Thoughts on economics and liberty

Info for the Occupy Wall St. movement: Entrepreneurs get only 2 per cent of the wealth they produce

A wave of SOCIALIST envy is sweeping USA – and now Melbourne.

Chris Breen, an activist from the socialist group Solidarity, told Green left Weekly: “We are in a world racked by inequality, where there is always far too much at the top; the CEO of the company I work for just got a 53 per cent pay rise up to $2.9m and in contrast up to a million people are going to starve in Africa.

“There is starting to be a movement around the world of people challenging that inequality, perhaps the most dramatic examples of this would be in Tunisia and Egypt — where the dictators in those countries have been toppled. Occupy Wall Street took its inspiration from Egypt and the movement in Spain.

“I am hoping this will become something more, but it is just the beginning so who knows. It’s important to support this event because we are all trying to change the world.”

Socialist Alternative activist Declan Murphy told GLW: “The global occupy movement is a very important movement as it is explicitly about reclaiming our democracy from corporate influence and from corporate power.

“I think it is telling that this movement has arisen globally in the circumstance of a crisis in the capitalist system. We have millions upon millions of people being plunged in to despair, declining living standards worldwide; austerity measures being brought in by governments.” [Source]

The ignorance of most people about how markets work is beyond dismal. They don't seem to know anything about what has made them wealthy in the first place. We need to give them a liberty primer, with articles such as I Pencil

These people don't realise that 98% of the wealth that entrepreneurs create goes to the PEOPLE, and only 2% goes to them:

A discussion paper published in 2004 by the economist William Nordhaus attempts to establish exactly how thin that slice is. Nordhaus reckons that innovators capture a “minuscule” 2.2 per cent of the total social benefit of their innovations. The other 97.8 per cent goes to consumers, partly because competitors soon catch on, and partly because no company, even a monopolist, can charge each consumer a price reflecting her individual willingness to pay.

Professor Nordhaus’s estimate can be regarded as, at best, an educated guess, partly because Nordhaus is only able to focus on innovations which lead to lower production costs and thus lower prices. If that’s the metric, developments such as the world wide web or penicillin barely register. Still, I think it’s safe to say that both Tim Berners-Lee (the web) and Alexander Fleming (penicillin) reaped far less than 2.2 per cent of the total value to society of their insights. [Source]

Why would anyone in his right mind be jealous of people who GIVE AWAY 98 per cent of the wealth they produce?

Of course, this 2 per cent of the wealth these people produce is a FABULOUS amount. They therefore become fabulously rich. But it is only 2 per cent. Don't forget that.

View more posts from this author
54 thoughts on “Info for the Occupy Wall St. movement: Entrepreneurs get only 2 per cent of the wealth they produce
  1. Rajat

    the post by Tim that you've referenced here, concerns "social benefit", rather than the monetary "wealth" you're referening to. There's a contrast here!!!

  2. Bhagwad Jal Park

    Misleading title no? Entrepreneurs and innovators are not the same thing. Also, CEOs are not entrepreneurs most of the time either.
    It's beyond doubt that in the US, inequality has increased dramatically over the past 40 years. Rich people pay a SMALLER percentage in taxes than other people. Why do you think that's fair?

  3. Sanjeev Sabhlok

    Dear Rajat

    That is mere semantics. The entire history of mankind is is the “social benefit” (i.e. increase in income, later converted into wealth) generated by entrepreneurs. Only innovation matters as far as growth is concerned.


  4. Sanjeev Sabhlok

    That’s largely semantics, Bhagwad – to distinguish between entrepreneurs and innovators. Innovation that is not converted into some form of action is not innovation, merely a pipedream. And entreprenuers not only exist within the private sector but within the government sector as well (e.g. faster better ways to kill the enemy in war). The point was simple – that it is futile to be jealous of someone who produces wealth.

    It is also inappropriate to consider CEOs of large companies as different to entrepreneurs. Their job is to continuously push the frontier of innovation, by identifying new ideas and better, cost-effective ways of functioning. They are paid for their ability to generate NEW wealth.

    Re: inequality increasing, that is neither here nor there. So long as it is earned through legal means, it is just.

    Re: the rich paying low taxes, I’ve already flagged this issue and discussed the appropriate tax system here: and here:

  5. Bhagwad Jal Park

    My mistake. I didn't mean "entrepreneurs and innovators." I meant "entrepreneurs and wealthy people/CEOs." Most CEOs don't innovate. They just try and increase profits. And most of the time you can increase profits without innovating.
    Additionally, a lot of wealthy people are not CEOs. They can be investment bankers for example. They don't innovate either.
    Let's talk about wealthy people separately from entrepreneurs.
    Anyway, you didn't say whether or not you were ok  with this graph: showing income inequality in the US over the last 20 years?
    Currently, the top 1% of the wealthy in the US earn 24% of the income. Also, social mobility has decreased dramatically with wealthy parents producing wealthy children. The number of people moving into the upper percentiles from the lower ones has been steadily decreasing:
    All this is a good thing?

  6. Bhagwad Jal Park

    Saying that entrepreneurs only get 2% is a straw man. No one is complaining against entrepreneurs. if I'm wrong, show me a quote from someone who says that entrepreneurs should not be wealthy.
    The mistake I think you're making is in assuming that all rich people are entrepreneurs and innovators. Almost no one is.

  7. Sanjeev Sabhlok

    Dear Bhagwad

    I did address the so called inequality issue. It is irrelevant so long as the process that created this “inequality” is just.

    I do not separate wealthy people from entrepreneurs. I consider Michael Jackson equally an entrepreneur as JRD Tata and Bill Gates. ALL wealth is ultimately produced, in a competitive economy, by providing a BETTER service at a LOWER (relative) cost. Investment bankers are not innovative? Please try being one. Also, you might want to study finance and investment at the masters level (which I have).

    To even remotely suggest that the invention of new markets for risk, the better pricing of risk, the computer systems that underpin investment banking and finance is not innovative merely indicates deep ignorance of the discipline. It is not innovative why don’t you try it out and become wealthy? It requires some of the highest mental skills and the continuous ability to devise less risky ways of making money for your customers. Not a trivial task!

    Anyone who doesn’t like this system should recall the communist alternative – where centralised planning pervades.

    In brief, while I don’t support US’s economic and financial system which is deeply contaminated by socialist, Keynesian ideas, it is still largely a place where innovators are rewarded FREELY and voluntarily by the open market. Michael Jackson didn’t become rich by singing rubbish songs that he forced people to buy at gunpoint.

  8. Sanjeev Sabhlok

    ALL rich people (except the looters who were kings in the past) have become so (rich), since the industrial revolution dramatically broke the feudal regime, ONLY by producing wealth through innovation. Some of that wealth they passed on to their children, but this wealth also originated in innovation.

  9. Bhagwad Jal Park

    Well, I personally have quite a bit of wealth. And no, I didn't innovate anything or even really earn it. I can tell you that wealth is such that when you have a ton of it, you can just make it grow. It doesn't require effort really. I'm one of the laziest people on the planet.
    Or you can just inherit it. And then for making it grow, just do what I did. If I had children, I would give them all my money without them earning a thing.
    How is being born rich innovating in any way?

