Posts filed under 'History of Finance'
Is modern finance more like electricity or junk food? This is, of course, the big question of the day.
If most of finance as currently organized is a form of electricity, then we obviously cannot run our globalized economy without it. We may worry about adverse consequences and potential network disruptions from operating this technology, but this is the cost of living in the modern world.
On the other hand, there is growing evidence that the vast majority of what happens in and around modern financial markets is much more like junk food – little nutritional value, bad for your health, and a hard habit to kick.
The issue is not finance per se, i.e., the process of intermediation between savings and investment. This we obviously need to some degree. But do we need a financial sector that now accounts 7 or 8 percent of GDP? (For numbers over time, see slide 19 in my June presentation.)
As far as we know, finance was about 1 or at most 2 percent of GDP during the heyday of American economic innovation and expansion – say from 1850. The financial system of the nineteenth century worked well, in terms of mobilizing capital for new enterprises.
Those banks had much higher capital-asset ratios than we have today. Even the dominant players were smaller in absolute terms and relative to the economy – JP Morgan, at his peak, employed less than 100 people.
No one is suggesting we go back to the nineteenth century (although abolishing our central bank would certainly have undesirable consequences in that direction). But is it really healthy – or even sustainable – to have a finance sector as large as what we face today? (It is surely not a good idea for finance to account for 40 percent of total corporate profits, see slide 16 – such performance, in an intermediate input sector, suggests someone else in the economy is being severely squeezed.)
There is a great deal of research that finds finance is positively correlated with growth, but this work has a couple of serious limitations – if you want to derive any robust implications for policy.
First, it is about the amount of financial aggregates (e.g., money or credit, relative to GDP) rather than the share of financial sector GDP in total GDP. I know of no evidence that says you are better off with a financial sector at 8% rather than, say, 4% of GDP.
Second, the research shows correlations not causation. So all we really know is that richer countries have more financial flows relative to GDP, not that more finance raises GDP in any linear fashion. Attempts to dig into causation tend to show that financial development is not the bonanza that it is cracked up to be.
Third, we know finance can become “too big” relative to an economy. Ask Iceland.
The work in this area is still at any early stage. Given what we’ve seen over the past 12 months, which way should we lean: towards believing in the positive power of finance, until the opposite is proven; or towards being skeptical of finance in its modern form, until we see evidence that this actually makes sense?
Surely out skepticism should extend to financial innovation. Show me the evidence that this kind of innovation really adds value, socially speaking – rather than providing a very modern way to extract amazing “rents”.
By Simon Johnson
Address of this post: http://baselinescenario.com/2009/09/01/the-nature-of-modern-finance/ (an experiment to help Kindle readers access the comments section more easily)
September 3rd, 2009
President Obama’s visit to Moscow this week may turn out to be a very good thing. Forget all this jibber-jabber about nuclear disarmament.
There is no better reminder than the former Soviet Union for how the fantasies of a few collectivist zealots can turn into unending nightmares for its people — and for how a state-run economy ends up with no economy at all.
If we’re lucky, a little Russian history on this trip will turn into a welcome wake-up call for Mr. Obama.
It’s not that Mr. Obama is some radical who carries a warm nostalgia for the Soviet Union from his university days. He’s way too young and too smart for that.
But the president believes in the state, certainly more than any other recent American president. He believes the state must actively intervene in the economy and that the state can bring about a better future. And it seems he believes it is his destiny to lead the state to that future.
In that way — and others — Obama reminds me of Vladimir Lenin, the founder of the Soviet state.
CNBC’s Jim Cramer made the Obama-Lenin comparison back in February. And the more I’ve thought about it, the more it holds.
Associated Press
A painting made during the Russian Revolution, showing Vladimir Lenin surrounded by revolutionaries, date unknown.
Of course, Obama is a reformer, not a revolutionary. And he’s certainly no communist.
But just like Lenin, Obama is a supremely self-confident leader — an intellectual heavyweight and a clever political tactician — an elitist moralizer and a populist champion. And just like Lenin, Obama carries the true-believers’ righteous fervor for “change.”
I was thinking of Lenin as I watched the president’s Rose Garden remarks on energy and innovation last Thursday.
After his eight minutes in front of the teleprompter, the president turned to walk away, and a reporter blurted out a question, “Mr. President, do you have a message for the small businesses on health and economy?”
The president should have just walked away. But it was as if he couldn’t stop himself as he launched into a rambling, haughty answer that I found…well, a bit scary.
It was scary because it demonstrated that Mr. Obama — almost half a year in office — still has no grasp of the everyday realities faced by America’s small businessmen. They can’t make payroll, but the president is directing them to buy LED lightbulbs and urging them to contact “clean energy” CEOs.
And it was scary because it showed that the president is still possessed by an unshakable conviction in the power of the state over the individual and of the future over the past.
As he put it in the Rose Garden, we have to change the health-care system. We have to change how we use energy. We have to change how we “train our young people.” “We are not folks who are scared of the future or look backwards. We always meet the challenges by moving forward.”
Political clichés? Of course.
