The Post-Keynesian were right. Again.

Before Samuelson hijacked the field (God bless him…) there were two distinct interpretations of Keynes’ Magnus Opus.  Actually, there were several, but there were two primary ones.  One held that his overarching theme was about various frictions in the market and the ability of government to address those frictions when needed, as well as manage effective demand.  That was the Samuelson wing, and thanks to his famous (and excellent!) textbook, it came to dominate Post-war economics.

But Post-Keynesians never completely faded away. Post-Keynesians interpreted The General Theory to be a treatise on the natural instability of capitalism.  A purely capitalist system, they (we) argue, is naturally unstable and can create positive feedback loops that don’t allow the economy to return to potential – or, more precisely, don’t allow it to return to potential fast enough to be bearable to any democratic system.

And what does this have to do with anything? Minsky etal figured out a long time ago that the market was inherently unstable and that waves of euphoria would lead a demand for ever-increasing profits.  When these ever increasing profits couldn’t be realized, money would quickly flow out of the system and the peak would become the trough.  And what does THAT have to do with anything?  Ask Bear Stearns.  or Countrywide Financial.  Or Lehman.  Or Freddie Mac.  Or any of the hundred of other financial institutions that were victims of their own euphoria.  People who argue ceaselessly about whether or not we should bail these companies out completely miss the point.  In reality, we have no choice but to do so.  The real point is this:  Let’s not chalk this up to a few bad decisions and act like it’s a unique event.  It happens every time.  Before Bear it was Long Term Capital Management and Enron.  Before Enron it was the REIT’s and the S&L’s (to be fair, the S&L’s were a very different situation…but that’s another topic).  Before the REIT’s it was the Hunt brothers.  I could go on…..

So instead of sitting around debating what should be done this time around (regardless of what anyone might think, the government is going to step in), let’s finally and at last take some steps to prevent this kind of euphoria again.  And lets discuss what those steps should be.  Instead of debating what should be done right now, let’s discuss what can be done to prevent the euphoria from developing in the first place.  Let’s talk about how to prevent hedge funds from becoming ponzi funds.    That’s the discussion that needs to happen, but every time one of these collapses happen we let the government pay off the right people and move on like it was a freak event. It’s not a freak event!  It’s the way the system works. The sooner we accept that, the sooner we can go about trying to fix it.

As for the ideas and solutions….That’s a later topic.  Ideas welcome….

Seven.