The latest depressing FT articles

[Sheilbh]

First on the origins of the crisis, which I've seen some newspapers refer to as the 'great recession'.  Interestingly apparently until the Depression every recession was called a depression.  Then it was decided that it was so traumatic that the word should be reserved for that event:

Seeds of its own destruction

By Martin Wolf

Another ideological god has failed. The assumptions that ruled policy and politics over three decades suddenly look as outdated as revolutionary socialism.

"The nine most terrifying words in the English language are: 'I'm from the government and I'm here to help.'" Thus quipped Ronald Reagan, hero of US conservatism. The remark seems ancient history now that governments are pouring trillions of dollars, euros and pounds into financial systems.

"Governments bad; deregulated markets good": how can this faith escape unscathed after Alan Greenspan, pupil of Ayn Rand and predominant central banker of the era, described himself, in congressional testimony last October, as being "in a state of shocked disbelief" over the failure of the "self-interest of lending institutions to protect shareholders' equity"?

In the west, the pro-market ideology of the past three decades was a reaction to the perceived failure of the mixed-economy, Keynesian model of the 1950s, 1960s and 1970s. The move to the market was associated with the election of Reagan as US president in 1980 and the ascent to the British prime ministership of Margaret Thatcher the year before. Little less important was the role of Paul Volcker, then chairman of the Federal Reserve, in crushing inflation.

Yet bigger events shaped this epoch: the shift of China from the plan to the market under Deng Xiaoping, the collapse of Soviet communism between 1989 and 1991 and the end of India's inward-looking economic policies after 1991. The death of central planning, the end of the cold war and, above all, the entry of billions of new participants into the rapidly globalising world economy were the high points of this era.

Today, with a huge global financial crisis and a synchronised slump in economic activity, the world is changing again. The financial system is the brain of the market economy. If it needs so expensive a rescue, what is left of Reagan's dismissal of governments? If the financial system has failed, what remains of confidence in markets?

It is impossible at such a turning point to know where we are going. In the chaotic 1970s, few guessed that the next epoch would see the taming of inflation, the unleashing of capitalism and the death of communism. What will happen now depends on choices unmade and shocks unknown. Yet the combination of a financial collapse with a huge recession, if not something worse, will surely change the world. The legitimacy of the market will weaken. The credibility of the US will be damaged. The authority of China will rise. Globalisation itself may founder. This is a time of upheaval.

How did the world arrive here? A big part of the answer is that the era of liberalisation contained seeds of its own downfall: this was also a period of massive growth in the scale and profitability of the financial sector, of frenetic financial innovation, of growing global macroeconomic imbalances, of huge household borrowing and of bubbles in asset prices.

In the US, core of the global market economy and centre of the current storm, the aggregate debt of the financial sector jumped from 22 per cent of gross domestic product in 1981 to 117 per cent by the third quarter of 2008. In the UK, with its heavy reliance on financial activity, gross debt of the financial sector reached almost 250 per cent of GDP (see charts).

Proportion of countries with banking crises


Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard argue that the era of liberalisation was also a time of exceptionally frequent financial crises, surpassed, since 1900, only by the 1930s. It was also an era of massive asset price bubbles. By intervening to keep their exchange rates down and accumulating foreign currency reserves, governments of emerging economies generated huge current account surpluses, which they recycled, together with inflows of private capital, into official capital outflows: between the end of the 1990s and the peak in July 2008, their currency reserves alone rose by $5,300bn.

These huge flows of capital, on top of the traditional surpluses of a number of high-income countries and the burgeoning surpluses of oil exporters, largely ended up in a small number of high-income countries and particularly in the US. At the peak, America absorbed about 70 per cent of the rest of the world's surplus savings.

Meanwhile, inside the US the ratio of household debt to GDP rose from 66 per cent in 1997 to 100 per cent a decade later. Even bigger jumps in household indebtedness occurred in the UK. These surges in household debt were supported, in turn, by highly elastic and innovative financial systems and, in the US, by government programmes.

