Tag Archives: financial crisis

Living on the never never

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I’ve been looking through an interesting book by UBS economist Paul Donovan and Julie Hudson, [amazon_link id=”1849714142″ target=”_blank” ]From Red to Green: How the financial credit crunch could bankrupt the environment[/amazon_link]. It starts with the simple point that people were relying on credit in two ways, using both financial and environmental resources for current rather than future consumption. In some cases the credit-financed consumer boom before the crisis accelerated the consumption of environmental resources, and in other cases had positive environmental benefits. More consumption clearly uses more of some materials and more energy; but has also encouraged investment in additional infrastructure (to use water more efficiently, for example) or innovation. In either case it’s important to note that the two are related, when thinking about what the crunch after the crisis implies for financial and environmental sustainability.

[amazon_image id=”1849714142″ link=”true” target=”_blank” size=”medium” ]From Red to Green?: How the Financial Credit Crunch Could Bankrupt the Environment[/amazon_image]

The bulk of the book looks in detail at different issues to explore the interactions between red and green credit. For example, a chapter on food discusses what actions could increase agricultural productivity while protecting biodiversity and soil quality, how the credit crunch is affecting the outlook, and also what changes in behaviour might be desirable . So declining real incomes could lead to reduced consumption of meat and less food waste, but these depend on changed consumer habits and changed practices in the food retailing business. On the other hand, there is less funding for R&D in agriculture and food production – unless the corporate sector concludes that it needs to do more to limit its exposure to supply chain risks like the horse meat scandal. Other chapters look at water, energy, infrastructure, housing, human health, and consumer goods.

The detail is all fascinating, and the book obviously covers a wide territory. It seems to offer a very practical and fruitful approach to turning the crisis to some longer term benefit by getting people to focus on specific actions to reduce the economy’s reliance on financial credit and at the same time economise on natural resource use and preserve natural assets. Ever since writing [amazon_link id=”B00GP1RV0U” target=”_blank” ]The Economics of Enough[/amazon_link] a few years ago I’ve been obsessed with the chronic short-termism of modern economies. So a book about what people can do right now to safeguard future living standards – written by a City economist too – was bound to appeal to me. Any investors who are genuinely interested in long-term returns rather than quarterly results will find it very interesting. However, although the advice in [amazon_link id=”1849714142″ target=”_blank” ]From Red to Green[/amazon_link] is practical and specific, it does highlight how much needs to be done by many people to lengthen the economic time horizon.

A call for stubborn unreasonableness

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[amazon_link id=”0691155240″ target=”_blank” ]Fragile by Design: The Political Origins of Banking Crises and Scarce Credit[/amazon_link] by Charles Calomiris and Stephen Haber is a fascinating exploration of the relationship between banking and politics, and raises some important questions. The bulk of the book is a series of historical narratives looking at the banking history of several countries – the US, UK, Canada, Mexico and Brazil. These histories are seen through the prism of the tight connection between finance and politics, in what the authors call the Game of Bank Bargains.

They argue that banking is inherently political because it is by design potentially unstable – pooling the money of many individuals to make loans to other people –  and depends on the enforcement of certain property rights by legal and political authorities to navigate the conflicting incentives. Three property rights challenges follow: the need for mechanisms to reduce the risk of government appropriation of banks’ assets (either outright, or through regulation, or by printing fiat money); mechanisms to protect depositors and shareholders from the banks’ managers channeling resources to themselves; and mechanisms to prevent borrowers from defaulting. Stability requires finding a balance between the conflicts of interest. It is rare – Canada is the exceptional case, having experienced no systemic crises since 1840 in contrast with the dozen in the US. Populist democracies and more autocratic governments make different types of political deal but both fail to balance the competing interests. Achieving a stable democracy with robust defences against populism is clearly a tricky tightrope act.

