What Would Hayek Say Today?

As the economic crisis continues, the less believable are sticking plaster solution. Four years in, Europe is moving forward toward a nasty recession, China is heading for a hard landing, the governor of the Bank of England is talking about a systemic banking crisis and George Osborne has annunciated spending cuts that will continue on the next six years. The United States is the only place where the news has been a little better, as the housing market is improving and unemployment is falling. What’s happening in America is that the Federal Reserve decided to use two rounds of quantitative easing to increase the money supply and enunciated its intent to keep interest rates low. This has helped people to believe that resurgence will eventually arrive, if the policy response is large enough for a long time. It is not known yet if this is indeed the case, since there have been many false starts after the financial system began failing in 2007. An authentic strength of the US economy will be divulged early next year, when tax breaks supporting consumption and investment expire, not to mention, when the world’s biggest economy begins to feel the influence of stagnation on this side of the Atlantic. There is another way of looking at the crisis. We are inhabiting a world of the living dead: a eurozone which will not collapse, but cannot be reformed; banks that are kept going by colossal amounts of electronically generated cash, yet cannot lend; people with homes that are worth no more than they paid for them, although they are able to stay put since interest rates are considerably low and lenders doesn’t have any desire to increase losses and policy that is neither one thing nor the other. There is a story, almost certainly dubious, that Friedrich Hayek used to talk about the state of the world while sharing his duties as an air raid warden with John Maynard Keynes on the roof of King's College Chapel in Cambridge during the Second World War. If they were still living, these economists would undoubtedly have acrimonious things to say about the way the global economy is being managed. Hayek believed that the zombie-like state of affairs exists is due to the refusal to allow banks that gave out money irresponsibly to go bankrupt. His analysis of the crisis would be that too much easy money led to too much useless investment. While not giving into the suggestion that spending should be maintained during a slump, Hayek would suggest that policymakers have to return to a place where production was sustainable and profitable. If that meant allowing banks to go under, then let it be. If nature’s cure took time, then let it be. Since the worldwide financial crisis began, western economists have made an effort to avoid the mistakes which Japan made in the 1990s. Hayek would articulate that western leaders have recapitulated the biggest policy error made by the Japanese that allowed over-leveraged banks hurt by non-performing loans to remain in business with the same pernicious outcomes. The Americans did let one bank, Lehman Brothers, fail in September 2008. Market pandemonium arose, along with fears that other banks would go under also and there was a complete change of approach. Banks were recapitalized thanks to the taxpayer and endowed with unlimited amounts of cheap money to keep them going. Hayek would state that this was basically a sticking-plaster solution, even though this is the biggest and most expensive piece of sticking plaster the world has ever seen and would draw attention to last week – more than three years after the Lehman went bankruptcy – that the only thing that was altered was that the centre of the problem was now in Europe.. Italian banks are more dependent now on their financial aid now than they were in 2008; last week’s action taken by six of the world’s central banks was set off by evidence that Wall Street no longer wanted to lend money to European banks. Hayek and his followers would conclude that there must be a cleansing of the system that remove the pestilence and what has happened in the past several years is simply postponing the inevitable. Surprisingly, it is not just free-market economists who believe in the power of creative destruction. The term, even though it is associated with Joseph Schumpeter, came originally from Marxist economic theory that held that each stage of development emerged out of the destruction of a system which into longer functioned. Socialism would follow capitalism as capitalism followed feudalism. The Marxists think that the efforts to muddle through will fail.
Reference
Krugman, Paul (2011, March). The Conscience of a Liberal. Retrieved January 20, 2012 from http://krugman.blogs.nytimes.com/2011/03/29/friedrich-hayek-zombie/
(2011, December). Look Back, Look Forward and Look Down, Way Down. Retrieved January 20, 2012 from http://theautomaticearth.blogspot.com/2011/12/december-5-2011-look-back-look- forward.html (2012, January). Friedrich Hayek. Retrieved January 20, 2012 from http://en.wikiquote.org/wiki/Friedrich_Hayek