How the ‘Experts’ Missed the Crash: Philosophical Flaws, No Sense of History
on December 11th, 2008 at 8:38 am
University of Texas Economics Professor James Galbraith is a son of the great US Institutional economist John Kenneth Galbraith, and a leading non-orthodox economist in his own right. He has developed highly innovative methods to measure economic inequality that are well documented here; he is a strident critic of conventional economics; and he has been as active in the USA as an analyst of and commentator on this financial crisis as I have in Australia. His many interviews on the topic are linked from this site.
Galbraith describes himself in this interview on Yahoo Finance’s Tech Ticker as a “financial ambulance chaser”, and someone who did see this crisis coming–unlike the vast majority of the economics professsion, who–like Australia’s own RBA (central bank) Governor Glenn Stevens–not only did not see this crisis coming, but didn’t know anyone else who did.
That’s because they have been raised solely within the neoclassical approach to economics, which has dominated the academic discipline of economics since the mid-1970s. They have been trained to uncritically believe in models of the economy based on the fantasies of hyper-rational individuals (who can predict the future), markets that are always in equilibrium, and a world in which money is simply a veil over barter. They don’t listen to professional economists like myself and James who reject this entire philosophy. By and large, they don’t even acknowledge that we exist.
One excellent question that was put to James by Henry Blodget is worth quoting in its entirety. Blodget quite justifiably expressed the belief that in their training economists look at history–a statement that shows he didn’t himself do an economics degree, because one of the first subjects that neoclassical economists eliminated to make way for their obsessions with “microeconomics” and “econometrics” was economic history:
Blodget: But obviously in training economists, especially academics who go through an incredible period where they’re learning and studying history, and you look back over history where you’ve had many of these complete crashes that were unforeseen at the time. How does academia deal with that? Is the story always told that “Oh yes, but we were stupid and unsophisticated then, and now we’re smart and therefore we’ll see it”? How do people explain that?
James’s reply was:
Galbraith: That’s an excellent question, but the reality is that training in economics does not involve coming to grips with history. Economic history is barely taught in graduate economics departments, and the history of economic thought isn’t taught at all. So figures that have been fundamental to understanding phenomena like the Great Depression–or for that matter the Great Crash–are simply not in the curriculum.
Keynes, who taught my father John Kenneth Galbraith–who understood the Great Depression as well as any figure in the 20th century–… you won’t find them on the reading lists. That is in some sense the shocking commentary on the intellectual direction that the profession has taken.
There’s much more worth listening to in this interview. There is, also, hope. The fact that serious intellectuals who are critical of neoclassical economics are now being listened to by the media and the markets–though not yet governments–is a sign that, possibly, the days of the delusional neoclassical approach to economics are coming to a close.
Unfortunately, it has taken a serious economic crisis–possibly the most serious in history–to bring that delusion to its knees. But in the meantime, people trained in that delusion are still in control of economic policy, and are charged with helping overcome a problem they did not foresee, and still do not understand.
Copied from your report homes4aussies ,
“Note, organisations that benefit from strong realestate markets include those in the realestate industry,
property wealth advising and consultation industries, building and construction industries, and finance
including mortgage broking and banking industries. Moreover, it is important to note that even state
governments have become particularly dependent on increased taxes from increased property prices –
property tax revenue increased 72% in 5 years! (6).”
One of the late major contributors to the US mega RE bubble was the massive propaganda campaign mounted by their Mainstream media (MSM) and Govt against consumers to keep diving into the debt pool. They unwittingly obliged until the BUST was so pervasive it was too late- the overwhelming carnage had arrived.
My sense is that is what we are witnessing right now in Australia. To speak against this propaganda makes you almost a social pariah.
GSM, I really don’t see your point, or your reason for describing me in that way.
I agree with this – “They unwittingly obliged until the BUST was so pervasive it was too late- the overwhelming carnage had arrived. My sense is that is what we are witnessing right now in Australia.”
What I am trying to do is inform people of the reality so as few people as possible “unwittingly oblige”, joining the bubble at this very late stage and getting crunched by it’s inevitable popping!
