are the people that got it right? Doesn’t someone want to give them a job in government?
I wondered a few months ago "What Economic School of Thought Will Prevail?" noting that Keynesian economics dominated until the 1970′s when Friedman’s monetarism gradually took over. Monetarism focused upon controlling the money supply and "letting the market work" and avoiding "excessive regulation", which translated into "anything goes." Greenspan, with his Ayn Rand objectivism, has been the poster child for avoiding excessive regulation. Robert Rubin and Lawrence Summers drank this KoolAid, with only slightly different flavoring. Rubin continues relatively un-reformed, saying that he would have done nothing different at CitiBank as of last April.
I hoped Behavioral Economics would enter the fray, to take over from the fictional and destructive Rational Economic Man. But the winner seems to be Keynes, whose thoughts do take into account the irrationality of the people whose collective activities make up the market.
Greenspan-ism can no longer vie for the title because Greenspan himself admitted his fundamental beliefs were wrong.
“In other words, you found that your view of the world, your ideology, was not right, it was not working,” Mr. Waxman said.
“Absolutely, precisely,” Mr. Greenspan replied. “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.” …
Those that continue arguing that markets and economies will work all by themselves are simply uninformed… they haven’t received the memo from the boss. Without rules, we have predatory capitalism, unstable capitalism, irrational capitalism.
Robert Sidelsky discusses Keynes more in an article today.
People are irrational, the Rational Economic Man does not exist, and the question becomes "what rule-based systems work?"
The basic question Keynes asked was: How do rational people behave under conditions of uncertainty? The answer he gave was profound and extends far beyond economics. People fall back on “conventions,” which give them the assurance that they are doing the right thing.
Conventions are habits or social norms. We are creatures of habit of course, with very little ability to be truly objective.
Above all, we run with the crowd. A master of aphorism, Keynes wrote that a “sound banker” is one who, “when he is ruined, is ruined in a conventional and orthodox way.”
There has been a lot of ruin recently. I don’t know how conventional it has been.
Conventions are really a nice way of saying "herd behavior."
Investors do not process new information efficiently because they don’t know which information is relevant. Conventional behavior easily turns into herd behavior. Financial markets are punctuated by alternating currents of euphoria and panic.
The "free trade" types follow the herd. They are resistant to contrary information. Even though Keynes said that net exports are a fundamental part of aggregate demand needed for an economy to run at capacity. The free traders tried to upend that maxim by saying trade deficits make us more efficient. But merely saying things a lot does not make it true.
A first principle of the new economics is that it must be reality based, not fiction based. The Rational Economic Man should be banished. The free trade theory has been implemented to make the U.S. the unilateral free traders in a world where others did not do so.
A national economic and trade strategy is needed, identifying fundamental components of an economy that we need, and enacting policies designed to build that economy.
You can’t even demagogue a "national economic and trade strategy" as socialism anymore, because of the bailout of the "Masters of the Universe."