  10. Sanjeev Sabhlok

    Well, then your’s is a good case study.

    If you were born into wealth then there are ONLY two possibilities about its original source: it was stolen from the people (i.e. your ancestors were rulers of some princely kingdom), or it was based on value added through production (including services).

    There is a serious limitation to wealth that is produced from theft. It doesn’t grow the pie. And as you spend your stolen inheritance, you will ultimately not have added any value to the world. Something on the lines of Prince Charles and his gang of ancestral thieves (sorry, “kings”!). I’m being a bit unkind, for even kings did perform a service, and those who did it well actually did facilitate the creation of wealth.

    However, if it was not based on theft then it was necessarily based on innovation.

    Please examine your family history and you’ll get to the root of your wealth. Let me know if there was any third way of generating wealth.

  11. Bhagwad Jal Park

    The point is Sabhlok, that I personally did nothing. Whatever my ancestors did was one thing. But wealth has a life of its own that gets divorced from who originally earned it.
    Second, one must assume that to earn fantastic wealth, you have to do something fantastic. Whereas I seriously doubt that those who earn wealt do anything beyond what the rest of us do – work hard.
    Finally, the fury over wall street is that in the blind quest to amass as much as possible, these guys engaged in malpractices which they shouldn't have in the first place. Like approving unqualified mortgages.

  12. Sanjeev Sabhlok

    You need to be very specific, Bhagwad – was your wealth stolen or produced? That’s the issue I’m after, not about your being an inheritor. That is a minor matter of no consequence in the history of the world.

    I’ll touch upon your other points later.

  13. priya shivani

    Wall st is NOT in the business of approving mortgages. They only invested in mortgage backed securities, CDS etc based on loans that Freddie Fannie Countrywide etc shoved down peoples throats becuase they had a mandate to "include"more subprime borrowers. Its mostly a result of govt interference, not wall street greed. The blame on Wall Street is misplaced and not many realize it, least of all the OWS protesters. 

  14. Sanjeev Sabhlok

    Indeed. The classical liberal thinker always asks first: has there been any distortion of incentives created by government intervention? And indeed, it was, in this case. That is the primary culprit. The fact that Credit Suisse and others misled markets about the risks of its securities by touting the AAA ratings it got (bought?) from Standard & Poor’s added to the mess. There was need for better regulation by the housing regulator, better regulation by the financial market regulator. But the problem was 40% the doing of the government, and 40% the doing of the Fed.

  15. Bhagwad Jal Park

    I think you misconstrue the motives of the protesters. When these guys protest on wall street, they're protesting against "corporate america" in general. Not just the specific function that wall street serves. Wall street is symbolic.
    Also, it's not the mere fact of inequality that people are protesting. Specifically, they're protesting a few things which are very wrong with the system such as:
    1. Lobbying and campaign contributions by corporations to political parties has led to the complete corporatization of law making. This leads to unfair laws being passed and laws with loopholes being created – such as those allowing corporations to plunder the retirement funds of their employees:
    An example is BP's oil spill reimbursement was capped at merely $75 million by law at the time. When Congress in the US voted to raise the cap to $10 Billion, it was blocked by a single senator from Alaska who had received enormous lobbying and campaign contributions from the oil companies (this is public information – there's no conjecturing on this.) You can watch her blocking the bill here:
    How can anyone be AGAINST corporations having to pay for cleaning up the MESS THAT THEY CREATED?!
    2. Corporations being treated as legal citizens. This would be ok if they got the same punishments as regular citizens. BUT how often is a company dissolved if it commits an egregious crime? Are their operations EVER suspended? (the equivalent of going to jail.) Fines which are imposed on corporations merely amount to "slaps on the hand." Why not instead fine a corporations profits for three years? THAT would be a real disincentive.
    3. The US SC ruled two years back that money was equivalent to free speech: essentially saying that rich people have greater capability for free speech than non rich people. It contradicted its own stand here in 1990 and 2003.
    There are a few reasons why people are pissed off. It'snot "anti rich." It's not "to hell with capitalism." It's not "socialism is good!" Those are simplistic and catchy ways of looking at it. The truth is much more complex. Unfortunately, it's far easier to put up straw men and knock them down.

  16. Sanjeev Sabhlok

    Dear Bhagwad

    Won’t go into details, but so long as full disclosure and transparency is allowed there is simply no other thing you can do in a democracy but to allow the laws to be made by representatives consistent with the constitution. The legislators are accountable to the people. It would be more helpful to specify the kinds of changes in the constitution (US/other) needed so that people can consider these changes and vote on them.

    Generalised leftist grievances are pointless, for they display total ignorance of both the economics and politics of the free society.


  17. Bhagwad Jal Park

    But this is exactly what's happening. In the US, no one is breaking the law. There's no hooliganism. It's all very democratic. The implicit goal is to let the lawmakers sit up and take notice – on pain of being voted out in the next elections.
    I was under the impression that your objections were ideological – namely that the protesters were misguided. I didn't think you meant that the protests were illegal!
    There's no law being broken in the US. Peaceful protests. So I don't see how they can be violating the constitution of the united states.
    In fact, this was the exact same route taken by the tea party protesters. Come to think of it, it's the same as Hazare's protest. In the latter case, there WAS a specific change that was suggested.

  18. Sanjeev Sabhlok

    I’m not commenting on the legality of the protests, but asking what specific changes they want – the precise changes in law they seek. It is nice to make fuzzy complaints about everything under the sun. But running a nation is not a trivial fuzzy job. Let these people propose SPECIFIC changes to the constitution/laws and these can be debated. Indeed, I’m suggesting that like AH’s movement they propose a specific change. Currently no one knows what these protesters want.

  19. Bhagwad Jal Park

    Ok. I thought when you bolded the words "consistent with the constitution", you were implying that their protests were not consistent with the constitution.
    But if that's your stance, how does the constitution come into play at all here? What does the constitution have to do with all this?

  20. Bhagwad Jal Park

    Oh Hazare proposed a VERY specific change. His wasn't a fuzzy protest. Ironically, lots of people held that against them saying they were "dictating terms" to parliament etc…
    Here, these guys in the US are venting their angst. They're letting the politicians know they're unhappy. They're saying its the job of the politicians to figure out what's wrong with the system and fix it. They're not lawmakers after all.
    And implicit in all this is that things must change….or else out!

  21. Sanjeev Sabhlok

    “Things must change” – well, that’s not going to help anyone. If these guys are fools who can’t pinpoint the precise change they want then they won’t get it.

    Re: AH, I had NO objection to his protesting, doing dharnas, etc. I only objected to his fast unto death threats which effectively meant dictating to parliament. Fortunately he figured that out himself and backed off from his untenable corner. If such methods are fine then every tom dick harry will start doing fasts unto death for everything under the sun. Fortunately OWS is feeding people, not making them fast unto death.