The historical narratives are very interesting and do underline the importance of the political context in shaping the banking system. As the final chapter points out, the narrative explanations do offer insights that general theoretical explanations of the financial crisis can not. The general theories fall into one of three categories: inherent structural mismatch of funds and the resulting liquidity risk; inter-connections between banks that give rise to spillovers and domino effects when one bank is in trouble; and the inherent operation of human nature with periods of over-optimism and myopia alternating with pessimism and retrenchment (the Kindleberger and Minsky version). What no general theory can do is explain the contrasting historical paths of the different countries. “The decisive influences determining whether the threats highlighted by these three theories will result in banking crises are political…. The extent of safety nets and prudential regulation are choices made by politicians, and in making those choices they are generally motivated by maximizing what is good for their own short-run political futures, not what is socially desirable in the long run.”

This seems completely persuasive to me. One gap in the book, however, is the part played by the globalization of finance and how that is related to the combination of national politics and international agreement. The historical narratives are entirely focused on the domestic politics of each country. However, globalization has obviously changed the political economy dynamic, even if only by making national politicians feel they face new constraints on their choices. The big global investment banks and the shadow banking sector are surely a key part of the story.

I do like the way the book ends: “As [amazon_link id=”0140437886″ target=”_blank” ]George Bernard Shaw said,[/amazon_link] ‘The reasonable man adapts himself to the world; the unreasonable man persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.’ Meaningful reform in a democracy depends on informed and stubborn unreasonableness.”

[amazon_image id=”0691155240″ link=”true” target=”_blank” size=”medium” ]Fragile by Design: The Political Origins of Banking Crises and Scarce Credit (The Princeton Economic History of the Western World)[/amazon_image]   [amazon_image id=”0140437886″ link=”true” target=”_blank” size=”medium” ]Man and Superman: A Comedy and a Philosophy (Penguin Classics)[/amazon_image]

Hard Times, continued

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Just arrived: [amazon_link id=”0300203772″ target=”_blank” ]Hard Times: The Divisive Toll of the Economic Slump[/amazon_link], by Tom Clark with Anthony Heath. It’s the fruit of a research project that ran from 2007-2012 in the US and UK, documenting the social effects of unemployment, foreclosure, increasing inequality. The researchers asked people in certain communities to keep diaries, which are combined here with data, interviews, and more conventional academic description. It looks a good companion, albeit totally different in style, to [amazon_link id=”0571251293″ target=”_blank” ]The Unwinding[/amazon_link] (wonderful book – I reviewed it here) – although without having read this one, I wonder how the US/UK comparison will work, given how different the two countries are.

[amazon_image id=”0300203772″ link=”true” target=”_blank” size=”medium” ]Hard Times: The Divisive Toll of the Economic Slump[/amazon_image]

As an aside, [amazon_link id=”014143967X” target=”_blank” ]Hard Times[/amazon_link] is one of the few Charles Dickens novels I enjoyed – aversion therapy in the form of school English lessons put me off the better known ones like [amazon_link id=”1853260045″ target=”_blank” ]Great Expectations[/amazon_link]. I did much better with the ones I read myself, [amazon_link id=”B004EHZXVQ” target=”_blank” ]A Tale of Two Cities[/amazon_link] being by far his best.

[amazon_image id=”1853262323″ link=”true” target=”_blank” size=”medium” ]Hard Times (Wordsworth Classics)[/amazon_image]

Canada versus Minsky, and the politics of banking

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With Eurostar journeys coming up, I anticipate making decent inroads into Piketty’s [amazon_link id=”067443000X” target=”_blank” ]Capital[/amazon_link], but meanwhile the enormous buzz about it makes it harder than ever to understand why the popular and intellectual anger about plutocracy has not translated (yet?) into political consequences.

This thought was underlined by browsing through [amazon_link id=”0691155240″ target=”_blank” ]Fragile By Design: The Political Origins of Banking Crises and Scarce Credit[/amazon_link] by Charles Calomiris and Stephen Haber. They write: “There is no avoiding the government-banker partnership.” The book combines history, economics and political science to analyse the nature of the state-bank relationship, within a framework of bargaining. One section compares and contrasts the US (12 systemic banking crises since 1840) and Canada (zero). Another looks at the relationship in authoritarian contexts and democratic transitions.

