Page 2 of 5 THE SHAPE OF US POPULISM, Part 6 The birth of the New Deal By Henry C K Liu
Reaganonmics responded:
"Greenspan is right, of course, that we will never have a perfect model of risk
in a complex economy. But the culprit was not imperfect models. It was failure
to ask common sense questions:
Q: Will houses prices keep going up forever?
A: Not likely.
Q: What will happen to the value of mortgage-backed securities when housing
prices stop rising or fall?
A: They will go down.
We didn’t need fancy models to answer questions like that. We
just needed to ask them."
Rivlin, a long-time defender of the economically helpless, stopped one step too
soon. The culprit was not merely the bankers who did not ask these common-sense
questions. The bankers knew very well the common-sense answers, but they
comforted themselves by also knowing that securitization left someone else
holding the bag of bad securities. The problem was not imperfect risk models;
it was faith in the myth of a perfect hedge.
The factors behind the 2007 credit crisis were: 1) under-pricing of risk during
years of debt bubble; 2) excessive leverage by market participants to magnify
profit on the way up which inevitably magnifies loss on the way down; 3)
conventional bank capital reserve requirements inadequate for overleveraged
exposures; 4) defective risk management models; 5) inoperative credit ratings;
6) unidentified and dispersed counterparties and 7) circular hedges. The sudden
re-pricing of risk and de-leveraging caused market failures.
Economists also feel '29 pain
A few days before the 1929 crash, the celebrated Irving Fisher, a highly
respected economist at prestigious Yale University who had worked out the
widely accepted equation of exchange between money and price levels, famously
predicted that: "Stock prices have reached what looks like a permanently high
plateau." Fisher stated on the day after the crash that the market was "only
shaking out of the lunatic fringe" and went on to explain why he felt prices
still had not caught up with their real value and should go much higher. Two
days later, he announced in a banker's meeting that "security values in most
instances were not inflated." For months after the crash, he continued to
assure investors that a recovery was just around the corner.
Both Fischer and Keynes were personally fully invested in 1929. They not only
failed to anticipate the crash but continued to deny it after the market
imploded, suffering significant loss of personal fortune, leading Keynes to
remark: "Markets can stay irrational longer than participants can stay liquid."
While Keynes, the shrewd speculator, fell short on the ability to get out of
the market near the top, he did have the unique ability to buy near the bottom.
In 1932 he started buying stocks and bonds yielding 15%, and gold stocks, even
though he did not consider gold a rational investment. Keynes was practical
enough to adopt a trading pattern independent of his insights on economic
theory. Having lost all personal wealth, Keynes turned to manage money for
insurance companies and became spectacularly rich as a result, being worth over
600,000 pounds sterling at the time of his death in 1946 (or about $24 million
in present terms), even though he had been completely wiped out in 1929 and
then again in 1937 when he lost three-quarters of his net worth.
Populist and socialist impacts from Europe
Reaction to the appalling social effects of the Industrial Revolution led to
the "Socialist Calculation" debate in Europe at the end of the 19th century.
With crushing poverty in fast-growing cities from the socioeconomic effects of
the industrial revolution and decaying rural areas from the collapse of
agricultural feudalism, critics of laissez-faire market capitalism argued that
free markets are prone to failure because they drive investment towards what is
most profitable rather than what society most needs, and that the market
mechanism generally fails also to distribute the created wealth equitably, thus
creating a structural supply/demand imbalance.
They asserted that a responsive government controlled by the people rather than
by capitalist special interests, with progressive regulation over the means of
production and patterns of distribution, could allocate resources, goods and
gains in a more efficient and equitable manner for the good of all.
The debate was between socialists, Marxists and other populist reformers on one
side and proponents of laissez-faire market capitalism on the other who argued
that markets could allocate resources and rewards more efficiently than even an
infinitely wise government could. Even granting that claim, markets by
definition do not act to produce populist goals because of uneven market power
among market participants. Free markets are threatened by unequal market power.
Disparity in political power leads to dictatorship which is more efficient than
democracy. Disparity in market power leads to monopoly which is also more
efficient than free markets. Yet efficiency is not an argument for injustice.
In the second volume of Capital, Karl Marx observes that because the
number of interlinked market conditions required for steady-state growth is too
large, too complex and too contradictory, capitalism cannot avoid structural
breakdowns. Soon after Marx's death in 1883, as Marxist parties grew in number
and as Western European states adopted democratic politics, many Marxists began
to accept the possibility of the national state being responsive to popular
will as a progressive agent of change. This populist trend was part of the
movement of revisionism, sometimes attacked by orthodox Marxists as
opportunism. This revisionist period in European socialism coincided with the
populist era in the US although there is no evidence that the two movements had
any direct connection, except a parallel populist reaction to industrialization
through capitalism.