It is because I feel very much a part of my community, and care very deeply for it, that I speak up. But I also believe that as well as hardship, a lot of good will come from the current recession (or depression). See this video to see what I’m about – http://au.youtube.com/watch?v=vKru2-Mm_PE
homes4aussies said,
Sorry, but I believe you have misunderstood me. I was trying to say I fully agree with your premise and having now looked breifly at your website (which i will view in depth in due course) will forward it to freinds and family – at great peril!!
I personally think you are doing an oustanding job.
I have been very focussed on watching the US housing devastation unfold and have been looking for a resource tracking this financial trainwreck in Australia.
The humble message I was trying to send out in my earlier post , gained from watching the US experience , was:
Do not trust mainstream media or the Govt to spell out the truth to you. We will only hear spin and BS from those sources.
http://business.theage.com.au/business/time-bomb-for-home-buyers-20081211-6ws6.html
‘Time bomb for home buyers’
‘ABOUT 300,000 Australian households could face “negative equity” next year — owing more money to lenders than their house is worth — if prices fall by 10 per cent as predicted.
Nicole Rich of the Consumer Action Law Centre said impending house price falls meant lenders should be discouraged from offering products that allowed people to “use their home like an ATM”.
“It’s not that they just make redraw available, they promote it,” Ms Rich said. “Some people are going to take advantage of the maximum 90 per cent redraw when they’re in difficulty.
“So by its nature it’s a product that appeals to people that are struggling a bit.”
While the Commonwealth Bank has removed its 100 per cent home loan, NAB will still lend 100 per cent of the purchase price of a property, less about 3 per cent mortgage insurance, to desirable borrowers.
Other borrowers with “equity loans” can draw on up to 90 per cent of the value of their home.’
GSM, apologies for misunderstanding.
I have been reading this blog and some of the comments on here for only a few weeks now. I started searching because I thought that surely “I cannot be the only one who can see what is really happening.” How wonderful it is to find that there is a whole community of sensible people out there.
I have no training in economics. I run a small business selling shutters and secutity screens to home owners.
For several years now I have been alarmed at the levels of borrowing I have been seeing first hand in the market. Young professional couples who buy a house for $900k and then spend $50k on shutters. You don’t buy 50 grand worth of shutters by saving a little from your pay each week.
I have upset a few dinner parties in the last couple years by telling all assembled that a big drop in house prices was a mathematical certainty. People didn’t and largely still don’t beleive it can happen here and they certainly don’t want to hear it.
Steve, I love your work. I have been back reading your posts and links.
A word of caution though if I may be so bold…..
Nobody likes a smart arse. I can appreciate that after years in the wilderness fighting the tide of stupidity you now feel rightly vindicated and the urge to shout “I told you so!” is very powerful. However good it feels though it doesn’t help you acheive your goals in the long run.
You have a lot to contribute to the world of economics and the broader community but your ideas will never be accepted if most of the stakeholders in the game hate your guts. A little humility goes a long way.
You might like to read ‘How Make Friends and Influence People’- it’s a cliche but it’s a classic and has helped me.
Keep up the good work.
moonatic
China is already in the middle of a huge smash. There is definitely some sort of conspiracy of silence here in MSM in Aus. When i was there in late october/early November
Real estate prices had fallen 30% right across China in just one month. Factory workers were losing 5 years wages in one month!
In Guangdong province a factory emoloying 6000 workers closed while we were there. We flew to Xiamen where a factory employing 4000 workes closed while we were there.
Factories were closing bankrupt everywhere
Factories who by now would have reasonably full order books for 2009 had NIL orders..nada…none!
The Canton Fair, which is their big rtrade generator was characterised by poor attendance. At the third session there was virtually noone there. Congregation areas where normally 500 people might be gathered…I’d count maybe 25-35. Our suppliers were telling us there was noone there from anywhere!
It’s put around that China has all this infrastructure spending they have announced. Noone seems able to determine of what was announced, what was already in process. in addition infrastructure builing in China is so massive it is difficult to see how they will acclerate it further.
Furhter you cannot simply take millions of workers working in export factories and send them to build infrastructure…even in China.
I hope the info helps. You sure don’t hear it from the media.
Cheers
Thanks outback oracle,
MSM is so full of BS. Worse thing is many sheeple believe their articles word for word.
