What Next? An Explanation of the 2008–2009 Slump and Two Scenarios of the Shape of Things to Come

Abstract

In order to build scenarios of possible futures and grasp the structural liabilities and tendencies of global financial markets, we do not need just historical analogies to past crises and collapses but also a conceptual-theoretical model that explains the characteristic mechanisms of financial markets. Firstly, I summarise the neoclassical understanding of financial markets and its characteristic effects. This understanding gave ex post legitimisation to the re-emergence of global finance in the early 1970s, and has subsequently justified and encouraged its rise to predominance in the world economy. I provide reasons to suspect that the orthodox account is misleading not only because it has been unable to anticipate the 2008–2009 crisis (or any other major crisis) but more fundamentally because it lacks insight even into the basic operations of financial markets. Secondly, I sketch an explanatory model of the 2008–2009 financial crisis, based on Keynes and Minsky as well as on concepts derived from Schumpeter, chaos theory and theory of collective action and rationality. This explanation provides the basis for two short-term scenarios of future developments, involving the possibility of a major crash in the late 2010s or around 2020; (also pathological) learning; and the emergence of green global-Keynesian policies and institutions. I conclude by suggesting that the era of neoliberalism is likely to come to an end by 2030, having lasted for about half a century.

Para poder crear situaciones de posibles futuros financieros y llegar a comprender las responsabilidades legales y las tendencias de los mercados financieros globales, no necesitamos tan sólo analogías históricas de crisis y desplomes anteriores, sino también un modelo teórico conceptual que explica los mecanismos característicos de los mercados financieros. Primero, resumo el entendimiento neoclásico de los mercados financieros y sus efectos característicos. Este entendimiento dio una legitimación retrospectiva al resurgimiento de las finanzas globales a principio de la década de 1970, y subsecuentemente ha justificado e impulsado su subida al predominio en la economía mundial. Proporciono razones para sospechar que el informe ortodoxo es desorientador no sólo porque no ha sido capaz de anticipar la crisis de 2008–2009 (o ninguna otra crisis mayor), pero fundamentalmente porque carece de conocimiento profundo de las operaciones básicas de los mercados financieros. Segundo, esbozo un modelo explicativo de la crisis financiera, en base a Keynes y Minsky como en los conceptos derivados de Shumpeter, la teoría del caos y de la acción colectiva y de la racionalidad. Esta explicación provee la base para dos situaciones a corto tiempo de desarrollos futuros, incorporando la posibilidad de un desplome mayor a finales del 2010 ó alrededor del 2020; (también aprendizaje patológico); y el surgimiento de las políticas Keynesianas verdes globales y de las instituciones. Concluyo con la sugerencia que la era del neoliberalismo probablemente llegará a su fin antes de 2030, habiendo durado cerca de medio siglo.

Keywords:

• crisis
• end of neoliberalism
• financialisation
• future
• Keynes
• Minsky
• neoclassical economics
• scenario
• super-bubble

Notes

To give a few examples of the declines in stock indexes, the Nikkei 225 stock market index dropped from 18,000 in July 2007 to about 8,000 in late 2008 and early 2009; the Dow Jones Industrial Average from 14,000 in October 2007 to about 8,000; and the Paris CAC 40 from over 6,000 in June 2007 to about 3,000.

For a discussion on whether the unrealistic assumptions of neoclassical economics tend to generate more irrelevance than ideology, or vice versa, see Guerrian (2009); and Lawson (2009). Neither category, of course, applies to those mathematical models that have been constitutive of market practices, such as the option pricing model of Fischer Black and Myron Scholes (1973).

This is a falsifiable empirical claim about the economic–political opinions of mainstream economists (how much is there diversity among the model-builders?; cf. Stiglitz, 2000, 2006).

The neo-Keynesian end of the acceptable left–right continuum within the mainstream (some state intervention vs. free markets) acknowledges that markets can fail to achieve full efficiency. ‘Part of the problem is the lack of perfect competition, part is the existence of externalities, and part is the fact that markets may take a long time to adjust to any disequilibrium given the often considerable short-run immobility of factors’ (Sloman, 1994, p. 411). However, this analysis implies that in the long run competition can be made more ‘perfect’; externalities can be overcome by privatisation and setting a price to everything; and factors can be made more mobile and ‘flexible’.

Including but not limited to: Dean Baker (2002); Gabriel Kolko (2006); Paul Krugman (2005); Ann Pettifor (2006); Heikki Patomäki (2005, 2007, ch. 6, 2008a, ch. 7 and 8); Nouriel Roubini (2008; about his earlier predictions, Mihm, 2008); and George Soros (2008a; about his earlier anticipations and consequent investment decisions, see Cassidy, 2008).

These critics of the standard neoclassical theory also avoided relying much, or at all, on econometric models that must assume continuity of the prevailing, relatively short-term trends expressed by the available data, as this business-as-usual assumption in effect translates into short-sightedness.

There are numerous ex post Keynesian–Minskyan analyses of the 2008–2009 global crisis (which started in the US already in 2007 as the sub-prime mortgage crisis). Perhaps most notably, see the special issues of Journal of Post Keynesian Economics, 30(4), Summer 2008, and Cambridge Journal of Economics, 33(4), July 2009. Paul Davidson's (2008) claim in the former journal that ‘a Minsky moment’ was never involved in the sub-prime crisis is based on a narrow specification of Minsky's theory. More generically, however, Minsky (2008) can be read as saying that in financial markets there is a tendency to innovate new instruments and engage in activities that increase risks and the amount of liabilities vis-à-vis incomes and thus make various (but not necessarily all) actors increasingly dependent on short-term liquidity. As will be specified below, the further this process goes, the more chaotic—i.e. sensitive to small disturbances—the financial system as a whole becomes.

Keynes did not, however, go very far in exploring self-fulfilling and self-denying prophecies or, in a longer time-span, self-reinforcing processes characterised by positive feedback-loops. For Soros (2008b), however, biased expectations and initially self-reinforcing but eventually self-defeating processes are the key to understanding how global finance works. These are part of my account below, too, but a systematic conceptual and theoretical discussion of these phenomena is beyond the scope of this paper.

There have been relatively few studies on the social practices of financial investments. Doug Henwood's (1997) Wall Street is one of the best accounts, although it only focuses on the stock and bond markets in the US. Leyshon and Thrift (1997) take a few preliminary steps towards this direction as well, but eventually they shy away from doing proper empirical research The theoretically (self-)reflexive insider accounts of Soros (1994, 1998, 2008b) have also been helpful.

Mistaking the abstract neoclassical models based on assumptions such as perfect foresight and competition for reality, neoliberal policymakers have first shifted financial activities and responsibilities from public to private actors, and then encouraged securitisation by transferring credit from bank-based to equity-based tradable forms. These moves led to the sub-prime mortgage crisis in 2007–2008 (Best, 2008, p. 366). The idea that competitive markets have a foresight that every single actor is lacking amounts to reification. Collective ‘free markets’ assume magical qualities that no human being can have, even though trading practices depend on human actors and investment decisions can only be made by them (automatic trading-protocols depend on humans who design them and allow them to operate on their behalf).

These benefits are, of course, individualist and relational. From the point of the growth of the world economy as a whole, and from the perspective of adequately sustainable and just global political economy, the effects of financialisation, and dominance of global finance, have been problematical. A worldwide framework of institutional arrangements has been created that, among other things, prevents a turn to a new genuinely upward phase in the world economy. With the rise of global finance, the average per capita growth has gradually declined and wealth has been redistributed in favour of the rich; and very little has been done to ensure ecological sustainability (see Patomäki, 2005, 2008a, ch. 5–8).