Throughout, the financial sector innovated ceaselessly. Warren Buffett, the legendary investor, described derivatives as "financial weapons of mass destruction". He was proved at least partly right. In the 2000s, the "shadow banking system" emerged and traditional banking was largely replaced by the originate-and-distribute model of securitisation via constructions such as collateralised debt obligations. This model blew up in 2007.

We are witnessing the deepest, broadest and most dangerous financial crisis since the 1930s. As Profs Reinhart and Rogoff argue in another paper, "banking crises are associated with profound declines in output and employment". This is partly because of overstretched balance sheets: in the US, overall debt reached an all-time peak of just under 350 per cent of GDP – 85 per cent of it private. This was up from just over 160 per cent in 1980.

Among the possible outcomes of this shock are: massive and prolonged fiscal deficits in countries with large external deficits, as they try to sustain demand; a prolonged world recession; a brutal adjustment of the global balance of payments; a collapse of the dollar; soaring inflation; and a resort to protectionism. The transformation will surely go deepest in the financial sector itself. The proposition that sophisticated modern finance was able to transfer risk to those best able to manage it has failed. The paradigm is, instead, that risk has been transferred to those least able to understand it. As Mr Volcker remarked during a speech last April: "Simply stated, the bright new financial system – for all its talented participants, for all its rich rewards – has failed the test of the marketplace."

In a recent paper Andrew Haldane, the Bank of England's executive director for financial stability, shows how little banks understood of the risks they were supposed to manage. He ascribes these failures to "disaster myopia" (the tendency to underestimate risks), a lack of awareness of "network externalities" (spill­overs from one institution to the others) and "misaligned incentives" (the upside to employees and the downside to shareholders and taxpayers).

. . .

After the crisis, we will surely "see finance less proud", as Winston Churchill desired back in 1925. Markets will impose a brutal, if temporary, discipline. Regulation will also tighten.

Less clear is whether policymakers will contemplate structural remedies: a separation of utility commercial banking from investment banking; or the forced reduction in the size and complexity of institutions deemed too big or interconnected to fail. One could also imagine a return of much banking activity to the home market, as governments increasingly call the tune. If so, this would be "de-globalisation".

US & UK house prices


Churchill called also for industry to be "more content". In the short run, however, the collapse of the financial system is achieving the opposite: a worldwide industrial slump. It is also spreading to every significant sector of the real economy, much of which is clamouring for assistance.

Yet if the financial system has proved dysfunctional, how far can we rely on the maximisation of shareholder value as the way to guide business? The bulk of shareholdings is, after all, controlled by financial institutions. Events of the past 18 months must confirm the folly of this idea. It is better, many will conclude, to let managers determine the direction of their companies than let financial players or markets override them.

A likely result will be an increased willingness by governments to protect companies from active shareholders – hedge funds, private equity and other investors. As a defective financial sector loses its credibility, the legitimacy of the market process itself is damaged. This is particularly true of the free-wheeling "Anglo-Saxon" approach.

No less likely are big changes in monetary policy. The macro­economic consensus had been in favour of a separation of responsibility for monetary and fiscal policy, the placing of fiscal policy on autopilot, independence of central banks and the orientation of monetary decisions towards targeting inflation. But with interest rates close to zero, the distinction between monetary and fiscal policy vanishes. More fundamental is the challenge to the decision to ignore asset prices in the setting of monetary policy.

Many argue that Mr Greenspan, who succeeded Mr Volcker, created the conditions for both bubbles and subsequent collapse. He used to argue that it would be easier to clean up after the bursting of a bubble than identify such a bubble in real time and then prick it. In a reassessment of the doctrine last November, Donald Kohn, Fed vice-chairman, restated the orthodox position, but with a degree of discomfort.

