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Product Details
| ISBN-13: | 9781782394518 |
|---|---|
| Publisher: | Atlantic Books |
| Publication date: | 09/17/2015 |
| Sold by: | Barnes & Noble |
| Format: | eBook |
| Pages: | 352 |
| File size: | 2 MB |
About the Author
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CHAPTER 1
After the Storm
I wrote The Storm during the summer and autumn of 2008, during the most severe financial and economic crisis of my lifetime. In the UK we saw the failure and seminationalization of RBS, Lloyds-HBOS and several smaller mortgage-lenders, followed by a severe contraction in production and living standards. There was, of course, a much wider global crisis, which was short-lived in the main emerging economies but has left deep wounds in most developed economies.
I return to the subject five years later, in a climate of guarded optimism, after five years in government as a decision-maker, when an economic recovery is in train – at least in the UK and the USA – and banks appear more stable. Cynics could say 'Storm? What Storm?' Forecasts for the world economy are of 3–3.5 per cent growth in 2015, followed by an increase the next year. The countries that were at the epicentre of the banking crisis, the USA and the UK, are each expected to record 3 per cent growth this year. By any standards other than those of the pre-crash boom, these are good figures which promise increased living standards for most people in the world.
But there are serious economic problems in the eurozone and Japan, and in important emerging economies, led by China and immediately affecting Russia, Brazil and Nigeria. Even the successful Anglo-Saxon countries have yet to see a growth in living standards, which fell sharply in the post-crash recession and have hardly recovered since. It is also clear that deep problems remain unaddressed, and some of the mistakes that led to the financial crisis are being repeated. Pessimists talk about a recurring cycle of credit boom and bust. Others predict 'secular stagnation' – a period of much slower growth, of economies running well below their potential. Some even predict both, as governments frustrated by economic stagnation, or worse, react by fuelling new credit booms.
The original climatic metaphor was, in some respects, misleading. Storms blow over. Damage is cleared up. Normality returns. Would it were that simple. Another metaphor would have been a heart attack which proved not to be terminal thanks to the prompt intervention of central bankers and governments, but which has done long-term damage to government budgets and to business lending, and which requires continuing life-support. This rather better conveys the sense of continuing damage and fragility. But 'the storm' conveys something else: disaster returning. Without stronger defences, the next storm could be as damaging as the last, or even worse.
In The Storm I sought to explain the crisis in terms of comparative experience. The major banking disasters in UK history – as opposed to the severe recessions of the 1920s and 1930s – occurred in the early nineteenth century and, before that, during the South Sea Bubble. There are uncomfortable parallels, despite the vast increase in scale and sophistication since those days. There is more contemporary insight to be gained from recent banking crises: in Scandinavia and Japan in the early 1990s, the latter leading to prolonged stagnation and the threat of deflation; and the Asian financial crisis of 1998/9. But all of these were localized and, except in Japan, involved temporary, albeit severe, impacts. The common thread is one of boom and bust credit cycles.
*
A historical approach helps to identify the best conceptual framework for explaining the crisis and its aftermath of chronic instability. As I argued in The Storm, understanding is to be found in the neglected work of Minsky and economic historians like Charles P. Kindleberger, who described cycles of speculative excess, 'bubbles', made possible by an accumulation of debt-leverage, offset by inflated and largely fictional asset values. In due course, the bubble bursts, causing panic, debt default, distress and economic contraction as individuals, companies or banks try to reduce their exposure by deleveraging. The economic consequences of such contraction in the wake of a financial sector collapse were described two centuries ago by J. S. Mill, but were formalized much later by Irving Fisher as 'debt deflation', or by Knut Wicksell in his theories of credit cycles. Richard Koo has described the contemporary variant as 'balance sheet recession' – based on a wider application of contemporary Japanese experience. The burden of debt – personal, government, corporate – makes for a reluctance to spend and invest, and a resultant downward spiral of recession or deflation. The cycle is completed when, in order to offset recession, monetary authorities run expansionary, low interest rate policies, which in turn create and feed the next asset bubble. There is plenty of evidence of that cycle at work today. The Bank for International Settlements, in its 2015 annual report, warns that there is a real danger of 'entrenching instability' and 'chronic weakness' in a world of abnormally low interest rates.
The problem, of course, with the big global picture is that it obscures the many particularities. The concept of 'debt deflation' or 'balance sheet recession' describes accurately and meaningfully today's policy problems in Japan and (much of) the eurozone. It is potentially, but not yet actually, an issue in the big Anglo-Saxon economies – were the recovery in the USA and UK to falter and were the current experience of zero inflation caused by falling commodity prices to become a sustained general decline in the overall price level. And it is a risk, though not current reality, in China, where high levels of corporate debt and price deflation currently coexist with rapid, but declining, growth.
