On Monday 6th December, I gave the keynote speech at a conference near Brisbane, Queensland (Australia) on the theme of Risk Management after the crisis. I was warned that the large audience of professionals (corporate lawyers, chartered accountants, risk managers etc. – people whose jobs I do not really understand) were tough cookies; that nothing could provoke them easily to reconsider their entrenched views. Thus, I rose to speak ready to be met by stone-faced people looking at me like an audacious fool. To my great surprise, my narrative on the Crisis in general, and on its European manifestation in particular, went down very, very well. Some asked to have the text of my speech. So I post it below. Before you read it, it helps to note that the question put to me by the organisers was: Did greed lead us to the Crisis?
Ladies and Gentlemen,
Two hundred and eleven years before Gordon Gekko, Adam Smith had already told a stunned puritanical world that Greed is Good. Not in these Holywood-scripted words but in essence the message was identical: Greed is a force of good.
Smith’s audacious point was that, as long as markets remain competitive, greed turns entrepreneurs into society’s useful idiots; into profit seekers who, unintentionally, because of cutthroat rivalry with one another, provide consumers with cheaper, better and more numerous commodities, all sold at cost. It is (Smith famously insinuated) as if an Invisible Hand turns raw Greed into Society’s servant.
Of course, poor Adam Smith was writing for another era and would most likely had withdrawn his prognosis regarding Greed’s goodness today. In this sense, Gordon Gekko, especially in the sequel to the original Wall Street movie, is more relevant to our day and age than the long dead Scottish moral philosopher.
- Is there an optimal amount of greed which the world exceeded before 2008?
- Did we have an overdose of an otherwise useful stimulant?
- Was Greed responsible for the Crash of 2008?
Time to make use of our flash interactive technology: Those amongst you who think that the GFC, the Crash of 2008, can be attributed to Greed please press the yes button. The rest press no.
And what about the euro crisis? Do you think it was the result of Greed by the governments of peripheral states, like Greece and Portugal, who borrowed too much during the good times? Once again press yes or no.
Well, it would be a pity if all you heard from me today simply repeated that which you already believe. So allow me to contradict the majority opinion by arguing that greed and loose ethics caused neither the Crash of 2008 nor the current eurozone crisis.
Lest I be misunderstood, let me make four things abundantly clear:
- Sometime after 1979 Greed did acquire a veneer of moral acceptability
- The financial sector did grow fat on insidious voracity, on criminal practices and on financial products that a decent society ought to have banned.
- The Greek government, along with a few others did allow borrowing to run riot and acquiesced to tax dodgers, pilfers of the public purse, vested interests and the like
- Governments worldwide did fall asleep on their watch, deregulating without rhyme or reason the very markets that ought to have been kept on a short leash
All this is self-evidently true. But none of it caused the Crisis in the US or in Europe.
But if it was not Greed and Profligacy, loose Morals and even looser Regulation, that caused the Crisis, then what was it?
To answer this question, we need to start at the very beginning. When the war ended, the United States understood well that to win the Peace, it was incumbent upon it to put in place immediately two mechanisms:
- A stable exchange rate system that would kick start world trade. Bretton Woods, in short. And,
- A Surplus Recycling Mechanism for recycling American surpluses abroad. For re-exporting (in the form of capital transfers) some of the American trade surplus back to Europe and Asia in order to maintain both the health of America’s key allies and, importantly, their demand for American exports.
One cannot overstate the centrality of The Surplus Recycling Mechanism to this postwar Grand Plan which was responsible for the longest, most stable, balanced growth period in the history of industrial societies. Essential to that success were the constant transfusions of capital by the US to support Germany’s and Japan’s economies and, moreover, its efforts to create and support vital zones around German and Japanese industries that could absorb German and Japanese surpluses. The EEC would have never had been established otherwise. And when Mao Ze Dong prevented a similar vital zone to be created in China for Japan’s surpluses, Washington turned the US market over to Japan’s industry, at great cost to its own.
This was no act of philanthropy toward Europe and Japan. It was rather a clear vision that hegemony requires that the hegemon recycles its surpluses so as to maintain its own industry’s aggregate demand. If only Germany understood that simple macroeconomic truth as well today, Europe’s problems would evaporate in a jiffy!
