What caused the economic crisis?

The Straits Times, 25/4/9, p.A24
The treason of the economists
By Robert Skidelsky

Quote1:
All epoch defining events are the result of conjunctures -- the correlation of normally unconnected events that jolt humanity out of a rut.

Comment1:
The author states a general rule.

Quote2:
The prosperity of the first age of globalisation before 1914, for example, resulted from a successful constellation of developments: falling transport and communication costs [etc]. ... By contrast, the poisonous international politics of the interwar years combined with global economic imbalances to create the Great Depression and World War II.

Comment2:
These are two examples of the general rule. Note that examples are not proof. Examples are offered only to illustrate.

Quote3:
Now consider the recent financial innovations. On the back of the new computer and telecommunications technology, a giant market for derivative instruments was built. ... What made the spread of derivatives possible was the ease with which the volume of debt for a given set of assets could be expanded. This scalability was magnified by the use of credit default swaps (CDSs). ... But financial intermediation would never have brought disaster ... save for the global imbalances arising from America's twin trade and budget deficits, financed to a large extent by Chinese savings. ... The financial crisis of 2008 was the start of a highly painful, but inevitable, process of deleveraging.

Comment3:
The author applies the general rule to the current financial crisis. He identifies the crucial events as: "new computer and telecommunications technology", "giant market for derivative instruments", ease of debt expansion, "credit default swaps", "global imbalances arising from America's twin trade and budget deficits", and "Chinese savings". What is happening now is the "highly painful, but inevitable, process of deleveraging".

Quote4:
This [conjuncture] interpretation of the origins of the present slump is disputed by the "money glut" school. In their view, there was one cause, and one cause only of the crisis: the excessive credit creation that took place under Mr Alan Greenspan's Federal Reserve.

Comment4:
The manner of this dispute is to offer an alternative and contradictory (meaning: impossible for both to be true) theory. The contradiction is located in the conjunctive theory requiring several causal events, and the money glut theory requiring only one cause.

Quote5:
This line of reasoning assumes that markets are perfectly efficient. If they go wrong, it must be because of mistakes in policy.

Comment5:
This is intended as a rebuttal of the "money glut" school, but serves only to elaborate the view -- because the author offers nothing to say markets are not perfectly efficient.

Quote6:
This view is also self-contradictory: If market participants are perfectly rational and perfectly informed, they would not have been fooled by a policy of making money cheaper than it really was. ...

Comment6:
This is also intended as a rebuttal of the "money glut" school. The "money glut" school says market participants would not be fooled by cheap money, and also that the only cause of the crisis is excessive credit creation [that is, they were fooled: Quote4]. These are contradictory claims. If a theory leads to contradictory positions, the theory must be wrong. Hence, the "money glut" view is wrong. The rebuttal succeeds. Note that this rebuttal of the money glut view does not prove the conjuncture view is correct. It is logically possible for both to be wrong.

Quote7:
This suggests a more fundamental reason for the economic crisis: The dominance of the Chicago school of economics, with its belief in the self-regulating properties of unfettered markets. This belief justified, or rationalised, the deregulation of financial markets in the name of the "efficient market hypothesis". ... Most of today's ... economists ... continue to work in the idological vicinity of Chicago. Their assumptions should be ruthlessly exposed, for they have close to destroying our world.

Comment7:
I am baffled by this end to the article. The "money glut" view has been rebutted. Hence, the "money glut" view is not the explanation for the economic crisis. Consequently, it does not seem reasonable to say that "a more fundamental reason for the economic crisis [is] the dominance of the Chicago school of economics".

END