Mr Kohn now states that "in light of the demonstrated importance to the real economy of speculative booms and busts (which can take years to play out), central banks probably should always try to look out over a long horizon when evaluating the economic outlook and deliberating about the appropriate accompanying path of the policy rate". Central banks will have to go further, via either monetary policy or regulatory instruments.

. . .

Yet a huge financial crisis, together with a deep global recession, if not something far worse, is going to have much wider effects than just these.

Remember what happened in the Great Depression of the 1930s. Unemployment rose to one-quarter of the labour force in important countries, including the US. This transformed capitalism and the role of government for half a century, even in the liberal democracies. It led to the collapse of liberal trade, fortified the credibility of socialism and communism and shifted many policymakers towards import substitution as a development strategy.

The Depression led also to xenophobia and authoritarianism. Frightened people become tribal: dividing lines open within and between societies. In 1930, the Nazis won 18 per cent of the German vote; in 1932, at the height of the Depression, their share had risen to 37 per cent.

One transformation that can already be seen is in attitudes to pay. Even the US and UK are exerting direct control over pay levels and structures in assisted institutions. From the inconceivable to the habitual has taken a year. Equally obvious is a wider shift in attitudes towards inequality: vast rewards were acceptable in return for exceptional competence; as compensation for costly incompetence, they are intolerable. Marginal tax rates on the wealthier are on the way back up.

Yet another impact will be on the sense of insecurity. The credibility of moving pension savings from government-run pay-as-you-go systems to market-based systems will be far smaller than before, even though, ironically, the opportunity for profitable long-term investment has risen. Politics, like markets, overshoot.

The search for security will strengthen political control over markets. A shift towards politics entails a shift towards the national, away from the global. This is already evident in finance. It is shown too in the determination to rescue national producers. But protectionist intervention is likely to extend well beyond the cases seen so far: these are still early days.

The impact of the crisis will be particularly hard on emerging countries: the number of people in extreme poverty will rise, the size of the new middle class will fall and governments of some indebted emerging countries will surely default. Confidence in local and global elites, in the market and even in the possibility of material progress will weaken, with potentially devastating social and political consequences. Helping emerging economies through a crisis for which most have no responsibility whatsoever is a necessity.

The ability of the west in general and the US in particular to influence the course of events will also be damaged. The collapse of the western financial system, while China's flourishes, marks a humiliating end to the "uni-polar moment". As western policymakers struggle, their credibility lies broken. Who still trusts the teachers?

These changes will endanger the ability of the world not just to manage the global economy but also to cope with strategic challenges: fragile states, terrorism, climate change and the rise of new great powers. At the extreme, the integration of the global economy on which almost everybody now depends might be reversed. Globalisation is a choice. The integrated economy of the decades before the first world war collapsed. It could do so again.

On June 19 2007, I concluded an article on the "new capitalism" with the observation that it remained "untested". The test has come: it failed. The era of financial liberalisation has ended. Yet, unlike in the 1930s, no credible alternative to the market economy exists and the habits of international co-operation are deep.

"I've a feeling we're not in Kansas any more," said Dorothy after a tornado dropped her, her house and dog in the land of Oz. The world of the past three decades has gone. Where we end up, after this financial tornado, is for us to seek to determine.

This is the first part of an FT series entitled the Future of Capitalism

Copyright The Financial Times Limited 2009

[Sheilbh]

And the equally depressing comment on whant to do:

Why the G20 must focus on sustaining demand

By Martin Wolf

Published: March 10 2009 20:30 | Last updated: March 10 2009 20:30

The summit of the Group of 20 leading advanced and emerging countries in London on April 2 2009 will fail. Its members are refusing to meet what Lawrence Summers, senior economic adviser to the US president Barack Obama, calls "the universal demand agenda". Conventional wisdom is the enemy. Alas, it is winning.

