Paul Samuelson has died. The godfather of so many current economists (literally so in one case – he was related to Larry Summers- but metaphorically through being the author of a book that must have brought economics to thousands of current professors), I bet I am not alone in wishing I had time to read his great books this Christmas.
Paul Krugman’s thoughts on Samuelson mention how ‘his discussions of speculation and monetary policy are particularly striking: they run quite contrary to much of what was being taught just a few years ago, but they ring completely true in the current crisis.’
This sounds both likely, and contrary to some prevailing theories about how conventional economics has no clue whatsoever about how to deal with bubbles, or about how dangerous they are. This has always struck me as overblown, and in the hands of some, annoying nonsense at that. My last course on my MBA in 2003 was all about Financial Crashes and Economic Theory, and the standard dilemmas about what to target monetary policy at were well-worn by then. Economists did not sit around, dumbstruck, by the notion of a bubble collapsing and causing such mayhem.
Which is why I think Paul de Grauwe is shutting the door on a long-departed horse when he calls for a new science of macroeconomics. Many professionals will have reacted to that article in the FT with “we knew it was not like that in the models. And here are 100 obscure papers to prove it”. Fact is, bubbles acquire political momentum, quite regardless of what the average economist thinks about them.
In fact, such problems were were well-worn even when Samuelson was a young man. My excellent bedtime reading, Lords of Finance, describes brilliantly the dilemmas for the 1920s Fed, which was struggling to balance the international consequences of the gold shortage in Britain, and its own problems with massive speculation. Many observers realised that there was a tremendous bubble in US stocks from 1928. But most of the solutions would not work. Regulate broker loans? Money can come from elsewhere, including overseas. Raise rates? It’s using a sledgehammer to perform fine surgery.
The parallels are eerie in places – in particular France as an accumulator of foreign exchange and gold, causing difficulties elsewhere after its earlier currency traumas had scared it into holding down a fixed exchange rate.
There are no easy answers to how to manage a speculative bubble – and few new questions. The ‘modern’ notion that bubbles are harmless, or non-existent because of market efficiency, has never been particularly influential in the actual markets. What has really changed since the 1920s is how we now expect the Fed and its international buddies to have learned from 1930-1939, and actually deal with the aftermath in a less cack-handed way. This is why people did not intervene in 2005 or 2003 or whenever to prick the bubble.
And as the author of Lords of Finance points out, there were plenty of calls to prick the 1920s bubble that would have been ludicrously early, and have done nothing but damaged the real economy, which was enjoying none of the highlife demonstrated by a few individuals in finance. The same would have been the case if Mervyn King or Bernanke had tried sticking rates up to 7% to kill off housing. All that would have happened is that they would have been blamed for the carnage that followed.