Interview with Nobel Prize laureate in economics Vernon L. Smith


Vernon SmithKourosh Ziabari – Tehran Times: Prof. Vernon L. Smith believes that economic sanctions cannot contribute to furthering the objectives of the mankind and simply throttle trade and human economic betterment.

According to the prominent American economist, dynamic and massive trade with other countries is an advantage, but inevitably leads to indebtedness and entails its own difficulties.

“Trade increases specialization and growth in income, most dramatically in countries with lower wages and material costs; their exports rise faster than their imports; their surplus foreign currency earnings are invested in these foreign countries. Chinese dollars earned from net exports are returned to the U.S. as capital inflows, used to buy not only U.S. Treasury bonds but also U.S. homes,” said Prof. Smith in an exclusive interview with Tehran Times.

Drawing a comparison between the two major economic policies that rule the world, Vernon Smith said that socialism cannot provide sufficient responses to the questions of the contemporary global economy.

“Socialism simply cannot deliver the goods. Over the world the more free an economy the higher their output, and the reduction in poverty. Nothing could be more important than reducing poverty and this is best achieved by expanding freedom,” he noted.

Vernon L. Smith is a professor of economics at Chapman University’s Argyros School of Business and Economics and School of Law in Orange, California and a research scholar at George Mason University’s Interdisciplinary Center for Economic Science. In 2002, he was honored to be awarded the Nobel Memorial Prize in Economic Sciences.

Prof. Smith is the author of several books and has worked with numerous academic and research institutes across the world.

Tehran Times has conducted an exclusive interview with Prof. Smith and asked him questions regarding the housing market crisis in the United States, the 2008-2012 financial and debt crisis in Europe, boom and crash bubble in the Wall Street and the prospects of American economy. What follows is the text of the interview.

Q: Prof. Smith; let’s start with the economic crisis in Europe. As you noted in one of your interviews, the strong EU countries are “footing the bill” for the profligate countries, and bailout plans are being proposed to help such crisis-hit countries as Greece and Spain get out of the current dilemma. However, there are powers, like Germany, which are opposed to the distribution of more cash between these countries. Would you please give us an overview of what the future looks like for the Eurozone? Are the bailout plans going to help these countries overcome the crisis?

A: I think it will give only short-term relief by protecting incumbent investors from default on public debt and private investment holdings. Current claims on assets have to be brought into line with the current market value of the assets so that any new capital can flow into new activities and receive thereturn on those new investments undiluted by the claims of past investors whose investments have de facto failed, but not allowed to be recognized. If Greece and Spain had been on their own currencies, market depreciation would have restored the balance, but that does not mean they should go off the Euro which I believe has brought more political stability. It means it is now more important for them to control their excesses.

Q: You’ve extensively written on the boom and crash bubble in the Wall Street. Based on your experimental studies, why do you think this crisis has taken place in the stock market in the United States? You had once referred to the oil price hikes as a possible reason. How could the sudden increase in the oil market contribute to the fluctuations in the Wall Street? Do you consider the political factors as having an influence on the decline of the Wall Street?

A: Oil price effects are only indirect: import expenditures rise, foreign capital inflows increase into the U.S. and that capital helps to feed the housing-mortgage market boom. The crisis was in the housing-mortgage markets, not the stock market boom and crash; the latter followed the decline in the economy and was the result of the housing price decline against fixed long term mortgage debt that negatively impacts the equity of households and their banks holding the mortgage debt. Whenever stock markets crash, margin debt is called, speculative investors take their lumps; margin debt is marked to the market and balance sheets are cleaned up as you go along. There is no negative net equity to freeze up the economy, as with housing and banking.

Q: I learned that you experiment market declines and other economic phenomena in laboratory through practical experiments. For example, Jerry E. Bishop once wrote in the Wall Street Journal in 1987 that you studied the booms and crashes in a series of 60 experiments. Would you please talk about the methods, instruments and applications you use for your experiments? Why have you turned to experimental economics to find the answer for such questions?

A: We have learned that the essential driver of asset bubbles is the inflow of new funds, cash or borrowings; without these, asset value hugs closer to fundamental value. In housing markets that translates into house prices tracking changes in income and house rents.

Q: One of the issues that emerged following the U.S. housing bubble in 2006 and 2007 was the collapsing of the subprime mortgage industry. Such subprime lenders as New Century Financial experienced enormous setbacks and it was reported that its stock plunged 84% and it was consequently forced to declare Chapter 11 bankruptcy. What are the underlying reasons for the downfall of the subprime mortgage industry? Is it going to regain its previous status in the States?

A: The bankruptcy process is necessary to restore stability. Everybody understands that the housing bubble was the result of excessive stimulus—if that was the problem; the solution cannot be more stimuli! Sub-primes collapsed because housing prices collapsed. I do not think sub-primes will regain their previous status; if I am wrong and they do, we are indeed due for regaining that source of trouble.

Q: In a 2010 article for The Daily Beast, you listed the U.S. states in which the majority of homeowners owe the banks more than their homes are worth. You said that the crisis was brought on by the governmental and private programs designed to make it easier for people to buy homes, the result of which was an unsustainable housing bubble. In what ways have these programs exacerbated the conditions of the housing sector? Why have they decreased the American people’s ability to buy homes? Is homelessness as a result of frequent foreclosures now a prevalent phenomenon in the United States, the world’s uncontested economic superpower?

