A single-minded approach to ambiguity

PUBLISHED : Thursday, 31 January, 2008, 12:00am
UPDATED : Thursday, 31 January, 2008, 12:00am

During this great bull market, I found myself repeatedly looking up the late Charles Kindleberger's Manias, Panics and Crashes: A History of Financial Crises, vainly trying to locate what stage of the cycle the market was at. Now, I am re-reading the last and crucial chapter, on the lender of last resort. Most people, nowadays, call it central banking, whose job it is to clean up after the boom goes bust. It's when the end of the world has finally come, the spoiled brats have royally messed up and Big Daddy is being called on to bail them out.

Not only do the brats feel ungrateful, they criticise Daddy for failing to act soon enough. And so there is now a long, unseemly line of top analysts and economists on Wall Street rounding on the US Federal Reserve and its chairman Ben Bernanke for failing to anticipate or react quickly to market drops. But, wait a minute, who created this mess which is now threatening the entire global economy in the first place?

There is a deep sense of entitlement among these paragons of Wall Street that is at once baffling and repugnant to most people. True capitalism is about taking risks, reaping the rewards and, if things turn bad, taking the punishment.

But this is not the way capitalism is practised in the United States, while it is claiming to show the world how free markets and democracy work. Corporate chieftains are rewarded no matter what, while the rank and file, and stockholders, take the fall.

This is the problem of moral hazard and entitlement that critics of the-lender-of-last-resort have warned about and that Kindleberger tried to address. Letting a wild fire burn itself out in a financial crash - letting those who deserve it, go belly up - may create an even greater threat for everyone down the road. This is the lesson of the Great Depression - the rise of fascism, the second world war, and so on - that contemporary central bankers have taken to heart. Someone has to be available to guarantee the solvency of the whole financial system.

Kindleberger's idea is for Big Daddy to assume an ambiguous posture, so the spoiled brats would never be sure he would intervene to save them, or let them fail. Ambiguity has an undeservedly bad reputation as a moral quality. With the right person or institution, it can be a refined, disciplined and thoughtful response to dilemmas.

Kindleberger wrote his most famous book as an aside. Long before, he was an architect of the Marshall Plan and an authority on international economic relations. He applied the same idea of a final lender as the hegemon, or world policeman, to the US, which he believed was necessary to underwrite the liberal world order of trade and commerce. One of the more successful US foreign policies has been its decades-old ambiguous posture on whether it would intervene if war ever breaks out across the Taiwan Strait. This has deterred the mainland from seeking a military solution and Taiwan from declaring independence.

President George W. Bush, a man of moral absolutes, came close to wrecking this set-up in 2006. I don't know if Kindleberger influenced this policy but his idea lends it a most articulate rationale. We may be seeing its demise, as the mainland grows stronger and US influence wanes in Asia.

Kindleberger's idea never had a chance with former Fed chief Alan Greenspan. Ever since his intervention on Black Monday in 1987, Mr Greenspan's unmistakeable signals to Wall Street were, to quote rocker Jon Bon Jovi: 'I'll be there for you.' He would never burst a bubble and ruin a good time. And he would always clean up afterwards. This was why he was lionised on Wall Street during his long tenure, yet his reputation promptly took a dive with the US housing market collapse. Dr Bernanke, Mr Greenspan's successor, looks set to continue his legacy, however reluctantly.

Economics was once called a moral science. But morality seems to have been removed from economics, at least in America.

Alex Lo is a senior writer at the Post