Monday, November 24, 2008

Bretton Woods and the Birth of "Irrational Exuberance"

“Money, get away.
Get a good job with good pay
and you’re okay.
Money, it’s a gas.
Grab that cash with both hands
and make a stash.
New car, caviar, four star daydream,
Think I’ll buy me a football team.”

Pink Floyd had it on the spot when they wrote one of the songs with probably the most complex time signatures for any modern rock harmony. It’s funny that the essence of this song has captured the crux of the current state of the US economy.

It signifies the “irrational exuberance” of the largest capitalist power in the world economy. From building trillion dollar military weapons to spending billions of dollars on block-busters, they seem to be invincible.

But scratch the surface and you’ll realize the reality: $1 trillion subprime debt. $9 trillion national debt. $2.4 trillion held by private investors. $600 billion held by Japan. $500 billion held by China.

James Fallow sums it up:
“every person in the United States has over the past 10 years or so borrowed about $4,000 from someone in the People’s Republic of China”

They were overconfident, reckless and arrogant.

The US catches a cold and the world sneezes.

Looking closer to home, we can probably make a safe bet on India. But what is currently happening here is also uncertain. We have our Prime Minister and Finance Minister who are both notable economists and yet unable to face the current crisis.

This brings us to the fundamental problems of the world economy.
Keynes in 1941, at Bretton Woods, suggested the forming of an organization that would act as a monitoring and regulating agency for the world economy:
The International Clearing Union.

The idea behind this institution was that the member countries would be able to contribute towards the institution which would then allocate the funds between wealthy and poor nations. At the end of the financial year, all countries would aim to balance their accounts, i.e. countries with deficit would have to make payments and countries with surplus would have to draw out their funds, leaving the countries on an equal footing. Both the excess and shortfall of funds would be charged interest. So the net result was social welfare.

This was vehemently opposed by the US which went on to propose and succeeded in establishing the two most famous organizations in our times: the IMF and the World Bank.

Thus in hindsight Keynes was arguably right. The US now finds itself hiving off the scraps of other nations and heading towards deep recession. With credit friendly citizens and rash decision making, even Friedrich von Hayek would not approve of.

Keynes was a blatant socialist and thus the US now is falling back towards the foundations of the Keynesian philosophy and reinforcing the theory by the fed bailing out the chapter 11 companies.

Don’t get me wrong; I love the idea of free markets and the proposition that the markets take care of themselves. But the changing global scenario suggests otherwise.

At the risk of sounding cliched, let me end with Pink Floyd again:

“Money, it’s a crime.
Share it fairly but don’t take a slice of my pie.
Money, so they say
Is the root of all evil today.
But if you ask for a raise
it’s no surprise that they’re
Giving none away.”

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