Of Pluto and Mars by Carlo Scognamiglio Pasini

019-025-Scognamiglio-Pasini ing 41-42-43 20-01-2009 18:14 Pagina 19 Carlo Scognamiglio Pasini Of Pluto and Mars The financial crisis of 2008 has seen the United States relinquish its title of “world monetary leader” – or Pluto – that it has held since WWII. In the field of security – that of Mars – this means that the European “Venu- sians” will need to wake up from their dream of being able to free-ride for- ever on the public good generated by America. Likewise, the powerful en- gines of today’s real economy (particularly China) will need to realize that the days when they could just get on with selling their products to the world, in exchange for a currency issued by an inexhaustible lender of last resort, are over. Finally, those countries poor in everything, but rich in en- ergy resources will learn that they can no longer sit at the table set by wealthy countries without accepting the re- Carlo Scognamiglio Pasini, honorary chair- sponsibilities that come with it. man of Aspen Institute Italia, is a professor of Economics at LUISS Guido Carli in Rome. “I came to rescue capitalism, not to bury it.” Gordon Brown, speech to the House of Commons, October 2008 With the global financial market crisis, John Maynard Keynes has made a comeback: his “discovery” of the business cycle phenomenon and his stance against a self-reg- ulated international financial market – defeated at Bretton Woods way back in 1944 – appear more timely than ever. Among those who stand to benefit from this restitutio memoriae is his most modern reinterpreter, Hyman Minsky, who succeeded in build- ing on the work of the great English economist with his theory on financial instabili- ty1. As we will see, according to this theory, financial variables play a pivotal role in explaining economic crises. A perfect understanding of these works and the lessons 019-025-Scognamiglio-Pasini ing 41-42-43 20-01-2009 18:14 Pagina 20 which can be drawn from them to deal with the crisis currently shaking financial mar- kets, has led British Prime Minister Gordon Brown to earn an undisputed position of leadership on the international stage. AFTER THE PANIC. The most dramatic and dangerous stage of the crisis – name- ly, dealing with a wave of panic as irrational as the rash enthusiasm shown for creative finance securities later downgraded to toxic assets – now seems to be drawing to a close. Yet its consequences on the “real” economy will persist for an unknown amount of time: the wealth destruction, caused initially by the “mania” for creative finance securities and then by the ensuing panic, is not yet quantifiable. For now, it is only possible to attempt to provide answers to two questions that emerged simultaneously when the financial bubble burst: firstly, what was it that led to the blow-out of the speculative bubble; secondly, was it foreseen or not by the economic models to hand. There is no doubt that the most direct cause of the bubble’s blow-out was endogenous to the American system of home financing and the consequence of years of overly- expansive monetary policy. Yet media reports are also making endless comparisons with 20 the grave crisis that began in 1929. These comparisons are partly justified as far as the effects of the crisis are concerned, but they are unfounded as regards the causes. THE CAUSES ARE DIFFERENT THAN IN 1929. The Wall Street financial bubble of 1929 was mainly fueled by the huge volume of capital flows triggered by the war reparations owed by defeated Germany to the victorious allies, as a consequence of what was a modern take on the Pax Carthaginiensis: the 1919 Treaty of Ver- sailles. In order to obtain the funds necessary to make reparations, Germany resorted to borrowing from the United States, which by then had already long been the world’s leading industrial power and, unlike today, had a massive current account surplus. These capital flows returned to the US in the form of industry orders and purchases of agricultural products, but also as speculative investment on the American stock market. In other words, the American trade surplus financed the country’s industry and agriculture, but also speculation on Wall Street. Hence, an excess of savings was transformed into a wave of speculation, precisely as described by Hyman Minsky. In the case of the current crisis, however, its origins lie in the American government’s excessive deficit and the deficit in the balance of payments current account – in other words, in a savings deficit which, likewise, leads to an enormous growth in the volume of financial resources in circulation. 