Thoughts

Better Global Financial Governance – The Need for Reforming the System and Abandoning Free Market Ideology

2011-10-27T22:15:00.000-07:00

Here is a talk that I gave at a Shadow G20 Workshop in Paris (29-30 October 2011)

Better Global Financial Governance – The Need for Reforming the System and Abandoning Free Market Ideology

Speech by Jan Joost Teunissen (founder and director of FONDAD) at the Shadow G20 Workshop in Paris, 29-30 October 2011 (Columbia Global Center, Reid Hall, Paris)

What kind of world are we living in?

If a psychologist would say, ‘You should think this, do that and accept what I tell you,’ a normal person would react by saying: ‘Hey, wait a minute, you cannot prescribe me how I should think or what I should do or accept.’ If a sociologist would do the same and prescribe how people in a society should think and behave, a normal person would say, ‘Sorry, you cannot prescribe us how we should think and behave.’ But, for some strange reason, when an economist does the same and prescribes how we should think and behave and what we should accept, it is felt as normal.

But this is not normal. Let me give another illustration of the absurdity of our world.

“If your unions are too strong and fight against lower wages and unemployment, or for healthy labour conditions, we will lower your credit rating thus forcing you to lower wages, increase unemployment and make labour conditions tougher.”

“If Greece has a problem in repaying its debt, we will increase the costs of repaying its loans.”

“If you refuse to privatise public companies or refuse to make it easier to lay off workers, we will not give you the loans we have promised you.” (said to Greece and Italy)

This is the world that is presented to us as “normal”. Why do people accept it as normal? Because they are told so, because they think it’s OK, because they are indoctrinated every day.

1. In this panel we discuss Global Financial Governance (GFG) and I suppose we have to give ideas of how it can be improved. But my immediate question is: Better GFG of what? Of the current international monetary and financial system? No, please not. I would prefer better GFG of a better system, because the current system has enormous problems and should have been reformed and fundamentally improved long ago. Why?

Let me give four reasons (there are more):

- First, because the current system has led, since the end of the 1960s, time and again, to financial crisis and economic instability, creating a lot of suffering for ordinary people.

- Second, because the system gives too much power and freedom to the financial sector.

- Third, because it creates credit and debt bubbles, as some experts realised already many years ago and now, with the crisis in the heart of the system, has become clear to everybody.

- Fourth, because the current system gives too much priority to finance instead of the real economy.

I would like to dwell briefly on the second point that there is far too much power in the financial sector. Every day you can hear in the news that governments are warned by the financial sector that they should do this or that, otherwise the financial sector, or the financial markets as they are usually called, will punish them with a lower credit rating and higher interest rates on loans. Governments seem to be powerless victims of a monster that they themselves have created when they decided in the early 1970s to let the private financial sector dominate international finance, and not reform the international monetary system as they had agreed in 2-year long negotiations (1972-74). And in the 1980s they deliberately deregulated the financial sector embracing fully the neoliberal agenda of deregulation, privatisation and free capital, an agenda faithfully advocated by mainstream economists.

Even though I think many people working in the financial sector have behaved and are still behaving irresponsibly, given the economic facilitating role that they ought to play – finance should be a means and not an end – and given the public responsibility of the financial sector, I blame first of all governments and mainstream economists for the mess we are in. Historically and politically, they are the ones responsible for it. They allowed the foreign financing of US deficits. They allowed the greed of bankers to have free play. They allowed the United States to finance its wars and have its military around the world including Europe, to defend Europe, with dollars lent by the rest of the world. They allowed global imbalances to emerge. They allowed the creation of a huge derivatives market of so-called innovative financial products that amounts to over 600 trillion dollars. And now these same governments feel powerless, or show they are powerless, against the vagaries, greed and profit-seeking of people switching huge anounts of money through international financial markets.

Yes, I’d like to stress it’s PEOPLE who are doing this. The neutral term “financial markets” is misleading. Financial markets are being talked about as if they are part of nature, as storms or rain showers that plague us and we are unable to protect ourselves against. But markets are managed and run by individuals, by so-called financial experts and economists. And their colleague economists working in the ministries of finance, in the central banks and other supervising bodies, and in the international financial institutions, let them largely do their tricks. They do not really limit the power of people operating in financial markets.

So this is not the global financial and monetary system that I would like to see governed or managed better by having, for example, a more powerful representation of emerging economies in international financial institutions (which I favour), or by making these same international financial institutions more powerful players in the global financial and economic arena. We need to reform the system! And we need to reform the dominant values, the ideology that maintains the system.

2. Even though over the last 4 years, after the crisis started in 2007, there has been much talk about the need to reform the system, and even though there have been many good technical and political proposals by individuals and groups coming together for this purpose, the effort of policymakers still seems to be largely to keep the current system going – with all its in-built problems and the certainty that it will lead to another crisis. Why do policymakers stick to the current system even though it has such serious problems and shortcomings?

Let me give you three reasons (but there are more):

- First, because policymakers are afraid of reforms that they do not know or are not sure about how they will function and what effects they will have. They rather prefer to stick to the routines they are familiar with.

- Second, policymakers are against reforms or are scared of reforms that do not have the agreement of mainstream economists and of people operating in the international financial markets.

- Third, policymakers have an interest in keeping the system basically as it is and only are prepared to make minor adaptations (which they themselves may see as major adaptations) to it. How they themselves would define this interest, I do not know. But I think they defend certain economic interests, certain political interests, and certain power relations that guarantee the continuation of these interests. I also think that policymakers see international financial markets as a key element of the system, and believe that governments and international financial institutions should intervene as little as possible in these markets, and only where it is really needed.

3. It is not the first time that the need for reform of the international monetary and financial system is being discussed and that sensible proposals to this effect have been made. Neither is it the first time that sensible proposals were not adopted, let alone implemented.

Efforts at reform of the system have been made on various occasions since the 1960s. The first efforts date back to the 1960s when dollar crises erupted because of US balance of payments deficits and the loss of confidence by other countries in the capacity of the United States to exchange dollars for gold. So there was a flight into gold and European currencies. These gold-dollar crises were “resolved” in 1971-73 by decoupling the dollar from gold and by moving from a system of fixed to flexible exchange rates. Then, in 1979, when there was another crisis of confidence in the value of the paper-dollar, it was “resolved” by a steep rise in US interest rates and by embracing neoliberal, monetarist policies. After that, in 1982, we had, primarily as a result of this steep rise in the US interest rate, the debt crisis of the 1980s in Latin America and a few other countries. Then, in the 1990s, we had several debt crises in emerging economies. During all these crises, wise men and women came together to suggest sensible reform proposals. Why have they had so little success in getting their proposals adopted and implemented?

I think partly because of the same three reasons I gave already: (1) policymakers are scared of reform, (2) policymakers are against reforms that meet the opposition of mainstream economists and people of the financial sector, and (3) policymakers have an interest in keeping the system as it is.

Let me elaborate on the last reason.

Policymakers want to keep the system as it is, not only because of sticking to certain economic policies and interests, but also because of sticking to certain political policies and interests. For example, in the 1970s and afterwards, NATO countries saw an interest in maintaining the US dollar as the key reserve currency of the system, as this would allow the US to finance with foreign-held dollars its military force for maintaining western dominance in the international political arena, and for military intervention.

Now, elaborating on the second reason, policymakers’ resistance to reform proposals that do not have the approval of mainstream economists and people of the financial sector, I see a serious problem with mainstream economists. They largely determine the terms of the “real”, or one could also say, the “false” debate. The problem of mainstream economists is that they have a biased and limited view of man & society, of how man and society should behave, and of what is “normal” or economically sensible behaviour. They presume, for instance, that normal behaviour should be driven by competition instead of cooperation and solidarity, and ruled by so-called free markets. I think we need a broader, social, political, ecological and philosophical view of man & society instead of the narrow view of mainstream economists.

There is yet another reason why reform proposals are not adopted, and that is that policymakers base their policies on limited and biased analysis of the crises, both of the crises of the past, and the crisis of today. A good example is the debt crisis of the 1980s in Latin America, in which the standard explanation was that developing countries had borrowed too much and western banks lent too much, while the alternative explanation stressed that the crisis was caused by a dollar-dominated global financial system that should have been reformed at least ten years earlier. I am one of those who presented in the mid-1980s the alternative explanation in an extensive article for the journal Alternatives that included long conversations with the famous economist Robert Triffin, who had advocated reform of the international monetary system since 1958.

4. What reform proposals of the system have been made over the last couple of years? Various reform agendas have been proposed, both by individuals and groups. Let me mention three group proposals that are relatively moderate, the one more than the other, but have not been adopted yet.

- The first is a report by a UN Commission, “Reforms of the International Monetary and Financial System”, headed by Joseph Stiglitz and presented in March 2009.

Stiglitz highlighted its proposals in a short article (Guardian, 27 March 2009) as follows. ‘There are several important lessons from the crisis. One is that there is a need for better regulation. But reforms cannot be just cosmetic, and they have to go beyond the financial sector. Inadequate enforcement of competition laws has allowed banks to grow to be too big to fail. Inadequate corporate governance resulted in… excessive risk taking…’

The UN Commission recommended the establishment of a Global Economic Coordinating Council, to co-ordinate economic policy, to identify gaps in the global institutional arrangement, and propose solutions. ‘For instance,’ said Stiglitz, ‘there is a need for a Global Financial Regulatory Authority… There is a need for a Global Competition Authority… There is a need for a better way of handling defaults of countries…’

The other important recommendation by the UN Commission was the creation of a new global reserve system. ‘The existing system,’ said Stiglitz, ‘with the US dollar as reserve currency, is fraying. The dollar has been volatile. There are increasing worries about future inflationary risks. At the same time, putting so much money aside every year to protect countries against the risks of global instability creates a downward bias in aggregate demand weakening the global economy. Moreover, the system has the peculiar property that poor countries are lending trillions of dollars to the US, at essentially zero interest rate, while within their country there are so many needs to which the money could be put. A new Global Reserve System is "feasible, non-inflationary, and could be easily implemented".’

- A more recent set of proposals for Reform of the Global Reserve System – from an Asian perspective – was made in a June 2010 ADB report, edited by Jeffrey Sachs and others. Its contributing authors included Joseph Stiglitz, Charles Wyplosz and Wing Thye Woo among others.

In its Recommendations, the report states that the group sees the global reserve system evolving into a multi-currency reserve system, with Asia holding close to half of the world’s total reserves. At the regional level, the report recommends to increase regional economic integration and policy coordination in Asia. At the international level, it recommends to ‘strengthen prudential capital market regulations, given the obvious failure of the financial system to effectively police itself.’ It also recommends convening ‘a brain trust of independent international monetary experts as chronic current account imbalances and varying exchange rate regimes, for example, can cause unnecessary friction between countries.’

Haruhiko Kuroda, President of the Asian Development Bank (ADB), stressed in the preface to the report: ‘Asia is no longer a minor player. It must take a more active global role. (…) I sincerely hope that this report will stimulate constructive debate – both within and beyond Asia – on how we can move to a more stable, efficient and equitable global reserve system that will better facilitate global trade and capital flows.’

These ADB recommendations are not radical reform proposals. In the individual contributions, several authors advocated more radical reforms. For example, Stiglitz repeated his plea for a new global reserve system (like Triffin did before, for more than 30 years during the 1960s, 70s and 80s). ‘The choice facing the international community,’ he said, ‘is whether to create… a new global reserve system, or to “muddle through,” moving from the dollar-based system to a two- or three-currency reserve system, which could be even more unstable and volatile. This paper argues that a new global reserve system is absolutely essential, if we are to restore the global economy to sustained prosperity and stability.’

- A third report, “Reform of the International Monetary System” (the Palais Royal Initiative), published in February 2011, was prepared by Tommaso Padoa-Schioppa, Michel Camdessus, Alexandre Lamfalussy and others.

Recently, on 4 October 2011, Camdessus presented its key messages at a Conference on Reform of the IMS organised by the Triffin Foundation of which Lamfalussy is the chair (I am one of its board members).

Camdessus started his presentation by conveying two convictions of the group: ‘first, that our collective failure in establishing over four decades a system deserving really this name has been one of the key factors of the crisis. No real system means no effective discipline, weak and uneven surveillance, and excesses of all kind: in current account imbalances, in indebtedness, in accumulation of reserves, in exceedingly volatile and destabilizing swings in capital flows, in exchange rates fluctuations with unjustified deviations from fundamentals... These are major misgivings, indeed.

From there, the conviction n° 2 that, as long as no credible responses are given to these problems, our increasingly integrated world economy becomes all the more vulnerable as it is simultaneously engaged in a process of transition toward a multicurrency regime.’

To face these risks, the Camdessus group proposed four avenues for reform: (1) better surveillance by the IMF, with ‘real transparency, teeth and fairness’; (2) strengthening of IMF instruments ‘in a world where financial developments overwhelm now the mere monetary and current exchange developments’; (3) a re-examination of the scope of the SDR to play a greater role in the system as a reserve asset; and (4) improving the governance of the IMF and its relations with regional organisations.

5. What can be done to get these three and other reform proposals adopted? How to influence policymakers? I know that the authors of the three reform reports mentioned are doing their best. There is a large role for journalists, politicians, students, intellectuals, unions, social movements, and for economists and other academics working within the institutions.

But let me go back to the provocative remarks at the beginning of my talk. The danger is that when unions and other people who go out demonstrating on the streets or occupying squares, lead to the lowering of credit rating, higher financing costs, loss of investor confidence and threats to governments that they will not receive promised loans, democracy is seriously undermined. You need countervailing views and values. And there is the other danger that is already manifesting itself, the danger that the current capitalist system, with its privileges for business and political elites, creates anger and frustration among people and stimulates xenophobic, nationalistic, anti-establishment, anti-intellectual movements and parties like we already have in the Netherlands.

So there is a task for all of us to demonstrate our concern, to defend democracy, particularly in the sphere of economic and financial decision-making that is too much dominated by the power of the financial sector and the opinion of mainstream economists. We can all contribute to creating a more democratic world, a world that no longer is dominated by financial markets and mainstream economists, a world in which economists broaden their view and look at the social, political and ecological aspects of society, talk to people, and listen to them.

Austerity - Who is right, who is wrong?