Any attempts by journalists/analysts to provide reasonable and logical aguements as to how bad things may get are labelled as fear mongerers.
By the way, on Rudd – nice one on promoting the great australian dream. You’ve given the green light and full encouragement for young people/couples to enter into a falling housing market. Whats going to happen one or two years down the track when their in over their heads, one of them has reduced hours or is unemployed, they end up getting foreclosed and suffer the long term financial pain and constraints of bankruptcy. Well done. Of course you could always give them a bailout.
Dear Icarus,
Point taken. I do try to restrain myself on the “I told you so” front, and just stick to the analysis, but occasionally when I see statements like Glenn Stevens’ that inspired the previous post–that he “knew of no one who predicted this course of events”–I can’t help myself.
This is not a time for shadenfreude, as Brett from Homes for Aussies said so poignantly on his recent YouTube video. Nor is it a time for vindictiveness–generally I go out of my way to emphasise that the economists whose delusional theories contributed to this crisis had the best of intentions themselves.
But every now and then, one of them says something that I simply can’t pass up.
And yes occasionally I overdo it on the “I saw this coming ages ago” front. The fact that this is true is no compensation then to those whose noses are put out of joint by it.
One of my favourites “scenes” in the “Hitchhiker’s Guide to the Galaxy” involves the graduate student who, via a stroke of genius, managed to create an “Infinite Improbability Drive” out of thin air.
Just as he is about to receive the Galactic Nobel Prize for Physics, he is lynched by an angry crowd of physicists who have suddenly realised “that what they really can’t stand is a smartarse”.
On the topic of the MSM (mainstream media), while there are elements there that receive warranted opprobrium from members of this blog, there are also many journalists who were themselves as incredulous about the mantra coming from some of their colleagues about eternal good times, ever rising property markets, etc.
As individuals, they themselves were often feeling the burden of excessive mortgage debt, and as journalists, they were often reporting the initial brush-fires of the downturn–rising evictions in Campbelltown; shonky practices by mortgage brokers; court cases like Permanent Mortgages vs Cooks that first alerted me to the empirical magnitude of the crisis (the first time I had taken a close look at the empirical data on debt for Australia was while doing the research for my Expert Witness case–beforehand I had focused only on the USA).
Don’t forget either that the MSM has given a huge run to my arguments–indeed, that’s what Gerard Henderson was wingeing about in his remarkable piece on me in the SMH features pages a couple of months ago.
So the MSM is a mixed bag. Yes there are career spruikers in it, and yes there will be editorials like those in The Australian, etc. But there is also the classic “4th Estate” behaviour sitting within it. Certainly if I had to compare how the economics profession, the government and media have served us during this crisis, the media would come out best.
moonatic and Outback Oracle:
CR reports that ISI’s Ed Hyman is now forecasting negative Q4 GDP in China. That would have been unthinkable a few months ago.
I agree that the MSM in Australia is either in denial about China, or is deliberately putting a positive spin on China so as not to frighten the punters. Alan Kohler gets it though: China Cracks
Great story from Michael Stutchbury in The Oz today:
Our China crisis.
The penny has dropped for Michael.
It will be interesting to see if this deflation scare materialize. The last time deflation was so hot was in 1998-1999 when The Economist was calling for 5 dollar oil, and Krugman was writing his “return to depression economics, and even Gary Schilling and his “deflation book”, coming out and calling for lower commodity prices when commodities was at a 200 year inflation adjusted low. Gary actually managed to time the bottom of commodity prices with his book perfectly. The second round was in 2003-2004, but that was a minor deflation scare compared to 1998. Now it’s the third round of the deflation scare. The people are crying wolf for the third time. So that makes it kind of interesting:)
Steve you have reminded me how much I love the Hitchhikers Guide- I will get it out and reread it
Moonatic
You commented that the unemployment figures do not “seem so bad”. You should remember that the method used to determine this is a total farce with one hours work per fortnight being considered as full employment. The actual employment has already fallen much more than indicated as part time employees are having their hours reduced.
As the problem escalates the unemployment figures created by the ABS will become more and more useless and irelevant.
