In current phase of the GFC* we are witnessing extraordinary Government intervention in the financial markets, with a host of countries providing enormous guarantees of bank liabilities, purchasing distressed assets or directly investing in ailing banks. Switzerland is the most recent country to follow this route, injecting around 6 billion Swiss Francs (A$8 billion) into UBS, gving the Government an estimated 9% stake in the erstwhile investment banking giant.
While the immediate aim of these moves is to save a financial system that is on the verge of collapse, there is also increasing concern that the ructions in the financial sector are a precursor to an extended global recession. This is also generating responses by Governments around the world. Here in Australia, the Rudd Government has announced a A$10.4 billion stimulus package, shelling out money to low-to-middle income families, pensioners and home-buyers.
While free-marketeers may be shaking their heads in despair at these developments, John Maynard Keynes must be smiling in his grave. Keynes, one of the great economists of the 20th century, was a firm advocate of the role of Government in providing counter-cyclical support to the economy, spending during a downturn and accumulating surpluses in the good times. In his masterwork, “The General Theory of Employment, Interest and Money”, Keynes made the point in colourful terms:
If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing. (p. 129)
Since Keynes appears to be back in favour all of a sudden, it may be worth exploring some of his other pearls of wisdom. For those banks who were convinced that the extremely depressed prices of mortgage-backed securities and CDOs of asset-backed securities had fallen well below “fair value” and would recover:
The market can stay irrational longer than you can stay solvent.
Those who think that share markets have been “oversold” may also consider heeding that advice. While on the subject of shares, many commentators have sought to sooth nervous investors with the tried and trusted assurance that in the long run shares out-perform other less risky investments such as cash and bonds. However, Keynes also made the following point:
The long run is a misleading guide to current affairs. In the long run we are all dead.
Finally, for those who are angry with the damage wrought on the world economy by the financial wizards of Wall Street, Keynes also offered the following assessment of capitalism:
Capitalism is the astounding belief that the most wickedest of men will do the most wickedest of things for the greatest good of everyone.
* Global Financial Crisis