Ed Miliband’s summer reading

It’s summer holiday time in England, where the reading habits of the political class are making headlines.  British photographers caught a clearly dressed-to-decompress Ed Miliband, leader of the UK’s Labour Party, loading up the family sedan with books for a vacation in Devon, and to judge from his choices the opposition leader is a man of serious tastes.  Near the top of his stack, visible thanks to this handy enlargement courtesy of the Daily Mail, is Fault Lines, by Raghuram Rajan, the FT/Goldman Sachs Business Book of the Year Award-winning book published last year by Princeton University Press:

According to another article, from the Guardian, one of Miliband’s aides joked, “The picture only caught the light reading.  You should have seen the heavy stuff.”

(By way of comparison, on top of Prime Minister David Cameron’s summer reading list is the novel Skippy Dies, described as “a comic account of life at a Dublin Catholic public school.”)

No doubt Fault Lines central theme—that inequality, both domestically and internationally, is at the root of our ongoing financial crisis—will resonate with the Labour Party leader.  But had he waited another month, Miliband could have picked up the paperback of Rajan’s book, with a new afterword by the author, and lightened his load a little!

It’s the End of the World as We Know It, and I Feel Fine…

Seth Ditchik, Economics Editor, puts the current financial crisis in perspective with 4 quick lessons gleaned from Princeton University Press’s impressive, and remarkably prescient, roster of economics titles.

Hey Kids! Enjoying the rollercoaster yet? It’s been a rocky road so far, and if history is any guide, there’s still a few stomach-turning churns left in the ride. As I tell anyone who asks, I’m not an economist, but I play one at the office; having spent a good chunk of my adult life talking to (some might say stalking) economists, though, I’ve picked up a few pointers as to how they think, and why it matters.

One thing I’ve learned is to take the long view; trying to predict for the short term is often a fool’s errand. (Of course, it was an economist who made the point that “in the long run, we’re all dead.”) Not surprisingly (says the editor), there are a few books that my esteemed employer has published which have some lessons to impart on our current economic crisis; allow me to drop some knowledge on you, Princeton-style.

Lesson #1: We’ve Been Here Before

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Before becoming The Most Powerful Man in the Known Universe, the Federal Reserve Chairman Ben Bernanke was a well-respected Princeton economist, where he was noted for his work on the Great Depression, a subject on which he published a book of essays with Princeton UP. If there’s one person in the government today that has a firm grasp on what makes economies tank, it’s Bernanke, and most mainstream economists will tell you that he’s the best person for the job at this crucial juncture in history. Though the origins of the Great Depression are still debated among economists, Milton Friedman and Anna Schwartz placed the blame squarely at the Federal Reserve’s feet, arguing that it did too little, too late. Bernanke, in comments reprinted in our recent edition of Friedman and Schwartz’s landmark book The Great Contraction, spoke of the enduring influence of this point of view on the current Fed: “Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

The good news is that Bernanke knows how to avoid the last Great Depression. The question is whether he can avoid the next one.

Of course, aggressive action by the government to intervene in American markets is by no means a new phenomenon; in 1914, then Treasury Secretary William Gibbs McAdoo shut down Wall Street for more than four months to deal with a monetary crisis at the outbreak of World War I. The tale is told in William Silber’s book When Washington Shut Down Wall Street; McAdoo’s actions averted a broader meltdown, nursed the Federal Reserve into existence, and launched America as a world monetary power for the 20th century. Not bad for a few month’s work! His recipe for stopping a crisis while minimizing collateral damage makes me hope that our current Treasury Secretary Hank Paulson has read it.

Lesson #2: Don’t Throw the Baby Out With the Bathwater

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You’re going to hear a lot about derivatives in the coming months. These very complicated financial instruments—which Warren Buffet termed “weapons of mass financial destruction”—will be blamed for much of the mess we find ourselves in; they also kicked your sister and stole your car keys along the way, to judge from the tone of rhetoric on the subject. But blaming derivatives for our troubles is a little like blaming the gun for a stick-up (idea for bumper sticker: “Derivatives don’t kill economies, people kill economies.” Too dorky?). Derivatives are neutral parties, equally capable of financing innovation and improving lives as they are at sowing the seeds for financial ruin.

