A delicate Balance: Book Review: Financial Express: 12th April 2015

‘The End of Normal’ book review: A delicate balance

What is normal? The End of Normal debunks the theory, saying there are no ‘normal’ conditions in an economy and that we will always have to strive to reach equilibrium

The End of Normal
James Galbraith
Simon & Schuster
Pp 291
R599
SEVERAL REASONS have been given for the financial crisis, from the black swan hypothesis and ‘fat tail theory’ to ‘too much government’ and inequality. As an extension, it has often been argued that the crisis was due to the existence of some bad people in the industry and bad policy pursued by the government. But this, as per James Galbraith, the son of economist John Kenneth Galbraith, is far from true. In his delightfully worded book, The End of Normal, Galbraith argues that when we sit back after a crisis looking to blame someone, we assume implicitly that there is something called ‘normal’ performance—it is this attitude that throws us off-guard in the face of any major deviation. And this is where we are wrong.
The concept of ‘normal’ came into vogue especially in the 1980s when Paul Volcker headed the Fed.  He, along with then US president Ronald Reagan, was able to make the US an economic superpower. By controlling interest rates and the supply of dollars in the market through borrowing, the US got other countries, especially oil-rich ones, to invest in its own debt. Commodities were dumped in countries in Africa and Latin America. As they imported more than they could export, they became indebted. Behind the lines, the US liberally extended aid to these countries, which used the money to buy goods from the lender. With this cycle set in motion, Reagan could go ahead and cut taxes and expenditure (also called Reaganomics), and bring about growth, which led to the creation of the concept of ‘normal’ or ‘the great moderation’.
However, there have always been exceptions, argues Galbraith, as in the case of the Asian crisis, S&L episode, dotcom bust, etc, when the markets failed. But it has become fashionable to assume that everything will be all right forever and the path will only be upwards. This has also led to long and pedantic debates between freshwater (monetarists) and saltwater economists (Keynesians) on why there would be forces that would always self-correct.
Economists like Ben Bernanke had argued that this new ‘normal’ was achieved due to a combination of structural changes, improved policies and a good dose of luck. Those from the rational expectations stable pointed out that depressions can never take place, as the market would ensure that they don’t. The use of complex models with a lot of Greek symbols helped prove that this would hold. The emergence of the famous DSGE—dynamic stochastic general equilibrium—models only proved this point. Galbraith adds here, almost tongue-in-cheek, that the goal of these models, as is the case with most of them, is not to clarify or charm, but to intimidate. He also quotes Paul Krugman, who has maintained that this brand of thinking mistook ‘beauty for truth’.
But Galbraith believes that there are four overwhelming reasons to believe that there is no normal, which also means that we will always have to strive to reach equilibrium. The first factor is natural resources. Earlier, the US had virtual hegemony over resources either directly or covertly through operations in Africa and Latin America. The oil issue lingers, as does that pertaining to other commodities, which can distort this assumed equilibrium. Further, the financialisation of commodities through futures trading will continue to ensure that attaining a ‘normal’ will always be elusive.
The second is the realisation of the futility of war. The author explains that waging a war on a territory by the US can help add to the GDP, something that was effectively used in the 1960s, starting with Vietnam. Now, the tenure of such battles has become shorter, with the Kuwait, Iraq and Afghanistan ventures being latest examples, where even public opinion has turned against war. On the moralistic ground, the US has often been accused of imperial overreach. On the economic front, there is concern, too, over the devaluation of the dollar, as the US runs deficits, which have increased the supply of dollars to the extent of being in abundance, thus causing apprehension of loss of value. This has led some countries to consider alternative currencies like the yen, pound, euro and even the yuan. This is a major change in the political and economic dynamics of the world.
Third, the digital revolution, which was what even economists like Robert Solow had spoken of in the 1950s, has the potential to cause major shifts in incomes. The growth of India as a centre of outsourcing can lead to a severe employment issue in the US. Further, new technologies can lead to the Schumpeterian path of creative destruction, which will ensure that there will always be volatility caused by such phenomenon.
Last, the breakdown in the level of ethics in finance can be very destabilising and Galbraith explains this well. You need bad assets like NINJA loans, which he calls counterfeits, to create big business. Then one requires someone to launder them, something the credit rating agencies did for all the collateralised assets. Last, they had to be sold, which was assiduously done by Bear Stearns, Morgan Stanley, etc. This was nothing short of financial fraud with all major institutions being involved.
The way the cycle works is that no one is happy with stable earnings. When things are normal, there is always a motive to seek higher returns even when it means taking more risk. Financial positions that are based on hedging are replaced with speculative positions, which lay the seeds for a Ponzi-like situation, which becomes self-fulfilling after a time. This is where the rub lies.
The author is quite caustic of the fact that while a lot of books have been written on the financial crisis, the word ‘fraud’ has never been used. Joseph Stiglitz uses the word ‘mischief’, Raghuram Rajan uses it only once in his book Fault Lines and Krugman brought it up once during the S&L crisis. This has been due to the fact that economists are either believers in the market and will never admit that it can be gamed or are Keynesians like Krugman, who feel that there is always a fiscal cure for this. Interestingly, he points out that all forecasters and economists work either directly or indirectly for industry through the role of consultants and hence always end up saying the same thing through prescriptions and solutions.
At another level, he argues that we need to use fewer resources and move away from maintaining such a large military force when it is not really required. In the same breadth, he questions the wisdom of having too large banks that do work—garner deposits and lend them to those who require them—which can easily be done by small banks. This would, on its own, help in monitoring the level of greed in the system. This can be called original thinking.
Galbraith is as charming a writer as his father and this book will be a delight for students of economics. When Galbraith invokes the writings of Paul Baran and Paul Sweezy, one gets a feeling of deja vu of the time when students studied Marxian economics. At the end of the book, you do tend to get convinced that our world will be dynamic in nature moving from one ‘equilibrium’ to another without quite knowing when the change will come.