Table Of ContentTHE CRISIS OF CAPITALIST DEMOCRACY
THE CRISIS OF
CAPITALIST DEMOCRACY
Richard A. Posner
HARVARD UNIVERSITY PRESS
Cambridge,Massachusetts,andLondon,England 2010
Copyright©2010bythePresidentandFellowsofHarvardCollege
Allrightsreserved
PrintedintheUnitedStatesofAmerica
LibraryofCongressCataloging-in-PublicationData
Posner,RichardA.
Thecrisisofcapitalistdemocracy/RichardA.Posner.
p. cm.
Includesbibliographicalreferencesandindex.
ISBN978-0-674-05574-2(cloth:alk.paper)
1.Capitalism. 2.Democracy. 3.Financialcrises. I.Title.
HB501.P6462010
330.12'2—dc22 2009050929
CONTENTS
Introduction 1
PartI:AnAnalyticNarrativeoftheCrisis
1.TheCalmbeforetheStorm:2001–2006 13
2.TotheAbyss:December2007–September2008 40
3.TheSpectreoftheGreatDepression:
October2008–March2009 80
4.BottomingOut:Spring2009–Autumn2009 109
5.TheMovementforFinancialRegulatoryReform:
June–December2009 165
6.DepressionandAftershock:2007–? 210
PartII:WhatLessonsHaveWeLearnedfromtheCrisis?
7.TheFragilityofFinance 249
8.KeynesRedux 267
9.TheEconomicsofUncertainty 288
10.TheCrisisofMacroeconomics 305
PartIII:TheWayForward
11.ReformYouCanBelieveIn 335
12.AmericainaWorldEconomy 363
Index 389
INTRODUCTION
Atthiswriting,itismorethantwoyearssincethebeginningofa
recession that turned into a depression in the fall of 2008, fol-
lowing the financial crisis in mid-September of that year. The
financial circuits had become overloaded; the banking industry
collapsedlikethelightbulb,shatteredbyanelectricaloverload,
onthecoverofthisbook.Thefirstreallyfrighteninganddanger-
ouseconomiccrisissincetheGreatDepressionofthe1930s,this
depressionalreadyhashadprofoundeconomic,political,institu-
tional,andintellectualconsequences,andtheconsequencesmay
continuetobefeltformanyyearstocome.Iamemphaticinre-
garding the economic downturn as a “depression.” The issue is
morethansemantic,buttoexplainwhywouldtakeuptoomuch
spacehere;Ideferittochapter6.
IfirstanalyzedthecrisisinmybookAFailureofCapitalism:
TheCrisisof’08andtheDescentintoDepression(2009),which
took the story up to February 2, 2009. The title alarmed some
readers, who thought I meant that capitalism has failed us and
we need something different. That was not my intention. I be-
lieveincapitalism.Butcapitalismisnotasynonymforfreemar-
kets. It is the name given to a complex economic system with
many moving parts. The buying and selling and investing and
borrowingandotheractivitiescarriedoninprivatemarketsare
2 INTRODUCTION
onlysomeofthosemovingparts.Othersincludeasystemoflaws
forprotectingpropertyandfacilitatingtransactions,institutions
for enforcing those laws, and regulations designed to align pri-
vateincentiveswiththegoalofachievingwidespreadprosperity.
Iftheregulatoryframeworkisdefective,itmustbechanged,be-
cause competition will not permit businessmen to subordinate
profit maximization to concern for the welfare of society as a
whole,andethicscan’ttaketheplaceofregulation.
Oneofthekeyregulatoryinstitutionsisacentralbank,which
in the United States is the Federal Reserve. The component of
capitalism that consists of a private banking system is unstable
andcanfail,andifitfailscanbringdownmuchoftherestofthe
economy with it. That is one reason a capitalist system cannot
consistjustoffreemarkets.Acentralbankhasakeyroletoplay
inkeepinganation’sbankingsystemworking,asdothegovern-
ment agencies involved in the regulation of banking, which in-
clude the Federal Reserve; indeed it is the most powerful of the
bank regulatory agencies. A combination of unsound monetary
policy and regulatory inattention brought on the banking col-
lapseofSeptember2008.
The Federal Reserve was not created until 1913, and before
then central banking in the United States was intermittent. An
economic literature advocates returning to “free banking” (that
is, no government creation or regulation of the money supply).
Andareturntothegoldstandard,forwhichtherearemoread-
vocates,wouldcurtailthepoweroftheFederalReserve.Butreal-
istically there is no alternative to a modern central banking sys-
temastypifiedbytheFederalReserveSystem.
The inherent instability of a capitalist economy is a fact, not
a criticism. The average growth of the U.S. economy has long
beenabout3percentayear,whichisgoodandhasmadeusthe
world’swealthiestlargenation,aswellastheworld’smostpow-
erful nation. But the actual growth from year to year oscillates
aroundthattrendline—oftendippingintonegativeterritory—in
anirregular,unpredictablefashion.Thisoscillationisthe“busi-
INTRODUCTION 3
ness cycle,” though the word “cycle” is misleading because it
suggests a smooth wavelike motion, like a pendulum; the real
motionisanythingbut.
One reason for the oscillation, perhaps the main reason, is
feedback effects. There is an analogy to climate, another inher-
ently unstable system. Carbon dioxide in the atmosphere raises
surface temperatures by trapping heat radiated from the earth;
thehighertemperatures,amongtheirothereffects,melttheAlas-
kanandSiberianpermafrost,releasingmethane,another“green-
housegas,”whichleadstoafurtherincreaseinsurfacetempera-
tures. Similarly, an asset-price bubble can form and then burst
andinburstingtriggerarecessionthatcan feed on itself untilit
growsintoadepression:demandfalls,sooutputfalls,sounem-
ploymentrises,soincomesfall,sothereisafurtherreductionin
demand as a result of which output declines further and unem-
ployment rises further. Eventually, as inventories shrink and
durableswearoutandcashhoardingbybusinessesafraidtoin-
vest and consumers afraid to spend produces a savings glut,
spending will increase, and the downward spiral will stop and
then reverse. In either direction, feedback effects will amplify
whatinitiallymayhavebeenonlyasmallchangeineconomicbe-
havior.Thoseeffectscangetoutofhand.Theydidinthe1930s
andagaininthefallof2008andthewinterandspringof2009.
Topreventthemfromgettingoutofhandrequiresactiveandin-
telligentgovernment.Governmenthasbeenactivesincethecrash
of2008;howintelligentisanotherquestion.
February 2, 2009, did not end my interest in the crisis; nor
did the economy and government obligingly stand still. Since
thenIhavewrittenonthecrisisinmyblog(sponsoredbytheAt-
lantic Monthly) called “A Failure of Capitalism” (http://corres
pondents.theatlantic.com/richard_posner/), in my separate blog
withtheeconomistGaryBecker(“TheBecker-PosnerBlog,”re-
cently moved to http://uchicagolaw.typepad.com/beckerposner/,
formerlyatwww.becker-posner-blog.com/),andinthefollowing
publishedwritings:
Description:Following up on his timely and well-received book, A Failure of Capitalism, Richard Posner steps back to take a longer view of the continuing crisis of democratic capitalism as the American and world economies crawl gradually back from the depths to which they had fallen in the autumn of 2008 and th
