You Can't Blame The Little Guy

The recent roller coaster ride on the stock market is a reminder, Tom Walkom writes, that the economy is fundamentally unsound. There are several reasons for the shakes and quakes:

First, income inequality persists. It affects not only the developing world but so-called advanced economies, such as Canada and the U.S.

As economist Andrew Jackson has pointed out in the Globe and Mail, census data shows that the gap between Canada’s top 10 per cent and the middle class continues to widen.

This is not just a moral problem. It is a practical one. Economies prosper when the broad middle classes make enough money to buy the goods and services produced. They sputter when those conditions are not met.

Second, wage growth is still low. It’s better than it has been since the recession of 2008 — in large part because, with unemployment dropping, workers have slightly more bargaining power.

But the structural forces that conspire to keep wages down — such as the decline of unions and the growth of precarious work — remain.

As well, whenever workers make significant wage gains, central banks threaten to reverse them.

But there is a bigger reason which goes directly back to the policy central banks adopted to deal with the Great Recession:

In the years leading up to the recession of 2008, central banks — including the Bank of Canada — focused overwhelmingly on inflation.

When prices threatened to rise too quickly, central banks would signal that they wanted a hike in interest rates. This hike would then lead firms to restrict their business activity and lay off workers.

With unemployment up, wages would be depressed, leading workers to buy fewer goods and services. And that in turn would curb price increases.

When word came out two weeks ago that wages in the United States had risen by 2.9%, the market took a dive. God forbid that workers -- who haven't seen a pay raise in a decade -- should start to get a piece of the action.

You can't blame the little guy if he thinks that what goes on at roulette table is rigged.

Image: ThoughtCo

An End to Magical Thinking

The last two weeks on global stock markets have been a roller coaster ride with which no theme park could compete. And, while many people saw it coming, what is most remarkable is that the so called best and brightest didn't. The question is why?

In the last thirty years of his life, the economist John Kenneth Galbraith saw the Keynesian consensus, which he had helped build, crumble. A new generation of economists, in an attempt to transform economics into a natural science, tried to build a set of mathematical models which could predict the future. It was, in fact, Milton Friedman -- Galbraith's academic antagonist -- who claimed that any theory should be judged, not on its realism, but on its predictive capacity.

The problem was that, at the heart of the new economic models, lay the bedrock assumption that human beings are rational creatures who make rational decisions. If one buys that assumption, mathematical economic models work. Galbraith contended that economics existed as part of a matrix which included politics and history, both of which offered a plethora of evidence that human beings often make irrational decisions. He claimed that any attempt to turn economics into a rational, self regulating system was, in effect, to believe in magic.

What the current gyrations on the world's financial markets proves is that Galbraith was right and Friedman was wrong. And, if there is any lesson to be taken from recent and future financial turbulence, it is that -- as Richard Gywn wrote this week in The Toronto Star -- we need to relearn that "when governments leave the marketplace to itself, as has been the prevailing ideology for the past couple of decades, the result is both an outburst of entrepreneurial energy and creativity but also a thundering great smashup."

The markets have taken some hope from the coordinated cutting of interest rates by central banks and from the American Congress's promise to cobble together a stimulus package. But, as Robert Reich wrote this week in his blog, "As a practical matter our only real hope for avoiding a deep recession or worse depends on loans and investments from abroad -- some major U.S. financial firms have already gotten key cash infusions from foreign governments buying stakes in them -- combined with export earnings as the dollar continues to weaken." Reich concluded that, "We're going to need the rest of the world to bail us out." We have been reminded again that, whether the subject is global finance or global warming, we are all in this together.

And we have been reminded that, whether the movers and shakers sat in the executive offices of Enron, or the White House, or City Bank, the story ended the same way. The new technocrats know a lot about statistical analysis. It's a shame they know so little about Sophocles, Aeschylus or Euripides. The Greeks could have told them that this was going to happen. Their predictions were based on a thorough knowledge of human nature -- not magic.