The various economic philosophies that have been developed, or revived, in response to the crisis reflect these particular circumstances. For many commentators and policy-makers, the main reference point is still the inter-war depression and the ideas of Keynes and Milton Friedman developed in response to events in the USA and the UK. Keynes is frequently invoked as offering an alternative economic model to austerity, meaning falling living standards and job insecurity. To be sure, there are key elements of Keynesian economics that are relevant to conditions of weak demand and high unemployment, as have been experienced in the recent past. There are also persistent surpluses of savings over investment on a global scale. The Keynesian approach points legitimately to limitations in aggressive monetary policy of the kind used today to support demand, and to the need for a better mix of monetary and fiscal policy. But monetary policy, building on the insights of Friedman and others from the 1930s, has been successful, at least in the short run, in staving off disaster in the USA, the UK, Japan and, more tentatively, the eurozone. And the Keynesian model was not developed in response to a banking collapse, with its impact on government finances and the accumulation of debt – so it is of some, but only limited, use in resolving our current problems. Moreover, the Keynesian and monetarist approaches are complementary and have the same preoccupation with weak demand.
In terms of fundamentally different approaches, the real alternative is the so-called Austrian school, which regards expansionary fiscal or monetary policies as pointless or dangerous, and relies instead on aggressive structural reforms and market forces – liquidating weak firms and banks – to make business investment more profitable. That is not to say that structural reform is exclusive to this branch of economic thinking. A belief in trade liberalization, or creating a favourable environment for private investment, or radical bank restructuring, can be seen as a third pillar of post-crisis policy, alongside expansionary monetary and fiscal policy. Indeed, the concept of 'balance sheet recession' or 'debt deflation' invites a combination of stimulating overall demand and measures to restructure or write down debt. In its more radical forms, the Austrian approach, derived from Hayek, Schumpeter and others, converges with a Marxist view of economic history: that modern capitalism faces a deep structural crisis which requires a purging of bad investment and debt – albeit through an entrepreneurial, not a workers', revolution.
One of the biggest casualties of the storm has been the theoretical underpinning of modern financial capitalism. The collapse of communism as an alternative model of economic organization led to a period of hubristic self-congratulation, even arrogance: an unwillingness to question the assumptions underlying the Western financial system. These included the belief that financial as well as other markets were essentially rational and self-stabilizing, together with a poor understanding, even on the part of their users, of the complex products being created. Standard economic models, still widely taught and widely used by policy-makers, have at their heart concepts of macroeconomic equilibrium and rational behaviour that have been denied in the real world. Not just free-market ideologues, but many social democratic advocates of a regulated and mixed economy, in the USA and the UK especially, accepted this comforting set of assumptions. In the event, they were wrong.
Those countries whose financial systems were insulated from world financial markets, and tightly regulated, as in China and India, escaped quite lightly. That, however, might simply reflect a stage of development rather than the discovery of a superior, state-capitalist, model. One of the questions posed by the storm is how to ensure that the benefits of liberalized financial markets in allocating resources in an efficient way can be reconciled with systemic stability. In other words, how much financial regulation is needed, and of what kind, globally and nationally? The question remains open. There have been some significant moves to regulate and reform banks, reviewed in chapter two, but these have been essentially national and only loosely coordinated. Large areas of financial activity, such as shadow banking, remain largely untouched by regulation: ticking bombs yet to be defused or, possibly, detonated.
*
There has obviously been much local colour and variety of experience within the global financial crisis. But there are several broad features that have defined this particular crisis.
The first is the importance of asset bubbles, based in particular on inflated property markets in Japan, the USA and the UK (and Ireland and Spain in the eurozone). The institutions that were in the eye of the storm were mortgage-lenders, like Britain's Northern Rock and the Fannie Mae and Freddie Mac in the USA. The toxic products that contaminated financial intermediaries were securitized loans, mainly built up by combining residential mortgages into new products. In the USA, Spain and Ireland, but not the UK, property price bubbles have fully, and painfully, burst, returning property values to pre-boom levels. In the UK, however, there have been signs of serious fresh house price inflation, at least in London and the south-east, superimposed on an already inflated market. I will argue later that housing inflation in the UK is not merely an issue for financial stability but is also creating great social tensions and inequalities. Serious property-based asset bubbles are now also emerging in Asia, including China. One of the legacies of the crisis is a better understanding of 'macro-prudential' policies to govern the lending policies of banks and other institutions, so as to manage asset bubbles independently of wider inflation. Arguably, these will represent a key new pillar of economic policy. But these mechanisms have yet to be tested in earnest, and they may be dealing with the symptoms of a deeper problem of monetary management in which asset markets are disregarded.