In the US, the spirit of Andrew Mellon, Treasury secretary to Herbert Hoover, remains alive. His advice – lamented Hoover – was: "liquidate labour, liquidate stocks, liquidate the farmers, liquidate real estate". Yet this foolish view is not animating US policy. The danger is not of doing nothing, but rather of doing too little. If such timidity fails, opponents will argue: these policies have failed. This will exacerbate confusion, making attempts at decisive action later on more difficult and ineffective.

The right thing to do is more than enough. It will always be possible to withdraw stimulus a year or two hence. It will be far more difficult to make action effective if depression, both economic and social, takes hold.

What, then, is "more than enough"? To answer that, we must recognise where we are. First, the recession is global (see chart). Countries heavily dependent on exports as a source of demand, such as Germany, Japan and South Korea, have been even worse affected than the US or the UK. Second, the forces underlying this recession are powerful and enduring. They include: vast losses in wealth (estimated by a study for the Asian Development Bank at close to a year's global output); huge overhangs of private debt in deficit countries; and a breakdown in the normal functioning of the financial system.

G20 economies


So what is to be done? Monetary policy is largely exhausted: even interest rates at close to zero fail to spur borrowing, and the world cannot devalue itself into export-led recovery. Monetary policy can – and must – unblock credit markets, sustain the money supply and support fiscal policy. The Federal Reserve has gone furthest in these directions. Others are being forced, willy nilly, to follow.

Fiscal policy has a big role to play. In an excellent paper, economists at the International Monetary Fund describe what is needed as "timely, large, lasting, diversified, contingent, collective and sustainable": timely, large and lasting, because the slump is here, harsh and enduring; diversified, because the effectiveness of each measure is uncertain; contingent, because surprises are surely in store; collective, because a stimulus will be more effective the more countries participate; and sustainable, because adverse reactions in debt markets must be contained.*

Against these standards, the stimulus packages are disturbingly modest (see chart). According to the IMF, even the US stimulus amounts to only a total of 4.8 per cent of gross domestic product . Moreover, as the IMF notes, automatic stabilisers are larger in Europe than in the US, because of more generous welfare provision.** Overall, the US is doing more than other big, high-income countries, but not so much more: relative to the pre-crisis year, the change in the overall fiscal balance is forecast at 5.7 per cent of GDP in the US this year, against 4.4 per cent in Germany.

Not surprisingly, critics condemn the recent US stimulus package as too small. Professor Martin Feldstein of Harvard University, former chairman of Ronald Reagan's council of economic advisers, argues that the "US economy faces a $750bn shortfall of demand", largely because of a $12,000bn decline in household wealth. The US package will, he suggests, offset just 40 per cent of the lost demand in 2009 and 2010. If so, the recession will be deep and prolonged. Prof Feldstein concludes that "a second fiscal stimulus package is likely". Indeed, it will be essential. But, by then, Mr Obama may have lost the argument and his authority.

Yet will to do more is weak, in the US and elsewhere. The principal justification for caution is concern over longer-term sustainability. This is a mistake: the principal threat to sustainability is not the crisis, but entitlement spending. Attempts to curb fiscal deficits when the private sector is cutting back sharply are likely to fail even in their own terms. Finally, fiscal policy cannot be made independently of what the private sector is doing – indeed, we are now seeing huge rises in fiscal deficits, because of past profligacy in private sectors, often of other countries.

Remember, not least, that even a 50 percentage point increase in the ratio of public debt to GDP imposes a permanent cost on taxpayers of 1–1½ per cent of GDP in a country able to borrow at real interest rates of, say, 2–3 per cent. Provided credibility is maintained, this is manageable and, indeed, less worrying than the waste inherent in any prolonged slump.

In short, halting the incipient depression comes first. For this to work, however, fiscal action needs to be credibly reversible: temporary spending and tax cuts aimed at high-spending groups will be more effective and less risky than broad tax cuts.

G20 heads of governments must resolve to do whatever is necessary to sustain demand at home and in vulnerable developing countries. They should abandon the conventional wisdom and, instead, dare to succeed.

