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Ask Dr. Reddy

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CAMBRIDGE -- Attending this founding conference of the George Soros-funded Institute for New Economic Thinking, at Kings College, Cambridge, one appreciates how much the Obama Adminstration could learn from thoughtful foreign observers of the financial crisis, who are far ahead of American thinking. Take the case of Dr. Yaga Reddy, the former Governor of the Bank of India, who addressed the meeting.

India had no financial crisis. Its high rate of economic growth continued unabated. Why? Because Reddy, over the objections of Western bankers, International Monetary Fund kibitzing, and kindred local banking pressures, simply did not allow the Indian banking system to engage in Wall Street-style speculation.

I first met Reddy at a U.N. conference in 2008 just as the financial meltdown was going critical. I asked him how India had managed to dodge the bullet. "We are a poor developing nation," Dr. Reddy said puckishly. "We don't really understand these securities, so we don't permit our banks to use them. We leave them to the advanced nations like you."

How did Reddy manage that trick? First, banks that wanted to issue complex securities were required to hold capital reserves against them. That requirement shut down the game of bank-sponsored gambling that crashed the American system. Second, as Reddy told me Saturday, the Indian central bank didn't just rein in banks. It also regulated other financial players.

For example, if a financial services company wanted to issue securities against car loans, or credit cards, Reddy also required them to post reserves. So none of the extreme leverage that afflicted the US financial system infected India. The Indian bankers who condemned him earlier in the last decade for denying them profits are now praising Reddy as a prophet.

I asked Reddy if he anyone in Washington was seeking his counsel. "No," he said. "If they want to ask me, I am in Hyderabad."

Well, we are asking. Later this spring, Steve Clemons of the New America Foundation and I on behalf of Demos will be sponsoring a U.S. visit by Dr. Reddy. Hopefully, our leaders will find time to meet with him. Nothing in the pending Dodd legislation on financial reform comes close to the prevention that the Indian central bank under Reddy's leadership was able to devise.

Another source of foreign wisdom who the Administration should be listening to is Richard Koo. Like Reddy, Koo is hardly a radical. His current job is chief economist of the Nomura Research Institute, the think-tank of the giant Japanese securities firm, Nomura. Earlier in his career, Koo was an economist with the Federal Reserve Bank of New York.

Koo's message to the conference was simple. Learn from Japan's mistakes and its belated recovery. Specifically, the United States would be making a disastrous error if we cut deficits too soon. If anything, we should be increasing deficits, to get create more jobs and get a real recovery going.

Basically, he said, in a deflationary financial collapse such as this one, there are two paths to solvency. You can reduce deficits, slow down economic growth, and balance your budget at a much-reduced level of economic output. Or, you can restore growth by relying on more government spending in the short run, and let improved economic performance and higher tax receipts lead you back to budget balance.

This should be a no-brainer, politically as well as economically. But most of the solons in Washington are opting for austerity and pain. Dr. Koo, who is based in Tokyo, is also coming to Washington later this spring, and members of the new fiscal commission, as well as senior administration and Congressional officials, would be wise to spend some time with him. His views can be read in more detail in his book, "The Holy Grail of Macroeconomics - Lessons from Japan's Great Recession" (John Wiley & Sons, 2008).

A third star of this event was Lord Adair Turner, head of Britain's Financial Services Authority. Turner was speaking off the record, but his other speeches and articles make clear that he takes a far more interventionist view of how to crack down on financial abuses than his American counterparts. Turner is friendly to much tighter controls on derivatives, a tax on financial transactions, coordinated international regulation, and he worries about whether the current remedies under consideration are sufficiently radical.

Britain's independent FSA is a good advertisement for reducing, rather than increasing, the powers of the Federal Reserve as proposed in Senator Dodd's financial "reform" bill.

And if the Tories win Britain's May 6th general election, Turner will likely be out of a job, since the Tory plan is to shut down most of the FSA and move its regulatory powers back to the Bank of England.

The takeaway from this summit conference of the world's most prestigious dissenting economists (including three Nobel laureates) is that (1) this financial crisis is not over; (2) if present legislative plans are the best that we can do, the pattern of bubble and bail will repeat itself; (3) only a political counterrevolution that leashes the power of Wall Street will enable the necessary reforms to proceed; and (4) mainstream economics has only begun to atone for its own complicity in legitimizing the financial bubble. Much of the conference can be viewed online.

Kings College was of course the home of John Maynard Keynes. Some of the sessions were held in the Keynes Lecture Theatre, and several of the speakers had studied with associates of Keynes.

One of the closing presenters was John Eatwell, master of Queens College, and a leading British Keynesian. Listening to Eatwell, I was reminded of a charming moment in late 1992, when Soros was scheduled to give a lecture at Cambridge. His host was Eatwell; Tory John Major was Prime Minister; only weeks earlier the British pound had crashed after the government had haplessly spent over a billion pounds in money markets trying to support the currency's value, and many blamed the crash on Soros's huge bets against the pound (which in fact suffered from more fundamental over-valuation.)

Eatwell began, "Ladies and gentlemen, this is the man who cost Her Majesty's Government a billion pounds." The audience gasped at the rudeness, Soros blanched, and Eatwell quickly added, "And the only thing I can say in his defense is that he will spend the money far better than Her Majesty's government would have."

Soros did -- and never more effectively than his latest $50 million dollar gift to underwrite a new economics.

Robert Kuttner is co-editor of The American Prospect, a senior fellow of Demos, and author of the new book, A Presidency in Peril