Second, debt, or 'leverage', matters – be it private or public, personal orcorporate, or in financial institutions. What has made this crisis so extensive and destructive is the sheer scale of the leverage achieved on the underlying assets, through financial innovation: the development of securitization markets and the proliferation of complex, exotic, financial instruments. Investment banks – stand-alone institutions like Lehman Brothers or Bear Stearns, or embedded within universal banks like RBS, Barclays and Credit Suisse, or within the banking arms of insurers, as with AIG – were stuffed full of such derivatives. They were rendered illiquid when confidence was lost and they became insolvent when large-scale asset impairment was exposed.
Much has been done to repair financial sector balance sheets, to identify and write down dodgy assets, and to write off bad loans – in part by transferring obligations to governments and also by offloading debts into shadow banking. But there is more involved than the balance sheets of financial institutions. The overhang of personal and public debt also remains very substantial and is growing. The Bank for International Settlements has shown that public and private debt (excluding financial institutions) as a share of global GDP rose from 160 per cent in 2001, to around 200 per cent at the onset of the crisis, to 215 per cent in 2013. In developed economies taken as a whole, debt levels were roughly double those of emerging markets before the crisis, and have continued to grow, with China catching up. Figure 1.1 shows that continuing increase on top of historically high levels.
The UK had one of the highest levels of debt to GDP before the crisis, at 240 per cent. Although household indebtedness did decline for a while, it is rising again and the overall debt figure remains high, at 275 per cent. The government obsession with public debt, now falling to a predicted 60 per cent of GDP by 2020, while household debt rises towards new heights of 170 per cent, according to the OBR, is particularly perverse. These figures do not reflect offsetting assets, such as appreciating house prices, but these are volatile and reversible, unlike the debt. A debt overhang, either business or household, has a dampening effect on spending and investment: what is called 'debt deflation'. If debt is owed to foreign investors, it opens up the prospect of a crisis of sovereign risk, as has happened in Southern Europe (or Latin America in the 1980s), or, if it remains with the banks (or shadow banks), of a fresh banking crisis. And as we move towards a more normal interest rate environment, debtors, both personal and commercial, dependent on low interest rates will struggle to remain solvent. Nor is there any easy escape. The classic remedies for debt overhangs – rapid inflation to wipe out the value of debt, or default and debt relief – are not available, at least at present. A continued period of very low inflation, or deflation, with low economic growth, will see an increased real burden of repaying debt.
A further feature of this particular crisis is that, more than with any other in history, it has involved globally integrated financial markets. Multinational companies have developed an appetite for sophisticated financial products supplied by their banks, which have in turn expanded to operate globally. A combination of technology, financial innovation and deregulation has made cross-border flows easier. Financial securities of growing complexity and variety have been traded in growing volumes in big financial centres like London, and markets have deepened, with risk quantified by credit agencies.
Since the crisis there has been some retreat by banks into national jurisdictions, although tighter regulation has been somewhat piecemeal and uncoordinated. Nonetheless, the fabric of financial market integration remains largely intact. What also remains is the way global financial markets continue to act as intermediaries, managing liquidity, as between countries that generate a surplus of savings (like Germany, China and OPEC Gulf States) and those that absorb the surpluses (like the UK and the USA). What isn't yet clear is whether the fundamental weaknesses of international governance – lack of policy coordination, with global institutions like the UN, World Trade Organization (WTO) and the International Monetary Fund (IMF)/World Bank being highly circumscribed – are storing up bigger problems for the future. One of the attempts to involve global institutions in a localized problem is the role played by the IMF, alongside European institutions, in the Greek problem. That stemmed from the recognition that a specific eurozone problem might well have global implications. But the apparent failure of the interventions, and Greece's default on IMF loans, has undoubtedly weakened the IMF's authority.
(Continues…)
Excerpted from "After the Storm"
by .
Copyright © 2015 Vince Cable.
Excerpted by permission of Atlantic Books Ltd.
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Table of Contents
Introduction,
Part One: The Global Context,
1 After the Storm,
2 Banking: Regulate, Retreat and Regroup,
3 Different Routes out of the Great Recession,
4 The Eurozone: Existential Threat,
5 China and the New Economic Centre of Gravity,
6 Globalization and its Enemies,
Part Two: The UK after the Crisis,
7 Boom, Bust and Recovery,
8 Life after Cheap Money,
9 The British Housing Obsession,
10 British Banking after the Banking Crash,
11 Getting the Long-Term Fundamentals Right,
Conclusion,
Appendix,
Bibliographic Note,
Acknowledgements,
Index,