Robert Shiller’s The Subprime Solution is getting a lot of interest these days, for obvious reasons; but my favorite book of his is The New Financial Order. In this visionary book, Shiller set out a number of ways in which derivatives could be harnessed to help ordinary people manage the everyday risks in their financial lives. He describes insurance policies, structured around derivatives, that would help cushion the impact of housing-price declines or periods of unemployment. One wonders whether our economy would be in its present state of free-fall were these sorts of policies widely available.

Many mainstream economists will argue that our current financial woes were brought about, in part, by too little financial regulation; but in the rush to re-regulate, we may risk stifling the very engines of innovation that have been the drivers of economic growth. Raghuram Rajan and Luigi Zingales’ prescient book Saving Capitalism from the Capitalists provides a compelling case for the middle ground: “…creative destruction, sustained by free markets, is the elixir that has let the free enterprise system flourish for so many years. Yet the disruptions that creative destruction spawns sometimes prove too big for a free society to survive without a safety net. Markets need to be preserved against their biggest enemy: Themselves.” The take-home message: let the bulls run on Wall Street, and catch those who are thrown off so they’re not too scarred to ride again.

Lesson #3: Beware of “Expert” Opinions

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Part of what landed us in our current mess is that we came to rely too heavily on increasingly quantitative models; what was meant for prediction became to be accepted as the gospel truth. Our models suggest that the market can’t fall by 40%; therefore, it won’t. Overconfidence in the power of numbers came to replace genuine decision-making. Riccardo Rebonato makes this point in Plight of the Fortune Tellers, which draws from his own experience in the financial industry. When we depend on models to manage risk, we miss that which can’t be computed—how human beings actually react to chance.

As the center of financial power shifts from Wall Street to Washington, we also need to be on the lookout for expert political judgment which is more “political” than “expert”. Philip Tetlock examines what makes for successful forecasting in the political sphere in Expert Political Judgment, using Isaiah Berlin’s fox and hedgehog as prototypes. Tetlock shows how the fox—an eclectic thinker who draws from a wide array of traditions, and is better equipped to improvise in response to changing events—is generally more successful than the hedgehog, who believes one thing, and lowers his head and barrels in that general direction no matter what the issue. Unfortunately, the media generally selects for the hedgehog, who plays better in head-to-head combat on television and in print by applying one solution to all problems (Budget surplus? Time for a tax cut! Budget deficit? You need a tax cut!).

Lesson #4: Depressed? Read Something Else

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All of this reading about financial ruin can’t possibly be good for you. Can I interest you in a nice murder-mystery? Marshall Jevons (actually the pseudonym for two economics professors, Kenneth Elzinga and William Breit) wrote two charming novels (actually three, but we don’t publish the third) about a Harvard professor and amateur sleuth who uses—you guessed it—economic reasoning to solve the murders he invariably happens upon. In the end, wisdom always prevails, and the truth is uncovered (I would have gotten away with it, too, if it weren’t for you meddling professors!), usually in exotic locales.

Russell Roberts described his new book The Price of Everything to me as Tuesdays with Morrie meets The Wealth of Nations, which is a pretty good summary of the book. Ramon, an idealistic Stanford undergraduate, gets involved with a campus protest against a big box store (and large university donor) after it temporarily doubles prices on the night an earthquake hits town. Ramon—also a superstar tennis prodigy (think John McEnroe) and a speaker at his upcoming commencement—gets involved in an ongoing conversation with the Provost (and former economics professor) Ruth, who has taken a curious interest in him. Along the way, he come to learn about the hidden order of economics that surrounds and sustains us. Is she trying to co-opt him, to avoid embarrassing the university in the eyes of an important donor? Or does she have something more profound in mind? It’s an uplifting story, and I’d like to think a beacon of hope in our troubled financial waters.