September 16, 2015

Bound to crash

Comment on Steve Keen on ‘Why China had to crash: Part 2’

Blog-Reference

Because Orthodoxy is a scientific failure it is, indeed, an intuitively promising approach to start from the exact opposite assumptions.

Roughly speaking, you have shown that leverage, or more precisely debt acceleration, is the ultimate cause of the boom/crash of the Chinese stock market. This is equally true for the subprime meltdown in 2008 and for the crash in 1929.*

The general conclusion is that markets do not work as the textbook story suggests and that the supply-demand-equilibrium paradigm is empirically refuted for the financial markets.

The pervasive boom/crash phenomenon tells us that the institutional framework and in particular the monetary order in the U.S. is fundamentally flawed. The conclusion for China and other countries is to identify the defect and to come up with a superior institutional framework.

Until now China has mainly adopted the U.S. financial market blueprint. Therefore, it does not come as a surprise that she crashes against the wall just like the U.S. did on several occasions since 1929.

Rethinking the actual stock market crash China first of all has to ask herself (i) whether she needs a stock market in the first place, and if so (ii), whether her stock market should institutionalize the possibility of leverage.

The U.S. are not very talented at institution building. The Wall St/Fed configuration is not a success story. If China wants to overtake the U.S. she has to create a superior institutional framework.

In a sense Modigliani-Miller was right: ultimately it is a matter of indifference whether a firm is financed by equity or debt. And if equity is not needed the stock market is not needed.

What China urgently needs is the correct economic theory. Financial crashes and persistent unemployment are the empirical mirror images of false monetary and employment theories. Standard economics has scientifically crashed, that is, China needs a superior approach. Can Heterodoxy deliver?

Egmont Kakarot-Handtke


* See ‘Mathematical Proof of the Breakdown of Capitalism