  22. Bhagwad Jal Park

    Also, you can't please everyone. Politicians in Congress like Chidambaram say that regular people can't form bills and tell the government what to legislate. Others say that people have to only give specific bill otherwise they're screwed…

  23. Sanjeev Sabhlok

    My point is simple – this particular group of “protesters” is TOTALLY confused. They can’t write one straight sentence, leave alone a law. If there are any educated people among them, however, let them try to at least SPECIFY what they want to see changed. I understand they can’t draft a constitutional amendment (beyond their head!) but at least a coherent paragraph?

  24. Bhagwad Jal Park

    Every movement has its intellectual base – those who don't usually dirty themselves on the streets, but who form the plank of the milling masses. It might seem that the guys actually camping out are dumb hippies, but rest assured if the time comes when specific suggestions are to be made, they'll turn to their intellectuals for help.
    Like I said before, the tea part base is even MORE scatterbrained. But they actually managed to form a party and get representatives in.

  25. Ranganath R


    Bhagwad has made many valid points about the motivations and the ideological underpinnings of the OWS movement. Regardless of whatever capitalist or free market or liberal demagogues may do to dismiss or trivialize it, it has the makings of a 'proletarian' revolt against the current entrenched financial and political elite of the USA. 

    As Bhagwad again points out, its leadership ranks and specific agendas are slowly emerging and crystalizing.   Anti-capitalist think-tanks like the CEPR are quite sure to provide intellectual and PR firepower to the OWS bandwagon.
    The symbolism of targeting the Wall Street is very striking and a very good strategy for mobilizing simmering middle class anger at the unholy and exploitative nexus of Washington and Wall Street Syndicate. 

    Bhagwad again in one of his earlier comments has presented a very good synopsis of the 'Charge-sheet' or petition of the middle class against 'Corporatism' or 'Big Business Megalomania' especially with reference to US supreme court ruling in the Citizens United case. 

    It cannot be dismissed as 'generalized leftist grievances' without going into the details of these accusations because the devil is in the detail. 

    For example, Does punishing Banks for Mortgage fraud that has been clearly pointed out by PI groups  need amendment to the US constitution?  Anybody with common sense and reason can understand this. Yet these financial robber barons are still at large!!

    Can classical liberalism remedy this state? Maybe but the ground reality is that large sections of the middle class and poor are not interested in the utopian ivory tower vision of that ideology. Also the added problem is that in the intellectual and political elite that keeps mouthing classical liberal cant and slogans, it is difficult to know the wolf from sheep. Reagan, Bush-Cheney and Clinton all swore allegiance to free market invincibility and yet collectively ruined the average American's dream

  26. Sanjeev Sabhlok

    Keynesian and other government failures have led to the current US crisis.

    Until clear headed people who insist on the proper role of government (regulation, not direct management of the economy, not picking winners for instance, not subsidising any group of people) become presidents, this mess will continue. The Republicans and Democrats are unfortunately not homogeneous entities, so they tend to vote social democrat/ social liberal.

  27. Ranganath R

    The last time the US system structurally broke down in the manner in which it is trending towards today was during the 'Great Depression' of 1930's.
    In the 1910's and the 1920's (the roaring 20's) Keynes was not much in the picture. The US of 1920's cannot be accused of practising socialism either. Government activism was also muted in those times. Yet the economy of the US collapsed in  a heap. 
    Irving Fisher who was very strong defender of capitalism before the market crashes of 1929 and 1932-33 then went to pioneer the debt deflation hypothesis. 
    According to the debt deflation theory, a sequence of effects of the debt bubble bursting occurs:

    Debt liquidation and distress selling.
    Contraction of the money supply as bank loans are paid off.
    A fall in the level of asset prices.
    A still greater fall in the net worth of businesses, precipitating bankruptcies.
    A fall in profits.
    A reduction in output, in trade and in employment.
    Pessimism and loss of confidence.
    Hoarding of money.
    A fall in nominal interest rates and a rise in deflation adjusted interest rates.

    This cycle is erriely repeating itself now after the housing/financial bust of 2007-09.  To the best of my knowledge neither Adam Smith nor Hayek dwelt much on this cyclical and structural weakness of  free market systems. 
    Recessions and Depressions were a recurring regular  feature in 18th and 19th century USA
    This link provides the detailed chronology of this
    The puzzle that no liberal or libertarian is answering is that when recessions and  depressions were as regular in the more orthodox capitalist 18th and 19th centuries as they were in 'Keynesian' and 'socialist' 20th century, how does that clinch the case of  classic liberalism as the better or the most ideal system. 
    That's why I increasingly feel that these paradoxes will continue to elude any economic or philosophical answer or explanation, but that sociology and behavioral disciplines combined with a historical analysis geared for  detecting discernible patterns in turns of mass psychology is more likely to come up with more credible answers and solutions. 

  28. Sanjeev Sabhlok

    I’m not an expert in economic history. However, the massive surge of statism and fabian socialism (supported by Marxian ideas such as central banking) clearly had much to do with the way things panned out. The following are “must watch” videos:

    It is almost always government dabbling into economic affairs that leads to cycles. These are NOT a normal part of a market. Very sporadic short bubbles might arise, but these are readily spiked by the market. An example is Sweden for most of the 19th century with its free banking system.

