Article from The Guardian newspaper

[Paul Davidson <pdavidson@xxxxxxx>]

Here is an article that was published in THE GUARDIAN

Paul Davidson
Monday September 2, 2002
The Guardian
Since March 2000, the terrorist organisation "the bears" have struck Wall
Street with a devastating impact on our enterprise economic system.
Al-Qaida terrorists on September 11 may have made a more dramatic impact on
our way-of-life, but the number of lives destroyed by the bears may
ultimately prove to be greater.
Clearly, there is a yearning for the equivalent of a Rudy Guiliani who
understands what has happened and seeks to quickly clear the debris and
rebuild a stronger financial system.
Unfortunately, the economists guiding the Republicans and the Democrats, as
well as Gordon Brown in the UK, and officials at theEuropean Central Bank,
the Bank of Japan and the IMF are at a loss to provide any helpful advice.
These economists have forgotten Keynes's vision for rebuilding a better
capitalist economy after the last great attack of the bears during the
second world war.
Keynes saw that any irrational demand for liquidity as the cause of
unemployment and depression in our otherwise wealth-producing enterprise
economy.
Liquidity is a double-edged sword. The good edge provides orderly,
well-organised security markets where financial assets can be readily
resold for cash. Liquid financial markets encourage savers to provide
funding to entrepreneurs for durable investments that savers would not be
willing to furnish if their investment was not liquid.
Liquid markets encourage savers to believe they have a fast exit strategy
to liquidate their position the moment they are dissatisfied with the way
matters are developing. This calms savers' fears of the uncertain future.
Without liquidity, the risk of funding investments as a minority owner
would be intolerable.
The bad edge appears when rampant fear induces a strong bearish view in
financial markets and most savers try to rush for the exit. In times of
fear, there are no "fundamentals" that determine the market price of the
equities.
More importantly, this irrational demand for a fast exit prevents
unutilised or involuntarily unemployed real resources from being used to
expand the economy's productive facilities. The result can be devastating
to whole industries and the national economy.
The financial market crises of the 1990s, cumulating in the 1997 East Asian
currency crisis and the Russian debt default of 1998, induced a seizing-up
of global financial markets in the autumn of 1998 that almost precipitated
a global market crash. The global economy still struggles with the
uncertain aftermath of these crises. The terrorist attack of 9/11 increased
uncertainty about the financial future.
It is time for policymakers to calm the nerves of financial market
participants by flooding the system with sufficient liquidity for all who
want to exit in an orderly manner.
Any potential disorderly decline in security prices can be offset by the
banking system if the central bankers know their job and their
responsibilities. During the stock market crash of October 1987, for
example, the Federal Reserve flooded banks, government bond market makers,
and other financial intermediaries with liquidity in order to encourage
them to buy the financial assets that the bears were fleeing from.
A similar but stronger action, flooding the financial system with
liquidity, was taken by the Federal Reserve immediately after the September
11 attacks. The Federal Reserve pumped $45bn (£29bn) into the banking
system and simultaneously eased the cash concerns of primary dealers in bonds.
On Thursday September 13, the Fed snaffled up all the government securities
offered by dealers, $70.2bn (£45bn) worth. On Friday, it poured even more
into the system. In effect, the Federal Reserve removed securities from the
public by making liquidity available to those who wanted to make a fast exit.
The price of financial assets can generate a wealth effect that can have an
impact on households' demand for real goods and services. As Keynes noted:
"A country is no richer when it swaps titles to capital at a higher price
than a lower one, but the citizens, beyond question, feel richer". It is
about time that Central bankers took positive steps to make citizens feel
richer, rather than let the terrorist bears make the public feel - and
actually become - poorer.
· Paul Davidson holds the J. Fred Holly Chair of Excellence in political
economy at the University of Tennessee. He is the author of Financial
Markets, Money and the Real World.
Guardian Unlimited © Guardian Newspapers Limited 2002

Paul Davidson
Editor, Journal of Post Keynesian Economics
Economics Department - 523 SMC
University of Tennessee
Knoxville, Tennessee 37996-0550
phone # (865) 974-4221
fax # (865) 974-1686
home phone  (865) 692-0802
http://econ.bus.utk.edu/davidsonextra/Davidson.html