But let’s not digress here. Our problems today have their roots in the collapse of that Global Plan back in 1971. If anyone wants to discuss the reasons for that collapse, we can do so in the discussion later. For now I shall concentrate on America’s response to that crisis. The US had to make a choice: One option was to tighten their belt and, in puritanical fashion, cut down their small but rising twin deficits: The trade deficit and the government deficit. Instead the US opted for something rather different, something quite audacious. For what Paul Volcker, the former Fed Chairman, called: The controlled disintegration of the world economy. This is what they did:
They turned the Grand Plan on its head: Rather than having a trade surplus, the US would now allow both its current account and its government accounts to go deeper and deeper into the red. And who would pay for the red ink? The rest of the world!
The idea was pure brilliance: Combine a twin (trade and government) deficit with a strong capital account surplus. Suck into the US other people’s exports and a tsunami of other people’s capital. Thus my term for the period after 1971: The Global Hoover: From the late 1970s until 2008 the US acted as a gargantuan vacuum cleaner that sucked in the trade surpluses of Germany, Japan and, later, China while, at the same time, attracting into Wall Street something in the order of $3 to $5 billion net on each working day.
What does this have to do with Greed, Financialisation and the Greek sovereign debt? Everything! They are all mere byproducts of this Grand Hoover.
As I said, Wall Street was attracting $5 billion of fresh capital from abroad every working day. On top of that, it was attracting another $5 billion daily from two domestic sources: Corporate profits (which were soaring as a result of accelerating productivity in an era of zero real wage rises) and the interest on debts incurred by middle and lower income groups in the US (the debts of Americans who borrowed on credit cards and against their homes to keep up with the Joneses, banking on ever increasing house prices).
Now, I have a question for you. One that does not require a push of your button: When every day of the week, for twenty years in a row, a banker has $10 billion more to play with than she had the previous day, what do you expect her to do? Nothing? Of course not! Even if she holds it in her hands for a few minutes before passing it on, she will find ways of making it work for her. It is the nature of the beast. That is what bankers do. Expecting them to do otherwise is like expecting a bird not to fly or a crocodile not to ambush.
Well, ladies and gentlemen, bankers did what bankers do. It came to be known as financial engineering and the new mode of business was labelled financialisation. Securitised derivatives, CDOs,CDSs and the like were the tools. And by golly did they work for them. Every one of the dollars that passed through their sticky fingers was pumped up using the new tools of the trade and yielded between $30 and $100 for them.
Was that the result of Out of Control Greed? No, Out of Control Greed was the effect. The cause was the tsunami of capital that went through their hands. And, if my analysis holds water, that tsunami was an integral part of the Grand Hoover that kept global capitalism going on the basis of the constant feeding of the US twin deficits; a feeding frenzy that kept Germany, Japan and China in business, and able to find markets for their increasing trade surpluses.
In short, ladies and gentlemen, Greed, Leverage, Financialisation and the Sovereign Debt of the deficit countries was to pre-2008 capitalism that which hell is to Christianity: Unpleasant but indispensible.
Meanwhile the instruments of financialisation, mainly the CDOs, evolved into something new: Into what I call Private Money. From 2000 onwards people wanted them for the sole reason that other people wanted them too. The word for money in Greek is nomisma. It comes from the verb nomizo which means to think. The Ancient Greeks believed that money is valuable if and only if we think it is. Well, as more and more people thought that the CDOs were valuable so the CDOs grew in value. Banks started treating them like Private Money. They used them to store value, as collateral in trading, as means of exchange with other financial institutions. And the great thing about it was that, unlike public money, Wall Street could mint as much of that Private Money as they wanted. And mint it they did! Piles of it were produced daily using poor American families’ mortgages as the main ingredient.
By 2007 for every one dollar issued by the Fed 50 dollars of this Private Money were circulating in the world economy. A small downturn in the American housing market was all it took to create enough doubt about the private money’s real value to turn it into ashes that run through the financiers’ clasping fingers. The rest, as they say, is history.
The US administration and the EU valiantly stepped in to replace the destroyed Private Money with many trillions of freshly printed public money so as to save Wall Street and Europe’s equally idiotic banks. But no sooner had the banking crisis ended, and the banks had breathed a sigh of relief that the taxpayers had saved them, that they had a brilliant idea. “States gave us so much money that they are now in trouble themselves. Why not use some of the public money we were given to bet that, sooner or later, the strain on public finances would cause some state to fail. But which one?” The answer was: Greece! Why Greece? Because it was the weakest link of the eurozone. And why should a eurozone country attract the bankers’ attention? Because the euro’s architecture was deeply flawed.