  29. Supratim

    May I add my two bits here:
    First, I find this whole OWS movement extremely interesting for one aspect – it is anarchic in nature, the protesters are self aware that they are being anarchic and they very actively resist "leadership" type people or programs or structures. They currently actively resist being co-opted by the "leftist" agenda of the trade unions or the Centre for Tax Reform or CEPR or the "Progressives" or who have you. I have been following the blogs of a couple of very active trade union leaders in the US, and they are scratching their heads as to how to have a meaningful dialogue with them.
    These same so-called, anti-capitalist protesters celebrated the life and times of Steve Jobs in unision – they co-opted him into their movement! They had no problems with his wealth or the fact that Apple stopped all CSR after Steve Jobs took over. He has not donated any thing major to charity either, unlike Buffet or Gates, neither is his estate going to do so.
    The lack of a coherent message is related to their leaderless state, IMO – different sets of people have gathered with different agendas, but with one clear angst – that they have been pissed on by the political classes. They are mad at both right wing and left wing politicians far more than they are even mad at the banks. So, I do not hold the lack of message against them – this is democracy in action, at a very, very basic level – village level, if you will.
    Second, I do think that OWS is not anti-capitalistic, in general – but, it is strongly against the big banks. Wall Street is not the symbol, it is the core of the problem. I will try to explain why below, bear with me, if it gets a bit long and technical.
    The playing field was created by the US govt with its virtual (and then actual) sovereign backing of Fanny and Freddy – this distorted the housing market hugely over the past 20 years – so, this was a liquidity bubble created by the US govt over 20 years! But, the average man on the street does not understand this distortion – the fact that the US govt was actually artificially boosting demand. It was artificially inflating the Great American Dream of household ownership. That was and remains the underlying cause of the great meltdown. 
    Then, with the repeal of Glas-Stegal by Clinton in 1996 – the Wall Street Banks got into the action. They saw $$$$ all over the place, some of the brightest brains on the planet (remember, many of these guys are math PhDs, physicists, even actual rocket scientists) started first packaging and selling, all of a Fannie/Freddie implied guarantee (which in turn was an implied sovereign g'tee). So, these guys were suddenly racking up yields of 14-18% on debt, that was actually sovereign! Compare with treasury yields – which were hovering below 5% then. It was like shooting fish in a barrel.
    Then, the smarter boys got up and said, hey how do we push up the yield curve? And, make 24% instead of 14%? Don't forget that the STUPID US govt was still the backstop. Until then, all of the debt were essentially being sold – so the wall street was just taking the spread. Then, they got the bright idea – double up! Let us bet our own books, too – ipos give us 4% fees, brokerage gives us 0.5%, M&A gives us up to 6% – and here are all the juicy yields that we are handing over to our clients. So, they start to bet their own books. And, their leverage goes up and up and up ….. Lehman ended up eventually with over 18x. Goldman was over 12x. JPM was over 6x, but they had commercial books, too.
    Then, the "masters of the universe" get the next smart idea – slice and dice, CDS and buy protection (options) against bad pieces of the slices. And, this is all still being funded by the liquidity spigot of the FED and the Fannie/Freddy backstop.  By 2003-04, this was all starting to unravel as no one really knew who held what and was on the hook for what, and fraud starts getting into the picture – the chase for yields kicking up another notch. So, you get sub-prime, you get incredible math and you get moral hazard from the rating agencies.
    It finally all unravels in 2008, and the process is still on – no one still knows who owns what and who is on the hook for what. That is why Europe is such a tinderbox today. I won't go into the whole bailout saga, as the debate for that can occupy us for the next 10 years.
    But, what does the average Joe see? He sees banks screwed up big time, including some fraud, and they get bailed out with their tax dollars, bank CEOs still making out like bandits and no jail time for anyone. They have forgotten about Fanny/Freddie, if they ever realised their importance and the US govt has been extremely shy about "outing" its own part in the mess, as well. The fact that Greenspan, Clinton, Bush, and the various Treasury secretaries have all led us to this point is not known or acknowledged by the average Joe – can't blame much. It was a very complex play. But, at a gut level, it plays to their distrust of both the right and the left in the US. The Tea Party was the first reaction, OWS is the second one. 
    So, OWS is really a backlash against the banks, against the re-possessions that have been happening (again some really fraudulently) and this whole feeling that the banks have gotten away with murder. Despite being a banker, an active investor and a true blue capitalist, I think this movement is good for the US – some of the stuff that the banks have done have not been punished adequately – this will keep the pressure up on the banks. Because one things is clear – we can NOT have any banks in any system that are too big to fail. That is why Lehman was such a good lesson, but unfortunately the US govt lost its nerve thereafter – can't blame them much. Like I said, no one one knows what is owned by whom.
    Watch Europe now for the next leg of the action, and buy Gold! Faith in paper currencies is going to be crushed, thanks to stupid governments.
    As far as all of those who point to statistics about income inequality are concerned, I think we should just point out one single fact to them: The last 30 years has seen some of the greatest technology innovation in HUMAN HISTORY, including one of the three epochs of technology change in human history (farming, steam engine, semi conductor chip). Obviously, you are going to see a huge change in income levels for the innovators and people who ride on their backs (this includes the CEOs). But, look at median incomes in the US or the Europe, however you want to slice or dice it, median incomes have risen for EVERYONE until 2008, and have FALLEN for EVERYONE since then. 
    If the OWS salutes Steve Jobs, we should just ask all the socialists to shut up – the OWS does not want to listen to them anyway.


  30. Supratim

    Ranganath said:
    "This cycle is erriely repeating itself now after the housing/financial bust of 2007-09.  To the best of my knowledge neither Adam Smith nor Hayek dwelt much on this cyclical and structural weakness of  free market systems. "
    Like the Average Joe, he misses the key point – this was not free market in operation. The US govt was gaming the rules and distorting the market, and the Wall Street Banks played by those  very same rules to first make a fortune, and then lost a part of it.
    Close down Fannie Mae and Freddie Mac and then we will talk about a free housing market in the US.

  31. Sanjeev Sabhlok

    Thanks, Supratim. That is excellent analysis of causes and echoes what I've observed and commented on in the past two years, starting with this:

    The blame, in my reckoning lies thus: US government 40%, US Fed 40% and Wall St banks 20%. It is hard to blame the Wall st (as you've rightly pointed out) for moral hazard created by incessant government and Fed intervention. It is like leaving piles of money lying around without any accountability – even the best of humans will succumb to temptation. Maximising utility subject to opportunity is what humans do best. The job of government is to not distort opportunity.

    On the other side, re: your view that this is not an anti-capitalist movement, I agree only partially. The reason is that an anti-intellectual "grassroots" movement as this is inevitably going to want more government as the solution. They don't understand either socialism or capitalism, being intellectually challenged, but their handout mentality (see this makes them leftists, wanting bigger government.

    I'll post your analysis and this further comment on a separate blog post, for not everyone reads comments.

  32. Ranganath R

    You said
    "Like the Average Joe, he misses the key point – this was not free market in operation. The US govt was gaming the rules and distorting the market, and the Wall Street Banks played by those  very same rules to first make a fortune, and then lost a part of it."
    My response : If free market is not operation now, was it in operation in US prior to the economic collapse of the 1930's?. What kind of market according to you should be given credit for the 'Roaring 20's'. If free markets can cause the'Roaring 20's', why should they escape blame for the 'Collapsing 30's'.  Also the Depression that started in 1873 was termed the long Depression. Can you tell me what kind of market system was prevalent prior to that and what caused that depression?
    Your analysis of the current crisis above is very good no doubt, but the conclusions and exercises in causation are ideologically influenced and hence at odds with facts if a fairly long period of economic history is taken in account
    Recessions and Depressions have been tracked since the 1790's and since then they have been regularly occuring in spans 10-20 years for recessions and 50-70 years for depressions. Is Govt. interventionism and socialistic tendencies to blame for each one of these economic failures?.
    The neutral economic explanation for a recession is interruption/decline of a business cycle, while in case of a depression, it is usually the result of  a structural collapse (like excessive Debt build-up which is most  of the times the culprit). The last depression was blamed on the stock market crashes, but honestly there is no consensus in the economics community about the real cause. But making of and looking for scapegoats in competing schools of thought like socialism and keynesian capitalism is bound to raise the charge of the heads-I-win, tails-you-lose argument of the classical liberals. Which said another way means that libertarians  are prone to extoll free market for economic successes while sticking all the blame for economic failures on govt. and socialism. This game can no longer fool critics.

  33. Sanjeev Sabhlok

    Dear RR

    Did you watch the videos I linked yesterday? – about the growth of massive state intervention in the last part of the 19th century and early 20th century (a reversion to mercantalism, in a way).