* Fiscal Policy for the Crisis, December 2008; ** The Size of the Fiscal Expansion, February 2009, www.imf.org

[Neil]

Why will there be a rise in the authority of China if globalisation falls apart?  Their entire economy is based around export.  No globalisation = no export = no Chinese influence in the world = Chinese civil war = All those people who were calling for China to become a superpower will be hanged for being so stupid.

[Valmy]

Why will there be a rise in the authority of China if globalisation falls apart?  Their entire economy is based around export.  No globalisation = no export = no Chinese influence in the world = Chinese civil war = All those people who were calling for China to become a superpower will be hanged for being so stupid.

Logic and common sense have no place when trumpeting the Yellow Peril.

[Sheilbh]

Why will there be a rise in the authority of China if globalisation falls apart?  Their entire economy is based around export.  No globalisation = no export = no Chinese influence in the world = Chinese civil war = All those people who were calling for China to become a superpower will be hanged for being so stupid.

China's got a financial sector that isn't collapsing.  And the Chinese banks are, I believe, quite popular because they argue that while the first shoots of recovery won't necessarily appeal in the US and Europe for a long time after recovery's started they'll be there in China very quickly because that's where we'll buy our shit.

[The Minsky Moment]

The FT is worth the price of admission just for Martin Wolf's Wednesday columns.

But I have to quibble with him a little on the last to the extent it emphasized the need for the US in particular to take more aggressive fiscal measures.  This may well be warranted.  But it should not be forgotten that this crisis has its roots in the structural distortions of international trade and financial flows - in particular the structural current account surpluses of China and Germany, and the current account deficits of the US, the UK and Spain (and to a lesser extent, Italy and more recently France).  To the extent that fiscal balances deterioration and fiscal pump priming occur more aggressively in current account deficit countries like the US and the UK than they do in the surplus countries of Germany and China, that root problem will not be resolved and thus any rebound will be only be a temporary reprieve before additional painful adjustments are required. 

Even if there is a recovery, the demand for US domestic assets is likely to be weak for years to come.  The Chinese understandably have limited appetite for continuing to accumulate endless supplies of US treasury securities.  But the only other option is either a sharp reduction in Chinese and German exports or a sharp increase in imports or at least much higher domestic consumption of internal domestic production.  So far, we have seen much more of the former than the latter, with painful consquences for all countries involved.  That result is inevitable as long as the Chinese and German stimulus lags behind the US.  In short the bar lines for China and Germany in Martin W's chart MUST be longer than that US and UK ones if we are to have any hope of avoiding the most painful adjustments.

[Neil]

Why will there be a rise in the authority of China if globalisation falls apart?  Their entire economy is based around export.  No globalisation = no export = no Chinese influence in the world = Chinese civil war = All those people who were calling for China to become a superpower will be hanged for being so stupid.

China's got a financial sector that isn't collapsing.  And the Chinese banks are, I believe, quite popular because they argue that while the first shoots of recovery won't necessarily appeal in the US and Europe for a long time after recovery's started they'll be there in China very quickly because that's where we'll buy our shit.

If globalisation ends, why would we buy our shit there?  Protectionist tarriffs and huge incentives towards local industry would end China utterly.

[The Minsky Moment]

China's got a financial sector that isn't collapsing. 

It isn't collapsing because every few of years, the government comes in and sweeps the bad loans into a state-managed "bad bank" that doesn't have to use real accounting.

It is one way of dealing with this kind of problem but I for one am not in any big rush to invest in the Chinese banking sector.

[Martim Silva]

First on the origins of the crisis, which I've seen some newspapers refer to as the 'great recession'.  Interestingly apparently until the Depression every recession was called a depression.  Then it was decided that it was so traumatic that the word should be reserved for that event:

The official definition of a 'Depression', by Investopedia.com, is:

"A severe and prolonged recession characterized by inefficient economic productivity, high unemployment and falling price levels."

