Would you like some bananas with your politics?

Interfluidity today passes along what has become one of my favorite Keynes quotes: I love the way this forces you to twist your perspective on the Roaring Twenties, the ensuing Depression, and, by implication, the massive stimulus project the Nazis undertook.

It seems an extraordinary imbecility that this wonderful outburst of productive energy [over 1924–29] should be the prelude to impoverishment and depression. Some austere and puritanical souls regard it both as an inevitable and a desirable nemesis on so much overexpansion, as they call it; a nemesis on man's speculative spirit. It would, they feel, be a victory for the mammon of unrighteousness if so much prosperity was not subsequently balanced by universal bankruptcy. We need, they say, what they politely call a 'prolonged liquidation' to put us right. The liquidation, they tell us, is not yet complete. But in time it will be. And when sufficient time has elapsed for the completion of the liquidation, all will be well with us again.

I do not take this view. I find the explanantion of the current business losses, of the reduction in output, and of the unemployment which necessarily ensues on this not in the high level of investment which was proceeding up to the spring of 1929, but in the subsequent cessation of this investment. I see no hope of a recovery except in a revival of the high level of investment. And I do not understand how universal bankruptcy can do any good or bring us nearer to prosperity…

He goes on to point out that the same cannot be said of the idiotic investments we made in our last boom period -- a 3,000 sq.ft. house with two SUVs in the garage is about the least productive investment I can think of.  If we extend our definition of the "boom" in the most recent cycle to include the internet bubble, the case is less clear, but at any rate his point is well taken.  We've malunderinvested in a lot of useless crap, as Bush might have put it.

Was this because of some grand failure of the free market though?  It seems to me that this was principally a failure of our political system.  He addresses this question, though only tangentially:

In theory, we have two overlapping systems, a financial system and a political system, whose shared purpose is to make information-dense decisions about how best to use or conserve our resources. It's not clear how we should make these decisions when both systems seem badly broken.

So, yes, let's be clear.  Both systems are broken.  But I think you miss something fundamental if you don't see how the problems are connected.  Finance is broke in large part because politics was already broken.  I mean this in two ways. 

First, on a practical level, the government simply reneged on its duty to regulate the market.  In the end anyone with a deep belief in the market as tool (as opposed to a fundamentalist faith in the market as a dogma) still can see that it's the job of politics to set up the rules of the game so that when the financiers and entrepreneurs compete for the spoils, they actually provide a benefit to other folks as well.  Politics designs, and finance executes. 

Second, if politics disdains design, finance will execute us right into oblivion.  The market, as machine, runs on its own logic of profit maximization.  If politics is broken enough to allow for its own purchase as a viable business strategy, it will, inevitably, be bought.  I'm sure loyal readers who hear me say "feedback loop" one more time will reach for their revolvers, so I will shift gears a bit ... 

Does this observation mean that economics or politics is more fundamental?  It seems clear that the answer should be politics.  An equilibrium tending free economic market governed by an invisible hand is actually a very special type of political game.  Economics is a sub-discipline of politics.  Not to be outdone, Interfluidity knows this as well.

Shlieffer and Vishny's famous coinage, "the limits of arbitrage" is not strong enough, because it suggests that efficient arbitrage is the norm subject to some exceptions and limitations. It is more accurate to view efficient arbitrage as the unusual special case, in bond markets as well as in equity markets.

I would extend this logic further, however, and say not only that the actual market works according to theory only on occasion and almost by accident, but that it's almost accidental that we even occasionally have a market to begin with.  We take democracy and markets for granted because we have seen a few rare examples of them, and because the idea is so pretty and easy to theorize about.  Unfortunately, the real world -- whether political or economic -- only teases us with an intermittent tractability.  This is actually true of every science we attempt, though it's obviously much worse if you're trying to invent a science of economics or politics.  In fact, I feel like this logic applies to whole bunch of problems, from the definitions of life and consciousness all the way to our efficient market theory and maybe even our basic philosophical assumption that stability is somehow more fundamental than change.  We pattern seeking monkeys are experts at making a general rule out of a tiny special case.

Kinda reminds me of the old math joke: "Classification of mathematical problems as linear and nonlinear is like classification of the Universe as bananas and non-bananas".