2010-07-23T04:00:00.000-07:00

A year before I established the Forum on Debt and Development in 1987 I wrote in the magazine Alternatives, 'Today there is probably no other area of human concern that affects more deeply the living conditions of people all over the world than that of international finance. Nevertheless, the main policy-making in this field is in the hands of an amazingly small group comprising central bankers and finance ministers in the rich countries, heads of international organizations such as the International Monetary Fund and big commercial bankers. The opinion of people outside this charmed circle of financial managers is hardly ever taken into account. This is a pity, since economic policy-makers tend by both temperament and training to be rather narrow-minded; their thinking moves in a groove.'

In the trailer of the film The Visitor shown above, it is said that 'You can live your life and never know who you are until you see the world through the eyes of others.' The film is not about the narrow-mindedness of a banker or a finance minister but of that of a university professor who drops into his standby New York flat one night, only to find that a young couple has been renting the place from a scam artist. Instead of having them arrested, the professor befriends his naive squatters - a Syrian jazz drummer and a Senegalese jewelry maker - who then get a chance to teach him about passion, playing the djembe, and post-9/11 immigration policies. As the professor fights to keep one of his new friends from being deported, his own world opens up.

Narrow-mindedness is a general human phenomenon, and not an exclusive quality or propensity of finance ministers and bankers. And obviously, not all finance ministers and bankers are narrow-minded. Johannes Witteveen, for example, a former finance minister and head of the IMF, is not narrow-minded. Nor is Tommaso Padoa-Schioppa (see my previous post), also a former finance minister and board member of the European Central Bank. Nor is Andrew Sheng, another former central banker who is part of the FONDAD Network (see for his views many of my previous posts on this blog).

A few days ago I saw an animated cartoon video explaining today’s crisis in simple terms. It’s a bit fast, and you may like it, or dislike it. The explanation is based on a lecture given by a real university professor (opposite to the acting professor in The Visitor), David Harvey, whom you may also like or dislike. But the issue is that this video, and the lecture on which it is based, show on the one hand the attempt to make things clear that seem to be too complicated for the non-expert, and, on the other, the attempt or tendency to present explanations as if they are ‘reality’.

This brings me to the topic of this post: Who should we believe, those who preach austerity as a key ingredient for managing the crisis, or those who criticize austerity as being the remedy?

Austerity was for a long time a taboo word in France, but even there it is now elevated to official ‘wisdom’. So now we have policymakers in the rich countries, except the United States, propagating austerity saying it is urgent and inevitable, while a few economists are criticising austerity saying it is a silly thing to do as it creates, rather than solves, problems. The critics include Paul Krugman (we live in a US-dominated academic and financial world, in which Krugman’s words are echoed daily in almost every corner of the globe), Joe Stiglitz (same story), Martin Wolf (less known, except to readers of the Financial Times), and Robert Skidelsky (who knows him?) – to name a few of the critics (there are many more including those who criticise in a more fundamental way the power system and the power policies).

I will nor repeat or try to summarise the debates on austerity that are raging on, but instead focus on one element in them that is crucial: who is right, who is wrong?

The answer to that question depends on what you believe in. Or it depends on what you think the causal relationship is between, for example, austerity and gaining confidence of financial markets, or between austerity and addressing the fiscal debt problem, or between austerity and the resumption of growth. Or between austerity and the reduction of unemployment, or any other relationship you can think of.

Can those ‘causal’ relationships be established unambiguously? I don’t think so. There are other factors, other variables, at play. It is difficult to isolate any and each of these factors or variables – such is reality economists (and others) are dealing with. Moreover, this ‘reality’ is sensitive to human beliefs, practices, routines, power relationships, power dynamics, economic doctrines, political and economic ideologies, interest groups, government or market intervention (both governments and markets are determined by human action and thinking) and what else you have in the global economy.

If we cannot establish causal relationships in an unambiguous manner, what do we do? To repeat my question: Who should we believe, those who preach austerity as a key ingredient for managing the crisis, or those who criticise austerity?

I am afraid we can do no other thing than search for the best or most convincing or most challenging answers by exploring the given reality, or envisioning a possible different reality. For this, an attitude is needed of ‘seeing the world through the eyes of others’.

Such empathy and open-mindedness (and curiosity) would help to understand better the economic ‘reality’ we are living in. Obviously, empathy is needed with the needy and not with the greedy.

In the 1987 Alternatives article mentioned above I quoted Robert Triffin who said that 'the economy is far too serious a thing to be left to the economists'. I still believe that the living conditions of people all over the world are too important to be determined solely or mainly by financial policymakers.

Moreover, as I explained in a speech about Robert Triffin last year, I still believe that a fundamental reform of the international monetary system is needed to solve the crisis instead of just managing it. Unfortunately, the debate on the need of reform is much less prominent than the debate on austerity. Jane D'Arista and Korkut Erturk have written recently a very good paper on the need and ways to reform the international monetary system which you can read by clicking here.

Padoa-Schioppa: "The attackers will return"

2010-05-18T03:53:00.000-07:00

Friends can turn into enemies. For many years governments and financial markets were close friends, governments giving the markets the freedom to do almost whatever they wanted and helping them when the credit crisis erupted. But in recent times that friendship is less obvious even though, or exactly because, markets continue to enjoy the same freedom -- and power.

Reflecting on the attacks over the past months by financial markets on Greece and other south European countries and the euro Tommaso Padoa-Schioppa, a former Italian finance minister and member of the executive board of the European Central Bank, has accused the financial markets of behaving like an invading army. He did so in an article published in the Financial Times of 13 May 2010.

Let me quote the first three paragraphs of Padoa-Schioppa's article:

'Over many months, a mighty army has advanced on the citadel of the European currency with the cry: “It will never work!” The army was quick and single-minded, the citadel slow and divided. The besiegers were thousands, steeled by convictions all the more fervent for their extreme simplicity. Their reasoning was as follows: the euro area is not a political union and can never become one, because Europeans have no appetite for it and nation-states will not relinquish power. The citadel, therefore, is doomed to capitulate and its stubborn resistance merely serves to create profit opportunities for astute traders.

Equally strong and simple was the credo of the defenders, who countered: “It can work!” For years, Europe’s heads of government and central bankers had preached that a currency without a state is a smart invention that can last forever. It accomplishes the miracle of removing monetary and trade tensions, while allowing the nation-state to remain the unique master. The Maastricht treaty of 1992 was the final step in the construction of the European edifice. No other transfer of sovereignty will, nor needs to, occur. The European Union can do without the ordinary fiscal, financial and monetary instruments that all textbooks prescribe.

Enemies as they are, the two camps share the same prime article of faith: that the nation-state is and will continue to be the absolute sovereign within its borders. Both believe that international relations will continue to be based on the twin postulates of internal homogeneity and external independence, a model invented by the Treaty of Westphalia of 1648.'

And let me quote the last paragraph of Padoa-Schioppa's article:

'The attackers will return. The outcome will, for sure, be decided by the rivals’ relative strength, but also by the nobility of the cause they fight for. The army is formidable but it bets on the wrong cause: a return to the old world of flexible exchange rates, where each country deludes itself that it can be insulated from its neighbours and tries to foster growth through competitive devaluations, reneging on debts when it sees fit. This can only produce economic misery, conflict and dangers for global security. The citadel fights for the good cause (saving Europe’s monetary union), but its persistent credo, which has for too long kept it disarmed, still hinders it from going all the way with the necessary reform. At stake in this struggle, ultimately, is the ideology of the omnipotent nation-state.'

Padoa-Schioppa's article prompted Andrew Sheng, a former deputy chief executive of the Hong Kong Monetary Authority and chairman of the Hong Kong Securities and Futures Commission, to write a 2-page comment. Let me also quote from his comment the first three paragraphs:

'The recent Greek debt crisis has brought into the fore the conflict between two major philosophies. One the one hand, there is the nationalists who believe that the nation-state will remain dominant in the new world order. On the other, there is the free market fundamentalists who believe that markets have changed the world into a borderless market space, whereby the market has more power than the state. Indeed, the market space camp laugh at the old guard, especially those bureaucrats who still think that the state remains more powerful than markets.

The reason why I bring this up is that one of the foremost thinkers behind the European Monetary Union, Tommaso Padoa-Schioppa, former Minister of Finance in Italy and former member of the European Central Bank, has recently written about the defense of the citadel of Euro against the army of market speculators who think that “the euro area is not a political union and can never become one, because Europeans have no appetite for it and nation-states will not relinquish power”. Who are the attackers? Mr Padoa-Schioppa identifies them as the army, whose “battalions were thousands of dealing rooms, connected into a global network acting round the clock. Its targets were selected by the intelligence of three rating agencies. Its morale was sustained by an unwavering faith: that we, the market, are those who know best.”

Who are the defenders? The European Union and the member state bureacrats, who are determined to regulate the market and bend the market to the dictats of the state. The Euro as a currency cannot be allowed to fail. On the other hand, the army of market traders think that “the citadel, therefore, is doomed to capitulate and its stubborn resistance merely serves to create profit opportunities for astute traders.”'

And let me quote another three paragraphs in one of which Sheng describes the financial market traders as "the very beasts that they [the governments] have rescued":

'In plain language, we cannot sacrifice the common good to the individual greed of market traders. But he or I have not appreciated that this generation of market traders were creatures of our own creation. A whole generation of fund managers, investment bankers and even retail traders have grown up in the last 20 years, feeding on the food chain of growing asset bubbles, precisely because central bankers and ministries of finance have allowed the markets to win with huge moral hazard. If markets quiver, the central bankers have lowered interest rates in Greenspan puts or ministries of finance have taken private sector losses into public books through total fiscalization or nationalization of bank deposits and losses.

The result is that I realized that these hordes of institutional investors, fund managers, analysts, and researchers, many of whom are dedicated professionals and my personal friends, have collectively become a mob that thrives off volatility and momentum. The level of bonuses and rewards are such that they all seek the instant analysis of complex information and if the thundering herd moves in one direction, they win. If they lose, the public pays. The agents of fiduciary trust have become the masters of the game. The regulators and state bureaucrats are still under an illusion that they are in charge.

The sad part of the current defense of the Euro is that I think that the EU bureaucrats are defending an imaginary Maginot Line, where the fiscal breaches are larger than they think (or they think they can plug). This is not to say that I think that they are wrong to defend, but that their tools and techniques are obsolete, because they are trying to defend by succouring the very beasts that they have rescued. Those who try to make the fiscal debt sustainable by keeping interest rates low are pouring ammunition to the attackers, whose carry trades thrive on low interest rates. The larger the guarantees for states and banks that are not viable, the more the ammunition that will be used to speculate against the Euro and to create arbitrage opportunities.'

In this battle, and other battles between governments and financial markets, citizens are mere watchers of the game. Unfortunately, they are the ones paying the costs.

Austeridad - ¿Quién tiene razón, quién está equivocado?

2010-02-26T07:39:00.000-08:00

Un año antes de establecer el Foro sobre Deuda y Desarrollo en 1987, escribí en la revista Alternativas, "Hoy en día probablemente no hay otra área de actividad humana que afecte más profundamente las condiciones de vida de personas en todo el mundo que el de las finanzas internacionales. Sin embargo, la formulación de políticas en este campo está en manos de un grupo increíblemente pequeño que comprende los banqueros centrales y ministros de finanzas de los países ricos, los jefes de organizaciones internacionales como el Fondo Monetario Internacional y los grandes bancos comerciales. La opinión de la gente fuera de este círculo mágico de los gestores financieros casi nunca es tomada en cuenta. Es una lástima, ya que los responsables de la política económica tienden tanto por temperamento y formación a ser más bien estrechos de miras, su pensamiento se mueve en una ranura.

En el trailer de la película The Visitor se dice que "Se puede vivir su vida y nunca se sabe quién es hasta que vea el mundo a través de los ojos de los demás." La película no es acerca de la estrechez de miras de un banquero o un ministro de finanzas, sino de la de un profesor universitario que una noche entra en su apartamento en Nueva York para descubrir una joven pareja que ha estado alquilando el lugar de un estafador. En lugar de hacerlos arrestar, el profesor se hace amigo de sus ocupantes ingenuos - un baterista de jazz de Siria y un artesana de joyas de Senegal - que luego tienen la oportunidad de enseñarle acerca de la pasión, tocar el djembe, y post-9/11 políticas de inmigración. Mientras el profesor lucha para prevenir la deportación de uno de sus nuevos amigos, su propio mundo se abre.

La estrechez de miras es un fenómeno humano general, y no una cualidad o propensión exclusiva de los ministros de finanzas y banqueros. Y, obviamente, no todos los ministros de finanzas y banqueros son de mente estrecha. Johannes Witteveen, por ejemplo, un ex ministro de Hacienda y jefe del FMI, no es de mentalidad estrecha. Tampoco lo es Tommaso Padoa-Schioppa (ver mi post anterior), también un ex ministro de Hacienda y ex miembro del directorio del Banco Central Europeo. Tampoco lo es Andrew Sheng, otro ex banquero central que forma parte de la Red FONDAD (véase, por sus puntos de vista muchos de mis posts anteriores en este blog).

Hace unos días vi un vídeo de dibujos animados que explica la crisis actual en términos sencillos. Es un poco rápido, y es posible que les guste, o no les guste. La explicación se basa en una conferencia dada por un profesor universitario real (en vez del profesor actuando en The Visitor), David Harvey, quien también les guste o no les guste. Pero la cuestión es que este video, y la conferencia en la que se basa, muestran por un lado el intento de aclarar cosas que parecen ser demasiado complicadas para los no expertos, y por otro, el intento o la tendencia de presentar explicaciones como si fueran "realidades".

Esto me lleva al tema de este post: ¿A quién debemos creer, a los que predican la austeridad como un ingrediente clave para la gestión de la crisis, o a los que critican la austeridad como el remedio?

Austeridad fue durante mucho tiempo una palabra tabú en Francia, pero incluso allí ahora es elevada a "sabiduría" oficial. Así que ahora tenemos gobernantes promoviendo políticas de ajuste en los países ricos, a excepción de Estados Unidos, diciendo que la austeridad es urgente e inevitable, mientras que algunos economistas critican la austeridad diciendo que es una tontería aplicarla ahora porque crea, y no resuelve los problemas. Los críticos incluyen a Paul Krugman (vivimos en un mundo dominado por académicos y financieros de los Estados Unidos, en el que las palabras de Krugman se repiten a diario en casi todos los rincones del mundo), Joe Stiglitz (la misma historia), Martin Wolf (menos conocido, con excepción de los lectores del Financial Times), y Robert Skidelsky (quien lo conoce?) - por nombrar algunos de los críticos.

No repetiré ni trataré de resumir los debates sobre la austeridad que se están llevando a cabo, pero me centraré en uno de los elementos cruciales: ¿quién tiene razón, quién está equivocado?

