The financial crisis and pragmatism

Following the recent financial crisis, there have been three kinds of reactions in general

The socialists are on a rampage denouncing capitalism, free enterprise, greed and the profit motive. It is difficult to miss a note of glee in their screams. It is almost as if the financial crisis and the alleged role of capitalism in causing it helps them get over the failures of socialism. However loud their screams may be, socialism is so completely discredited today that their screams are irrelevant.

A small number of free market advocates are using principled arguments about the working of the free market and the nature of government interference in the economy to interpret the crisis as a failure of the unfree market. However well reasoned and sound their arguments may be, these are not the men who run things today and the immediate impact of their ideas is going to be small.

The most interesting reaction is the one by the pragmatists. They claim that the financial crisis demonstrates the failure of deregulation and that what is needed is better regulation, more in line with the modern realities of today’s markets. They claim that the focus of the debate should be not whether regulation is needed or not, but what sort of regulation is required. They reject any principled arguments as “just theory”. What is interesting about their reaction is that they are the ones who were in charge of the situation the whole time. These are the people who “believe” in free markets and the gold standard and fiscal discipline and claim to be protecting capitalism. By doing what? By chairing the federal reserve. The blatant contradictions do not bother them. After all Bernanke is supposed to have said “There are no atheists in foxholes and no ideologues in financial crises”. Even after a century of failed attempts at regulation, these pragmatists are still searching for better ways of regulating the economy. There is an old saying that goes “When you find you have dug yourself into a hole, the first thing to do is to stop digging”. But perhaps that too is “just theory” for these pragmatists.

Sadly, more regulation and more crises is what we are going to get, atleast until pragmatism gets discredited. For that to happen however, we need to learn that the way to get out of a crisis is not to renounce principles, but to discover, understand and practise them. Understanding the ideas in these piecies would be a good beginning.

The end of Capitalism?

In the wake of the collapse of financial markets, a number of people are asking “Is this the end of capitalism?” But what is capitalism? Are the current political/economic systems really capitalist? Here is a dictionary definition of capitalism:

an economic system characterized by private or corporate ownership of capital goods, by investments that are determined by private decision, and by prices, production, and the distribution of goods that are determined mainly by competition in a free market.

While this definition makes no mention of any political system, it implies a political system that does not have the powers to engage in economic activity. Clearly such a political system does not exist today. The US economy, commonly regarded as capitalist runs on a fiat currency, the price of credit is decided by a central banking system, investments and production are controlled by antitrust laws and regulatory authorities, prices are controlled by tariffs and subsidies, distribution is controlled by federal grants and welfare schemes. This is not a capitalist system by any stretch of the imagination. That it is so regarded is only an indication of how little the concept is understood.

The collapse of the financial sector of the US economy is not a failure of capitalism but a failure of centralized control of credit. The crisis is commonly projected as a liquidity crisis. But the loss of liquidity is just an effect. The cause was the bad credit provided to unwise borrowers by setting artificially low interest rates. The responsibility for the crisis clearly belongs to the federal reserve. What we are witnessing now is not the end of capitalism. Capitalism ended about a century ago when the world switched to an elastic fiat currency. What we are witnessing is another demonstration that credit-based elastic unreal money necessarily leads to catastrophic failures.

Update: I have a more detailed post about Capitalism here

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