April 04, 2013
In his column today Robert Samuelson talks about the euro zone crisis and its latest manifestation in Cyprus in the context of the new book, The Alchemists, by his Washington Post colleague Neil Irwin. At one point he tells readers:
“The constant goal, as Irwin shows, has been to prevent a collapse of the global financial system, which could plunge the world economy into a genuine depression. Everyone embraces the goal…” (emphasis added)
Well not everyone shares the goal of preventing a financial collapse at all costs. That’s in part because some of us know that there is no reason that such a collapse would plunge the world into a genuine depression.
The world has the tools to reverse the impact of a financial collapse and restore the economy back to a normal growth path. This was demonstrated a decade ago by Argentina. It defaulted on its debt and broke with the dollar in December of 2001. This led to a full-fledged financial collapse, which was followed by a sharp plunge in output in the first quarter of 2002.
By the second quarter its economy had stabilized. By the second half of 2002 its economy was growing rapidly and by the summer of 2003 it had made up all the ground lost from the financial collapse. It continued to growth rapidly until the world recession brought Argentina’s economy to a standstill in 2009.
Source: International Monetary Fund.
While it is possible that the “alchemists,” the central bankers in the euro zone and the United States who are the title characters in Irwin’s book, are not as competent as Argentina’s policy makers, there is no reason that a financial collapse should have led to a full depression. Economists since Keynes have long understood the steps necessary to prevent a depression, so it would require an extraordinary level of incompetence to allow a collapse to lead to a depression.
It certainly would be best to have a solution to the financial crises in Cyprus and the euro zone that did not involve a collapse, as would have been true during the Lehman crisis in the United States in the fall of 2008. However, given the enormously bloated financial sector in the United States and elsewhere in the world, it may well be better to have a solution involving a collapse that would wipe out this powerful interest group than a government bailout that leaves it intact.
The bloated financial sector acts as on ongoing drain on the economy since it pulls out more than it contributes to the economy as was shown in a recent paper from the Bank of International Settlements. In addition, because of the financial industry obsession with inflation, it is likely to use its political power to stifle growth in order to minimize the risk of inflation.
Contrary to Samuelson’s assertion, there are people who disagree with him on the need to save the financial industry. (It was the industry whose survival was immediately at stake, not the system as he asserts.) It is striking that he would try to deny the existence of people on the other side but this sort of argument is characteristic of DC elite opinion as when they assert that “nobody” saw this crisis coming. When you have a weak argument it is easiest to just try to exclude the other side from the debate.
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