La respuesta a esa pregunta depende de lo que uno cree, o depende de lo que usted piensa qué es la relación causal entre, por ejemplo, la austeridad y ganar la confianza de los mercados financieros, o entre la austeridad y abordar el problema de la deuda fiscal, o entre la austeridad y la la reanudación del crecimiento. O entre la austeridad y la reducción del desempleo, o cualquier otro tipo de relación que se pueda imaginar.

¿Pueden estas "relaciones causales" ser establecidas de forma inequívoca? No lo creo. Hay otros factores, otras variables, en el juego. Es difícil aislar cualquiera y cada uno de estos factores o variables - esta es la realidad que los economistas (y otros) están tratando. Por otra parte, esta "realidad" es sensible a las creencias humanas, las prácticas, las rutinas, las relaciones de poder, la dinámica del poder, las doctrinas económicas, las ideologías políticas y económicas, los grupos de interés, la intervención de gobiernos y mercados (tanto los gobiernos como los mercados están determinados por la acción humana) y cualquier otra cosa que se tiene en la economía mundial.

Si no podemos establecer relaciones causales de manera inequívoca, ¿qué hacemos? Para repetir mi pregunta: ¿A quién debemos creer, los que predican la austeridad como un ingrediente clave para la gestión de la crisis, o los que critican la austeridad?

Me temo que no podemos hacer otra cosa que buscar las respuestas más convincentes o más desafiantes mediante la exploración de la realidad dada, o imaginando una realidad diferente. Para ello, es necesaria una actitud de "ver el mundo a través de los ojos de los demás."

Tal empatía y apertura de espíritu (y curiosidad) ayudaría a comprender mejor la "realidad económica" en que estamos viviendo. Obviamente, la empatía que se necesita es con los necesitados y no con los codiciosos.

En el artículo de 1987 en "Alternativas" mencionado anteriormente, he citado a Robert Triffin diciendo que "la economía es algo demasiado serio como para dejarlo en manos de los economistas." Sigo creyendo que las condiciones de vida de gentes en todo el mundo son demasiado importantes para ser determinadas exclusiva o principalmente por los gobernantes de las políticas financieras.

Por otra parte, como lo expliqué en una conferencia sobre Robert Triffin el año pasado, sigo creyendo que una reforma fundamental del sistema monetario internacional es necesaria para resolver la crisis en lugar de limitarse a su gestión. Desgraciadamente el debate sobre la necesidad de la reforma es mucho menos visible que el debate sobre la austeridad. Jane D'Arista y Korkut Erturk han escrito recientemente un artículo muy bueno sobre la necesidad y la manera de reformar el sistema monetario internacional que se puede leer haciendo clic aquí.

PS1: Pinchando los enlaces salen textos en un mal castellano que, de origen, son en inglés. En el texto original de este post (en inglés), que se puede ver en la entrada más arriba, o pinchando aquí, los enlaces dan acceso a los textos originales en inglés.

PS2: Este post no es del 26 de febrero sino del 23 de julio 2010. Lo publiqué en un viejo post borrador.

"Please send a Christmas card to Wall Street bankers"

2009-12-15T04:17:00.000-08:00

Early in the morning I tend to begin my day with reading articles from the media in France, Malaysia, UK, Deutschland, España, Estados Unidos (in Spanish), US, Brasil, Chile, South Africa, Nederland.

Then I use certain key words (such as 'global currency', 'international monetary reform' and 'carry trade') to do a "Search News" in various languages, which provides me with more interesting articles from various websites including the press agencies.

When I find an article interesting, I send it to myself and, when I think it might be of interest to one or more members of the Fondad Network (the picture above is of one of them, Charles Wyplosz, and the picture below of another, Andrew Sheng), I send it to them as well, highlighting a few paras or quoting the article fully, and raising a question.

Based on these articles an interesting discussion may develop between a few members of the Fondad Network (which is larger than the one included on the Fondad website), and if I think the discussion is of interest to the larger Fondad group, I send it to them too.

It would take me too much time to report on these discussions in this blog -- as I have done sometimes in the past. However, I'd like to share with you a few thoughts that were exchanged recently about zero-interest rate policy (ZIRP).

The discussion started with an article I sent around in which it was argued, "by pegging interest rates at zero percent, the Fed is inflating speculative bubbles worldwide [including China]".

This prompted Charles Wyplosz to say that this statement was not only totally misguided reasoning but also very dangerous. "The Fed deals with US economic and financial conditions, which are weak enough to justify very low interest rates. The impact on China only exists because the Chinese authorities have decided to peg the RMB to the dollar," he stressed.

Andrew Sheng responded, "Charles, who is really being helped by the low interest rates? I can understand why the real sector needs zero interest rates but the 30 year fixed rate mortgage is still 5% per annum, more in real terms. The real winners are the bankers who pay themselves massive bonuses on the back of government guarantees and subsidies from the central banks and then depositors around the world."

Charles Wyplosz retorted, "Assuming that the zero interest rate policy has the effect that you describe, and only that effect, it is redistribution within the US, something that is striclty a US issue. It has no bearing whatsoever on China's monetary policy."

Subsequently, I sent around an article by Andrew Sheng, "A year in crisis - who pays?", in which he says:

"Thanks to the zero interest rate policies, the world is one big carry trade and emerging markets are very bubbly.

Investors are now once again caught between greed and fear. Greed drives a lot to join the momentum play, fear rising as prices go higher and higher. (...)

It is not surprising that the world is schizophrenic about both deflation and inflation.

Economists like Paul Krugman and Nouriel Roubini are in the camp of deflation, whereas investors like George Soros and Warren Buffett are signaling that they are worried about inflation.

Of course, for those with lots of debt, inflation would be welcome because that inflates away the real value of the debt. For those savers whose returns are not higher than the inflation rate, they will share the burden of the inflation tax.

What is quite clear is that most of the world is going to pay for this crisis. So, please send a Christmas card to those Wall Street bankers who are enjoying record bonuses to remind them that all of us are paying for their party."

If you want to read the full article by Andrew Sheng, the link is here.

Macro-prudential regulation

2009-07-13T03:17:00.000-07:00

Avinash Persaud sent me some thoughts about macro-prudential regulation which are worth reading (again). Here is what he says:

The counter-revolution begins: the rise and premature fall of macro-prudential regulation

An early consensus to emerge from the wreckage of the global financial system was that in addition to the old, we needed a new type of regulation: macro-prudential regulation. This became so readily accepted, at a time when policy makers were ready to accept almost anything that appeared to be affirmative action, that the term, “macro-prudential regulation”, quickly became a cliché: over-used and poorly understood. So poorly understood, it now appears, that despite much talk of the need for macro-prudential regulation and its cousin, “systemic risk regulation”, it is actually hard to find any detailed macro-prudential regulation in the US Administration’s White Paper. Bank of England Governor, King, has also pointed out that despite being given broader responsibility for systemic risk by the UK Government, he has not yet been given any macro-prudential tools to achieve it.

The term macro-prudential regulation was probably first used in the late 1980s by Andrew Crockett, former General Manager of the Bank of International Settlements. In more recent years his colleagues at the Basle-based BIS, in particular, Bill White and Claudio Borio, championed the idea along with some policy officials –it may be unhelpful to them to identify them by name - and macro-economists like Charles Goodhart, Jose-Antonio Ocampo, myself and others. The point of macro-prudential regulation is that financial firms acting in an individually prudent manner may collectively create systemic problems. Macro-prudential regulation is a response to a failure of composition problem: we cannot make the financial system safe, merely by making every financial institution and product safe.

Proposals to improve the regulation of firms, products and markets - contained in the US Administration’s White paper - are generally a good thing, but they are not macro-prudential. Moreover, these proposals neglect the critical observation that we have spent the last 20 years tightening up micro-prudential regulation and yet financial crashes are just as deep if not more so and they do not occur randomly, which a failure of a rogue firm might imply, but always follow booms. This boom-bust cycle implies there is something “macro” going on we need to address urgently.

A common source of macro-prudential risk is common behaviour by financial firms - often as a result of closer adherence to tougher micro-prudential rules. During booms, asset prices rise and measured risks fall. Acting prudently, financial firms will feel it is safe to expand lending. All financial firms expanding together will lead to a scramble for assets that will create, post-hoc, excesses in valuations and lending. During the resulting crashes asset prices collapse temporarily and measured risks soar. In “Sending the herd off the cliff edge” (IIF, 2000) I showed how all financial firms responding to common prudential, market-based risk controls, would lead them to want to sell the same assets at the same time, creating a liquidity black hole.

Macro-prudential regulation is about encouraging different behaviour than a prudent firm would follow, wherever this prudential behaviour could undermine the financial system if followed by everyone. It is rather like the paradox of saving. Individually saving is good; collectively we can have too much of it. A classic macro-prudential tool that Charles Goodhart and I have advocated is to raise capital adequacy requirements, not for all times, but specifically when aggregate borrowing in an economy or a sector is above average in an attempt to put sand in the systemically dangerous spiral of rising asset prices leading to rising borrowing to buy assets, leading to rising asset prices. This is doable as the Spanish have shown with their counter-cyclical provisioning. India could be said to have carried out macro-prudential regulation when the RBI tightened up credit conditions for lending in the housing market during the recent housing boom. Counter-cyclical measures will not end boom-bust cycles, but they may reduce their amplitude.

Another macro-prudential tool is to take a holistic approach to the financial sector and encourage certain risks to flow to places with a capacity for that risk. When the crash comes, firms that can absorb short-term liquidity risks, perhaps because they have long-term funding, are not forced to join the selling frenzy in the name of common prudential rules for all, but are more able to buy and diversify liquidity risks across time. This would forestall the implosion of the financial system that would occur if there are no buyers, only sellers.

Buried beneath the US Administration’s proposals are hints at counter-cyclical provisioning, extra capital for liquidity risks at banks and differentiated accounting, but the Paper essentially gives to much to those carrying the pitch forks in Congress who argue that what was wrong was that we didn’t have enough regulation. The brave observation is that we had too little of the right, and too much of the wrong, regulation. Doubling up existing regulation will satisfy the justifiable moral outrage against bankers that many voters feel; but it will lead to more of the same in financial boom and bust because it is insufficiently macro-prudential.

Avinash D. Persaud is Chairman of Intelligence Capital Limited, Chairman of the Warwick Commission and Member of the UN Commission of Experts and Pew Task Force on financial reform and Emeritus Professor of Gresham College.

Reform or crisis management?

2009-05-13T07:07:00.000-07:00

Interviewing Robert Triffin in 1985 in his room at the University of Louvain-la-Neuve.

Last week I gave a speech at a conference in Louvain-la-Neuve (7-8 May 2009) in which I advocated fundamental reform of the international monetary system. In my speech, "Why should we have listened better to Robert Triffin?", I refer to the March 2009 plea by China's central banker Zhou Xiaochuan to create a new global reserve currency replacing the dollar and I remind that three years earlier Fan Gang, member of the Monetary Policy Committee of China's central bank and member of the Fondad Network, made a similar plea in his contribution to the Fondad conference and book Global Imbalances and the US Debt Problem: Should Developing Countries Support the US Dollar?

At the end of my speech I discuss the likelihood that the world's policymakers will finally adopt and implement a fundamental reform of the international monetary system in an updated version of the Triffin Plan or any other plan that departs from the same basic idea that we need a truly international global reserve asset as key currency of the system.

Given the reactions by US, European and Japanese policymakers to the Chinese and Russian proposals I expect that the process of reform will be slow. Let me quote the end of my speech:

US policymakers, Japanese policymakers and a few European policymakers immediately reacted to the news about the need for "a new global currency" by saying that a fundamental reform that implied replacing the dollar was neither necessary, nor likely in the near future. A number of academics and columnists said the same. But the UN Commission headed by Stiglitz advocated fundamental reform of the international monetary system, and so did the Italian minister of economy, Giulio Tremonti, recently, according to news agency Reuters (30 April). So, is reform about to take place?

I don't think so. The power groups and interest groups opposing fundamental reform of the international monetary system are still strong. The routine of the bureaucrats and bosses in both official and private institutions is likely to prevent action. The policymakers of the NATO countries - with the exception of Italy ? - do not seem to be eager starting a process of negotiating a new monetary system that replaces the dollar as key currency of the system. The Europeans rather prefer to maintain the dollar and improve financial regulation.

Does the old dream of Robert Triffin remain a dream, a utopia?

My hope is that Triffin's dream will become true. The problems of the current system (its instability, its proneness to crisis, its unfair treatment of developing countries) are too big to let them drag on. We should not wait with reform until the next crisis emerges because the costs are too high. It would also be proof of low intellectual quality of our policymakers, and of low intellectual quality of the academics working with them, if they would let drag on the system as it is. Why should they not change it?

I'd like to end my talk with an encouraging quote from Triffin. When I interviewed him in 1985 for the Dutch and Belgian magazine Intermediair, I asked him if he was never accused of being naïve by still believing in the possibility of reforming the international monetary system. "Yes," he answered frankly.

- And what is your reaction to this reproach? I asked.

'Well, I give the answer Ben Gurion once gave: to be realistic today you need a great deal of utopia. Running away from the most obvious solutions is not realism. It's crisis management, condemning you to more and more crisis management."

Latest unemployment figures (taux de chômage) in Europe

2009-04-30T21:35:00.000-07:00

I am going to copy a French article with the latest figures about unemployment in the European Union provided yesterday by the statistical bureau of the EU, Eurostat. For those who do not understand French, just take a look at the figures and try to grasp to what countries they are related. (I think that for solving the world's economic problems one needs people who make an effort to understand other languages than solely their mother tongue. A few other characteristics may be needed as well.)

The issue in this blog is how the rise in unemployment is connected to the current crisis, what the main causes of the crisis are, and how they can be remedied. I will come back to that in another post. Then I will stress again the need for fundamental reform of the international monetary system. The old Plan of Robert Triffin (first developed by him already in 1957) to replace the US dollar with an international reserve currency that is not the currency of one country, has gained powerful support from the Chinese, the Russians and others.

Let's now turn to the unemployment figures:

Selon les chiffres publiés aujourd'hui par Eurostat, l’Office statistique des Communautés européennes, dans la zone euro, le taux de chômage corrigé des variations saisonnières s’est établi à 8,9% en mars 2009, contre 8,7% en février. Il était de 7,2% en mars 2008. Dans l’UE-27, il s’est élevé à 8,3% en mars 2009, contre 8,1% en février. Il était de 6,7% en mars 2008.