During the great depression unemployment was calculated by trade unions and, as best I can discover was done on an hours lost basis. For example if someone got 4 hours per week work on the Hungry Mile he would be considered as ~10% employed ~90%unemployed. By the ABS rekoning of today he would be 100% “employed”.
The GDP figures are also dodgy so to place much credibility on 0.1% of “growth” is another bad joke.
It’s all like Aldous Huxley’s Brave New World, with one exception, the epsilon minus’s not the alphas are in charge. They do look different but they must be cloned because they all sing the same neo classical economic nonsense tune.
On that point Brightspark, check out the unemployment and underemployment figures maintained by CofFEE (the Centre of Full Employment and Equity) in Newcastle:
http://e1.newcastle.edu.au/coffee/
They provide a far better estimate of true unemployment than the ABS series.
“Home sellers in Perth are doing it toughest with an auction clearance rate of around 16 per cent, down from 50 per cent a year ago.”
http://www.abc.net.au/news/stories/2008/12/15/2446375.htm
Might be the sign of a serious turning point in Perth’s real estate market.
- Ernie.
Perth falling the hardest makes the most sense to me. They had the biggest run up of everwhere. How many stories did we hear about Perth prices rising because of the mining boom? More like overly optimistic positive sentiment and massive credit growth. Ouch!!!
In 1997 I was a 20 year old sleeping on floors in the UK with < $1000 of total worth.
In 1999 I was a IT engineer with my own company who had all my money invest in the NASDAQ. I managed to triple my money buying biotech and dotcom companies.
In April-May 2000 I lost 85% of my portfolio, add to this the IT down turn and 2000 wasn’t a fantastic year economically but my company still had plenty in the bank and I had time to research.
During 2000 I tried to figure out how markets work, how money is created and what went wrong with my investments. With the aid of the internet I realised I had been a fool you got caught up in the hype and the bubble. But soon I also started to understand the system.
I read article after article about the the Rothschilds, the Morgans, the Bank of England, etc… Some of these articles were a little unorthodox, one lead to another and soon I’m reading about the New World Order. None of it meant much to me; I thought they were predominantly written by right wing militant Christian groups. The months past and I was concentrating on my career… then 911 happened and some of the damn articles I had read predicted this very event. They described a false flag operation in order to curtail civilian freedoms. I must admit the uncanny prediction did make me pay attention because “the doom sayers” describe a quite unpleasant future. Sure a lot was just delusional BS, but the fact that I had read about such an event did unsettle me.
Anyway I read about how the next big event was going to be economic and they advised one buy physical gold which I did @ US$300 /oz. A lot of the predictions were so alarming I decided to leave the UK for Australia, which I did in July 2002.
I unfortunately started to dwell some of the dire predictions, and I thought the market was going to crash without warning any day, so I was cashed up earning 4% while I could have been in the market getting 15% like every one else. I also ready back in April that the crash was planned for September, and the Fed had stop publishing M3 money data…
Here’s the point of my comment: Do you think it’s possible that the events we see played out in the “news” have been orchestrated to serve a fiendish elite global agenda? Don’t get me wrong I don’t think the banks and fund managers are in cahoots to bring down the Western financial system, but I do know if you provide alcohol to poorly educated young men and introduce a few women in to the mix there will be trouble… I just can’t predict when.
Welcome aboard Rayons,
And no I don’t believe there’s a conspiracy behind all this. The basic reason–human incompetence and the sheer impossibility of coordinating so many “in the know”.
When given a choice between a stuff-up and a conspiracy as the explanation of some disaster, I go for the former every time (almost–there always is the odd Watergate, and they almost always backfire).
The characters who are supposed to be in on this conspiracy know less about how the system operates than Bernanke or Paulson or any of the others currently charged with fixing a mess they don’t understand.
Things like the conspiracy nuts picking September 11? All you had to do was read the New York Times some years earlier, know that there had been an unsuccessful attack on the subway of the World Trade Center, and just predict another one.
Hanlon’s razor (or a close interpretation)
“Never attribute to malice that which can be adequately explained by stupidity”
Essentially there are so many short-term benefits to the system that we ignored the long-term problems. When presented with an economy where asset prices are appreciating rapidly (two-thirds of adults own a property, almost all have shares through superannuation), unemployment is relatively low and wages high thanks to stimulation of the economy by debt it all looks wonderful.
