Clowns and Jesters on the Economic Crisis

To me, there are two major kinds of jokes: those made by clowns and those by jesters.

Clowns make jokes by being the jokes. Slamming a door on their hands, tripping over their own feet, and falling into a pit are just a few examples. Others laugh at clowns simply because they find their jokes foolish, and sometimes to the point of being ridiculous. On the other hand, jesters make jokes by delivering the truth. Although their jokes may often sound outrageous, they merely reveal the implausible-but-true sides about the very world that we live in. People laugh at jesters because they find their jokes too witty, too true, too overwhelming, and perhaps too sad, to the point that they can do nothing else but laugh.

In his various appearances on CNBC and Fox News during 2006 and 2007, Peter Schiff predicted that a financial crisis was on its way and that the U.S. economy would enter a longer-than-ever recession. What’s more, he further stressed in that the subprime mortgage problem would transform into a large-scale mortgage crisis in which sky-high real estate prices would crash back down to Earth. At that time, most economists and financial forecasters laughed at Schiff in denial, thinking that he was full of nonsense.

Later in 2007, the U.S. housing market collapsed, which then turned into an ongoing series of economic crises throughout the world.

Today people have found out that Schiff was not a clown who cried wolf, but a helpless jester who tried to warn everyone that all the great things happening before the crisis were just too good to be true. Indeed too much consumption and borrowing rather than production ended up harming the well-being of the U.S. economy. Indeed aggressive speculative buying and incomplete lending standards turned out damaging the health of the local real estate market. Not only have Schiff’s revelations ultimately won him a penny from Arthur Laffer, but they have probably brought a triumph for Austrian economics over supply-side economics – having low tax rates, as well as lenient monetary and fiscal policies as incentives for businesses to increase the supply of goods did not promote the U.S. economy at all; most Americans plainly could not afford to consume any of them because they did not produce or even save enough to accumulate wealth in the first place. When the credit market – a vital source of “income” for Americans – tumbled, so did the entire economy. And it did, both theoretically and actually. What the critics of Schiff can do now is to laugh, and be laughed, at their own stupidity.

But Schiff was not completely right.

Also as a zealous believer in “the holy invisible hand,” Schiff asserted that the government should not intervene at all since the current economic crisis was rather a solution. To some extent, it makes good theoretical sense. The main theme of capitalism has always been that good businesses survive and bad ones do not. The deaths of greedy and irresponsible businesses, such as Lehman Brothers, are merely what were needed to make capitalism work.

However, capitalism as a theory contains a number of flaws. An important and blatant one has to be the widening of the rich-poor gap. Adhering to the laissez-faire spirit, advantaged businesses and individuals continue to succeed while disadvantaged ones continue to fail. As a byproduct of such mechanism, the poor unfortunately have to become poorer as the rich get richer and fatter everyday. It is only capitalism that can make a place both heaven and hell at the same time (see Hong Kong).

The current crisis also presents another undisputable defect: under the market economy system, where everyone is free to act upon their self interest, things can go out of control at any second. All the major aftermaths, expected (see the 2008 stock market crash) and unexpected (see Bernard Madoff’s investment frauds), that have broken out over the past three years clearly explain this argument.

And to be frank, the “capitalism” we experience in America is not Adam Smith’s good old capitalism anymore. Like many other western administrations, the U.S. government nowadays tends to pursue the Middle Way between socialism and capitalism in order to ensure the stability of the economy. The establishment of Federal Reserve, U.S. Treasury and various regulatory agencies probably serve as an implicit acknowledgement that there should at least be minimum standards and limited regulations so that the economy can grow in a manageable manner.

Anyhow, pushing too unrealistically for an economy with almost zero government intervention in order to validate an ideology created several hundred years ago may not be a sound idea. Perhaps Schiff deserves some giggles for being too “capitalist” after all.

Let’s face it. Adam Smith does not rule the world anymore – the U.S. government itself has already leveraged billions of trillions of taxpayers’ money on bailing out “too big to fail” banks and carrying out a “too big to possibly repay China” stimulus plan.

Although this is what we all need to learn to accept, one must say that Fed Chairman Ben Bernanke’s decision to create over 1 trillion new dollars really challenges everyone’s tolerance. Having previously failed to see the subprime mortgage crisis snowballing like other “clowns,” Bernanke has now printed such an enormous amount of new money to subsidize failing investment banks, to acquire toxic assets, and to replace the collapsing credit market with the Fed. While Bernanke, based on his extensive research on the Great Depression when he was still a scholar, believes that such move would save the economy from a worse collapse, he is actually exposing the U.S. economy to another potential danger: hyperinflation. This seems to me somewhat of a radical strategy that tries to ease a short-term pain by inflicting a long-term one.

Moreover, Bernanke should realize that the current economic crisis is much more convoluted than the Great Depression. Nassim Nicholas Taleb suggested that nowadays the Internet and globalization generate too many extreme variations that are underestimated by economic models relying on mathematics and theories. Therefore, using an outdated case study – here, the Great Depression – to formulate solutions for the current crisis is probably not very responsible of the most powerful central banker in the world to do.

Maybe there are times when we do not know whether we should laugh or be mad at someone’s outrageous action – well, it’s still too early to make a judgment.

Even though many critics (see John Kay and Liaquat Ahamed) remain unhappy with those who are in charge of the world’s financial system for being too theoretical and academic, what’s done is done. While keeping our fingers crossed for those critical measures to eventually work out, we should focus on coming up with feasible reforms in attempts to prevent an even bigger economic crisis from happening in the future.

As for myself, I would rather listen to the street-smart all-time winners than those book-smart pedantic scholars. One great role model to learn from would be George Soros, who was the biggest winner during the 1997 Asian Financial Crisis and made a solid 8 percent return last year (see his recent article on financial reform for details). Like an intelligent jester, Soros can shed light on the present economic climate just in a few concise sentences, and then offer insights about financial reforms with a sense of humor – he jokingly made an analogy between credit default swaps and buying life insurance on someone else’s life while owning a license to kill him. Most importantly, what Soros preaches is not theoretical reasoning, but wisdom based on experience.

Dear straight-A economists and bankers, perhaps it is time to stick less to theories and models, and pay more attention to what is actually going on in the economy. Also, think carefully for yourselves before and after you laugh. Because you never know who would end up being the clown.