Parmi les États membres, le taux de chômage le plus bas a été enregistré aux Pays-Bas (2,8%) et les plus élevés en Espagne (17,4%), en Lettonie (16,1%) et en Lituanie (15,5%).

Trois États membres ont enregistré une baisse de leur taux de chômage sur un an, vingt-trois une hausse, tandis que le taux est resté stable aux Pays-Bas. Les baisses ont été observées en Roumanie (de 6,1% à 5,8% entre les quatrièmes trimestres de 2007 et 2008), en Bulgarie (de 6,1% à 5,9%) et en Grèce (de 7,9% à 7,8% entre les quatrièmes trimestres de 2007 et 2008). Les plus fortes hausses ont été observées en Lituanie (de 4,3% à 15,5%), en Lettonie (de 6,1% à 16,1%) et en Espagne (de 9,5% à 17,4%).

Conquer the monster?

2009-03-19T03:33:00.000-07:00

People protest during France's second nationwide strike in two months, to demand a boost to wages and greater protection form the crisis, in Marseille Photo: AFP

There is too much information about the economic, social and political problems in this mad world. I mean, all this information seems to contribute more to continuing the mess we are in rather than solving it.

Almost every day I continue reading articles and analyses. How can I put some order in it, distil the useful, make it my own, and share it with others?

The best would be to throw out a few thoughts and stay close to my feelings. I have the impression that too many of the people I read -- all this information is written by people -- are driven by the desire to impress rather than share in a modest and friendly way information or views. In doing so, they reproduce the monster, even though their intention may be to conquer it.

Another problem is that important information is missing and that there is little agreement among economists and politicians about the origins of the current economic crisis and the best ways to solve it. In my previous post I reiterated my view that the crisis stems from a too little controlled, global financial system based on the US dollar and reported with some optimism that the Chinese prime minister seemed to share this view, at least partly. But I am afraid this view will lead to a change in the system only if it is shared more widely. My guess is that most policymakers are more interested in making work again the current system than replacing it by a new one. All the talk about "reform" and "overhaul" of the system is more rhetoric than reality.

Then there is the problem of arrogance among economists. In particular, U.S. economists are good at telling the general public, the government or anyone else what is good for them. Paul Krugman did so recently in Spain, recommending to lower wages and prices, but he is no exception. Could you think of a psychologist prescribing you how to behave?

Nonetheless, economists have hardly any authority to tell you what's good for you. They are social scientists and their object of study is dependent on what you and others are doing and longing for, individually and as members of groups and organisations. Economic advice is based on all kinds of assumptions about a limited aspect of human behaviour and should be discussed in a broader social and political context. Unfortunately, this rarely happens, thus promoting the status of economists to that of doctors of society -- a status they cannot live up to and ought to tell people they do not deserve.

This morning I read in the Telegraph that today, "Up to two million people were expected to take part in more than 200 demonstrations protesting against President Nicolas Sarkozy's handling of the global financial crisis. The biggest was in Paris, where militants called for an increased minimum wage and higher taxes for the rich."

Why are so few economists and politicians advocating higher minimum wages for the poor and higher taxes or lower salaries for the rich?

PS: Later I read that Krugman received 100,000 euros for his lecture in Spain. I did not find official confirmation that he indeed received that amount.

Halt (stop) and help !

2009-01-30T05:20:00.000-08:00

In my previous post I said that citizens should not feel powerless vis-à-vis the current economic crisis and leave its resolution to the policymakers. However, I’m afraid Western policymakers themselves are increasingly feeling powerless too. They do not seem to be able to stop the crisis.

Initially the focus was on irresponsible behaviour of the banks, but now Western governments are getting under fire. In France, where Sarkozy as chair of the EU was internationally praised for his energetic approach to the crisis, a large majority of the population (70% according to a poll) supported a wide-ranging strike against the government held yesterday. The strikers blame Sarkozy that he is responding inadequately to the crisis, and helping the banks but not the ordinary people. The BBC reported: “So where, the French people are now asking, did the 360bn euro shore-up fund to guarantee banks come from? This, at a time when the government was busy slashing thousands of public sector jobs, trimming pension benefits and planning massive cuts to the education budget.”

Yesterday, at the annual meeting in Davos, China’s premier Wen Jiabao blamed the US (and the EU) for the current economic breakdown. “Inappropriate macroeconomic policies,” an “unsustainable model of development characterized by prolonged low savings and high consumption,” and “the failure of financial supervision” all contributed, said the Chinese leader. He also attacked Western financial institutions’ “blind pursuit of profit” and their “lack of self-discipline”.

Premier Wen also blamed the Western-designed global financial system for the world's current economic problems. He said: “The current crisis has fully exposed the deficiencies in the existing international financial system and its governance structure. We should expand the regulation of the international financial system, with particular emphasis on strengthening the supervision on major reserve currency countries.” Pointing to “major reserve currency countries”, Mr. Wen clearly thought of the United States in the first place, as the system is still based on the US dollar.

I share premier Wen’s critique of the dollar-based global financial system. More than twenty-five years ago, in a long article, I blamed the same system for the outbreak of the debt crisis in Latin America and warned that it would create future international crises. In the following years, as director of FONDAD, I organised international meetings where, time and again, high-level experts discussed the flaws of the global financial system and suggested ways to remedy them. Policymakers participated in these meetings and welcomed the constructive ideas presented. But they did not have the willingness, energy or power to put them into practice.

Now we are in the midst of a mess that policymakers find difficult to address. We should not leave it to them to come up with a better system and better policies.

Why citizens need to express their opinion

2008-12-07T23:30:00.002-08:00

Everyone who is in a position to do so, should get involved with thinking about best ways to solve the current international financial crisis. “Don’t leave it to the economists!” warned Robert Triffin when I interviewed him more than twenty years ago in Louvain-la-Neuve. “Just as Clemenceau once said that war is much too serious a thing to be left to the generals, I think the economy is far too serious a thing to be left to the economists.”

Talking to friends and people I meet I notice disbelief and distrust that “normal citizens” can contribute to addressing the financial and “real” economic turmoil. Others, who write critically about the crisis in articles and blogs, seem to be absorbed by anger and a feeling of powerlessness and describe as gloomy a picture as possible – without hope.

We will not get a more stable, just and democratic system if citizens around the world keep feeling powerless. We better increase their (our) empowerment by imagining alternatives. The policymakers need democratic guidance; they need our views. Even though they might have some good ideas as to how to solve the crisis, we still need much more democracy in economic policymaking.

To keep things simple, I see three levels at which citizens can contribute. First, at the level of daily conversations with friends and others – stimulate each other to increase your knowledge and express your opinion. Second, at the level of public opinion – contribute to public debates in meetings and in media (including blogs). Third, at the level of discussions among economists – explore strategies that are broader and/or more in-depth than mainstream opinion among colleagues.

Citizens around the world, awake, and don’t feel powerless. Ask around, read, be informed and express your opinion.

The credit crisis and the crisis of capitalism

2008-12-03T03:21:00.000-08:00

The credit crisis is a sign of deep problems of the capitalist world. But these deep problems are hardly considered by mainstream economists and policymakers trying to solve the crisis. Both groups tend to limit their scope and view. They see the resolution of the credit crisis mainly in terms of improved regulation and, possibly, some minor changes in the global monetary and financial system.

However, this is not the best way to find a long-lasting solution. Even though earlier crises were solved in the same way and even though the capitalist system has proven to be able to adapt itself to new circumstances, a broader approach is needed.

"Capitalism" and "capitalist" societies show different varieties. Capitalism in Germany is different from that in France, and capitalism in the US is different from that in China. The US is often seen as a "pure" or neoliberal capitalist society, but it has many governmental business-supporting institutions and mechanisms. Private companies are grateful for these mechanisms and have no problem in asking for government support, neither yesterday nor today. On the contrary, commercial banks and other companies have asked for massive government support and still continue to do so. And both the US government and European governments have been willing to provide the hundreds of billions of dollars private companies asked for.

The above illustrates two serious problems with the current steering of capitalist economies. First, there is a lack of vision in the policies pursued so far and envisaged tomorrow. Second, there is a lack of ideas and institutional mechanisms to make the economic policymaking more democratic.

The resolution of the credit crisis still lies in the hands of a very limited group of economists and policymakers. The rest of the world is merely bystander – hoping for the best.

"Dreaming" about ways to tackle the democratic deficit in economic policymaking is not a childish hope (see my post of November 27). It is an ideal politicians and citizens around the world should energetically defend. Addressing the democratic deficit in economic policymaking is one of the great challenges of our times. Citizens and politicians should take this challenge much more seriously.

Bill White: "The current financial system is inadequate"

2008-12-01T02:59:00.000-08:00

On this blog I have included on various occasions the views of Avinash Persaud and Bill White (see e.g. posts of June 29, May 7, and May 4, 2008). A few days ago, Avinash sent me an e-mail to thank me and others for the support we gave to his work "on the inevitable failure of banking regulation". He referred to a column by Martin Wolf in the Financial Times who had praised, among others, Bill White and Avinash for their excellent writings on the dangers of a credit crisis.

I would like to draw your attention to a speech made by Bill White on the prevention and management of financial crisis. In the speech he addresses the important issue of whether the current international financial architecture is adequate.

"My answer must be that it is not," says Bill White. "Financial crises are generally enormously costly, and we have been faced with them repeatedly over the course of the last few decades. Indeed, we are currently in the midst of a crisis which, being at the heart of the global financial system, could turn out to be the worst of them all."

If you want to read Bill's analysis you can click here.

Childish hope

2008-11-27T00:01:00.000-08:00

When making coffee in my Bialetti Venus 4 I thought: the reason I have difficulty in writing that long article which includes the views of Triffin, Witteveen, D'Arista, Kenen, Williamson, Sheng, Persaud, Woo and others is that I realise too many written pieces are waiting to be read, and long articles will never be read seriously, I mean seriously by people who should read them as they are the ones taking decisions about the future course of the world economy.

I also thought: the plea, the longing in my post of yesterday is too idealist, too childish, because how can you expect or hope (esperar expresa ambas cosas) that we may live one day in a world where everybody has equal chances?

However, it is that hope or longing that inspires my work.

Is it too early?

2008-11-26T03:01:00.000-08:00

Who has a vision of the future of global finance and the global economy? It seems that most social scientists and other thinkers are absorbed by crisis management.

Is it too early to think about a different world, a world where everybody is enjoying economic stability and the benefits of economic welfare?

Is it too early to envision the vision, the global institutions and the global and national institutional attitudes needed to realise such world?

My uncle Gino's advice

2008-10-13T00:33:00.000-07:00

When I see myself in the mirror shaving my face I always think of my uncle Gino from Toronto, who used to give investment advice (he had his own investment letter for many years). One morning, the only morning I stayed at his home near Toronto, he told me I did not need to hurry when shaving, as this would not finish the job more promptly. Just do it quietly, he suggested.

This morning I had to think of my uncle Gino's advice when I was hurrying back to my computer to write a post I've wanted to write for a long time, about visions of the future of finance in the global system. Why should I be in a hurry, I said to myself, if it won't speed my writing?

The picture shows my uncle Gino in his youth. He died a couple of years ago, in Canada, the country that had become his as he emigrated in the late 1940s or early 1950s. I know him as one of my many uncles and aunts in Canada (my brother also lives in Canada). Gino was a successful investment adviser until he lost his money, not because of an international crisis but because of something else.

PS: I see the original date of drafting the first two paragraphs appears as the date of this post. However, today it's 25 November, so "normally" I would feel that I should hurry to finally get that post out on visions of the future. But, listening to my uncle Gino's advice and seeing the speed of information and the speed of financial transactions as one of the problems of global finance and development... slow writing and slow financial transactions may make a better contribution to world stability than all this crazy and unthoughtful chasing after financial news and financial opportunities. Es la locura en que vivimos actualmente, it is the madness in which we are living these days.

Solving the credit crisis: we need a visionary view

2008-10-06T07:19:00.000-07:00

To understand the functioning of the global financial system, prevent its crises and propose a better system, is a tremendously challenging job. No economist alone or group of economists would be able to do that job. In order to do it properly, one needs an overview and comprehensiveness of knowledge (including that of the other social disciplines) that economists alone cannot possess. Thinkers from other disciplines are needed as well.

Most officials working at ministries of finance and central banks see it differently. They still think they can do the job. However, we do not only need technical expertise but also a broad and in-depth view that takes into account how the system works for all citizens, rich and poor.

OK, I agree, the most urgent job for officials is now to manage the crisis as good as they can, and make steps towards a better regulation of financial markets. But even accepting the adagio that “only small steps are possible”, we still need a broad, visionary view of the system.

Can we create such visionary view? How?

The last laugh

2008-10-04T20:54:00.000-07:00

In the media and the bakery shop around the corner, I hear more and more people say that the global financial system is ludicrous. Yesterday, in my daily newspaper NRC Handelsblad Dutch writer Willem van Toorn said, "It is amusing for the outsider that the army of economists, who always have said to us with serious scientific economic faces that we should not stop growing, now do not seem to have any scientific text available and instead speak with deep concern about 'the emotion of the market'."

Willem van Toorn's concern (and amusement) with economists was shared the day before in the same NRC Handelsblad in a column by Jan Sampiemon, a former Chief Editor for Foreign Affairs and former Deputy Chief Editor of NRC Handelsblad. He said:

"European politics followed until the beginning of this week European business, which was captured by the new US managerial capitalism. … Among other things, you recognise an ideology by the commonness of opinion among nearly all those who are dealing with the issue as economist, politician, CEO or journalist. Relevant questions were not raised. 'Fundamentals' could not be debated and scientists who raised critical questions were turned to the corner where they could puzzle over their stalled career."

I circulated these two quotes among a number of economists of my FONDAD Network (the group is larger than the link indicates) and in response one of them sent me a nice video clip. I think it will make you either smile, burst out in laughter, or laugh like "een boer met kiespijn" (a farmer with toothache), as the Dutch expression goes. According to my dictionary the English would say, "laugh on the wrong side of your face (mouth)".

The Last Laugh - George Parr - Subprime - subtitulos
Cargado por erioluk

Fixing the financial crisis: an agenda for regulatory reform

2008-09-25T05:01:00.000-07:00

I read a paper I like a lot. It has been written by Jane D’Arista and Stephany Griffith-Jones, two experts in international finance, both concerned with the functioning of the global financial system, its current crisis and its (likely) effects on people less fortunate than the rich.