Match that with current trends.

Why will there be a rise in the authority of China if globalisation falls apart?  Their entire economy is based around export.

Contrary to popular western belief, the majority of chinese growth is based upon domestic demand. And even those numbers are misleading, as they are most often not measured correctly.

The Economist offers a more insightful analysis (full article avaliable in the site):

http://www.economist.com/finance/displaystory.cfm?story_id=10429271

(...) If exports are measured correctly, however, they account for a surprisingly modest share of China's economic growth.

The headline ratio of exports to GDP is very misleading. It compares apples and oranges: exports are measured as gross revenue while GDP is measured in value-added terms (...)

That said, the problem with the modern Economy is VERY simple. People are greedy. Eventually, greed turns into blindness, blindness into stupidity. Stupidity breeds disaster.

In other words, a proper Economy cannot exist without proper State oversight. And to a private banking sector that has the ability to create money (and thus controls the money supply, which gives it massive power over the State and its politicians, thus opening the door for the bankers to do whatever they want in the long run) is just plain madness.

I once saw an american movie where it was directly stated that "GREED works", as it was what made the american economy great. We are now starting to see the true results of that line of thought.

[The Minsky Moment]

The Economist offers a more insightful analysis (full article avaliable in the site):

http://www.economist.com/finance/displaystory.cfm?story_id=10429271

(...) If exports are measured correctly, however, they account for a surprisingly modest share of China's economic growth.

The headline ratio of exports to GDP is very misleading. It compares apples and oranges: exports are measured as gross revenue while GDP is measured in value-added terms (...)

Can't read the article - don't have "pay per view credits"

But from the excerpt it is talking about proper measurement export/GDP ratios.  That may be an item of academic interest, but the more immediate concern is simply the size of the current account.  These represent real flows that must be balanced by corresponding capital outflows.  Speculating about the domestic value-added content of exports doesn't make that problem go away.

[Cecil]

I once saw an american movie where it was directly stated that "GREED works", as it was what made the american economy great. We are now starting to see the true results of that line of thought.

http://www.youtube.com/watch?v=GQnCFdjLJAM&feature=related

[garbon]

We are now starting to see the true results of that line of thought.

A bunch of whiners?

[MadImmortalMan]

We are now starting to see the true results of that line of thought.

A bunch of whiners?

What the backlash against it causes.  ;D

[Martim Silva]

But from the excerpt it is talking about proper measurement export/GDP ratios.  That may be an item of academic interest, but the more immediate concern is simply the size of the current account.  These represent real flows that must be balanced by corresponding capital outflows.  Speculating about the domestic value-added content of exports doesn't make that problem go away.

There is also another point it makes, that marks the difference between China and the US. China has factories - it has the ability to produce.

The US, on the other hand, became a "service" economy, a change lauded by the healds of 'globalization'. 70% of Americas' economy became based on consumption. The country outsourced most of its manufacturing - to China, India and lots of other places. It can produce little now - a great difference when compared with 1929.

Also, to put this crisis in proportion: nearly half the worlds' wealth is now gone.

http://www.reuters.com/article/newsOne/idUSTRE52966Z20090310

Private equity company Blackstone Group LP (BX.N) CEO Stephen Schwarzman said on Tuesday that up to 45 percent of the world's wealth has been destroyed by the global credit crisis.

"Between 40 and 45 percent of the world's wealth has been destroyed in little less than a year and a half," Schwarzman told an audience at the Japan Society. "This is absolutely unprecedented in our lifetime." (...)

http://www.youtube.com/watch?v=GQnCFdjLJAM&feature=related

In a nutshell, the economic path the US has taken for decades (and I can tell you it is a very mild picture that is presented. The reality is far worse by many degrees of magnitude). When impossible delusions crash, they crash HARD.

[MadImmortalMan]

Quick! Start up the five-year plans immediately!