The euro, it must be remembered, was conceived at the height of the Grand Hoover’s reign. Germany thought that it could extend its growth model to the eurozone. Convinced that the Grand Hoover would continue to suck in its surpluses, Germany thought that its surpluses could expand further within Europe if deficit countries like Greece, Spain, Italy etc. were given a strong DM-linked currency. Germany’s condition for sharing its currency with the rest was that nothing else would be shared except for the common currency: Debt, taxes, government expenditure would be all nation-state-specific. Each euro of debt would belong to one country only and no surplus recycling mechanism would be set up.
Now, a child would have told you that, the moment you bind economies together into a currency union between some disparate countries without a surplus recycling mechanism, you write the script of a future crisis. The Americans knew that when they established Bretton Woods and quickly added the surplus recycling mechanism, beginning immediately with the Marshall Plan. The eurozone never learnt from that experience which, ironically, had brought the EU into being all that time ago. The current crisis is the direct outcome of such negligence and the sovereign debt crisis is its manifestation; not its cause.
Of course, while the Grand Hoover worked its magic, sucking up the German surpluses and keeping alive the worldwide glut of cheap private money, all seemed well. While the imbalances within Europe were getting larger, cheap private money allowed deficit states to cover the gap by borrowing. But when the Grand Hoover splattered and died, Europe’s underlying imbalances came to the fore.
The banks and the hedge funds saw this. So, they picked the weakest link in the eurozone and bet heavily that it would break first. And so it did, earning the issuers of CDSs great rewards in the process. And so the creation of private money was on again! This time not as CDOs based on subprime mortgages but on CDSs based on European peripheral debt.
The result is the most abhorrent of twin crises: Insolvent member states on the one side owing trillions to banks that are practically insolvent as they do not expect to get their money from the states. Thus they do not lend to business, which makes the recession worse and pushes the states further into the clasps of insolvency. A textbook case of a vicious circle.
And what is the EU doing? Instead of attacking, at once, the member-states’ debt and the banks’ potential losses the EU is forcing upon bankrupt states new, expensive loans with which they must payoff the bankrupt banks which, naturally, panic when they hear that the condition for these loans to the states is more austerity which will ensure that the states will not generate the tax receipts to repay both them and the EU in the medium run.
- A remedy worse than the disease.
- Madness in action.
- Irrationality at work.
And so the nightmare gets darker and the only thing that may wake our leaders up is the euro’s collapse.
In summary,
- Greed and Debt are mere manifestations of an underlying process that started decades ago
- The toxic economic theories, toxic banking practices and toxic government deregulatory policies that seem responsible for the Crash were all byproducts of the tsunami of capital that sped across both oceans toward Wall Street for at least two decades
- The only lasting remedy would be a new system of exchange rates that is combined with a brand new surplus recycling mechanism
Ladies and gentlemen, our world has been in trouble for two years now because the Grand Hoover is out of order, beyond repair, kaput. Without it, no amount of tinkering or wishful thinking will do the trick.
Some replacement must be found quickly and the markets will not fashion it spontaneously. It is not what markets do.
It will instead take political courage and foresight of the highest order; practical intelligence of the sort that the US authorities displayed after 1945.
While our current crop of Lilliputian leaders seem unlikely candidates for such glory, it is a test of our democracies that we force them to rise to the occasion.
Or to replace them with people who will.
Europe is the obvious place to start. Both because it is the source of the greatest uncertainty and because a solution to the euro crisis can be effected in a few weeks simply and rationally (if anyone is interested, I can tell you how during the discussion).
Such success in Europe would then help steer the world at large nearer to a new rational global order.
But if we Europeans fail now, it will have been the third time in a century that we will have taken the world down with us. Our collective future will then be a bleak landscape strewn with the corpses of a generalised depression, indelibly marked by our generation’s failure to meet its challenges head on, immersed in the petty antagonisms between peoples and persons who failed to discern their common interest. In history’s austere judgment, we will be blamed for the new, postmodern 1930s that is the most likely product of our dithering.