The paper is called “Agenda and criteria for financial regulatory reform” -- a key issue that needs to be addressed urgently. In my view, all policymakers, officials, opinion-makers (any academic teaching or writing is an opinion-maker) or other person interested in the current financial crisis should read the paper and, if possible, do something with it.

The first introductory paragraph is worth quoting fully:

“The severe turmoil in the most “advanced” financial markets that started in the summer of 2007 follows many deep and costly financial crises in the developing economies during the last twenty five years. This more recent crisis, like previous ones, is the result of both:
(a) inherent flaws in the way financial markets operate – such as their tendency to boom-bust behaviour – and
(b) insufficient, incomplete and sometimes inappropriate regulation.
Financial crises tend to be very costly from a fiscal point of view (i.e., that of the taxpayer), from their impact on lost output and investment, and from their impact on people, many of whom are both innocent bystanders and poor.”

The second introductory paragraph is also worth quoting fully:

“It is therefore urgent and important to reform financial regulation, so that it makes financial crises less likely in the future. Those new systems of financial regulation should attempt to deal with the old unresolved problem of inherent pro-cyclicality of banking as well as financial markets. They should also deal with such new features as the growing scale and complexity of the financial sector, the emergence of new, as yet unregulated actors and instruments, as well as the increased globalization of financial markets. To do this adequately and to avoid regulatory arbitrage, regulation has to be comprehensive.”

As the remainder of the paper is 25 pages long, I cannot continue quoting every paragraph I like. So let me just highlight a few of the insights the paper provides.

“A key market failure in the financial system is the pro-cyclical behaviour of most financial actors, which leads to excessive risk-taking and financial activity in good times, followed by insufficient risk-taking and financial activity in bad times. As a consequence, a key principle and desirable feature for efficient regulation is that it is counter-cyclical, to compensate for the inherent pro-cyclical behavior of capital and banking markets.”

“After the eruption of the sub-prime mortgage crisis in the summer of 2007, criticisms of past and present policies of the Federal Reserve and other regulatory authorities became more frequent. (…)The Fed’s monetary influence weakened as it gave priority to deregulation and innovation and abandoned credit flows to the procyclical pressures of market forces, ignoring ways in which monetary policy itself had lost its ability to stabilize financial markets and the economy. It paid no attention to the way that foreign capital inflows drove up the supply of credit and failed to notice the explosion of debt that unchecked credit expansion produced. And, as debt soared, the Fed ignored the asset bubbles it fueled. (…). Together with its failure to criticize and curb abusive lending practices, the Fed’s passivity in responding to major changes in financial structure and regulation contributed to the prolonged and pervasive reach of the credit crunch that the sub-prime mortgage defaults unleashed.”

“Over the past 30 years, the US financial system has been transformed by a shift in household savings from banks to pension and mutual funds and other institutional investment pools. (…) The implications of these shifts in saving and credit flows have radically altered the way the financial sector functions, reducing the role of direct lending in favor of trading, investment and asset management.”

“At [a] 1993 conference, former Bundesbank Vice President Hans Tietmeyer’s … argued that, in a number of countries, deregulation and financial innovation had altered the transmission mechanisms for monetary policy to the real economy and had “generally made it more difficult for monetary policy makers to fulfill their stability mandate”.

Subsequent events have underscored the accuracy of these remarks. In the 15 years since they were made, however, the major central banks have taken no steps to improve the monetary transmission mechanism. On the contrary, they countenanced further innovation and deregulation and promoted the view that market-based solutions … could replace the quantity controls (reserve and liquidity requirements, lending limits and capital controls) that had been targeted for removal by the advocates of liberalization.”

When Jane and Stephany come, on page 12, to their criteria and principles for financial regulatory reform, the paper turns too detailed that it allows for quoting. You can read the full paper on the Fondad website, under “Other Publications”.

There is one concluding remark with which I like to finish this post:

“The discussion of a global financial regulator needs to be put urgently on the international agenda. In the meantime, efforts at increased co-ordination amongst national regulators requires top priority. It is also urgent that developing country regulators participate fully in key regulatory fora, such as the Basle Committee. Given their growing systemic importance, it is absurd and inefficient if they do not.”

Three schools of thought on crisis prevention

2008-06-29T23:55:00.000-07:00

A few months ago Bill White, chief economist of the Bank for International Settlements (BIS), made an interesting speech stressing that "the first and crucial point" for proposing solutions to the credit crisis is "agreement on the nature of the problem". I think that the lack of such agreement is one of the reasons the credit crisis still lingers on. It also tells us that the risk is great the crisis will not be tackled in a fundamental way -- not even in the moderate way suggested by Bill White and some of his colleagues at BIS.

What are the underlying causes of the current financial turmoil? Bill White sees at least two schools of thought: one that asks itself "what is different", and the other, "what is the same". Most analysts follow the first school of thought, but Bill and some of his colleagues at BIS see more value in the second school. Why? Because the financial system "is inherently procyclical and thus chronically prone to bubble-like behaviour", argues Bill. To remedy this procyclicality we need a "new macrofinancial stability framework" (see also Bill's chapter in a recent Fondad book, "The Need for a Longer Policy Horizon: A Less Orthodox Approach").

Bill White observes that the school of "what is different" focuses on new developments in financial markets. Emphasis is put on the massive expansion of the subprime mortgage market in the United States, the growing use by banks of the originate and distribute model, the reliance on off-balance sheet vehicles, the development of new structured products, and the reliance on ratings agencies in marketing them.

"These new elements, originally thought likely to produce a welcome spreading and diversification of risk bearing," observes Bill White, "seem instead to have materially reduced the quality of credit assessments and also led to increased opacity. The result has been the generation of enormous uncertainty both about how large the prospective losses from defaults might be, and about where those losses might be concentrated. In this environment, everyone has become suspect, including the large banks at the heart of the financial system. Market liquidity and funding liquidity dried up, and the interbank term market effectively closed down. Moreover, there were significant knock-on effects, initially on other markets that rely on the interbank market for price fixing, but subsequently on a whole host of other markets where asset prices were considered to be richly valued."

"If it is these new market developments that have been responsible for the observed turmoil," says Bill, "then this suggests solutions that seek to preserve the benefits of the new products while reducing the unwelcome side effects. In the short term, this would imply injections of liquidity by central banks, and potentially other government agencies, to reliquify markets."

Bill's concern is that, in the aftermath of most historical bubbles, the focus of attention shifted to new instruments and techniques and the role they played in the process, while the key factor - leveraged speculation - was commonly ignored. "Evidently, it is more comfortable for all concerned to blame the essentially unpredictable side effects of new developments than to admit to having failed to see the build-up of all too traditional exposures."

Following the second school of thought Bill White asks himself what is the same about the current market turmoil compared to previous financial crises. His answer is "that in virtually every case, the crisis was preceded by very rapid credit expansion, which manifested itself in part in higher asset prices." These gains provided the collateral to justify even more lending and increased the appetite for risk-taking, on the side of both lenders and borrowers. As a result, leverage increased even as the general quality of credits deteriorated, and investment and consumption went beyond long-term trends. "At a certain point, usually when earlier expectations about profits or future income growth began to look unrealistic, this whole endogenous process went into reverse. In effect, boom turned to bust."

Based on the historical evidence Bill makes two observations. "The first is that the moment of change generally arrived completely unexpectedly, with the trigger for the event commonly being far too inconsequential to explain the resulting mayhem. This is precisely because a "trigger" is not the underlying "cause" of the problem. A second observation is that the turning point was almost never preceded by any significant degree of inflation. In particular, prices were falling in the United States in the late 1920s, were rising only very slowly in Japan in the late 1980s, and averaged only around 4% in Southeast Asia when that crisis hit in 1997."

What are the characteristics of the "new macrofinancial stability framework" suggested by Bill White?

"The first characteristic of such a framework would be a primary focus on systemic developments. In particular, attention would be paid to the dangers associated with many people and institutions having similar exposures to possible common shocks. The recognition of endogenous forces with potentially non-linear outcomes would be a further important theme. Evidently, this would not reduce the attention paid to the good health of individual institutions, but it would put such concerns into a broader context.

A second characteristic would be still closer cooperation between central bankers and regulators in assessing the build-up of systemic risks and in deciding what to do to mitigate them. What is needed is to find the point of optimal interaction between the more top-down approach of central bankers and the traditionally (though this is changing) more bottom-up approach of the regulators. Each perspective has much to offer. As an aside, such closer cooperation need not, though it could, imply a reversal of recent trends towards setting up independent regulatory agencies with responsibilities for both financial institutions and financial markets.

A third characteristic would be a much more "symmetrical" or countercyclical use of policy instruments. In this regard, the new framework would simply mirror the accepted wisdom for the conduct of fiscal policy: namely, that the good times should be used to prepare for the bad.

More specifically, monetary policy would lean against "booms" in the growth of credit and asset prices, particularly if accompanied by distorted spending patterns that opened up a real risk of subsequent reversal. This latter point is crucial if we are to distinguish between what is being recommended here and the quite different proposition of "targeting asset prices". Regulatory policy would have a similar bias, with risk spreads (for expected losses), provisioning (for subsequent changes in expected losses), and capital (for unexpected losses) being built up in good times and run down in bad."

Hervé Hannoun, the deputy general manager of BIS, added in a recent speech that there are three schools of thought on financial crisis prevention:

– The first school of thought considers that it is illusory to "lean against the wind". Asset price and credit booms are not preventable, and the real policy issue is to be ready to "clean up the mess" when the bubble bursts.
– The second school of thought considers that it is desirable to lean against the buildup of serious financial excesses. But monetary policy cannot deal with financial bubbles and asset price exuberance. Prudential and supervisory policy is instead the right tool for that.
– The third school considers that both monetary policy and macroprudential policy can and should be used to lean against the wind. A macrofinancial stability framework should be implemented to pre-empt financial excesses and "serial bubbles".

Hannoun emphasises that the third school of thought, the "macrofinancial stability framework" school, recommends leaning against the wind by making use of both monetary and supervisory instruments to pre-empt serious financial excesses.

"In this conception, macroprudential policy (the supervisory tool) has a crucial role to play in reducing the procyclicality in the financial system. But monetary policy also has a role to play in that respect. The recent financial turmoil suggests that monetary policy may have to counteract excessive credit expansion and asset price booms even if price stability were achieved. The key argument is that central banks should not rule out leaning against the wind by raising interest rates to stop asset price bubbles and credit booms from getting out ofhand: in other words, prevention is better than cure."

Bill White warns that the difficulties we face today in financial markets, with their potential to have significant effects on the real economy, indicate clearly that the costs of not having a new macrofinancial stability framework could be large.

Asset Bubbles and Inflation

2008-05-20T02:24:00.000-07:00

Wing Thye Woo sent me a piece on the state of the US and global economy identifying the financial markets as the flashpoint of the problem and asked if I could post it on the Fondad website (you can find it there under “Other Publications”) and circulate it among friends to get feedback. The first thing I did was circulate it among a small group of the Fondad Network and this prompted a debate among a few of them on which I report.

The first one commenting on Wing’s piece was John Williamson. He said that he was in general agreement with Wing’s paper, except that he did not think Wing had made the case for departing from targeting inflation as an objective.

“His argument can equally well be taken,” said John, “to suggest that central banks should examine phenomena like what is happening in asset markets when they assess the implications of current policies for future inflation levels. One might still have times when the criterion suggests the desirability of tightening monetary policy despite a current inflation rate that looks under control. But if in fact the assessment is that asset markets are inflating for rational reasons that cannot be expected to blow up, then surely it is appropriate to let it happen. (And I am not persuaded that one should rule out this possibility by assumption.)”

Wing responded, “I agree totally that it is not always possible to separate asset bubbles from fundamentals-driven asset price increases. I do think, however, that there are some occasions where many reasonable observers could identify bubbles, e.g. the Chinese stock market in 2007. Of course, unanimous agreement is not possible because, if it were possible then there would be no trade in the asset. The Fed's job has just gotten a lot harder now that it finds that procedural simplicity is foolish when hard-to-identify events do occur.”

Then Andrew Sheng came in, commenting, “However difficult that a judgement has to be made, those in position of responsibility are paid to make that judgment. To say that it is difficult and you don’t have theory to help you make that judgment seems to be a cop out. The dilemma is that the cost of making a wrong call has either huge personal consequences or huge social costs.

The issue is whether you think monetary policy is interfering with the free market. If you believe that the market will take care of itself, let’s have no central banks and regulators. But if you have such institutions, someone must make the judgment call when a bubble is forming and when you have to lean against the wind.

What I have never understood is why the margin tool (lowering the loan to value ratio) was never used if there was reluctance to use the interest rate tool. We have seen it all before. When the bubble forms, we all say that this time it’s different. No, it’s not.”

Avinash Persaud added, “It is one thing to say that monetary policy should be mindful of not inflating asset market bubbles and another to say that it should try to prick bubbles. (Geneva Report 2 on Asset markets and central banks tackled this issue well.) While I believe policy as a whole should lean against asset market bubbles (the costs and consequences of not doing so are severe) it is not clear to me that it should be monetary policy that shoulders the burden or that it can do so well.”

Avinash went on, saying, “The level of interest rates required to prick a bubble in its most expansive state would be intolerable for the rest of the economy. (What level of interest rates would be required to prick a bubble based on a belief that property prices rise by at least 10% per year and where investors are 95% leveraged?)

Better then for regulatory policy to carry a large part of this burden.

Indeed, given that the principal purpose of regulation is to avoid systemic crises and the root of most of these crises is a prior asset market bubble, it would seem appropriate for regulatory policy to try to temper the increase in leverage that goes with bubbles. It would also mean that we would be “adding instruments” to macro policy at a time when liberalization and globalization has had the side effect of reducing instruments.

At the heart of most financial crises is leverage, the rise in leverage prior to the crisis based on some confidence that risk has fallen, and the subsequent deleveraging. Charles Goodhart and I have been working on a proposal to add a capital charge based on the rise in the leverage ratio above a pre-determined level. This may act as an added brake and a source of higher capital and reserves that can be used when the crisis hits.”

This prompted Andrew Sheng to say, “Avinash, I couldn’t agree with you more. Irrespective of regulators or central bankers or the division of responsibilities, a key issue is the choice of tools. You have either a price tool (interest rate) or the quantitative tool (leverage or credit supply). Hence, if you don’t want to use one, you may have to use the other.

The central bank is in charge of macro tools, but one of our dilemmas is that there is no accepted measure of macro-leverage. So, if you add the philosophy of minimally interferring with the market, then you are unlikely to use the leverage tool. Add in the confusion of responsibility whether the central bank is both a regulator and monetary policy agency, then the specialist regulators are waiting for signals from the central bank and individually in silos, they may not be able to stop the bubble forming.

