Economics vs.The Crime of Our Time

The economic indicators and equations are no longer with us. Economists have not yet raised the gaze of the “dark side of economic fundamentals”- the criminal and dodgy side of economics.

Economic Modeling vs. Crime of Our Time: Where Does the Economic Darkness Come From?

The financial crisis we live in now is the outcome of the Dark Age of Economics of our time- was the conclusion after reading and writing (here) about the book by Farmer R.E.A “How economy works: Confidence, Crashes and Self-Fulfilling Prophecies”. The unreliability of economic thoughts is to blame for all the political, banking and leading economists’ sins in the 30’s, the 70’s and the 08-09’s financial crisis. At the same time, crisis and shocks are desirable- they transform our economic thoughts (hopefully for the better), the time of crisis is the time for changes. All this create economic uncertainly, which makes the economic recovery slower than desired.

In my next blog I will reflect on the following: where does the source of the “darkness” of economics come from? Where are limits of economic modeling? And what is to be fixed to recover/transform the economy?

Different schools of thinking - different policies: Who is right and who is wrong?

Classical and Keynesian economics are the two main economy schools, which in turn, form different understandings of how the economy works. These different economic paths have different impact on our lives, because economists create different proposals and politicians create different policies, depending on which economy school they believe in.  

If classical economics is right, then no intervention is needed: markets will eventually return into equilibrium. Any governmental intervention (such as bailouts, legislations) shifts markets even further out of the equilibrium. According to classical economics, any stock market crash is the correction according to future fundamentals, anticipated by investors. Any intervention in form of capital injections and bailout is thus just wasting taxpayers’ money.

Nevertheless, the fundamentals of classical economics can also be blamed for inefficient policy making. As Farmer said:

“Decades of training in classical economics have blinded our best and brightest minds to the fact that the long-run unemployment rate is not independent of aggregate demand. High unemployment is an inefficient waste of resources that reflects a failure of the market system, and the restoration and maintenance of full employment requires collective action in the form a well-designed government policy.”

If classical economics is applied, which is also the foundation of modern finance, we should not experience financial crises at all, just a little market adjustment to new information.

If Keynesian economics is right, the governmental intervention is not inevitable if the financial stability is to be sustained. When stock markets crash, and by pumping liquidity into the system, governments convince investors and depositors to regain confidence in markets. The governmental actions should rescue the economy from a depression.  

Having said that, application of the Keynesian economy frameworks cannot predict the exact outcome. Singular mechanisms work differently in different time zones, different decades and in different cultures. Applying the same policy in 2008-2009, which worked in 1987 stock crash (On Monday, October 19,1987 there were the second and larger Black Monday in U.S. history, and Alan Greenspan responded to the huge drop in the stock market by announcing publicly that the Fed stood ready to lend any necessary amount of cash to the banks), will not necessarily  give the same outcome today. In 1987, the injection of capital was successful, the confidence was restored and the markets had escaped the crisis. The similar policy has not proved to be the “cure” policy in the 2008-2009 financial crises.

 Thus, there is no guarantee in politicians’ actions. This is a political gamble, using taxpayers’ money. Sometimes the gamble can pay-off (like on 1987), sometimes not (the recession had occurred following 2008 market crash in spite of governmental actions). Thus, there is no guarantee that Keynesian economics are right.

In fact, comparing the Keynesian policies in the 70’s to the fiscal policies of our days is also dubious. As Krugman said on his blog, the policy in the 70’s had nothing to do with Keynesian fiscal policy- and did not involve increasing debt. Thus, the application of loose policies and relaxed national deficit will have different outcomes in light of the level of national indebtness.

Either there is no guarantee in the correctness of economic models. Empirically, neither side of economy school can be easily tested and modeled. The severe evidence of the latest financial crisis have proved that markets could be priced wrongly for longer than a shot-run period, as well as the marked failures will not always be corrected by the “powerful institutions”. 

Still, the economic profession believes that, combined together, all existing economic thoughts and frameworks (classical, Keynesian, political, behavioral, mathematical, financial, macro, micro, evolutional) do create a solid general theoretical base for our understanding of economics.

It still gives the change to all economists to show off their mathematical and logical reasoning expertise. This mathematical reasoning creates an illusion of the “idealized” vision of economics and the illusion that relying on something else will be just creating wrong illusions, or believing on something that is not true. Therefore, economists are still in search of finding new correlations, building new models, or (dis)proving old models with an updated dataset and making new speculations and assumptions as well as incorporating different general logical reasoning. All this create a massive body of economic theoretical literature with dubious generalisability.

From another side- it doesn’t matter- it's too big to grasp

The unreliability of economic modeling, its illusions and “wrong” thoughts creates economic uncertainty.

But at some point, it doesn’t matter. Something is totally missed by statistics and financial modeling from the real world: the criminal and dodgy side of economics.

The advanced economics and finance is not only about equilibrium and whether it can be fixed or not. Advanced economics is also about ILLIGAL outflow/inflow of funds, money laundering, corruption, fraud, “efficient tax” transactions, and financial flows to and from tax havens. Recently, these “economic frictions” have gained higher weight in the complex mechanism of economics as ever. Sometimes I think these frictions should actually gain the status of fundamentals. But rarely are they “evident” in good times, only in bust times do we hear about financial and economic crimes, illegal transactions, Ponzi schemes, you name it.

