Davos Man’s Depression

The so-called “efficient markets” model, which holds that prices fully and efficiently reflect all available information, also came in for a trashing. So did inflation targeting: the excessive focus on inflation had diverted attention from the more fundamental question of financial stability. Central bankers’ belief that controlling inflation was necessary and almost sufficient for growth and prosperity had never been based on sound economic theory; now, the crisis provided further skepticism.

While no one from either the Bush or Obama administrations attempted to defend American-style free-wheeling capitalism, European leaders argued for their “social market economy,” their gentler form of capitalism with its social protections, as the model for the future. And its automatic stabilizers, with spending automatically increasing as economic woes increased, held out the promise of moderating the downturn.

Most American financial leaders seemed too embarrassed to make an appearance. Perhaps their absence made it easier for those who did attend to vent their anger. But business leaders from the “real” sector and the few labor leaders who work hard at Davos each year to advance a better understanding of the concerns of working men and women among the business community were particularly angry at the financial community’s lack of remorse. A call for the repayment of past bonuses was received with applause.

Indeed, some American financiers were especially harshly criticized for seeming to take the position that they, too, were victims. The reality is that they were the perpetrators, not the victims, and it seemed particularly galling that they were continuing to hold a gun to the heads of governments, demanding massive bailouts and threatening economic collapse otherwise. Money was flowing to those who had caused the problem, rather than to the victims.
Worse still, much of the money flowing into the banks to recapitalize them so that they could resume lending has been flowing out in the form of bonus payments and dividends. The fact that businesses around the world were not getting the credit they need compounded the grievances expressed at Davos.

This crisis raises fundamental questions about globalization, which was supposed to help diffuse risk. Instead, it has enabled America’s failures to spread around the world, like a contagious disease. Still, the worry at Davos was that there would be a retreat from even our flawed globalization, and that poor countries would suffer the most.

But the playing field has always been unlevel. How could developing countries compete with America’s subsidies and guarantees? So how could any developing country defend to its citizens the idea of opening itself even more to America’s highly subsidized banks? At least for the moment, financial market liberalization seems to be dead.

The inequities are obvious. Even if poor countries were willing to guarantee their deposits, the guarantee would mean less than that from the United States. This partly explains the curious flow of funds from developing countries to the US – from whence the world’s problems originated.

Moreover, developing countries lack the resources to engage in the massive stimulus policies of the advanced countries. Making matters worse, the IMF still forces most countries that turn to it for help to raise interest rates and lower spending, worsening the downturns. And, to add insult to injury, banks in advanced countries, especially those receiving aid from their governments, seem to be pulling back from lending in developing countries, including through branches and subsidiaries. So the prospects for most developing countries – including those that had done everything “right” – are bleak.

As if all this were not enough, as the Davos meeting opened, America’s House of Representatives passed a bill requiring American steel to be used in stimulus spending, despite the G-20’s call to avoid protectionism in response to the crisis.

To this litany of concerns we can add the fear of borrowers that the massive American deficits would drain the supply of global savings, and worries of holders of US dollar reserves, that America may be tempted to inflate away its debt. At Davos, those who trusted the US not to inflate away its debt intentionally worried that it might happen unintentionally. There was little confidence in the none-too-deft hand of the US Federal Reserve – its reputation marred by massive monetary-policy failures in recent years – to manage the massive buildup of debt and liquidity.

President Barack Obama seems to be offering a needed boost to American leadership after the dark days of George W. Bush; but the mood in Davos suggests that optimism and confidence may be short-lived. America led the world in globalization. With American-style capitalism and America’s financial markets in disrepute, will America now lead the world into a new era of protectionism, as it did once before, during the Great Depression?