Hence, you have to have a unified view whether a bubble is forming and someone has to take a lead in that judgement and decision. This is a matter of will, the willingness to make a judgment call and be evaluated by the market whether you avoided the bubble or not. What you and Charles have suggested is the micro-regulatory tool to ensure that individual institutions fine-tune their risk management. This is very useful but as we have learnt, these tools do not prevent greed of bankers from making all kinds of excuses, such as accounting and Basle rules, not to make the precautionary measures against taking on excessive leverage. The best rules do not stop bad behaviour. Strict and clear enforcement does.

Ultimately, it is the greed factor and the incentive structures, particularly personal interests, that drive the bubble and leverage forward. Central bankers have a fiduciary duty to somehow stop the ordinary crowd from allowing themselves to go mad. From time immemorial, leaders have to make personal sacrifices for the public good, this includes being blamed for taking or not taking key decisions. C’est la vie.”

Then Stephany Griffith-Jones commented, “I totally agree with Avinash. Particularly for developing countries it is crucial of course to include exchange rates as a key asset price.”

John Williamson rejoined the debate and said, “Bubbles are by definition movements in prices that cannot be explained by fundamentals like interest rates, so I agree hat it would be foolish to rely on monetary policy pricking bubbles. That might easily involve intolerable strains on the rest of the economy. I think this consideration adds a reason as to why monetary policy should not follow the Woo formula of targeting a price level that includes asset prices, but that it leaves intact my version which says that the implications of any bubbles for future inflation should be taken on board by the central bank in formulating its monetary policy.

Where I do agree with the subsequent discussion is that regulation and not monetary policy should bear the main burden of curbing bubbles. Without having read the Goodhart-Persaud paper, it seems to me that their proposal is very much along the right lines and not primarily directed at microeconomic factors.”

Stephany's second comment was, “As I wrote, I strongly agree with Avinash and now John on the centrality of regulation to limit the increases in asset prices. It is very encouraging to see that so senior a policy maker like Mishkin is moving along similar lines that several of us have been developing for some time, (as reflected in today's FT, of 17 May, where he is quoted as arguing in favour of countercyclical regulation). It would be great for this group to come up with specific proposals on this aspect, building on the Goodhart-Persaud FT article, and their other work, on John's book, and on the work that José Antonio and I have done on countercyclical regulation, on the Spanish provisioning system, etc.

I think a key precondition for doing this effectively is far more complete information for regulators on what is happening in financial and banking markets, e.g. derivatives, so they can see where excessive TOTAL leverage is developing, including in areas with no capital requirements. Ideas like that of Soros to bring OTC derivatives on the exchanges- could be helpful to identify total leverage.”

The discussion goes on. Comments are welcome. You can also send them to my email address, to be found on the Fondad website under "Contact".

Dogmatic thinking

2008-05-07T03:07:00.000-07:00

I don't like dogmatic thinking and dogmatic statements, but in several posts I have spoken about ministers of finance and central bank presidents as if they would be dogmatic thinkers by definition. Or, at least, that's the impression you may have gotten.

However, I'd like to stress that I do not think all ministers of finance and all presidents of central banks or all managing directors of the IMF, are dogmatic in their thinking, writing and speaking. Or that they are always dogmatic. How would I dare to think that!

I have high esteem for several (former) ministers of finance and central bank presidents (or their deputies) and I am happy that a few of them "belong" to the FONDAD international network. I don't need to mention their names, most of them you can find in the list of the FONDAD Network on our website.

Let me make one exception: Bill White (his official name is White, William). I have high esteem for his thinking and his commitment. I remember vividly how he shared with me many, many years ago, long before the subprime and credit crisis emerged, his concern about US credit markets. At the time, I understood that his public statements were more careful and less articulate, and I still understand that. For many years, I have also been more careful and less articulate than before I created FONDAD.

To finish this brief thought, I think you have to take into account certain roles you have to play. Being careful in your words does not mean you are a conformist. It may just mean that you apply a bit of self-censorship, for certain reasons. Whether those reasons are good, depends on your own assessment. Others have nothing to do with that -- unless you are interested in hearing their opinion.

A passionate view

2008-05-06T22:57:00.000-07:00

There is one thing I'd like to add to the previous post, not an extremely important thing for those who like "pure" economic arguments, but a significant thing for those who like to look beyond numbers.

In the previous post, I only highlighted the gist of Avinash Persaud's article, not the flavour. I mean, he wrote the article in a personal way, with a personal voice, and I not only like that but also think it is significant when you make an argument. Let me illustrate my point by quoting the first paragraph of Avinash’s article:

"Flash back 10 years to May 1998. The Asian financial crisis is unfolding. I am sitting on the J.P. Morgan dealing floor in Singapore. My trip to Jakarta has been cancelled because of rioting. Students have been killed and women raped. Regional currencies are in free fall. Local equity markets are imploding. Credit-rating agencies are 'helpfully' responding by slashing credit ratings. The region's vaunted political and economic stability is collapsing before my eyes. On the Morgan dealing floor, we can't tear ourselves away from the electronic screens transmitting the bloodbath tick by tick. I feel the primordial pull and guilt of passersby to get a closer look at a ghoulish car accident."

In my view, writing style is more than style. It reveals emotions. Thinking about (financial) globalisation requires a passionate and a dispassionate view. The one without the other reduces economics to either numbers – in the case of a purely dispassionate view – or emotions.

Economics is not about numbers but about people. In another post, I'll say something about the need for a passionate view.

The photograph of the man on his chair comes from "U.S. Camera 1939", Edited by T.J. Maloney, and published by William Morrow & Company, New York.

Bad economics

2008-05-04T00:41:00.000-07:00

I like sound analysis and sound reasoning. I dislike "sound economic policies" as they usually refer to dogmas.

I like discussions in which good arguments are explained if needed, and I dislike discussions in which good arguments are dismissed (usually by economists vested with power) without considering them seriously.

I like simplicity where possible, and I dislike simplicity when complex analysis is needed.

With this, I would like to introduce Avinash Persaud, whom I see as a sound thinker whose thoughts should be taken more seriously by policymakers.

Avinash Persaud has written an article, “Financial Regulation: Sending the Herd over the Cliff. Again”, that he sent to me saying it will appear in the June 2008 issue of the IMF's Finance & Development. Its basic argument is that risk models of banks create a false sense of safety and make crises worse when they emerge. In 1998, when the Asian financial crisis unfolded, and Avinash still worked with J.P. Morgan, he “learned first hand that whereas risk-sensitive systems may help banks manage their risk during quiet times, they are not crisis-prevention measures: they make crises worse.”

In 1999, Avinash wrote a Prize winning essay, “Sending the Herd off the Cliff Edge: The Disturbing Interaction of Herding Behaviour and Market-Sensitive Risk Management Practices”, and noticed it was dismissed by regulators as “too theoretical or extreme”.

In his recent article, Avinash disagrees with the regulators’ charm with market risk models that banks use and their proposal to incorporate these models in the new rules of Basel II.. “The reason we regulate markets over and above normal corporate law,” says Avinash, “is that markets fail from time to time, with devastating systemic consequences. If the purpose of regulation is to avoid market failures, we cannot then use risk models that rely on market prices as the instruments of financial regulation. (…) Risk sensitivity as a regulatory principle sounds sensible only until you think about it.”

Avinash stresses that market failure relates to the economic cycle. Banks and markets underestimate risk in the up cycle and overestimate risk in the down cycle. “In an up cycle, market participants always see some new paradigm that tells them the cycle is dead or that it’s ‘different’ this time. (…) At the top of a boom, the risk models prescribed in Pillar 1 of Basel II, whether using market prices or the ratings of credit-rating agencies, will be telling banks that they are running less risk and are better capitalized than they will in fact turn out to be when the credit cycle turns.”

In Avinash’s view, Basel II is bad economics. “It tries to use market prices to predict market failures and destroys the natural, liquidity-inducing diversity in risk assessments. What it ends up doing is precisely what regulation should be designed to avoid: acting procyclically.”

The economy is too serious a thing to be left to the economists

2008-04-25T00:03:00.000-07:00

A better management of the current financial crisis requires a profound analysis of its causes, a wise consideration of possible responses and a visionary view on how the global financial system could be improved to prevent, as much as possible, future problems.

This is not an easy task and is not what happens today.

Today we are seeing central bank presidents, whom we have given the responsibility to maintain a healthy national and international monetary system, and ministers of finance, whom we have given the responsibility to propose the best possible financial policies nationally and internationally, making statements that are proof of powerlessness or lack of vision, or both.

How to change this dangerous incompetence?

We, the peoples of the world who, when we are living in democracies, have vested responsibility and authority with ministers of finance and central bank presidents (to name just the highest in "authority"), are the only ones who can give the answer.

Economists should help us, with their technical knowledge and insights, to develop a vision of a global financial and economic system that would enable a fair chance and fair living for all, now and in the future.

Robert Triffin, a famous analyst of the global financial system, once said to me: “Just as Clemenceau once said that war is much too serious a thing to be left to the generals, I think the economy is far too serious a thing to be left to the economists.” (see the second para in my article "The International Monetary Crunch: Crisis or Scandal?")

Managing the crisis (1)

2008-04-22T07:10:00.000-07:00

"Central banks have kept interest rates very low for many years. This has led many banks to seek juicy returns – to protect shareholder value, as they say – by taking unreasonable risks. This has also led to massive foreign exchange reserves accumulation all over the world. The great unwinding must now take place," said Charles Wyplosz in the Financial Times of 21 December 2007.

Yesterday, the Bank of England presented a rescue plan of 62.5 billion euros for commercial banks affected by the credit crisis, the largest rescue plan ever by England's central bank. One of the banks in trouble, the Royal Bank of Scotland, last year still celebrated its conquering of ABN Amro.

"The central banks have done everything they can to keep financial markets orderly. They have taken the risk of feeding the moral hazard beast and what did they achieve? So far, they have avoided the much feared Big Crunch, but the end of the tunnel is not yet in sight," said Charles Wyplosz in the FT of 21 December 2007.

Charles warned that "further cash injection (by central banks) will not provide the permanent solution – the return of interbank lending. For that to happen, banks need to be reassured about each other. Recapitalisation is the only solution."

He added, "If a company has suffered, or is about to suffer, heavy losses, its shareholders will have to partake in the trouble. Delaying tactics prolong the misery without solving the problem, which will not go away. We now see that the willingness of central banks to provide liquidity at reasonably low cost is only allowing the shareholders to delay the time of reckoning. (...) The message must now go out: unless banks take up their losses and raise the required amount of capital, there will be no more liquidity."

Charles saw a simple solution: let the Sovereign Wealth Funds buy the shares needed to recapitalise the banks.

Stephany Griffith-Jones and José Antonio Ocampo have written an interesting paper on Sovereign Wealth Funds (SWFs) from a developing country perspective. They observe that these funds "have helped calm fears about banks' solvency and helped contain the inevitable reduction of share prices."

"A reason why SWF investment in banks has been welcomed," they observe, "is because they tend to take relatively small shares in banks, and none of them sit on bank boards. Additionaly, SWFs are perceived as having longer term horizons (for example as compared with private equity or hedge fund investors) which makes them less sensitive to market volatility."

In a next post, I will highlight other points in José Antonio and Stephany's paper. I will also report on an insightful article, "Financial Regulation: Sending the Herd over the Cliff. Again", I just received from Avinash Persaud and of which a version will appear in the June edition of the IMF journal Finance & Development.

What do you think of the Bank of England's rescue plan? Is it good? Is it bad? Is it nor good nor bad?

Let's help the poor in the US and elsewhere

2008-04-20T23:56:00.000-07:00

Sometimes I feel we are so busy with our own business that we forget to think about what is happening in the world. Or we think that we are dealing with what is happening in the world, but are doing so in a little effective or wrong way.

Last week I was shocked by a small article on page two of an Amsterdam journal, Het Parool, which said that 28 million people in the United States will need food stamps and that the number of people needing these stamps had increased by 30 percent since the beginning of the credit crisis.

Only in New York 1.1 million depend on food stamps. The victims are people with low-earning jobs in shops, the cleaning industry, kitchens of restaurants and workers in the construction sector. These 'working poor,' as the article observes, often spend 10 percent of their earnings on gasoline (petrol) and a substantial proportion of their income on food.

I have a revolutionary thought: let our European ministers of international development cooperation advocate a change of neoliberal policies in the United States and other countries affected by neoliberal policies, to combat poverty in the US and elsewhere including our own countries.

Doing just that our development aid industry would make a healthy turn away from too much a focus on bookkeeping of money given or lent to developing countries to, what in my view is the essence of international development cooperation, economic and social policies for the well-being of all.

The picture comes from a book I spent hours and hours looking at in my youth, "U.S. Camera 1939", Edited by T.J. Maloney, and published by William Morrow & Company, New York.

Preventing the crisis (4)

2008-04-17T01:37:00.000-07:00

To be able to prevent a crisis one has to know its origins or possible causes. As with previous financial crises, the current crisis is generally treated in a too simple way, not taking into account more fundamental causes than the problem with mortgages and new financial instruments.

Jane D'Arista is one of those economists who have a broader and more profound view on crisis emergence and crisis prevention. Commenting on emails by John Williamson and Stephany Griffith-Jones, Jane applauds “the discussion of the yen carry trade and its role in both financing excesses and supporting balance of payments imbalances”. The yen carry trade is a topic discussed by John in his paper and Stephany suggested that macroeconomic action would be one way to curb it, but that it should be accompanied by regulatory actions, to ease the task of monetary authorities, “who if not face a wall of money, that makes their interventions more difficult and expensive.”

Jane adds, “Leverage, too, was a critical ingredient in the crisis”, and notes, “national regulators completely ignored the BIS and IMF warnings about the amount of speculation in the global financial system and the threat it posed for a systemic meltdown.”

Jane disagrees with Stephany's view “that there is no link between (global) imbalances and the financial crisis and that US budget deficits were the cause of the inflows that funded the consumption spree. The inflows were particularly strong during the period of the budget surpluses in the late 90s when the spending spree was shifted from the government to the household sector and took off from there. Policy was part of the problem - including the strong dollar policy supported by the Fed's attention to the interest rate differential between the dollar and other major currencies in that period - but the capital flows problem has been a mixture of many contributing factors.”