For example, recently, the Economist has turned the world into attention of the role of tax haven in rich and developing countries in the economy. We used to believe that offshore transactions are about cost cut. However, it is actually more about tax neutrality, and sometimes, cheating. As these tax havens serve clean as well as dirty money, much of the offshore industry lies in the statistical shadows.  

“Developing countries as a whole don’t face a debt problem, but a huge offshore tax-evasion and money-laundering problem”, says Gabriel Zucman of the Paris School of Economics. “The outflow of funds, as with the euro zone “turns some of them (EU countries) from big debtors into creditors”.

I might have the courage to say that I have professionally also “experienced” how income can be moved around the world to minimize their tax liabilities. The transaction models are very complex (due to segregation of duties, they are often “out of understandable reach”), with the final outcome that profits are moved to the lower-tax entities and expenses to the higher-tax one. According to accounting rules and transfer-pricing audit, these sorts of transactions are legal, however, the actual benefits are hidden from the statistics and other authorities, which in turn make the national balance under/overestimated.   

These funds which continually flows to and from tax havens indeed diminish governmental tax revenue, incentives to build institutions at home countries, as well as employment opportunities.

While corporations are out-flowing their incomes to law-tax countries, the financial markets can be in short of liquidity, and in call for help from (none)governmental institutions.

In Denmark, for example, the liquidity “help” came not from the government, but from the biggest Danish pension fund, ATP, which in the times of 2008-2009 financial turmoil injected more than 240 million DKK  to secure the financial stability of the Danish banks (incl. Danske Bank, the biggest bank in Denmark), Danish currency and Danish obligations.

These rescuer transactions were made in the shadow from the public revelation, which is a disturbing reality, as these operations were funded by the pension savings of the majority of the Danish residents.
Today, this injection of capital into Danish banks (incl. Danske Bank) by the ATP is seen as one of the main financial activities that saved the financial stability from the economic collapse in Denmark. However, there was no transparency of the ATP’s action until Berlingske, a newspaper, brought in into the public knowledge, almost 5 years later. 

From one side, was this knowledge available to public earlier, the economy, on my opinion, would had been now in a much severe critical stage and in much dipper financial distress due to potential deposit withdrawals and mass bank runs and panics.  

From another side, market transparency of economic transaction is the most important source of a healthy financial system. Market transparency is important since it is one of the conditions required for a free market to be efficient.

In my example, the relevant actors have deliberately failed to bring this information into public knowledge. This is one of the examples, why we should question the market efficiency, the credibility of market information and reliability of political actions: the most important market information can be hidden.

There is also a book by Danny Schechter “The Crime of Our Time: Was the Economic Collapse “Indeed, Criminal?”, who provides the examples  that leading market players  have deliberately turned free markets into vehicles for mass manipulation and control.
In one of the examples, he refers to an interview with Bill Moyer, who explained that many failed banks were deliberately brought down, and:
“The way that you do it is to make really bad loans, because they pay better. Then you grow extremely rapidly, in other words, you’re a Ponzi-like scheme. And the third thing you do is” leverage up. It’s hugely profitable and “inevitable that there’s going to be a disaster down the road.”

Schechter names many other crimes of our time, including:

–        “Fraud and control frauds;

–        Insider trading;

–        Theft and conspiracy;

–        Misrepresentation;

–        Ponzi schemes;

–        False accounting;

–        Embezzling;

–        Diverting funds into obscenely high salaries and obscene bonuses;

–        Bilking investors, customers and homeowners;

–        Conflicts of interest;

–        Mesmerizing regulators;

–        Manipulating markets;

–        Tax frauds;

–        Making loans and then arranging that they fail;

–        Engineering phony financial products; (and)

–        Misleading the public.”

So, partly, economics of our time is created on money, which is made by stealing it, slicing it to cut their tax bills, moving abroad, misrepresenting information, cooking the books and committing the fraud and secretly injecting the liquidity. And worryingly, this mechanism is even institutionalized: authorities and accounting rules approve this sort of transactions, CFO’s get bonuses, insider dealers get returns, banks sell toxic junk and the lenders and investors accept it, and public is still in the financial shadow.

So, how many economic models capture these frictions? I have not seen any…

In order to recover the economy, we need new models and perspectives of economics, but more importantly, we need to re-build honesty, transparency and even understanding of economic transactions not only on the macro, but also on the micro level.

The failure to face the problem of economic crime, market information, actions and frauds constitutes a huge barrier in the path of economic recovery. The financial system can’t be fixed until it’s cleaned up and rebuild in a transparent and honest manner.

Therefore, for the politicians, instead of quick- fixing the economy by increasing consumption, austerity, deficit cliff, they have to deep to the root of the problems: there is a need to face the problem of economic crime. And for the economists instead of finding new models and correlation, more academic work needs to be done to illuminate this crime.

For us, ordinary people, as Schechter said: “We need proof of who’s on the take followed by “a jailout, not (another) bailout.”