The times when debt hasn’t expanded (mid 70′s, early 80′s and early 90′s) haven’t been particularly good times, people lost jobs, businesses collapsed, etc. “Good economic management” has been ascribed to times when debt expanded and the faster the better. Steve has a DebtWatch issue on this.
Some of the mainstream economists have been blaming greed and poor regulation. My expectation is that if we were better regulated the interest rates would just be lowered further to ensure that debt expanded, otherwise the economy stalls. So when there is a shock in the economy there is less margin to drop rates and people start defaulting earlier.
Thank you Steve. I hope you are right.
Based on the information I have obtained and what I believe to be rational sociology, the events of the past 9 years point to a sinister reality.
And while I agree that stupidity was/is/will be the locomotive, I believe this was factored in.
Lets try and spin this another way….
Your goal:
1.- Create the biggest most powerful financial entity
Some considerations:
1.- Financial Services Modernization Act of 1999. (cost the banking industry some US$300M in lobbying)
2.- Global mechanisms to purchase foreign financial entities, operate in other countries & expansion of industry requiring your services.
3.- US (UK’s too) primary industries are Defence and Financial Services (so you have friends in government).
How would you address your goal?
As the head of a large financial institution you have a considerable amount of tools at your disposal; so paying a couple 100 “Research Institutes” who hire a couple 1000 “Experts” is well within your budget.
The FSM Act of 1999 while a boom for you has force other nations to adopt similar deregulation (GATS & FTA) through the WTO in order to compete.
I would “in hindsight” do exactly what “they” did (expansion of debt, sale of crap to anyone, etc, etc). I would go for broke because the prize is substantial and I know the other players are also going for broke, I also know there has to be at least 1 final winner because my industry makes the world go round. And I know that even if I fail I have been and most probably will be generously compensated for my effort. My goal isn’t to consider the social consequences.
Now, for the big picture…
Your goal:
1.- Create a one world government, with your trusted ones as the “rulers”.
How would you go about completing your goal?
Yes of course it’s an unbelievably prodigious challenge… but so is rolling out a collaborative application used by 30000 employees in 14 countries with multiple redundancies & failovers; with people who have difficulty using email.
World domination isn’t a new game, it’s been played for 1000′s of years. The plots and subplots in this game have always been complicated, convoluted and camouflaged.
I unfortunately don’t poses the intellect to play this game to it’s conclusion, but after following it for 8 year I can see the brilliance behind some of the moves and I understand the logic behind others… so this Credit Crunch wasn’t unexpected, I’m just surprised they decided to name it like a breakfast cereal.
And in order to play the game you must be very well versed in “history” because that’s what you use to model your moves… and even I know that past deregulation has ALWAYS caused trouble.
Thank you.
PS: Please excuse my grammar errors, sometimes I am unable to see that which I don’t wish to see.
rayons, read my previous post. This is simply about a system where everyone thinks they are winning. Home owners are happy, banks are happy, governments are happy, most people are happy because they have a job. Even those that have gone into excessive debt are happy because they will end up making money, or so they think. Creating lots of money means that everyone has lots of money, just don’t try to spend it. No conspiracy theories required.
Ken I’m not sure I understand you.
But I guess it could be due to differing world views. While I’m sure some people are just bumbling along with no direction, trying to make some “money” there are others who have direction and “money” is only a tool used to control the bumblers.
Direction in life doesn’t necessarily equate to an evil surreptitious plan. I also fail to see the/a conspiracy… if you want things done right you have the laws changed to meet your goals.
I think you may gone of on a tangent with the rest of your comment… blog title is “How the ‘Experts’ Missed the Crash: Philosophical Flaws, No Sense of History”… I contend that this was planned and executed. As with all plans I’m sure it didn’t go exactly as planned, but I’m sure it set the direction. My rational for this lies in the events preceding and proceeding.
PS: http://en.wikipedia.org/wiki/Michel_Chossudovsky may help you formulate a more expansive world view… and in order to level it out read some http://en.wikipedia.org/wiki/Lawrence_Summers and http://en.wikipedia.org/wiki/Paul_Volker