David Warsh: WWI, the elites and the 2008 crash

  By DAVID WARSH

BOSTON

A century after the outbreak of World War I, in 1914, and the memory of the wholly unexpected series of horrors to which it led, many commentators are feeling a little gloomy. Ordinarily I am persuaded by whatever sensible, knowledgeable, well-connected Martin Wolf has to say.

So I was surprised last week to find the chief economics columnist for the Financial Times arguing that our future is once again threatened by ignorant elites, just as it was in the years after 1914.  This time, he wrote, the best and the brightest have been mismanaging the peace rather than bungling a war and its aftermath.

Wolf’s bill of particulars: First, the economic, financial, intellectual and political elites mostly misunderstood the consequences of headlong financial liberalization. Lulled by fantasies of self-stabilizing financial markets, they not only permitted but encouraged a huge and, for the financial sector, profitable bet on the expansion of debt. The policy making elite failed to appreciate the incentives at work and, above all, the risks of a systemic breakdown.

When it came, the fruits of that breakdown were disastrous on several dimensions: economies collapsed; unemployment jumped; and public debt exploded.

The policymaking elite was discredited by its failure to prevent disaster. The financial elite was discredited by needing to be rescued. The political elite was discredited by willingness to finance the rescue. The intellectual elite – the economists – was discredited by its failure to anticipate a crisis or agree on what to do after it had struck.

The rescue was necessary. But the belief that the powerful sacrificed taxpayers to the interests of the guilty is correct.

It seems to me that the history of the last 40 years is susceptible to a very different interpretation:

That the Cold War, which began with the partition of Europe after 1945 and the Communist Revolution in China in 1949, entered its last phase with the five-day meeting of the ruling committees of the Chinese Communist Party in December 1978, little more than two years after the death of Mao Zedong;

That the financial liberalization in the West, in the U.S. in particular, began just in time, in the Seventies, to facilitate the entry of China into the global market system, starting in 1979;

That markets in the Eighties in general coped very well with a vast expansion of world trade; and that the immediate aftermath of the Cold War saw remarkably little loss of life, except in the Balkans;

That experts in the Nineties navigated a series of crises in Mexico, in Asia, in Brazil and Argentina, preserving the international financial system and maintaining global growth;

That when the 25-year  boom ended, in 2008, with the threat of a systemic breakdown of terrifying proportions, thanks to a global banking system that had evolved in ways that were little understood, central bankers correctly diagnosed the panic and  Congress passed its test, appropriating funds necessary to preserve the banking system.

At least in the U.S., the necessary rescue probably cost the taxpayer little or nothing. The loans have been repaid. The severe losses – homes, jobs, earnings, careers, the fisc – stemmed from the deep recession, which otherwise could have been much worse. (The continuing crisis in the Eurozone is another matter. So is the Middle East.) True, by hampering the Fed’s ability to act, the Dodd-Frank Act probably makes it harder, not easier, to deal with the next crisis. But there is still time to deal with that.

I’d like to think that Wolf was simply writing for his audience, which consists almost entirely of those elites whom he castigates. There’s nothing wrong with leaning against the preferences of your readers.  He cited weakening bonds of citizenship amid growing inequality and the constitutional disorder of the Eurozone as further evidence that elites are losing touch..

It seems to me more reasonable to fear that the rise of China and India to superpower status may cause increasing friction with their neighbors and with the West. The experience of World War I suggests that there may be something about coming into the club that wants a war.  That was the case with Prussia’s becoming Germany, and Russia’s designs on the Ottoman Empire in the run-up to August, 1914. This time the problem of climate change may be enough to keep the lid on.

Some pretty serious trials lie ahead.

David Warsh, an economic historian and long-time financial journalist, is principal of www.economicprincipals.com.