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Wednesday, Jan. 7, 2009

Lessons of the credit crunch


The credit crunch and the deepening recession have provided church leaders, politicians, economists, journalists and armchair philosophers with a good excuse for moralizing and for expounding their views on what happened, why it occurred and what to do to prevent a recurrence.

The queen is reported to have asked one guest: "Why didn't anyone foresee the coming economic crisis?" Why indeed? When "all in the garden is lovely," anyone who forecasts rain is condemned as a doomsayer, and it is only when the rain starts that everyone rushes to save their belongings from the downpour. Some items are damaged irretrievably, other are permanently rusted.

Church leaders, including bishops in England and Germany, have blamed greed and the materialist consumer society for the financial crisis that triggered the recession. They also see some long-term benefits arising from the crisis. They predict, probably wrongly, that people will be less willing in the future to run up credit-card debt and take on obligations that they cannot afford, and will recognize that happiness does not lie in having the latest fashion accessories or the latest gadgets.

They also condemn the dishonesty of people in the financial world who covered up losses and tried to gain fortunes by using dubious financial engineering. The Madoff scandal, they suggest, was made possible by the blind greed of individuals and companies who were deluded into thinking that Madoff could continue to deliver exceptional returns.

Politicians, responsible for encouraging or at the least permitting an unsustainable boom in house prices and a huge growth in consumer credit, refuse to accept responsibility and blame the bankers for their incompetence and greed. They ask why the bankers made so many mistakes in assessing risk and why did they allow clever whiz-kids to invent ever more complex financial instruments, which while spreading the risks managed to hide those risks.

A few officials and bankers have at last begun to admit that they should have done their jobs better, but there has not been enough public contrition to satisfy the critics.

Economists and the media have tended to concentrate on forecasting the depth of the recession and the long-term policy implications. A few on the left of the political spectrum have argued that the credit crunch demonstrates the failure of capitalism and emphasizes the need not only for much more stringent oversight and regulation, but also a reversion to controlling and directing the flow of capital.

Others accept the need for better regulation, but take the view that there is no way that man can be prevented from trying to find new ways of getting rich quickly (inevitably at a cost to others). They argue cogently from the history of the great depression after World War I and the history of so-called socialist economies that protectionist policies and direction of capital through fully nationalized banks would only exacerbate and extend the crisis.

In my view the liberal economists are correct, but regulation to protect the majority from the machinations of the few has to be better and more efficiently enforced, although we must be careful not to stifle enterprise in the process.

In Britain the political controversy over economic policy has been oversimplified. The government allege that the Conservative opposition aim to tackle the crisis by trying to reduce public indebtedness, whereas they think that the only answer lies through a Keynesian boost in demand brought about by tax cuts, bringing forward public spending and low interest rates.

The Conservatives have not been very clever in presenting their proposals, which do involve tax cuts. The government for its part have attempted to disguise some of the long term implications of their policies. The temporary cut in the VAT from 17.5 percent to 15 percent has been costly and almost certainly ineffective. Attempts to save jobs through aid to companies in difficulties may also end up by propping up companies whose products are no longer in demand. The British economy almost certainly needs a Keynesian boost but it is questionable whether the government's package is the right one.

The policies adopted by the British government in the current crisis, which arose from the bursting of the credit boom, seem to some to be aimed at a further expansion of credit. The banks have been told to lend as much as they did in the past. Low interest rates, which are likely to go even lower in 2009, should reduce the interest burden on holders of mortgages and credit-card debt. At the same time they will penalize savers, who should be encouraged to save more in an aging society, and pensioners, who rely on interest from savings. The moralists understandably moan that the irresponsible are rewarded and the virtuous penalized.

The decline in the value of sterling suggests that in the eyes of the rest of the world the British economy will suffer more in 2009 than those of the United States, the euro-zone countries and Japan. This is possible but not necessarily going to be the case.

The Obama factor may help the U.S. to weather the crisis. The euro zone is far from immune. The Japanese economic scene, despite or perhaps because of the strong yen, looks particularly bleak.

The next general election in Britain is not due until 2010. Prime Minister Gordon Brown's ratings have increased in recent months. He sees himself as "the savior" of the world (a Freudian slip of the tongue that caused mocking laughter in the House of Commons), but the odds are against another Labour Party win.

The most important election in Europe will be that in Germany in which Chancellor Angela Merkel may again be victorious. In Japan, Taro Aso will need political cunning and an extraordinary amount of good luck if he is to remain prime minister after the election, which must come in 2009.

Hugh Cortazzi, a former British career diplomat, served as ambassador to Japan from 1980 to 1984.


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