Jane stresses, “So far, the IMF has contributed good analyses of developments and has - like the BIS - called attention to both macro and financial excesses but without effect. Bill White and the BIS have also offered prescriptions for a macroprudential framework (including in the FONDAD volume) that need further exploration. The need to redirect central banks is, in my view, key to reviving stability and I am working on a paper for the Minsky conference at the Levy Institute (April 17-18) that deals with that issue.”

I look forward to seeing Jane’s paper, which should be ready by now, April 17, and hope to report on it in a next post.

I hope Bill White and others (Mark Allen? Charles Wyplosz?) will join the discussion.

There are more papers I will discuss on the blog like the ones I received from Jan Kregel, José Antonio Ocampo (co-authored by Stephany) and Rob Vos.

Preventing the crisis (3)

2008-04-16T03:00:00.000-07:00

One possible way to prevent crisis is regulation. It is the regulator’s hope that good regulation will prevent trouble.

In response to John Williamson’s paper Stephany Griffith-Jones said in an email that she particularly liked John’s emphasis on “regulatory failure and need for improved regulation, including the possibility of forbidding certain transactions or activities.”

Stephany added, “This sounds radical, but if the social benefits are clearly below the social costs of certain activities, it seems the role of regulators should be to curb them.”

With “certain activities”, she referred to new financial instruments such as collateralised debt obligations (CDOs) and asset-backed commercial paper (ABCP), which lay at the heart of the crisis that erupted in 2007. Would better regulation of these new financial instruments have prevented the crisis?

This is difficult to say. With hindsight, it’s always easy – compare marital conflict and war. But if the rules had been different, would a crisis not have happened?

I don’t know if Stephany thinks that with better regulation of “certain activities” a crisis would have been prevented. There are other causes as well, I think. Anyway, I will ask her what she thinks.

Stephany reported that Joe Stiglitz and others are advocating an agency that would review financial instruments from this perspective: its social benefits and costs. She compares the job to one of an agency that reviews medicines “to check before they are released that they have no unintended negative effects that would outweigh their positive impacts.”

This is an interesting thought. Can it be but into practice?

Stephany went on saying that it would be interesting to discuss in a planned FONDAD workshop the regulatory implications of the current crisis. She suggested that we should look at more accepted ideas that need a strong push for something to happen. For example, we might consider regulating rating agencies, and modifying Basle 2 “to eliminate procyclicality of capital requirements, or even postpone Basle 2 introduction so it does not deepen the current slowdown (an idea mentioned briefly at a recent G24 meeting and hinted at in the Financial Times).”

This all sounds very interesting. I will ask Bill White what he thinks.

The question remains whether good regulation can prevent crisis.

(to be continued)

Preventing the crisis (2)

2008-04-16T00:10:00.000-07:00

Every crisis between men can be prevented, be it a marriage crisis, a strike, a war, or a financial crisis.

Yesterday I read that someone considered the current international credit crisis "man-made". A non-sensical statement, because it could not be otherwise.

How could the current crisis have been prevented? That's a more difficult issue. It requires analysis, and opinion. Yes, without opinion, no explanation. And, usually, there is not one explanation but several.

Some people assume that facts explain. You need them, but you should never believe you have them all. There is always more.

Explaining requires reduction or abstraction, that's what makes it attractive and convincing – up to a certain degree.

Complex matters can be made crystal clear but sometimes the beauty (aesthetics) of explanation obfuscates reality, particularly in social sciences (economics) and politics where reality is subject to opinion and willingness of change.

The current financial crisis is complicated and simple at the same time. Not because it’s about numbers, figures – as I said before – but because it is man made. All made by men is simple and can be understood, even though it sometimes seems complicated.

But preventing a crisis remains difficult.

In the next post we will see what some of you say about it.

Preventing the crisis (1)

2008-04-14T21:15:00.000-07:00

Those who suffer from a crisis wish the crisis would have been prevented. This applies to the debt crisis of the 1980s and all other crises that preceded (e.g. the crisis of the 1930s) and followed it (e.g. the Mexican crisis and the Asian crisis of the 1990s).

So the question is: could a crisis have been prevented?

Thousands, if not millions, of pages have been written about crises of the past to answer this question. On the current crisis, less has been written about its possible prevention. Many observers seem to find this hardly an interesting question, but I think that in five or ten years the literature on the possibility of preventing this crisis will be equally voluminous.

In the previous posts both John Williamson and Andrew Sheng have spoken explicitly or implicitly about the question of whether the current crisis could have been prevented. In a next post, I will highlight their thoughts and that of others.

Many of you have sent me their thoughts and it is high time that I include them in this blog, which is mine but aims to be yours as well.

Early this morning, at about 5am, I thought I should have on the blog a series of thoughts about (1) explaining the crisis, (2) preventing the crisis, (3) managing the crisis, (4) reforming the system.

The first series (explaining the crisis) has started already and will continue. This post starts the second series.

Explaining the crisis (4)

2008-04-14T00:10:00.000-07:00

"With due respect to John and Andrew," says Zdenek Drábek in an email, "what their interesting exchange demonstrates is that it is time to clarify the role of regulators. There seems to me to be two separate issues under discussion - regulating for 'market stability' (monetary policy) and 'bank supervision' (against fraud, 'tunnelling' etc.). I know it is sometimes difficult to distinguish between both activities - viz. Bear Sterns, Northern Rock - but the distinction is important for the debate about the role of regulators."

Another thought I heard recently is a proposal to have two types of banks or investment institutions, one investing safely and the other speculatively. I don't know who has suggested this and if my reporting is correct, but it made me think about the viability of such proposal. Is it thinkable that we would have the first type as the dominant financial institution and the second type as the play game for speculators? Obviously, those engaged in the speculative business should not have their losses covered by the community. But where do you draw the line between safe and speculative investments? Is gold a safe investment? Isn’t its price as volatile as that of newly created financial instruments?

Don't get me wrong, in my view the "viability" argument should not be used to reject fruitful ideas. It should be used for refining and sharpening proposals. If there is anything we need now, it is creative proposals. Unfortunately, most policymakers tend to be very little creative and not willing to discuss the thinkable.

The "viability argument" is one obstacle that blocks solutions, vested interests and power is another.

Explaining the crisis (3)

2008-04-12T04:50:00.001-07:00

In the draft version of my previous post, I had written that Andrew Sheng absolved central bankers from blame for the international credit crisis.

Asking Andrew if he agreed with my judgment of his paper, Andrew replied that he thought the word “absolved” was too strong. “Regulators do share some of the blame,” he said, “but they were neither equipped nor structured to deal with a macro crisis, because they are fettered in silos. The real problem lies in mindsets. The market knows best mindset does not mean that the market is always right. Triffin is right. Who wants to go against the crowd in a feeding frenzy and take away the punchbowl? Central banking and regulation are not in the popularity business. When they are, or when they are captured by the vested interests (who may prefer that they are in silos) then the collective action of private greed at public cost must inevitably lead to crisis. The self-organized and reflexive nature of markets mean that central bankers and regulators must lean against the wind. They may not be able to stop the tide, but they would be doing their jobs.”

In a subsequent exchange of emails, John Williamson replied that he was not suggesting that the regulators could be expected to deal with a financial crisis, “but that if they had acted differently we would not have had a crisis at all. Admittedly it is not unambiguous where regulation ends and central banking begins, but the ‘financial authorities’ encouraged the trends that culminated in the crisis instead of leaning against them. And such leaning would have involved different regulation rather than higher interest rates. That is what I meant.”

John’s reply prompted Andrew to observe, “I recognize that it is difficult to separate completely where central banking ends and where supervision or regulation begins. The real issue is the mindset – are you liberal on market entry and financial innovation, and where do you begin to tighten regulation when you think that the financial institutions are skating on thin ice?”

Andrew continued: “The mindset of ‘market knows best’ is that you allow liberal financial innovation, without checking, since the prime brokers are supposed to look after their own money well. Greenspan explained that house-owning democracy is good (per his biography) and did not look into the quality of the lending nor the due diligence. By refusing to lean against the wind at the central bank level, he allowed the bubble to form. He could have tackled the excess leverage through imposing higher margins, but he refused to do so in 2000 and also the 2004/2006 mortgage excesses. He also allowed interest rates to go too low.

Using the present structured examination techniques, the bank regulators in US,. UK and EU were not able to detect these excesses. Everyone worried at the macro level, and no one did the forensic examination at the micro-level. So, if you do not think there is a problem at the macro-level, and do not do enough examination at the micro-level, how can the regulators have "leant against the wind"? Worse, there are so many silos in the regulatory structure (which Paulsen is trying to consolidate) that no individual regulatory authority could have leant. The last time CFTC tried to impose some restraints on derivative trading, it was beaten back by Congress.

The point I was trying to make is that the central bank is in charge of overall monetary policy and systemic financial stability. Greenspan was at the helm in charge of bank examination also. There is no excuse for him, to blame the lack of judgement on whether a bubble exists, nor on the inadequacy of risk management tools. The central bank is paid to make these judgements. If monetary policy denies that core inflation should include asset prices, then monetary policy was in fairy land.

I recognize that there is a problem with the techniques that regulators use to try to stop market excesses. But if the overall philosophy is to allow the market to take care of itself, then the regulators on their own, in their silos, cannot do that much. The fact is that no one wants to stop a bubble on the way up, but everyone wants to blame the regulators after the bubble implodes.”

John Williamson responded: “Andrew, I was not attempting to defend Alan Greenspan, who (as you point out) was also a principal regulator. It is in the latter capacity that I would mainly criticize him. Yes, certainly one wants someone to think about “whether a bubble exists” (the idea that central bankers should not try to identify bubbles because they cannot be 100% certain is dreadful). But having reached that conclusion one does not break a bubble by raising interest rates (since by definition a bubble is a price rise that is not explained by things like interest rates), but by telling people to stop doing certain things. I call that regulation (though it may be supplemented by things like raising margin requirements, even if this probably would have been ineffective). Yes, it involves recognizing that the market does not always know best, because they go on dancing until the music stops. In economist’s language, this is to acknowledge there may be differences between private and social costs.

The job of regulators is surely to do well-directed forensic examinations at the micro level. I agree that you cannot blame individual low-level regulators who are not well directed. I hope no one thinks I suggested otherwise.”

John’s clarification prompted Andrew to add, “I don't think we disagree. Leaving interest rates too long was a problem, and raising margin rates would have helped, as long as someone cried Cassandra. Unfortunately few did. Makes me think that the self-organized nature of markets and incentives are such that the cycle of boom bust is inevitable. I think Greenspan has been chastized enough by the media to remind all leaders to do what they feel is right.”

(to be continued)

On the picture you see the Amsterdam office of FONDAD. I feel privileged that I can work now all days (and nights) from home rather than commuting daily between Amsterdam and The Hague, as I did during 21 years. The address is Nieuwendammerdijk 421, 1023 BM Amsterdam. The house stands on a dike and at the back slowly sinks in peat-soil. It has a garden and you are most welcome to drink a cup of tea or glass of wine in the garden if the weather permits. Behind the shop window was a vegetable shop; now it is crowded with books. I'm afraid I won't have the time to read them all (again). Never mind, life is beautiful and I do read a book picked from the shelves every now and then. "Economics in Perspective: A Critical History" (1987) by John Kenneth Galbraith is one of the books waiting to be taken from the shelves. I think Andrew recently read it (again). Who of you has read it? What did you think of it? Another book waiting to be taken from the shelves is "History of Economic Analysis" by Schumpeter. I'd like to reread the chapter on Money, Credit, and Cycles (pp. 1074-1135 in my edition of 1967, printed in Japan). Robert Triffin was a student of Schumpeter. Triffin told me, “The great thing is not to choose a topic at the university but to choose a man. At that time at Harvard the greatest man undoubtedly was Joseph Schumpeter and I learned my economics from Schumpeter.”

Explaining the crisis (2)

2008-04-07T00:34:00.000-07:00

Before I get to the papers Andrew Sheng and John Williamson sent me, I'd like to quote from a conversation I had with Robert Triffin a long time ago.

Entering Triffin’s room at the University of Louvain-la-Neuve on that crisp, blue-sky morning of 30 January 1985, I saw papers piled up everywhere, making me feel at home immediately. Triffin asked, "Why don't you have anymore in the Netherlands people like Jan Tinbergen? Where are the new Tinbergens?"

I tried to answer his question, prompting Triffin to observe, “People tend to be too conformist. Economists, by trying to explain the policies that happen, tend to whitewash and justify them.”
“Why?” I asked.
“They want to be ready to move from academics to political jobs.”

I don’t think that is the only, or major reason for being conformist… Anyway, let’s turn to Andrew and John, and see if they are "whitewashing and justifying" the policies that led to the international credit crisis.

In his paper, John blames the supervisors. “The prime responsibility for the financial turbulence that is currently afflicting much of the world is to be found in inadequate supervision. The authorities welcomed the process of financial intermediation, rather than recognizing its dangers and imposing rules that would have provided a counterweight to the greed that drives the private financial sector.”

Andrew, on the other hand, himself a former financial regulator, recognises that regulators do share some of the blame, but thinks that their problem is that they lack understanding of what happened in the financial markets. And, he observes, they may have contributed to the emergence of crisis by providing a too stable financial environment. “Prolonged stability of values of risks, liquidity and prices may lull market participants into leverage behaviour that escalates until the system becomes more and more unstable.”

In a subsequent discussion by email, Andrew stressed he does not think it is fair that regulation is to bear the brunt of the blame. “Regulators do not create bubbles and individually, there is very little that they can do to stop them appearing. Central bankers, on the other hand (and I am a former central banker) have a lot of responsibility on that front, but the prevailing mood is that they can't predict them nor can they determine when they can peak, so they prefer to deal with the aftermath.”

I think Robert Triffin would have loved to participate in the debate. Would he have accused John or Andrew of whitewashing and justifying the policies that led to the international credit crisis?

(to be continued)

Stock prices

2008-03-31T02:13:00.000-07:00

This morning I looked for an hour at CNBC -- a channel for those who love to talk about prices. They talk about changing prices as if it is the largest joy in life, and the most important matter in the world.

To be more precise: they talked about stock prices. What do you think of stock prices? Do you like them? Do you read them?

I've always skipped stock prices in newspapers, I don't even saw them really. But now I was looking at them, for an hour, and they couldn't escape my eye as they moved on and on on the screen, and as the men and women on the screen seemed to have the most lively and amusing conversations about them.

