The transformation of capitalism

Capitalism is like an computer operating system for mankind that evolves as the society changes.

Capitalism 1.0 was the start, beginning with Adam Smith and the Declaration of Independence. Smith's famous 'invincible hand' meant economics and democratic politics are utterly separate and politicians didn't meddle much, because that wasn't their role.

Capitalism 2.0 took over during the Great Depression with the New Deal and the widespread abandonment of gold. The John Maynard Keynes-cum-FDR stage now got the politicians involved because they believed only the state, its elected leaders and their academic advisers, could provide the conditions for business recovery.

1979 till 2008 was the period of Capitalism 3.0 when Mrs Thatcher and Ronald Reagan came to lead, after a period of economic stagnation. Politicians now skipped to the sidelines, and the much of the public sector was privatised and leaving monetarism and market forces to do the job. After the oil crisis in 1979, global GDP growth took off as oil prices drop, helping both inflation & interest rates to come off from double digit levels. The world economy “never had it so good” when it comes to growth rates

Capitalism 4.0 began with “The econonomic consequences of Mr Paulson in 2008”. Here, Mr Kaletsky attacks Hank Paulson for almost destroying the global financial system. He claims that by nationalizing Fannie Mae and Freddie Mac and letting private shareholders evaporate Paulson effectively made it impossible for investors to buy shares in financial institutions. Hank Paulson for almost destroying the global financial system. He claims that by nationalizing Fannie Mae and Freddie Mac and letting private shareholders evaporate Paulson effectively made it impossible for investors to buy shares in financial institutions. Speculators selling short financial firm stocks then took over and brought the system to the point where Lehman collapsed and a bank-run of institutional investors set in, demanding their money back from other financial intermediators. Since Paulson did not want to use government powers (money) to bail out these institutions, the credit markets froze. Free market fundamentalism almost brought down the global economy, and that only when the British showed to the US what must be done with the TARP money the US was able to return markets to more tranquil waters.

Now in version 4.0, we must all be more pragmatic, more watchful, more engaged, less didactic, less blinkered, less wedded to theories that can't always work. Along this path, there is no set of laws, no neat package of theories, that can do the job for us. Success in key stage 4.0 demands brains constantly engaged, logic relentlessly applied. Financial markets are likely to be a lot more volatile and growth could come in spurts.

What is happening at the euro zone?

Why the current account mattered in the case of first private sector, then sovereign debt crisis. The answer goes something like this. A country that has its own currency is not really in risk of sovereign default. It can “print” its currency to pay off debt, which will worsen the exchange rate but solve the debt problem. Creditors get their money back, but bear the whole exchange rate risk. Also, the public sector can bail out the private sector to full extent if a real estate boom has caused hundreds of billions of loans to turn sour/toxic. Now, the euro zone is a different beast.

In the euro zone, countries cannot “print” their own money. Their debt is nominated in euros, which is equivalent to a foreign currency. In order to bail-out the financial sector sovereign debt has to be emitted in foreign currency and cannot be absorbed by domestic central bank operations. Of course, the ECB can act as a lender of last resort and give liquid funds for financial assets that are “distressed” – there is no buyer at all, or not enough buyers, or the price is too low, or all of these. In order to help the economy repay euro-denominated (foreign) debts, a positive current account would be important to secure an inflows of euros above what is needed to pay the import bill. That is why, in short, the current account matters in the euro zone’s indebted nations.

If the ECB would guarantee to provide (unlimited) funding for all euro zone governments, the financial troubles would go away.