By Martin Wolf 

Paul Volcker is the giant among contemporary central bankers, both literally and figuratively. He it was who had the moral courage to crush inflation as chairman of the Federal Reserve between 1979 and 1987. When Mr Volcker speaks, people listen. What he had to tell the economic club of New York last month was well worth listening to. His summation, cited above, was so devastating, because so true.

Mr Volcker noted that this crisis is not unique. On the contrary, “today’s financial crisis is the culmination, as I count them, of at least five serious breakdowns of systemic significance in the past 25 years – on the average one every five years. Warning enough that something rather basic is amiss.” Those who do not heed such warnings are fated to suffer something yet worse.

So what is to be done? There is a part of me – quite a large part, in fact – that says: “Forget regulation: it will never work. Apart from normal laws against fraud, let the financial system live and die by the laws of competitive markets. If businesses fail, let them simply go down, with all their shareholders, customers and employees. Meanwhile, we will remind users constantly of the dangers.”

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Martin Wolf 

Of the two crises disturbing the world economy – financial disarray and soaring food prices – the latter is the more disturbing. In many developing countries, the poorest quartile of consumers spends close to three-quarters of its income on food. Inevitably, high prices threaten unrest at best and mass starvation at worst.

The recent price spikes apply to almost all significant food and feedstuffs (see charts). Yet these jumps are themselves part of a wider range of commodity price rises. Powerful forces are linking prices of energy, industrial raw materials and foodstuffs. Those forces include rapid economic growth in the emerging world, strains on world energy supplies, the weakness of the US dollar and global inflationary pressures.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Martin Wolf 

As the latest World Economic Outlook from the International Monetary Fund remarks, “the world economy has entered new and precarious territory”. What are perhaps most remarkable are the contrasts between booming commodity prices and credit-market collapses and between buoyant growth in emerging economies and incipient recession in the US. So where are we? How did we get here? And what should we be doing?

The WEO’s answer to the first question is that the US economy may shrink by 0.7 per cent between the fourth quarter of last year and the fourth quarter of 2008. This is a big shift from the 0.9 per cent increase over that period forecast in the January WEO Update. Moreover, growth is expected to be only 1.6 per cent over the following four quarters. Meanwhile, the eurozone’s growth is expected to fall to just 0.9 per cent between the fourth quarter of 2007 and the fourth quarter of 2008.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Martin Wolf 

Nice try; no cigar. That was my reaction to the attempt of the banking community to forestall additional regulation, by recommending “a suite of best practices to be embraced voluntarily”. It was also the reaction of the policymakers meeting in Washington over the weekend. More regulation is on its way. After frightening politicians and policymakers so badly, even the most optimistic banker must realise this. The question is whether the additional regulation will do any good.

In an interim report on “market best practices”, the Institute for International Finance, an association of bankers, offers devastating self-criticism.* Here then are some of the weaknesses it identifies: “deteriorating lending standards by certain originators of credit”; a “decline of underwriting standards”; an “excessive reliance on poorly understood, poorly performing and less than adequate ratings of structured products”; and “difficulties in identifying where exposures reside”. Would you buy a voluntary code from people who describe their own mistakes in this brutal manner? I thought not. There are two powerful additional reasons for not doing so.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Martin Wolf 

When a wave of destruction hits, everybody looks for somebody to blame. Alan Greenspan, former chairman of the US Federal Reserve, once lauded as the “maestro”, has, to his discomfort, become the scapegoat. But even though I dare to disagree with him on some points, much of the criticism is highly unfair. Mr Greenspan remains the most successful central banker of modern times. More important, blame distracts from the challenge, which is to understand what happened, why it happened and what we should do.

As Mr Greenspan pointed out in his response to his critics in the Financial Times on Monday, the housing bubble was not unique to the US. On the contrary, as the background chapter on housing in the International Monetary Fund’s latest World Economic Outlook shows, US experience was far from exceptional. On the contrary, the biggest apparent overvaluations occurred in Ireland, the Netherlands and the UK.

The chart shows the proportionate increase in house prices between 1997 and 2007 that cannot be explained by the fundamental drivers: affordability (the lagged ratio of house prices to disposable incomes); growth in disposable incomes per head; interest rates (short- and long-term); credit growth; changes in equity prices; and changes in working-age population. Thus, the rises reveal the extent to which a country has experienced what seems to be a bubble. The US is in the middle ranks.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Martin Wolf 

You have enjoyed a debt-financed spending spree. But times are now harder: you find it impossible to roll over your debt; you have to pay much higher interest rates than before; or you find that the value of the assets you pledged as collateral is now less than your loan. What can you do? Provided enough of you are in trouble, you call for help from the fairy government-mother.