    The simplistic analyses of macroeconomists of all brands are a waste of time. Please look deeper. ALWAYS ask: what and where was the government dabbling in the economy? That is the ONLY correct question to ask. A simplistic mindset is not going to get you the answers (assuming you are a scientist not someone who “knows” the answer in advance). I also gave you the example of Sweden which allowed free banking and did not suffer from ANY business cycle. Did you read the relevant paper? It is linked through my monetary policy article.

    Also, pl. note that so far there has been NO free society according to my definition. So freedom lies ahead, not behind. And the results of freedom are clear – massive innovation and prosperity.


  34. Ranganath R

    I did not watch the videos in your comment, since I focussed more on responding to Supratim's analysis. But I will surely go thru the video.
    I am not seeking to deny the reality of government intervention whether in the society or government. While what and where was the government dabbling in the economy?  are valid questions, but not the ONLY correct question. 
    Another question that critics of  interventionism are NOT asking is at whose behest the Government  is dabbling in the system and economy. Is it not at the behest of the CAPITAL owners, elite and BIG BUSINESS  who have the power and the were-withal to lobby, bribe and influence government representatives? 
    Do not make me laugh by saying that Government is intervening at the request of labor unions and unrepresented millions s in the poor and the middle class. 
    Yes Government oversteps on regulation, but in many cases that is because it is forced by public opinion when Capitalists periodically bring the economic system to its knees by their own excesses and overkill. 
    US govt for example did not set up Fannie Mae and Freddie Mac out of their love for or faith in socialism or Keynesianism, but because it was coaxed/lobbied/bribed and manipulated by Banks and Insurance oligopolies who wanted a parking spot for their mortgage risk.  Government interventionism in that sense is the favorite alibi of 'rouge capitalism' 
    I am not a scientist, but rather a student of economic and social phenomenon. I also began my journey  of knowledge very much in love with capitalist tenets. I once earnestly believed that markets are the best allocators of capital and resources. But as I am studying this crisis and economic history, I no longer take that as a gospel truth. Market includes many millions like you and me who are very fallible. 
    Whatever the excellences of liberalism, I cannot bring myself to accept that it can make or even approximate infallibility of the society, state and economy. 
    You remarked that 
    "Also, pl. note that so far there has been NO free society according to my definition." 
    Is it not plausible that this holy grail of freedom and liberty was repeatedly thwarted by the same Capitalist owners and Business, whom you have no hesitation in crowning them as innovators and creators of prosperity

  35. Sanjeev Sabhlok

    “Do not make me laugh by saying that Government is intervening at the request of labor unions and unrepresented millions s in the poor and the middle class. ”

    Indeed, it is these groups that have driven the socialist agenda across the world. Even a VERY cursory knowledge of economic history will illustrate that. The creation of public sector business institutions across the entire West in the middle of the 20th century was driven by these groups. And no, these are not “unrepresented” groups. They are the bulk of the voters.

  36. Supratim

    You said: "My response : If free market is not operation now, was it in operation in US prior to the economic collapse of the 1930's?. What kind of market according to you should be given credit for the 'Roaring 20's'. If free markets can cause the'Roaring 20's', why should they escape blame for the 'Collapsing 30's'.  Also the Depression that started in 1873 was termed the long Depression. Can you tell me what kind of market system was prevalent prior to that and what caused that depression?"
    I am unable to respond to the above question as I am not a student of economic history nor have I spent much time on analysing the 20's and the Great Depression yet. I have only recently become more interested in this past issue because of our current economic issues – looking for parallels and laterals. However, if you are going to bring in the 20's and 1929 Depression, then you also have to look at Japan, circa the 80's and the 90's.
    The latter is a topic I am much more familiar with – and one key reason I think Keynesian solutions are fundamentally flawed and are also NOT be able to reinflate a liquidity trap, its supposed key advantage over the Austrian School. Japan is proof of this failure – the Japanese govt has been trying to inflate their way to growth for the past 20 years, without success. And, from what little I know of the 1929 depression, all the Rooseveltian intervention and government priming of the pump also did not get the US out of its depression/recession – in fact, unemployment worsened after a small pick up in 1932. It was World War II that got the US out of its recession.
    And, the other aspect that Keynesians do not want to discuss is the US' continuing growth and prosperity post 1945 – when all the factories supporting the war effort had to go back to consumer use production (where was the demand going to come from?) and all the men returned from the war without a job – so unemployment should have soared, and the US should have plunged back into recession. Yet the US had some of its best years until the 1970s. So, what happened here?
    RE: "Your analysis of the current crisis above is very good no doubt, but the conclusions and exercises in causation are ideologically influenced and hence at odds with facts if a fairly long period of economic history is taken in account"
    There is no ideological twist in this causation – as both a practitioner and an analyst, I am just laying out the course of events as they happened. And, I am not letting the banks off the hook for their frauds, either. But, the key issue really was the easy liquidity policies of the Fed and the implied sovereign backing for housing mortgages. Banks had nothing to do with either. In fact, commercial and community banks in the US have complained loudly and long against Fannie/Freddy and their distortion of the mortgage market and rates.  This was a populist measure enacted by the US govt.
    RE: "Recessions and Depressions have been tracked since the 1790's and since then they have been regularly occuring in spans 10-20 years for recessions and 50-70 years for depressions. Is Govt. interventionism and socialistic tendencies to blame for each one of these economic failures?."
    Don't know, can not answer as I have not studied this in detail. However, a boom bust cycle in a specific segment of the economy can be a natural part of any economy and free markets and usually is due to imperfect market information and asymmetricity – the problem is that most govts think this is a "bad thing" and that the citizens require protection from a natural growth and decline in specific segments of business or economy. So, then they go about construction various "safety nets", which invariably exacerbate the problem by taking a segment specific problem and making it region or country wide. To create a real liquidity bubble, you need the govt's active role, as the govt controls money supply. If money supply was to be fixed,  then a lot of these issues would just not happen. But, which govt will give up its right to borrow beyond prudential limits or its right to print money?

  37. Supratim

    All economic activity should follow the Sine curve, if responding to free market stimuli and the demand/supply curve – so, strong growth and recessions alternating between each other is not a problem for me. I would rather take the US model, where they have a 2-yr recession for every 6-8 years of growth, than the European statist model (Germany, France, Italy, Nordic), where there is stagnation, small decline or small growth. The average US growth trumps the average European growth by miles – and, as a net result, overall US growth and prosperity has outstripped the Europeans.
    Depressions and liquidity traps are a different issue altogether – scarier and with unpredictable paths. That is why the current meltdown is so difficult to manage or analyse. We are coming off a 20-year liquidity inflation bubble.

  38. Supratim

    A good quotation:
    One of the sad signs of our times is that we have demonized those who produce, subsidized those who refuse to produce, and canonized those who complain.
    – Thomas Sowell

  39. Sanjeev Sabhlok

    Dear Supratim

    The reality is that there has rarely been an entirely free market. The closest I can see is the IT bubble of the mid-1990s. That was a classic example of what you call “imperfect market information and asymmetricity”, basically a case where investors who did not understand the market thought they’d free ride on the boom. It is these IGNORANT people who inflate stock prices (or asset prices) beyond sustainable level, and the KNOWLEDGEABLE dump the stocks close to the peak, leaving the bill to the fools to pick up.

