Should the Financial Crises Be Avoided?

 

Governments are continuously trying to avoid another financial crisis. Let's see what happened, according to some experts, during and after the financial crisis of 2008:

 

[Quoted from: It seems that a new global crisis is approaching, which may be harder than 2008. Is Russia prepared?, (In Russian), September 18, 2019, Source: Meduza, https://meduza.io/feature/2019/09/18/pohozhe-nadvigaetsya-novyy-mirovoy-krizis-kotoryy-mozhet-byt-tyazhelee-2008-goda-rossiya-k-nemu-gotova]

 

In short, in 2008 it turned out that innovative technologies “suddenly” had changed the global financial market. Huge international investment funds and banks have learned, without the participation of state central banks, how to create money from virtually nothing. For example, they collected debts that would never be paid, such as the mortgage debts of poor Americans, packed them together with not so bad debts in the new financial instruments, and then sold these instruments to other investors. In the summer of 2008 when it turned out that these tools were worthless a trillion-dollar hole formed in the financial market. This led to the fall of several of the largest banks and the deepest recession in the world economy and deflation since the 1920-1930s. Due to the fact that the financial market was one of the most advanced in the sense of globalization, almost all the countries of the world suffered one way or another.

 

Governments and central banks of developed countries launched a fight against the crisis on two fronts. First, they tried to plug the resulting financial hole by adding newly printed money to the economy. For this money, the authorities bought their assets from some banks. Such a measure is called “quantitative easing”; It was used in the USA until 2014. Second, the authorities imposed new regulation standards on the banks and investment funds so that they could no longer create “toxic” instruments.

 

On the front of “mitigations” a battle was won: the economies of developed countries recovered; growth continues for more than 10 years. Regulation has not brought a complete victory.

 

The mechanism of increasing the instability of the “fuse” (financial system) is obvious. The more money that is not backed by either the “gold equivalent” or actually produced goods and services is thrown into the market, the more “financial instruments” turn out to be disconnected from real value, the less stable the financial system is. Thus, the faster it collapses as soon as another serious, protracted crisis occurs.

 

Increasing the instability of the financial system is an objective trend. This trend is latently associated with increasing complexity of the economic system. Economy must be protected from both unwanted overloads and waste of resources, and financial crises provide for such protection.

 

Now let's consider another side of this phenomenon. The government attempts to reduce the instability of the financial system. What could the government do? Either install the “jumper” or reduce the sensitivity of the fuse. In the financial world, the former means to issue additional finances into a temporarily disconnected circuit. The latter means limit the ability of financiers to make money from the thin air.

 

Vadim Shefner wrote a wonderful story “Belated Shooter”, in which several unfortunate inventors travel to Moscow in one compartment to defend their inventions. There is one who invented the eternal fuse. He showed to others the drawing of an ordinary fuse, but all-metal. People tried to explain him that the fuse should blow so that everything else would not burn, but he stood his ground, “Imagine how much people could save worldwide on the fuses!”

 

Same here: finance play the role of a fuse that should blow first, before the rest of economic circuit burns. Simply replacing the blown fuses with new ones does not help, fuses will burn until the short circuit is eliminated. If the fuse is replaced with a "jumper," then all the wiring might burn. The cause of the crisis is not in the blown fuse, but in a real short circuit, maybe, in several short circuits at once...

 

You can call a "jumper" as you like, even a "quantitative easing." Its essence does not change with different name. Resources are being poured both into the area where the crisis occurred and into the neighboring ones that suffered “for the company”. Most of these resources are wasted due to an unresolved systemic crisis. So what? The good thing is that activities continue in other areas. The measure is quite effective. The crisis should be overcome by completely different mechanisms little dependent on the flow of resources to the affected area, so a developed economy can survive a waste of resources to a certain level. Unaffected by systemic crisis areas of human activity do not suffer.

 

On the other hand, “regulation” cannot be successful by definition. The financial system evolves by the trend of "increased profitability." What could be more profitable than “making money from thin air”? What could happen with all attempts by lawmakers to “stop” this trend? As a Russian legislator once said, “A hundred people are working on a law, trying to ponder and consider everything that is possible. And then millions of people work to circumvent this law. So, they win!” It is impossible to stop the development by any laws or by-laws, especially if this development is driven by a mechanism that is much more powerful than any laws. Profit is one of the most powerful mechanisms in the modern world. Lawmakers could possibly fight against it, but one cannot hope for success.

 

Let us pay attention to one more phrase, “Due to the fact that the financial market was one of the most advanced in the sense of globalization, almost all countries of the world suffered in one way or another.” This is a manifestation of another pattern of evolution of the financial system as a fuse: the desire to reduce the number of fuses in the economic circuit. From the point of view of stability and operability of the entire economic circuit, one should put its own fuse near every more or less important part of circuit. But then you have to constantly run and replace the blown fuses. It is better to put one fuse on the entire circuit and then replace only it. Likewise, it is disadvantageous to create a separate financial system for each industry or even for each state. Global financial system is more effective. But at the first more or less serious crisis, its collapse will bring down economies of many individual states.

Fuse | Financial and Systemic CrisesRoles of Finances

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Len Kaplan

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