Thus, George Magnus of UBS, among the wisest analysts of this crisis, has already observed, with some approval, that the crisis “is spawning an array of well scripted but highly unconventional public policy responses” – that is to say, rescues of various kinds.*

Over-indebted individuals have just three choices: reduce spending below income, sell assets they own to somebody else or, if the worst comes to the worst, default. But one person’s debt is another person’s asset, one person’s expenditure is another person’s income; one person’s sale is another person’s purchase and one person’s default is another person’s loss.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Martin Wolf 

Remember Friday March 14 2008: it was the day the dream of global free- market capitalism died. For three decades we have moved towards market-driven financial systems. By its decision to rescue Bear Stearns, the Federal Reserve, the institution responsible for monetary policy in the US, chief protagonist of free-market capitalism, declared this era over. It showed in deeds its agreement with the remark by Joseph Ackermann, chief executive of Deutsche Bank, that “I no longer believe in the market’s self-healing power”. Deregulation has reached its limits.

Mine is not a judgment on whether the Fed was right to rescue Bear Stearns from bankruptcy. I do not know whether the risks justified the decisions not only to act as lender of last resort to an investment bank but to take credit risk on the Fed’s books. But the officials involved are serious people. They must have had reasons for their decisions. They can surely point to the dangers of the times – a crisis that Alan Greenspan, former chairman of the Federal Reserve, calls “the most wrenching since the end of the second world war” – and the role of Bear Stearns in these fragile markets.

Mine is more a judgment on the implications of the Fed’s decision. Put simply, Bear Stearns was deemed too systemically important to fail. This view was, it is true, reached in haste, at a time of crisis. But times of crisis are when new functions emerge, notably the practices associated with the lender-of-last-resort function of central banks, in the 19th century.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Martin Wolf 

Hardly a week goes by without the implosion of a hedge fund. Last week it was Carlyle Capital, with an astonishing $31 of debt for each dollar of equity. But we should not be surprised. These collapses are inherent in the hedge-fund model. It is even conceivable that this model will join securitised subprime mortgages on the scrap heap.

Getting away with producing adulterated milk is hard; getting away with an investment strategy that adds no value is not. That was the point made by John Kay, in a superb column last week (this page, March 11). With the “right” fee structure mediocre investment managers may become rich as they ensure that their investors cease to remain so.

Two distinguished academics, Dean Foster at the Wharton School of the University of Pennsylvania and Peyton Young of Oxford university and the Brookings Institution, explain the point beautifully*. They start by asking us to consider a rare event – that the stock market will fall by 20 per cent over the next 12 months, for example. They assume, too, that the options market prices this risk correctly, say at one in 10. An option costs $0.1 and pays out $1.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Martin Wolf

What am I bid on financial sector losses from the US subprime mortgage crisis? Do I have advances on the $100bn suggested by Ben Bernanke, chairman of the Federal Reserve, only last July? Yes, I now have $500bn from the gentlemen from Goldman Sachs. Any advances on $500bn? Yes, I have $1,000bn-$2,000bn from Nouriel Roubini of New York University’s Stern School of Business. Any advances? Going, going, gone.

It is easy to be cynical about this ascending auction of scary prognoses. But we cannot ignore them.

In “Why Washington’s rescue cannot end the crisis story” (this page, February 27) I analysed the implications of aggregate financial sector losses of $1,000bn. That figure was in line with estimates by Prof Roubini and George Magnus of UBS.
I concluded that even this would be manageable, if painful, for an economy as big and a government as creditworthy as that of the US. Prof Roubini objects that I have taken the downside too lightly. He now argues that financial losses might amount to $3,000bn.

The remainder of this column can be read here. Debate from our panel of economists appears below.

By Martin Wolf

Soaring commodity prices, rising headline inflation and weakening economic growth: for those whose memories stretch back to the 1970s, this combination brings painful memories. It reminds them of the mistakes made by the central banks that accommodated the upsurge in inflationary expectations rather than contained them. Inflation was finally brought back under control in the early 1980s. But the costs of letting it escape were huge. Could we be making the same mistakes again?

In the US, headline consumer price inflation was 4.3 per cent in the year to January. In the eurozone, it was 3.1 per cent in the year to December 2007. In both cases, there was a gap – in the case of the US, a huge gap – between the headline rate and the “core” rate, which strips out volatile prices of energy and food.

If this were a temporary deviation, one would ignore it. But it has been continuing for years, particularly in the US (see chart). A cynical observer might well conclude that the Federal Reserve threw caution to the wind years ago. That is what Arthur Burns, then Fed chairman, did in the early 1970s, under pressure from Richard Nixon, then president. Has that been happening again in recent years? The question is surely a fair one.

Continue reading Martin Wolf’s column here, and read comment from forum members and contributors below.