    The solution to this ignorance is not government intervention but caution by the fools. The fools must follow Warren Buffet’s advice and refuse to invest in something they don’t fully understand (Fair disclosure: I’m in the group of fools and lost over $10,000 in the burst of the IT bubble, and like a fool, sold my Apple stocks just when Steve Jobs was re-hired by Apple – stocks which would today have been worth nearly 15 times their late 1990s value, and not just recovered, but over-compensated my losses).

    Freedom means the freedom to make mistakes and learn. Learning is costly. When you apply the cost of learning to the free market, you realise it leads to friction, and hence to violation of the Efficient Market Hypothesis.

    The solution is not to dump taxpayer money into the pocket of fools (and thus distort everyone’s incentives), but for the fools to grow wise.


  40. Ranganath R

    Re: your comment "Indeed, it is these groups that have driven the socialist agenda across the world"
    Agreed that Labor Unions drive, propagate, articulate and influence the socialist agenda across most parts of world. That is their job and their very reason for existence and sustenance. Expecting a Union to not evangalize socialism is like asking a being to stop breathing. Making a scapegoat of unions for economic problems is very lame exercise in criticism. The point that was not answered is whether Govt listens more to Unions and special interest groups (SIG) (evironmentalists, climate activism, animal rights, minority advocacy) than to private capitalist interest groups (PCG) (Big Business, Pharma, Oil & Gas, Bankers, Wall Street, Hedge funds)
    What is the evidence to show that it is the will/voice of SIG that is prevailing over that of PCG. Ultra conservative rightists like you have yet provide any conclusive evidence that PCG are losing the battle with the Govt and bereaucracy.
    If you pose this
    "The creation of public sector business institutions across the entire West in the middle of the 20th century was driven by these groups"

    My next question will be can you point out which group of unions and voters lead the drive for which public sector business institutions?

    Two excellent books by investigative journalists David Cay Johnston, Jacob Hacker, Paul Pierson


    show with evidence, charts and studies how Private Interest Capitalists group manipulate public policy, institutions and laws to serve their narrow private ends and wealth megalomania. It precisely names the private interest player groups and their various sins 

    I am sure there is somebody on the ultra-right to dig as much dirt on the unions and socialist advocacy groups. The point is that PCG is no less guilty than SIG. Also PCG has demostrated its lobbying, bribing, manipulative and PR firepower many times. It has even infiltrated US supreme court and judiciary.

    Now you do not consider poor and middle classes as 'unrepresented' because they constitute the bulk of the voters. Surely you must be joking (and that too a cruel joke) if you are implying that elected politicians are representatives of this unfortunate and devastated collection of masses. To know that elected officials take their votes from the poor and middle class and go work for the benefit of the rich and the elite does not even need a cursory look at any history. But to accept it and stop making the poor and middle class the favorite punching bag of polemical attacks requires intellectual honesty and need to take off one's puritancal liberalist blinkers.

    There has always been far greater danger to freedom, liberty and egalitarianism from machinations of Capital Owners, Big Business and private interest groups, than from socialist advocates and exploited poor and middle classes.
    Innovation, creativity and wealth creation are not supposed to be used as pretexts for looting and cornering scarce resources and denying majority of the population their fair share in income and assets.

    When there is evidence in public domain of the guilt, avarice and even malafide motives of the PCG, why are you ready to jump the gun and always shoot the socialist messengers.

  41. Sanjeev Sabhlok

    Dear RR

    I’m afraid there is NO FAIR SHARE of income and assets except that which is earned. Let people CONTRIBUTE and then earn. No freebies exist or should exist. Stealing is not earning. That’s what socialists want.

    I’m NOT at all saying that those who break the law should not be punished. Instead, I’m strongly in favour of good regulation and enforcement (justice). However mixing up issues as you (and other socialists) do doesn’t help anyone.

    I agree with you that those who cheat must be punished. But don’t even try to punish those who earn from their own effort. The vast majority of “capitalists” are hard working innovators and I detest those who want to destroy human motivation and incentives by stealing from them. Socialist must learn to distinguish good from bad. The vast majority of wealth producers are doing a GREAT favour to humanity. For the crimes of a few black sheep (who SHOULD be punished and will be in the India I talk about), don’t destroy the ONLY engine of wealth production in this world.

    Your continuous ill-informed and blind sniping at hard working diligent honest people who produce 99% of the world’s wealth (through their innovation) is getting a bit much. I will no longer take further comments from you on this topic.

    You refuse to read my books, you refuse to learn, yet keep harping on. Are you sincere about learning or not? If so please demonstrate that you’ve read and understood at least BFN before coming back to this blog.

  42. Bhagwad Jal Park

    I thought I'd point out that the "Occupy Wall Street" movement has some very articulate and intelligent people behind it including the pulitzer prize winning journalist Chris Hedges. In fact, CBC conducted an interview of him and was forced to apologize for the abuse the interviewer hurled at him. It's a miracle how he kept his cool in a dignified manner:

  43. Sanjeev Sabhlok

    Well, on the point Chris was making I’m fully behind him. Always have been.

    He does, however, forget that 80% of the cause of the problem was NOT because of whiz-bang financial engineering and mirror and smoke, but the role of the US government in forcing banks to lend to subprime borrowers and the Fed’s insistence on keeping rates so low that it became super-profitable to lend to virtually anyone. That’s 80% of the problem.

    I agree the CBC interviewer was poorly equipped (mentally) to deal with an intellectual like Chris. But Chris’s argument still doesn’t prove that corporations are the problem. They are merely taking advantage of excessive government and Keynesian policies.

    And the fact that Obama did not insist on NOT bailing out these banks is once again HIS problem, not of those like me who advocate capitalism, not crapitalism.

    Btw, Obama appeared to be a total nut bar (nut case?) when he alleged that “abusive practices got us here in the first place”. Well, these were the GOVERNMENT’S OWN ABUSIVE POLICIES, not of the businesses that are took advantage of the incentives so created by this government abuse. My impression of Obama has dived after hearing him talk like this. He needs a basic economics lesson.