The First World War brought about irreversible socioeconomic changes in Europe
that continued after the war itself and even outlasted its geopolitical
consequences. After Marx's death in 1883, orthodox Marxism was represented by
Friedrich Engels, and after Engel's death in 1895, by Prague-born Viennese Karl
Kautsky. A post-Marx revisionist challenge to orthodox Marxism came from Eduard
Bernstein, who argued that socialism can only replace capitalism as a conscious
choice of the people channeled through political education, rather than merely
preparing for inevitable revolution from structural contradictions. A similar
populist position was taken by Sidney and Beatrice Potter Webb and the Fabian
Socialists in Britain and Jean Jaures in France, who was assassinated for
opposing the war by an ultra-nationalist, three days before its outbreak.
As centrist leader of the German Social Democrats, Kautsky was denounced by
Lenin as an ideological renegade. Kautsky in turn accused Bolshevism of being a
conspiracy movement that initiated revolutionary changes for which there were
no economic presumptions in Russia.
Bernstein's opportunist trend in international Social Democracy began at the
end of the 19th century in Germany. Bernstein believed that a socialist
infrastructure within capitalism would evolve from struggles for workers rights
and from worker pension funds as a powerful source of capital. This belief
seems to have been validated by developments in advanced economies towards the
latter part of the 20th century. Today, global capital markets are dominated by
pension funds from both advanced and emerging economies. Whether socialist
goals can be achieved through capitalistic markets remains an unresolved
question that still awaits further field data. At this juncture, it appears
that economic populism has become an unintended byproduct of free market
capitalism.
Rise of National Socialism in Germany
In Germany, the rise of the National Socialists was enhanced by their ability
to cut across class lines to reach a mass constituency and to transform them
into the first real Volkspartei in German history. The electoral
successes of the Nazi movement did not simply reflect national resentment
against the harsh terms of the Versailles Treaty or the hardships of the
Depression. Germany, when presented the completed document without the benefit
of a hearing, refused to sign the Versailles Treaty. No self-respecting
political figure would lend his name to such a shameful document. Two unknown
representatives from a coalition of Social Democrats and Catholic parties
finally consented to bear the burden of historic shame.
The Nazi rise to power was the result of a general populist awakening. World
War I was the defining event in populist activism to various degrees around the
world and definitively in Germany. Total war had spawned an unprecedented level
of both voluntary and involuntary comradeship among the German people and an
outpouring of populist self-expression had articulated the common experience of
struggle and defeat.
The outbreak of World War I in 1914 unified the historical political divisions
in German society. Catholics, Lutherans, Jews, conservatives, liberals,
socialists, and particularly the middle class, were all filled with a new sense
of nationalism. As the war dragged on, old divisions resurfaced. Subsequently,
suspicion of Roman Catholics, Social Democrats and Jews grew. In 1916, the
German High Command conducted a Judenzahlung (Jewish census) that
disproved allegations of a lack of patriotism among German Jews, but the survey
was not made public despite the fact that most German Jews viewed the war as an
opportunity to prove their commitment to the fatherland.
On the other hand, big business capitalists such as Krupp, the steel making
giant, were found to be manufacturing and selling arms for both warring sides
for profit. Companies skirted wartime price control by switching to
uncontrolled goods, which created shortages that led to tensions between the
more resourceful cities and the countryside and, more importantly, exacerbated
hardships and bred social discord. By 1917, there were over 500 labor strikes
across Germany, resulting in over 2 million total man-days of work lost.
Striking workers were looked upon as unpatriotic by management while big
business traded with the enemy all through the war. The German psyche was
fixated on the "stab-in-the-back" myth (Dolchstoblegende) to attribute
Germany’s defeat in war to internal political conspiracy rather than military
shortcomings.
The end of imperial Hohenzollern rule opened a valve for democratization to
circles well beyond the constituencies of the left. Petit bourgeois and peasant
populism championed the Volksgemeinschaft. This was the people’s
community that rejected the egocentric claims of special interests, the
multinational outlook of the imperial sovereign, the internationalist network
of the aristocracy, the proletarian centrism of Marxism and the profit-driven
big-business capitalism. At the same time, the community insisted on
localization of politics to respond to the needs of the common man and on
structural socio-political reform to toward a people’s state. In the people's
community, class struggle is condemned and private property is tolerated as
long as it benefits the whole community.
