Reluctant radical

29 Aug 2014 By Edward Hadas

Martin Wolf is still recovering from the financial crisis. In his new book, the Financial Times economics commentator admits to being surprised at the depth, breadth and length of the economic malaise which followed the near collapse of the global financial system in 2008.

“The Shifts and the Shocks: What We’ve Learned – and Have Still to Learn – from the Financial Crisis” is partly a cogent review of what went wrong before, during and after the crunch six years ago. But the part economists and policymakers could usefully focus on is the writer’s conclusion that the best ideas for the future are far from the mainstream.

Wolf digs far deeper than the obvious bad behaviour of banks and their employees. His main insight is broad and depressing. Finance has become fragile: “Over the last four decades, the world economy does not seem to have functioned without huge financial excesses somewhere.” Those excesses often end in a sharp reversal.

Unintended consequences abound. Some emerging economies fixed their currencies at low levels, generating huge trade surpluses and accumulating massive reserves. Their motivations, to support rapid growth and insulate themselves from crises, were admirable. But their policies led to money sloshing around in the global financial system, encouraging incautious lending and making crises more likely, not less.

As for the euro zone, Wolf does a fine job explaining how the German economic virtues of competitive wages and a large trade surplus combined with a worthy belief in European unity brought massive trade imbalances within the bloc, subsidising financial imprudence in the member states which received Germany’s surplus euros. The single, unifying currency became a source of division.

“The Shifts” combines many ideas, including global changes in the balance of savings and investment, intellectual shifts in favour of self-regulating markets, and cultural and technological moves towards a more integrated world economy. Additional references to demographics, inequality and psychology may sometimes leave readers scratching their heads, but Wolf mostly succeeds in fitting it all together and explaining how it led to such a mess.

The second half of the book is more intellectual. It is a persuasive critique of the economic and financial ideas that were proven wrong and of policy responses so far – and an open-minded introduction to some ideas that have not yet received the attention they deserve.

There is pain in Wolf’s tone, perhaps the result of a trained economist watching many of his profession’s central beliefs fail in real life. There is also frustration, for instance in his description of timid and often wrong-headed official actions. His discussion of new banking rules – insufficient on capital requirements and excessive on red tape – is particularly strong.

Having concluded gloomily that much of the conventional wisdom and organisation of the financial system is fundamentally flawed, the author isn’t afraid to examine possibilities that most economists dismiss out of hand. One example is the notion of funding government deficits through direct money creation – a kind of quantitative easing on steroids.

Another is what would generally be considered the retrograde idea of limiting international activity by banks. Wolf reckons lenders and investors in general rely too much on their national governments to be given free rein across borders.

He even suggests that smaller economies might experiment with a banking model that’s entirely different and much narrower than what’s usual, a version of the so-called Chicago Plan from the 1930s. Bank deposits would be fully guaranteed by the government but lenders and investors would be exposed to losses. Wolf thinks the disruption to the current system might be worth the risk.

In short, a level-headed centrist intellectual at a mainstream business newspaper thinks the financial system could be doomed to recurring crises without a radical reconstruction. Coming from such a writer, the judgment is both alarming and worth taking seriously.


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