  44. Global Investor

    While the author of this post claims to be one with the  views and sentiments of Chris Hedges, his subsequent 'reasoning' gives it all away.
    Look at this statement " 80% of the cause of the problem was NOT because of whiz-bang financial engineering and mirror and smoke"
    This kind of statement is fraught with extreme economic ignorance of how financialization ( conversion of a commodity into a financial product) operates. If the result is round one of financial/economic collapse with the post-Lehman Bros credit freeze, one of the prominent causes of that was surely the mammoth growth and spread of 'Financial Innovation' in the form of derivatives like  options, swaps and futures. What these instruments do is extremely over-leverage underlying assets such as stocks, bonds, houses, currency, interest rates etc and transform into complex bets in the name of hedging, speculation and liquidity provision. 
    In the financial world it is accepted that leverage works as a double-edged sword, which is why any risk management principle would always insist on safegaurds like margin, transperancy and disclosure of price discovery. 
    According to economic historian Justin fox, the size of this market is around 450 Trillion $, which is also an underestimate if we go by BIS sources who estimate it to be upwards of 600 T $. This is many times the Global GDP itself. Many monetary claims (like swap fees and CDS premiuims) are based on this extravagant figure, which has very little basis on actual asset size and value.  That itself is a big global level financial risk. This behemoth of a market violates all the principles of margin adequacy, transparency and proper disclosure of price discovery which should be bedrock of any risk management system.
    Claims on this kind of fuzzy figures have triggered defaults cause sales of actual underlying assets at throwaway prices. Actual $ of subprime loan has been levered 20 time or more on the derivatives market. If an underlying risky asset like a subprime was not levered 20 times or more, systemwide run on credit claims would not have happened on  this scale. And Lehman Bros was levered more than 50:1 
    This monster of a derivatives market has primarily originated from USA whose Central Bank (Fed reserve) is very unlike other Central Banks of the World. It has a mandate to subserve certain governmental policies on inflation and employment, but is neither owned nor managed by that government. It is owned by private banks and in real sense always serves the interest of the private  banking in USA. To consider the Federal Reserve as a part of US Govt is itself a very big fallacy. 
    The author in one his subsequent statements show this typical ignorance by considering the Fed reserve as an arm/agent of government.  
    His next statement "but the role of the US government in forcing banks to lend to subprime borrowers and the Fed’s insistence on keeping rates so low that it became super-profitable to lend to virtually anyone.  is even worse 
    If the author is really implying that US government forced subprime lending, it is very bizzare and outrageous, though he is not the first to make these kind of claims. First of all in a system like US it is not possible to force any banking institution to lend to a special category of customers. It is not like agricultural lending and loan melas by Indian national banks in the pre-1991 reform era. Such a thing cannot be done in US if a legislation does not mandate it. Also these subprime loans were rated as AAA by rating agencies who are not surely controlled by the US Govt.  In fact govt SE's like Fannie Mae and Freddie Mac hid behind these ratings to revel in the subprime party.  
    The next contradiction is that if low interest rates makes it possible to be super profitable to lend to anybody, why lend mainly/mostly to subprime which are the riskiest borrowers. It could very have been lent to many other borrower types. Risk management and money management is the responsibility of the lender, which cannot be transferred to the Govt or central bank. Lowering of interest rates has manifold objectives which any student of monetary policy would appreciate. Lowering of interest is not a carte blanche or licence to engage in irresponsible and risky lending. Blaming interest rate policy for very poor lending standards is a very backwards form of reasoning. Just because some political speeches were made by either Clinton or Bush about housing being at the center of the 'American Dream' cannot be construed as a signal to Banks to go ahead and make undocumented loans and then repackage them and onward sell them as gilt-edged MBS.   
    Even more dangerous is the author's tendency to absolve private sector and banks of any accountability by laying all blame on the government . The government in fact was honoring the conventional wisdom of the last 30 years that market knows best and and that deregulation is the best regulation. If US and the west were not tending progressively towards deregulation, derivatives market would never have grown to its current size. 
    Another unfortunate and reckless statement of the author is "Btw, Obama appeared to be a total nut bar (nut case?) when he alleged that “abusive practices got us here in the first place”. Well, these were the GOVERNMENT’S OWN ABUSIVE POLICIES"
    The abusive practices that Obama is referring can be clearly documented for the Credit Card industry for example. The author does not specify what the Government's abusive policies. It is not clear what is the connotation of the word 'ABUSIVE' for the author. If lowering of interest rates and keeping it there for 1 1/2  years is abusive, he is curiously silent  on the effects when over the same period of 1 1/2 to 2 years the Fed Reserve took the interest rate up from 1% to 5.75 %. If keeping rates low were bad, why is the raising of interest rates not good. Also while free market devotees are all fired up over the Fed Interest rate policy, why are those same people quiet about the interest rate or yield on the 10 Year Treasury bond, which is not set by the Fed Reserve. It is today at 2% and market determined and beyond the control of Fed reserve  and it is not very much above the Fed rate of 0.25%. 
    It is really unfortunate that in the eagerness to prove a point about one's ideology and make dramatic opinions that a very casual and  careless attitude is displayed towards serious topics of economic systems, policies and issues. 
    Making brazen misstatements and claims like this just to indulge one propensity for intellectual witch hunting lowers the quality  and dignity of discourse on economic issues

  45. Sanjeev Sabhlok

    Dear “Global Investor”

    Thanks for trying to provide a counterpoint. I suggest you consider reading this, which you’ve perhaps missed:

    Note that there WAS a housing regulator, and there WAS a financial regulator. Both failed miserably. That’s called GOVERNMENT failure – failure to regulate.

    Note too that financial engineering is NOT primarily the discipline of leverage. At least in 1992 when I studied this issue (see my term paper/ presentation here: and

    These are HEDGING instruments for future risk. They smooth and minimise risk. They also allow people to speculate on future asset prices, thus deepening and thickening the financial markets, permitting a range of investment options suited to individual risk preferences. The “written” value of these instruments is far greater than global GDP, but that is because these incorporate entire exchange values between parties to the instrument. Particularly when you consider future asset values, their total nominal value will naturally seem very “inflated”.

    The failure was not of financial engineering but of the HOUSING REGULATOR who allowed repurchase of SUBPRIME mortgages from primary banks by Freddie Mac and Fannie May. These were INDEED forced down the throat of primary banks by the government. Thereafter the housing regulator allowed these to be rated AAA (everything in USA must be rated AAA else the government goes into mental depression). Once these COERCIVE mortgages had been rubber-stamped by the GOVERNMENT regulatory system, only then did the financial instruments come into play – at that point completely becoming incoherent and therefore extremely dangerous.

    Anyway, I do not aim to specialise in the US financial system for which I care precisely TWO hoots, but for the Indian system which I believe must be based on sound principles, and for which we must learn from these MAMMOTH Keynesian government failures.

  46. Sanjeev Sabhlok

    Here's something to add (for Mr. Global Investor)

    Letters to the Editor
    Watertown Times
    260 Washington St.
    Watertown, NY 13601

    To the Editor,

    In his letter of October 23 criticizing George Will’s column on Elizabeth Warren, Mark MacWilliams of Canton repeats a number of fallacies about the recession and financial crisis that should not go unchallenged.

    MacWilliams refers to Congress deregulating the financial industries but offers no specifics. In fact, since 1980, Congress has passed four new sets of regulations for every one deregulatory act, and between 2001 and 2008, there were nine new sets of regulation and not one bit of deregulation. Those recent regulations included the Basel capital requirements, which created powerful incentives for banks to sell off the mortgages they originated and buy them back as mortgage backed securities, which they otherwise would not have done.

