William White, chairman of the Economic and Development Review Committee at the OECD and former chief economist at the Bank for International Settlements (BIS), says the risks posed by global debt levels are greater today than they were in 2007 and that central banking monetary policy has lost its effectiveness. He also explains the crucial differences between modern macroeconomic modeling and complexity theory (or viewing the economy as a complex adaptive system) and the key lessons this has for policymakers, both fiscal and monetary.
Here's a portion of his recent interview with Financial Sense airing Friday on the Newshour page:
"If you think about a crisis period as a period of deleveraging, in fact this has not happened and we've gone in the very opposite direction. Now, on the household side, clearly there have been some improvements made but on the corporate side in the US, things have gotten significantly worse—the debt ratios for corporations have gone up very substantially as has government debt...
More importantly—again, when I say the situation is worse today than it was in 2007—in 2007 this debt problem was essentially confined to the advanced market economies. Since then, the debt ratios—the private debt ratios in particular—have exploded in the emerging market countries and so we now have in a sense a global problem whereas in 2007 you might say we had a regional problem with the advanced market economies. But now it's basically everywhere so, yes, I do think that the situation is worse than it was then...
When I first came to the BIS in 1994, we started warning about the credit flows into Southeast Asia well before the Asian crisis happened and...it was in the early 2000s that we really started to focus on what was going on in the advanced market economies... The story that we were telling then was really one of the Greenspan put starting in 1987 and every time there was a problem, the answer was to print the money or ease monetary conditions and the debt ratios ratcheted up and up and up...
So we had this problem in '87 and the answer was easy money; then we had this problem in 1990-1991 and, again, the answer was easy money. The response to the Southeast Asian crisis was don't raise rates even though all sorts of other indicators said you should. Then it was easy money again in 2001 and, of course, in 2007...every time the headwinds of debt have been getting higher and higher and the monetary easing required to overcome that has had to get greater and greater and the logic of that takes you to the point where you say, well, in the end monetary easing is not going to work at all and...that's where I am today... Unfortunately, we are still, as far as I can tell, both the BIS and myself are still talking to a brick wall...
There are a lot of reforms that could be carried out that in the fullness of time would increase growth, increase potential, and increase the capacity to service debt so there's a lot of things that might be done but it all starts off with a recognition, which we do not have, that monetary policy is not the solution to this particular problem and that it may, in fact, be making it worse. To put it in a nutshell, if it's a debt problem we face and a problem of insolvency, it cannot be solved by central banks through simply printing the money. We can deal with illiquidity problems but the central banks can't deal with insolvency problems...
In a way, I think the economists have made what the philosophers would call a profound ontological error. They have assumed that the economy is understandable and they have therefore assumed that if they can understand it they can control it.
And I guess the point is—and this is the ontological error—what you can understand about a system depends upon its nature and the nature of the economy...and all the interactions between the real and the financial side are in constant change...constant evolution. Systems like that cannot be completely understood and they certainly can't be completely controlled so this is a fundamental mistake that I think the economists and modelers have made.
The difficulty with having made a mistake of that sort is that it leads you to do things that in the end prove to be just wrong. The difference is how do you tend a machine and how do you tend a forest? These are very different animals and they have a very different nature. And if you look at the economy as a complex adaptive system basically you end up with a bunch of assumptions about how it works that are absolutely at the opposite end of the spectrum of the assumptions made in modern macroeconomics...
Just the very fact that you embrace the concept of the economy being a complex adaptive system can lead you to some very simple but very important lessons. Lesson number one from all of these other areas of complexity, like traffic, crowd movements, spread of crime, social webs, mobility of disease and epidemics—this list goes on and on of these things...but if you embrace this then what you can do is go back to the basic lessons that have been learned from all of these other disciplines and say what does this teach us for economics? And lesson number one—and these are all very simple lessons—is these systems break down all the time and they break down according to a power law, which basically says you get a big breakdown very infrequently and you get little breakdowns all the time...
Lesson number two is that you can't predict when the system will break down precisely or where it will break down precisely but in a sense it doesn't matter because it's the system you want to focus on. And it is possible to get some sense of this system is getting stretched beyond its capacity to recover. And I think this is one of the central lessons of the BIS, which is the levels of credit—the stock of credit—and sometimes the rate of growth of that credit is of such a magnitude that it is clear that there's going to be some bad things that come out of it...which is what makes me so fearful about China..."