019-025-Scognamiglio-Pasini ing 41-42-43 20-01-2009 18:14 Pagina 21 The twin deficit phenomenon is determined by the presence in a given economy of significant, persistent and simultaneous deficits in the government’s accounts and in the balance of payments current account. The first type of deficit indicates that the government’s tax revenues are not sufficient to cover public expenditure, while the second type indicates a savings deficit, which occurs when imports of goods and serv- ices exceed exports. 21 GUNS AND BUTTER. The twin deficit made its appearance in the United States during the Reagan administration (1981-1988), as a consequence of the acceptance gained by the ideas of Arthur B. Laffer about supply-side economics, and of the es- calation of the Cold War during the period that preceded the collapse of the Soviet system. The tax burden was alleviated, thus leading to a reduction in tax revenues. At the same time, there was a sharp rise in arms spending, which reached over 6% of America’s gross domestic product. This policy, which we may term “guns and butter”, was made possible by America’s low level of foreign debt and, in particular, by the fact that the dollar represented then – as it does today – the principal currency for international trade and for the accu- mulation of currency reserves. The dollar bill and US Treasury Bonds were both well- 019-025-Scognamiglio-Pasini ing 41-42-43 20-01-2009 18:14 Pagina 22 accepted by the international community, and this made American rearmament possible in a strategic race with the Soviet bloc, without having to lumber American tax- payers with a particularly hefty tax burden. This was the decisive battleground between the Western democracies and the Soviet empire. The latter was, in turn, forced to increase its military spending, which reached a “wartime” level of over 15% of GDP. The socialist economies, which were already in serious difficulty due to their lack of technological preparedness, were lit- erally devastated by the race to keep up with military spending, flinging their popu- lations into chaos and misery and thus bringing to a close the battle between the two power blocs, at odds with each other since the end of the second world war. The global division of roles, the specialization, or the “division of labor” – as Adam Smith would have put it – became glaringly evident during the first Iraqi crisis (in 1991), when the United Nations responded to the invasion of Kuwait by Saddam Hus- sein by authorizing military intervention. The military action was led predominantly by American forces, but was financed to a great extent by the Arab oil-producing nations. Later, during the Clinton administration, the United States resumed a policy of 22 multilateralism – or, if you like, a Jeffersonian profile of being “humble but strong”. Military expenditure was gradually reduced to 3% of American GDP and, thanks to the “dividend of peace”, the public deficit was lowered until it was transformed into a surplus. The flow of financial resources from abroad to the United States continued in the form of foreign investment, thus fueling the strong growth of the American economy. The “war on terror” – after the dramatic attacks of September 11, 2001 and the military campaigns led by Americans in Afghanistan and Iraq – saw a return of the situa- tion that had preceded the end of the Cold War. The United States simultaneously filled the role of “world security leader” – once again raising spending on strategic military deployment to 6% of GDP – and that of chief economic and financial center of the world. As a result, the twin deficit resurfaced in America’s public accounts. At present, the US current account deficit is 700 billion dollars a year (or 5% of American GDP). Mean- while, the world’s three principal exporters (China, Germany and Japan) have a surplus of 800 billion dollars, to which can be added the surpluses of the hydrocarbon-producing countries, which have been growing with the rise in oil prices. During this period, there was also a polite war of words conducted from the western shores of the Atlantic against European partners. The Europeans, “from Venus”, it was suggested, were able to enjoy the delights of their countries in peace because the Americans, “from Mars”, had taken care of security issues. The “specialization” of 019-025-Scognamiglio-Pasini ing 41-42-43 20-01-2009 18:14 Pagina 23 roles among countries even became the subject of literary and mythological forays. However, in order to measure up to these evocative claims, the United States, as the epicenter of world economic power, found itself playing the role of Pluto as well as that of Mars. Still, if during the time of the Pax Britannica the world had functioned more or less along these lines, then why should we not think that the golden age of Queen Victoria has returned? A RUDE AWAKENING.

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