    Contrary to MacWilliams, our current mess was not the result of “predatory capitalism,” but the predictable consequence of government intervention and crony corporatism. Nowhere does he mention the Federal Reserve’s role in pushing interest rates so low that banks were being paid to borrow, nor does he have a word to say about Fannie Mae and Freddie Mac having privileged access to the Treasury to buy up all of the questionable mortgages that banks originated. He also ignores two decades of Congress’s role in mandating that banks lend to marginal borrowers.

    MacWilliams needs to ask himself why, if this was really capitalism, banks would make loans to people they thought could not pay them back. If corporations are greedy profit-seekers, why would they risk customers not being able to pay unless they believed that those mortgages could be sold off to government-sponsored enterprises like Fannie and Freddie who would, as they did, get bailed out by the government?

    If all the traffic lights in Watertown were stuck on green, we’d hardly blame the drivers for the ensuing accidents.

    When government distorts the signals and incentives facing producers and consumers, the blame for the resulting disaster should fall on government not the private sector. The crisis and recession are what happens when you put “people before profits.”

    Finally, MacWilliams should learn who does assure that his toaster doesn’t explode by actually looking at it. He’ll find the stamp of not a government agency, but Underwriters Laboratory, a private firm that provides quality assurance for appliance makers and consumers. Unlike the government cartel of financial rating agencies that failed miserably last decade, the privately operated UL has decades of success behind it.


    Steven Horwitz

  47. Global Investor

    Apropos derivatives :As quoted by you
    These are HEDGING instruments for future risk. They smooth and minimise risk. They also allow people to speculate on future asset prices, thus deepening and thickening the financial markets, permitting a range of investment options suited to individual risk preferences. The “written” value of these instruments is far greater than global GDP, but that is because these incorporate entire exchange values between parties to the instrument. Particularly when you consider future asset values, their total nominal value will naturally seem very “inflated”.
    I will reserve my detailed opinion till I can go thru the references cited by you. But based on my knowledge and information of the current trends in derivatives, I feel less inclined to agree with the above sales promotional pitch about  derivatives driven speculation deepening, broadening and thickening financial markets. If I am permitted an analogy from the insurance industry, the obverse side of the speculation in the coin of financial arrangement  is the 'absence of insurable interest'. In the interests of advancing the objective of promoting depth, breadth and liquidity of  financial transactions/system diluting  the principle of  existence of insurable interest is inevitable. But it is necessary to have limits on how much this tenet can be compromised.
    For example the GDP size of major economies do not exceed 100 T. When compared with the size of the 650 T, it seems a leverage of 6.5 which may seem deceptively manageable. But if  it is compared with the US real/physical economy ( approx 10 T if the financial economy is excluded), the leverage will be 65 times, which is scarily huge and disproportionate. Even the argument of exchange values between multiple parties is accepted, the size of option/instrument value is increasing not because of multiplicity of counter-parties but layering of speculative bets. There is another feature that is somehow escaping the attention of  economic and regulatory experts, which is that opaqueness and complex structuring of these instruments is in fact becoming their defining feature. How can opaque and complex instruments smooth and minimize risk. If the MBS fiasco has been blamed on lax housing regulation, Then what about the LCTM hedge fund collapse event. That is considered a classic case study in how complex layered instruments can trigger cascading defaults when bets start unwinding. The argument of future values of underlying assets causing inflation in the designated value of derivatives is not convincing either since that will raise the question of methodology of estimating future values of commodities/asset. What conservative or reasonable discounting or NPV method would justify a future value of even 5/10 times the current value of an asset, let alone higher ones that have ballooned the size of  this market
    My point is that regulation apart, there is a serious need to rethink the whole economic and social utility of this kind of shadow economy or banking system. This shadow economy thrives on opacity and secrecy. You cannot regulate something that is opaque and non-transparent. It is no surprise then that the financial industry always protests/browbeats any attempt to regulate the derivatives market.  The few rare attempts to look into any financial reform is always painted as an effort/conspiracy  to strangle the liquidity and depth of financial markets
    Coming to your point about prescriptions for reform of Indian financial system, you say 
    "India’s Reserve Bank should get out of the business of creating money and fixing the price of money. It should become an independent regulator of a private money and banking system. Its current functions should be unbundled: coins and notes should be issued only by private banks; the lender of last resort function should be performed by private insurance companies. "
    My response is 
    After passage of "Fiscal Responsibility Act'  there are constraints on monetization decisions of RBI. In the last decade, RBI has achieved and displayed a lot of autonomy and has commented and tried to set expectations that has served to some extent to act as a check/moral restraint on govt fiscal profligacy. Especially in the last few years the RBI has been an anti-inflation hawk and far from creating more money, has used its policy  mostly well to moderate the impact of  short term foreign and FII flows. RBI does not engage in currency rate pegging like China's central bank for instance. It intervenes in the forex market, but using a range and discretion. For example the RBI has not intervened recently to correct the fall in the rupee to Rs 50 to a dollar in the last 2 weeks. 
    Of all the major Central banks in the world, RBI got the best marks and that  too from BIS for its prudent  navigation of the indian monetary system during the financial crisis period. From YV Reddy's tenure onwards, the stewardship of RBI and its regulatory record has been close to examplery inspite of carping criticism from the likes of Surjit Bhalla. 
    Now on what basis will private bank print notes and coins, since the gold standard is no longer with us. How do we know that multiple private banks will manage money creation and circulation any better than RBI. 
    The admission of a need for lender-of-last-resort is itself an anomaly in a free market system, since philosophically in a free market system, failure/liquidation is the outcome of a business failure and such a lender is nothing but an instrument of bailout. Letting that aside, how can private insurance companies be effective lenders of last resort. When a system wide panic results, why would a private insurance company be anymore liquid than the commercial banks. Don't private insurers also practice a form of reserve or fractional banking system. Their asset is mostly premiums which is always a fraction of  their potential claims. Also they may not have access to deposits which is the key driver of liquidity. So on what basis can they guarantee or secure the claims of other financial parties. 
    Unless there are ideas that can change/transform some of the weaknesses inherent in a fractional/reserve banking system, mere  shuffling of the onus of  liquidity provision from one agent to another (from Central Bank to private insurer) does not seem like an effective reform piece.

  48. Sanjeev Sabhlok

    Dear GI

    I’d like to talk to REAL people, so pl. disclose your name. This is inappropriate – you MUST not hide behind shadows.

    Second, your points are specious and have been easily and readily rebutted. All it requires is an open mind and curiosity. I’ve provided many pointers on this blog itself. Search for “central banking” and the like. There are numerous BETTER alternatives to RBI in the case of India. I’ve already indicated why central banking is IMPOSSIBLE, being a central planning exercise. It will always distort the market.

    Further, and this is important – the reason you DON’T need a government “insurer of last resort” is because you can readily establish a regulatory system that ENSURES precisely this – through private sector insurance. It doesn’t take a genius to design such regulations. One of the best ways to insure is to require mandatory gold reserves which are held by a separate, third party.



Leave a Reply

Your email address will not be published. Required fields are marked *