Following Kaiser Wilhelm's abdication, the self-indulgent Weimar Republic
witnessed the proliferation of petit-bourgeois organizations in sufficient
scale to contain the radical left. Denying the validity of class struggle,
though still divided along occupational lines, the new populism anticipated a
"national socialist" consensus, the political realization of which proved
beyond the ability of Weimar bourgeois parties to achieve. The militant
Freikorps were too nihilistic to construct an effective political strategy.
Instead, the National Socialists became the first party to actualize the
populist consensus percolating below the surface since 1914. To the electorate,
the Nazis stood for social inclusiveness, economic productivity, and a racially
infused ethnic nationalism that championed the resurgence of Germanic destiny.
Field Marshal Paul von Hindenburg, victor of the Battle of Tennenberg in 1914
against two powerful but ill-led Czarist Russian armies, defeated a rising
Hitler in a runoff presidential election in 1932 but was obliged by popular
demand to appoint Hitler chancellor in January 1933. Hindenburg at first
regarded the Nazi Party as a convenient tool that could be manipulated to
undermine the harsh terms of the Versailles Treaty and to act as an ideological
antidote against the Marxist left, and to provide an effective way out of the
Depression. The Enabling Act (Ermไchtigungsgesetz: Gesetz zur Behebung der
Not von Volk und Reich - Law to Remedy the Distress of the People and
the Nation), was passed by the Reichstag on March 23 and signed by president
von Hindenburg the same day, in reaction to the Reichstag fire, granting the
Chancellor the authority to enact laws without the participation of the
Reichstag for four years. After Hindenburg’s death in 1934, Hitler declared the
office of president vacant and made himself "Fuhrer", combining of the office
of president and chancellor.
Marx on free trade; Lenin on imperialism
Marx argued that free trade would accelerate the structural contradiction
within capitalism and bring about its evolution towards socialism. Lenin
observed that imperialism as the highest stage of capitalism would delay
perpetually its evolution towards socialism and such delay could only be
overcome by political revolution. When the end of World War II, the war to save
democracy, failed to bring about the end of Western imperialism around the
world, national liberation struggles against residual imperialism broke out
like forest fires. But the Cold War split the national liberation struggles
between capitalist and socialist paths, diluting its strength and delaying its
final victory for another half century. After the Cold War, economic
globalization promoted by the sole remaining superpower became the dominant
trend. Opponents of globalization see it as having taken the path of
neo-imperialism.
Almost two decades after the Cold War ended in 1991, signs that globalized free
trade is facing structural collapse are clearly visible and populist resistance
to free trade has become more vocal even in the advanced economies that benefit
most from it. Bernstein viewed protectionism in early 20th century Germany as
helping only the financial elite to protect domestic industry from foreign
competition at the expense of the laboring masses, as cross-border movement of
capital was restricted by all governments.
Today, with globalization of deregulated financial markets and unrestricted
cross-border movement of capital and funds, voices advocating protectionism
tend to come from the laboring masses in the advanced economies, whose members
are seeing their jobs shipped overseas by transnational corporations controlled
by global capital and their wages pushed down by cross-border wage arbitrage.
Russian populism
Ukranian economist Michal Tugan-Baranovsky (1865-1919) whose 1894 book provided
one of the first coherent and thorough economic theories of business cycles,
suggested that capitalism, despite its many contradictions, could achieve
steady-state growth, so the breakdown of capitalism was not inevitable as
practical experience up to his time had shown. If anything, capitalism was
entering an ameliorative phase in the early 1900s through humanist reform by
incorporating many of aspects of socialism.
Tugan-Baranovsky argued that cycles are driven by an independent investment
function and that, ultimately, overinvestment becomes the cause of recessions
and that there is not necessarily a secular movement towards "destruction" but
rather only wave-like patterns of boom and bust in capitalist economies. In
another 1905 work, Tugan-Baranovsky extended this observation to argue that
there are conditions whereby capitalist economies can arrive at a "stationary
state" and thus arrest their move towards terminal crisis. Tugan-Baranovsky
eventually adopted the views of his previous opponents, the Russian Populists
(Narodism), on co-operative economies.
The Russian political intelligentsia was "fired with a vast and general zeal
for struggle" against Narodism, which Lenin
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