A: New home construction far outran the growth in household earnings and could not be sustained. Many of the foreclosed homes are being bought by cash investors to rent, or in hopes of a further rise in prices, or both. Stability requires us to return to new home construction that tracks growth in household income.

Q: Data released by the BEA show that more than 70% of the U.S. GDP is for personal consumption. In 2012, $11.119 trillion of the total $15.685 trillion produced went toward household purchases. Is this figure alarming for the American society to revise its consumption pattern? It was reported that $2.564 trillion was consumed for non-durable goods in the year 2012. What’s your assessment of these figures? Do you consider this consumerist trend a disadvantage for the United States?

A: About 75% of private product – GDP less governmental expenditure, has long been consumed annually in the form of nondurable goods and services. That is a source of great stability. Instability comes from the other 25%, mostly housing, sometimes augmented by consumer durables, rarely by firm’s investment in plant and equipment.

Q: When we look at the list of the world countries by external debt, we realize that the top 20 countries are the ones which have the most dynamic and vivacious economies with the highest GDP rates among the world countries. Is it that extensive trade with different countries and international organizations naturally leads into an increase in the external debt? There are countries on this list which have a high volume of bilateral and multilateral trade with their partners, but are not indebted countries. How do you explain it?

A: Trade increases specialization and growth in income, most dramatically in countries with lower wages and material costs; their exports rise faster than their imports; their surplus foreign currency earnings are invested in these foreign countries. Chinese dollars earned from net exports are returned to the U.S. as capital inflows, used to buy not only U.S. Treasury bonds but also U.S. homes. My colleague just sold his D.C. area condo to a Chinese national.

Q: What’s your viewpoint regarding the fluctuations of the gold market? I don’t know for the United States, but in my country, many people from the medium-income families consider gold as a capital and a short-term investment, and try to buy jewelry and gold to sell it in times of need, especially when the price of gold goes up. Why is it that the price of gold rises when the dollar declines?

A: I do not follow the gold market, but I would suggest that people are simply getting out of depreciating money to get into more stable money. Selling dollars to buy gold itself reduces the value of the dollar and increases the value of gold.

Q: Do you consider the 2008-2012 financial crisis in Europe and the United States an economic depression? It resembled some aspects of the Great Depression which preceded the World War II and took place between 1929 and 1941, such as a recession lasting for 2 years, a decline in the GDP, abnormal large increases in unemployment, large number of bankruptcies, etc. what’s your viewpoint on that?

A: We avoided outright depression, but now suffer from low growth. The decline was less steep than in the Great Depression, but we have been stuck in a low growth rut. Likely, when in time we start to recover strongly, we will have inflation.

Q: Do you think that the economic crisis in the West could be resolved through adopting monetary policies? What kind of monetary policy would be more appropriate for the United States and Europe; an expansionary policy or a contractionary policy?

A: Monetary policy has involved cyclical interaction with the housing-mortgage market: low interest rates eventually restore housing demand, the economy expands, inflation takes off, interest rates rise, housing is reined in and the economy turns. This pattern is unlikely to change soon. A central banker who sees the boom coming and puts on the brakes early will be seen as acting contrary to the public interest. People live in the present. Politicians are elected based on current conditions and popular thinking. Here is a mental experiment to allow you to see the problem: Imagine Ben Bernanke tightening money in 2004-5, ahead of the collapse, 2007-9, to restrain the housing boom. If the recession had come earlier and been less severe than the Great Recession, how can he prove that what he did was better than the alternative? Likely he would have been relieved of his job, as having caused the collapse!

Q: To evaluate capitalism and socialism, which of these economic systems do you think can lead to more self-sufficiency in production, competitive markets and greater benefits? You may admit that both systems face certain threats and are subject to challenges. So, which of them can be more resistant and powerful in the face of crises and threats which emerge ahead of them?

A: Socialism simply cannot deliver the goods. Over the world the more free an economy the higher their output, and the reduction in poverty. Nothing could be more important than reducing poverty and this is best achieved by expanding freedom. China, by liberalizing its export markets is growing and enabling more of its people to prosper, but internally they have a long way to go in expanding freedom in economic choice and in civil liberties.

I was a socialist as a teenager and young adult. So: “When I was a child, I spoke as a child, I understood as a child, I thought as a child: but when I became a man, I put away childish things.”

Q: Iran has been under a huge amount of economic sanctions by the United States, EU member states and other individual countries over its nuclear program for a period of 10 years. Have you observed cases that such sanctions could lead to the depreciation of the national currency and result in hyperinflation and economic stagnation? How is it possible to tackle the ensuing consequences of the sanctions in economic terms, aside from political negotiations and diplomatic efforts?

A: I am opposed to sanctions; it throttles trade and human economic betterment. I wish only more freedom for the Iranian people. How we can get there from here I cannot say, but sanctions will not serve to achieve it.

Q: You’ve been awarded the Nobel Memorial Prize in Economic Sciences, which is almost the most prestigious award that an economist can receive. What’s your viewpoint about this award and the publicity opportunities it gives to the economists? How has your life changed after you were awarded the prize?

A: Much ado over what I was doing and wanted to do anyway. It has not changed what I do in research and teaching. People who campaign for it know not what they do. I have tried to keep it from spoiling me. More than anything I do not want the world to change me.

This interview was originally published by the Tehran Times international daily.