January 25, 2008 | posted by Michael Baxter in credit crunch, global economy |

And so George Soros says we are witnessing the “end of a 60-year credit boom.” Is he right, what can we do?

Maybe the problem lies with the man who is widely considered to be the greatest economist of the 20th century: Keynes.

Mr Keynes once said, “The long run is a misleading guide to current affairs. In the long run we are all dead.” He also argued that the solution to the economic depression that was hurting so much at the time he wrote his most famous theories, was to go out and spend.

The thing is, Keynes died over 60 years ago now. He was right, in the long run, he did indeed die, but right now, we are living in Keynes’s long run.

Now, in fairness to Keynes, he wasn’t omnipotent. When he was writing, inflation was not the big problem, at least it wasn’t in the UK and US.

But the post-war years have been characterised by high spending every time there was recession. This, surely, has created what Mr Soros calls the 60-year credit boom.

Back in the 1970s and 1980s it seemed to be changing. When he was Prime Minister, James Callaghan once said, “We used to believe you could spend, spend your way out of recession. But I tell you in all candour, that option no longer exists.” Margaret Thatcher tried to go against Keynes’s theory – and her way of dealing with economic disaster was to cut spending, to try and get finances on a solid footing. Reagan spearheaded a similar approach in the US, but it was short-lived.

Under George Bush senior, the US budget deficit went through the roof, and under Thatcher, Nigel Lawson’s credit boom took hold.

Economic text books used to say the most advanced economy in the world should have a balance of payments surplus, and the developing countries the deficit. But it is all different now, the US has the deficit, China the surplus. There is no precedent for this.

We are also seeing the increasing emergence of a new school of economics, though. George Soros is a signed-up member – he says that markets do not have a self-correcting mechanism, and the solution to the global crisis is global collective action. The man, though, who is emerging as the voice of this new school of thought is Joseph Stiglitz. He has even been hailed as the successor to Keynes. (By the way, Keynes was into global collective action; remember, the IMF and World Bank were partially his idea.)

Above (Good news strikes), we told how banks and the IMF saved the day back in 1998. Well, not everyone agrees. Some, people, including Mr Stiglitz, would argue the price of economic stability in the West back in the late 1990s was economic recession in Asia and Russia.

This time around, though, the problems seen in the US with subprime – which, by the way, we are sure marks just the beginning, are too close to home. It is not practical to get someone else to carry the can.

Then throw into the pot growing US protectionism. Peter Mandelson, the EU trade commissioner, is worried about Hilary Clinton. The Telegraph quoted him as saying, “The things she’s been saying reverberate around the world…This is the last year the Doha trade round can survive. There is little chance of a breakthrough after this president leaves office. People in the current administration tell me the US is turning into a protectionist country. It is a serious concern.”

So, in other words, at a time when Stiglitz and Soros call for collective action, the US could be in danger of turning in on itself.

The big hope has to be that the US is in such a mess, that it needs the Sovereign Funds. Maybe, by being forced to court foreign capital, it will be forced to toe the line on international trade.

These are the most important issues of the year – a theme we will no doubt return to many times.