Suddenly someone pops in from France. A nice looking man, typical Frenchman, impeccable English, with a nice French accent. Then an Italian businessman, the businessman of the year !, pops in, also in impeccable English, with less of an accent than the Frenchman. He is a bit older than the Frenchman and does not wear a tie but a black pullover. The Italian is more relaxed -- he seems to have made his fortune already. Or do those who have gained a fortune always want more?

Then a lady walks back and forth on the screen, not doing exercises but pointing vividly at man-size graphics with... prices ! She seems to enjoy them, and seems to think that we enjoy then too. Do you?

My brother (Herman) said in a comment to my previous post that he was not amused when he saw the prices of his stocks fall. He lost (a lot of?) money. I promised him to write a comment on his comment.

The above is, in part, my comment. I could say more about it but hesitate to say too much as it has already become clear how I think about stock prices. Gaining and losing -- it's all in the game.

What about pensions and pension funds. I obviously hope that my pension will not be wiped away by a crisis. That's why I'm engaged with crisis prevention for already more than 25 years...

No, I was kidding. The real reason I'm engaged in crisis prevention is that I am concerned about people whose living conditions are much less fortunate than mine. I don't have any reason to be concerned about my own fate. I do worry, however, about other people's fate.

I remember vividly a letter from a (poor) Chilean friend of mine who lost his savings in a banking crisis in Chile. I also remember vividly my worries about my brother who had to face exorbitant high interest rates after the change of monetary policy in the United States at the end of the 1970s, just after he had emigrated to Canada and had to indebt himself to set up a dairy farm.

So here you have my thoughts, brother.

On the picture you see my brother and me, not yet discussing stock prices.

A critical mind

2008-03-27T05:48:00.000-07:00

My son and I are driving to the Rotterdam office of Fondad, to fix some IT problems (he, not me). My son studies physics but still has a keen interest in economics.

"I find it ridiculous that banks can let public institutions pay when they incur large losses," says my son.
"You are right," I say.
"I find it ridiculous that people make such a problem about falling stock prices."
"You are right," I say.

My son considered studying economics. Next year he wants to study theoretical physics. To what use will he put his critical mind?

The picture of him and me is of about ten years ago, during a holiday in France. I read today the article in Le Monde Diplomatique and will refer to it in one of my next posts.

Explaining the crisis (1)

2008-03-25T04:24:00.000-07:00

The global financial system looks complicated, but is simple, even though it does not present itself as simple. True, it's not easy to grasp its simplicity. Once I made an effort, in a long article, "The Monetary Crunch: Crisis or Scandal?" (to be put soon on the Fondad website), and I was not fully satisfied.

I have received several papers in response to my request for articles about the international credit crisis (which started last year as a subprime mortgage crisis in the US). In the first two posts on explaining the crisis, I'd like to discuss unpublished papers by John Williamson and Andrew Sheng.

The first time I came across John's name was in the early 1980s, when I spoke to Robert Triffin who referred to him. Ten years later, I had the pleasure of inviting him to a Fondad conference about "The Functioning of the International Monetary System" (see Fragile Finance). Since then John has been a great contributor to Fondad conferences and books.

I saw Andrew's name for the first time in the early 1990s. Last year I invited him to a Fondad conference in Kuala Lumpur about "Globalisation, Asian Economic Integration, and National Development Strategies: Challenges to Asia in a Fast-Changing World". I enjoyed Andrew's contributions in the conference and our private conversations.

My assertion that the global financial system is, or ought to be, a simple matter departs from the idea that the crucial variable in the system is prices: prices of assets (houses, for example) and prices of loans (payment of interest and repayment of principal), or whatever else that carries prices. What is there more simple than prices?

It is the essence of prices that they can rise and fall, and so do the prices of assets and loans. Nothing complicated.

The complication begins when people expect prices to be stable. Then you are in for trouble. As John says, "trouble started when house prices [in the US] stopped rising and started falling".

However, bankers and central bankers should have expected the falling of house prices since booms do not go on for ever. "The existence of a boom must have been clear even to central bankers (some of whom assert that they cannot be expected to identify bubbles)," says John.

Again, this has nothing to do with "complicated" economics, it's just the simple behaviour of commercial bankers (lenders), house owners (borrowers), and central bankers (regulators and supervisors).

Where then is the complication in the subprime mortgage loan crisis? In the slicing, dicing and packaging of the subprime mortgages into new financial instruments such as "special investment vehicles", says John.

As a result, "financial intermediaries did not know where many of the losses would end up, and to avoid unpleasant surprises they aimed to stop lending even to counterparties that would normally have been regarded as rock-solid."

So it is the panic and uncertainty that led to the subprime mortgage crisis in August 2007.

Then, as with previous financial crises, the crisis quickly spread and deepened. "While the first impact was on the mortgage and interbank markets, many additional assets have now been affected," observes John.

This is also nothing new. From previous crises we know that chain reactions happen.

As John says, "A fall in the value of certain assets triggers calls for increased collateral ... by those who have used those assets as collateral ... the affected institutions are forced to sell other assets, whose prices therefore fall; and that in turn sets the stage for the further propagation of the crisis."

Instead of chain reaction you can also call it "contagion" -- not a very complicated economic notion either.

So it seems that financial crises have more to do with (mass) psychology than anything else: expectations, uncertainty, fear, herd behaviour, contagion, etcetera.

In the next posts, I will continue discussing John's ideas and I will include thoughts of Andrew as well as those of others. I just glanced at the opening lines of a front page article in Le Monde Diplomatique, "Crises financières, n'en tirer aucune leçon..." Will it contain interesting thoughts?

Another light thought

2008-03-18T23:42:00.000-07:00

Another light thought before I get to the serious business of analysing the current turmoil of global financial markets: economics is nothing more -- and nothing less -- than opinion supported by certain facts. Opinion can change, as happens in economic science, and facts can change, as happens in reality.

There are many other thoughts one can derive from or associate with this light thought.

In the meantime, I have received many interesting articles from you. Thanks! I will write about them.

Too seriously

2008-03-18T01:33:00.001-07:00

A small thought in between: I think that one of the problems of our world is that economists talk too much to each other and that non-economists take them too seriously.

The same applies to politicians.

And journalists?

This is not to say that I'm against serious economic analysis. On the contrary.

Explaining (dollar) debt crises (1)

2008-03-16T23:28:00.000-07:00

As I said in my previous post, explaning the debt crisis Bernard Snoy put more emphasis on the way the international monetary system had evolved. In his speech of June 7th, 1986, he said: "When the Bretton Woods monetary system collapsed in 1971, this caused great economic and monetary uncertainty, and the large U.S. budget deficit led to an increase in lending and borrowing in U.S. dollars outside the U.S., notably on the uncontrolled Euro-markets. Together with the sudden increase in oil prices and the oil-producers' subsequent preference to place their revenues in short-term deposits in commercial banks, the conditions leading to the massive increase in international debts were set."

In these two sentences Bernard said a lot of things other "analysts" of the debt crisis did not say: (1) its relationship with the international monetary system; (2) global economic and monetary uncertainty; (3) large US budget deficit; (4) US debt leading to an increase in lending and borrowing in US dollars; (5) uncontrolled international capital markets; (6) oil producers' preference to place their revenues in short-term deposits in commercial banks.

These six factors are worth dwelling upon and applying to the current crisis in international capital markets. I would like to do that in a next post -- if you haven't done so already in your comments (will there be comments? I'd like to invite Barbara, Wing, John, Jan, Peter B., Charles, Stephany, José Antonio, Rob, Mark, Ricardo, William (Bill), Louis, Zdeněk, Yung Chul, Roy, Bernardo, Eugene, Brian, Jane D', Bernard (Snoy), Dani, Barry, György, Esteban, Andrew (Sheng), Matthew, Yılmaz, Ernest, Benno, William, Amar, Amar, Henk, Nout, Age, Stijn, Geske, Geoffrey, Mohamed, Onno de, Rogério, Heiner, Eisuke, Geng, Yunjong, Fan, Robert, Marek, Gerald K. (Gerry), Jan, Li-Gang, Johannes, Liliana, Osvaldo, Jeffrey...)

I still owe you the question I raised in the June 7th 1986 debate organised by Dutch christian-democrats (attended by Balkenende) and the reply by Onno Ruding, both according to the report. Here comes my question: I "asked whether the allies of the U.S. would be willing to use their influence in order to plead for a reduction in military expenditures, so as to reduce the U.S. budget deficit and thereby lead to a lower interest rate."

And Ruding answered: "At the heart of today's discussion is whether the U.S. should decrease its budget deficit, not how it is to do so, however interesting that might be for the U.S. itself or for those in favor of reducing military expenditures."

Ruding and Balkenende

2008-03-12T23:09:00.000-07:00

When in the 1980s the debt crisis emerged, I was astonished by the superficiality of most analyses. Generally it was argued that developing countries had borrowed irresponsibly or that banks had lent irresponsibly (stupid countries and stupid banks) and that, therefore, the only solution was that developing countries cut down their expenditures and increased their capacity to pay their debts. Strangely enough it was much less frequently and prominently argued that banks had to accept a write-down of their loans.

But what was missing most was an in-depth analysis of how the debt crisis had emerged, what its origins had been, and how much it had to do with the way the international monetary and financial system had evolved.

A similar feeling of astonishment invaded me when in 2007 the so-called subprime mortgage crisis emerged. Again, superficial analysis prevailed, which can be summarised as "Stupid loans by stupid banks".

Recently, when thousands of papers went through my fingers as I was moving the Fondad office from The Hague to Amsterdam, I came across a report of a meeting I had attended on 7th of June 1986 about "The International Debt Problem", organised by the Dutch christian-democratic party.

And whose names did I find in the report as participants? Yes, indeed, the current prime minister of the Netherlands (Balkenende), a former minister of finance and now banker (Onno Ruding), several professors and MPs, my friend Bernard Snoy, and others.

There were two guest speakers at the June 1986 meeting, Onno Ruding (then minister of finance) and Bernard Snoy (then chief of the Finance and International Relations Unit of the European Office of the World Bank).

Ruding argued that the debt crisis was a problem of middle-income countries who, luckily, had become to realise that they would have to do the job of finding solutions as the problem had been of their own making. "The solution isn't to be expected from getting more money wherever it might be found, but must be based on sound financial policies and economic adjustments, involving mid-term policies with a structural impact," said Ruding according to the report.

Ruding also saw a role for the World Bank and the IMF, the first in promoting appropriate micro-economic policies and the second in providing advice at the macro-economic level (I'm still quoting the report).

And what about "the industrial creditor countries"? They should lower their interest rates, said Ruding ("in particular a reduction in the U.S. budget deficit would lead to lower interest rates which in turn would lessen the debt-servicing burden for developing countries"), reduce protectionism, achieve more economic growth, and take specific financial measures such as export credit guarantees ("which the Netherlands is willing to do for those developing countries who are willing to effectively make the necessary adjustments in their own policies").

After Ruding's speech there was a lively discussion in which I also participated. One of those who raised a question was the young christian-democrat Jan Pieter Balkenende. He felt the debt problem should not only be treated from a financial, economic point of view, "but through its relevance in the economic, cultural and political fields on the international level."

Ruding replied, "As for the influence of for example cultural matters, one can note that in some countries the statal sector is far too extensive and that privatisation is needed. However, on the international level, the role of governments should not be reduced."

In a next post, I will continue my report of this 1986 meeting by highlighting a few of Bernard Snoy's remarks, who has much more of an eye for the way the international monetary and financial system had evolved. I will then also quote my question to Ruding and his answer.

Independent thinking

2008-03-11T03:09:00.000-07:00

There are five prominent realms of knowledge, reflection and action:

1. politics
2. science
3. business
4. government
5. media.

Our daily life is influenced by all five, in different mixtures. Reflection and action in some of the realms are perceived as more individualistic and independent while others are considered more collective, conformist and bureaucratic.

Strangely, journalists, scientists and politicians often see themselves as individualistic and independent, even though their thoughts and actions are much more collective and conformist than they think.

Government officials and business people are bureaucratic (I never understood why bureaucracy is ascribed mostly to government institutions, while larger organisations, be they public or private, tend to be bureaucratic) and usually recognise their collective and conformist attitude.

Economists are active in all five realms and most economists working in science see themselves as independent, individualistic thinkers. However, they are much more collectivist and conformist than they think. Do they lack critical self-reflection?

There is a tremendous lack of independent economic thinking and I see this as one of the problems of our society (which needs critical analysis) and of economics as science. Economists like to see themselves as independent thinkers, but in fact provide mostly conformist thoughts.

Obviously, this problem is not confined to economics, but of all social sciences it is perhaps the economic science (is it a science?) that has fallen most prominently into the trap of false pretences.

Because of "society's" view of economics, giving it too high a status? Because of the power of business? Because of the lack of critical reflection by journalists and politicians, and by scientists, business people and government officials?

In a next post I will have a critical look at economics and journalists, whose profession and pretences I know, both as an observer and a participant. I will write as well something about economics and politicians. Scientists, business people and government officials will come later.

Fresh thoughts!

2008-03-06T00:30:00.000-08:00

In the mid-1970s, I began to read literature on international finance, mainstream journals like Euromoney, Institutional Investor and newspapers like the Financial Times, and alternative journals such as Development Dialogue (Sweden) and many journals in Spanish and French – as a necessary counterweight to Anglosaxon mainstream thinking and because I like to read and speak Spanish and French.

In the mid-1980s, I was able to create an international forum to discuss the functioning of the international monetary system and the debt crisis, the Forum on Debt and Development (FONDAD). I established it with the view that the debt crisis of the early 1980s was a symptom of a malfunctioning, flawed system – see, for example, my article “The International Monetary Crunch: Crisis or Scandal?”, Alternatives, Volume XII, No. 3, July 1987. (We will put it on FONDAD's website).

A few weeks ago my assistant Adriana and I started moving our office to Amsterdam (headquarters) and Rotterdam (book sales). Thousands of papers, journals, letters and books passed through my hands. My fingers are dry and hurt, and I am exhausted by the selection process.

I have thrown away most of the literature on international finance I had stored and filed over 30 years, not through the window but as old paper to be recycled, to create room (espacio) and stimulate fresh thoughts. Valuable articles and books remained such as those of Robert Triffin.

The picture above shows Robert Triffin and me, in his room at the Université de Louvain-la-Neuve in Belgium, during one of our long conversations in the early 1980s.

Going through the thousands of papers in my old office I found interesting letters and papers whose existence I had forgotten. In next posts I will tell about them. One thought I had when going through the dust of old stuff is that the past harbours interesting ideas for the future.

Nonetheless, I was able to throw away a lot, creando espacio para nuevos pensamientos.