[amazon_image id=”0691155240″ link=”true” target=”_blank” size=”medium” ]Fragile by Design: The Political Origins of Banking Crises and Scarce Credit (The Princeton Economic History of the Western World)[/amazon_image]

One important conclusion is that no general theory can explain why banking crises have not been equally likely in all countries in the recent past. For example, [amazon_link id=”0071592997″ target=”_blank” ]Hyman Minsky[/amazon_link]’s theory of endogenous excess followed by fear has enjoyed a revival – indeed there was a recent BBC Radio 4 Analysis on it (Why Minsky Matters) that is well worth a listen – but why was Canada exempt from these oscillations arising from human nature? It isn’t that Minsky is wrong, but rather that context matters for crises too. “Useful propositions about banking generally are only true contingently, depending on historical context.” And, to mangle [amazon_link id=”0140449175″ target=”_blank” ]Tolstoy[/amazon_link], every country (except Canada?) has its own unhappy politics.

Which brings me back to the strange absence of any political consequence of the financial crisis for banking. Bankers will complain about excess regulation but the only result has been to cause them to employ more compliance officers, and more lawyers to game the regulations. There has been little action on leverage and capital ratios, next to none on scandalous rent-seeking bonuses and none at all enforcing competition and new entry. The financial sector isn’t the only locus of the modern plutocracy, but it is one of the most significant.

One possibility is that the political classes are befuddled because – as I describe in [amazon_link id=”0691156794″ target=”_blank” ]GDP: A Brief But Affectionate History[/amazon_link] – the national accounts figures overstate the contribution of the financial sector to the economy. Maybe some politicians genuinely believe they cannot risk killing the goose that’s laying the golden eggs even if it is keeping all the eggs within its own nest. Whatever the explanation, the bargain between banks and politics is working for bankers, and not for other citizens.

Here is an excellent VoxEU interview about the book with Charles Calomiris. For now, I’m off to St Pancras and on with Piketty.

[amazon_image id=”067443000X” link=”true” target=”_blank” size=”medium” ]Capital in the Twenty-First Century[/amazon_image]

The dollar, the unthinkable and the inevitable

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What is [amazon_link id=”0691161127″ target=”_blank” ]The Dollar Trap[/amazon_link]? In this book Eswar Prasad argues that the US grip on the global financial system has increased, not diminished, since the global (or North Atlantic, if you’re in China) financial crisis. The core of the argument is that foreigners (ie. non-Americans) have too much invested in dollar assets to permit a significant decline in the US currency. What Barry Eichengreen flagged in his book as the country’s [amazon_link id=”0199642478″ target=”_blank” ]Exorbitant Privilege[/amazon_link] continues (he too predicted there was nothing to knock it off its perch, despite the ‘rise and fall’ subtitle). The chart of the day in The Economist today, setting out the decline in emerging market currencies during the past nine months – accelerating just recently  – only underlines the asymmetry.

[amazon_image id=”0691161127″ link=”true” target=”_blank” size=”medium” ]The Dollar Trap: How the U.S. Dollar Tightened Its Grip on Global Finance[/amazon_image]

It can’t last, of course. Danny Quah’s research (pdf) shows that the world’s centre of gravity for economic activity has shifted from the Atlantic firmly into Asia. [amazon_link id=”B00I124BKO” target=”_blank” ]Jim O’Neill argues that behind the BRICs are coming the MINTs[/amazon_link], and even a near-term decline in the growth of emerging markets will not reverse the shift. Yet as Prasad concludes, “The situation is rife with paradoxes.” The US relative status in the world economy is inexorably shrinking, it is a fiscal mess, the monetary taper will cause havoc, yet despite this fragility, it is hard to see what can dislodge the dollar from its perch.

I’m certainly not going to risk a prediction. But I would observe that in general fragile systems can persist in that state for a long time, but when the end comes, it’s often a sudden and catastrophic collapse. The unthinkable can become the inevitable.