But the president seems to actually believe his clichés. And some of his Rose Garden remarks could have been lifted from Lenin’s speeches circa 1918 – the same hectoring tone and the same mockery of opponents who long for the “status quo”.
Even Mr. Obama’s call to move “forward.” “Forward!” in fact was one of the Soviets’ favorite slogans.
The good news for those of us who are a little freaked out by Mr. Obama is that even Lenin did an about-face after the utter failure of his initial hard-left economic policies.
By early 1921, faced with the ruin and famine wrought by nationalization of the economy, the Bolsheviks re-instituted a quasi-capitalist economy with its New Economic Policy. Ironically, the NEP was aimed to help small businessmen — the very same people that the Obama economy so desperately needs nowadays.
Lenin called the NEP taking “one step backward to take two steps forward.” While he’s in Moscow, President Obama may want to ask someone at the Kremlin, just what Lenin meant by that.
Editor’s Note: Mr. Newmark was a student in Moscow in 1984, worked with George Soros on Russian economic reform in 1988-89 and ran the Goldman Sachs Moscow office from 1992-1994.
Why Barack Obama Is Like Vladimir Lenin – Evan Newmark, Deal Journal
July 7th, 2009
Why inflation is around the corner
The government wants inflation to some degree. Congress and the White House have spent nearly $3 trillion recapitalizing U.S. banks, revamping the domestic manufacturing industry and replacing a portion of the consumption spending Americans have not been able to afford. The economy is recovering as a result, but U.S. debts are also ballooning. The nonpartisan Congressional Budget Office projects that the U.S. deficit will exceed $1.8 trillion this year.
The government doesn’t plan on paying off that debt or the interest on it without some help from the Fed. Earlier this year, the central bank announced it would directly purchase $1.75 trillion worth of U.S. debt in the form of mortgage-backed securities, U.S. Treasurys and agency debt. In essence, the Fed’s action “prints” more money and injects it into the economy.
Is Inflation Our Next Big Worry? – Catherine Holahan, MSN Money
June 26th, 2009
Combine Japanese cultural tendencies toward formality, politesse, and indirection with the usual central banker’s love of opacity and econo-jargon, and you’d expect that a meeting with the Deputy Governor of the Bank of Japan would be a one-way trip into a cloud of vagueness. But in a meeting Monday, Kiyohiko Nishimura, Yale-trained economist, former Tokyo University professor and deputy governor of the Bank of Japan, gave one of the most lucid and useful explications of the credit crisis and its aftermath that I’ve heard– and I’ve heard a lot of them. And even more surprisingly, it was pretty optimistic.
A Japanese central banker is well situated to comment on the current global crisis, given Japan’s own sad history of dealing with the overhang of a credit/real estate bubble—or, more accurately, of not dealing with it. The government and private-sector’s uncertain policies condemned Japan to a traumatic lost decade of slow growth.
Nishimura shared a talk he’s been giving—including at a Federal Reserve Bank of Chicago conference in May—about the comparative post-bust experience of Japan in the 1990s and the U.S. today. It’s titled: “The Past Does Not Repeat Itself, But it Rhymes.” The rhyming can clearly be seen in a chart showing what he dubbed a “remarkable resemblance in developments between the U.S. crisis and Japan’s ‘lost decade.’”
The U.S. is experiencing what Japan did in the 1990s, but seven times faster.
U.S. Crisis is Like Japan’s, Only Seven Times Faster – D. Gross, Newsweek
June 26th, 2009
Diane Francis, Financial Post Published: Monday, June 22, 2009
American opponents to President Barack Obama’s announced reregulation of the financial sector are billing the issue as capitalism versus socialism or even communism.
It is not the case. This is not the economic version of the Cold War, and the search for a new architecture does not mark the death of capitalism.
In fact, free enterprise was nearly murdered by Wall Street, AIG and other reckless financial institutions. They did not meet their defined responsibilities. They bent the law to bypass rules governing their behaviour. Many of them abandoned traditional banking and got into the gaming business. And they brought the world to the brink in the fall.
The role of government is appropriate in the financial sector because of its importance to sustaining a healthy capitalist system. Banks, brokers, insurers and others are licensed by the government to benefit society by being astute gatekeepers to success. They deploy their own capital and savings from the public honestly by investing in worthy individuals and entities that will create wealth, then repay their loans.
Government’s role is necessary because these institutions, in turn, exist as a result of deposits from the public and shareholders’ money. They have a fiduciary obligation to responsibly use other people’s money for the benefit of all. The rules dictate who, what and how they lend or insure, as well as how they leverage.
But what Wall Street and the others did was lend, or insure, obscene amounts of money to inappropriate entities for inappropriate reasons without any market discipline. There were no clearing houses for the trillions in derivatives they created, no markets for them, no pricing mechanisms, no leverage restrictions, no capital allocation and no transparency or proper accounting.
They were not players in a free-enterprise system, but were gamblers rigging the system for their own benefit.
America’s financial punters sank the legitimate and regulated credit system. They collected upfront fees and played fast and loose with credit instruments; witness estimates that the notional value of credit default swaps and other risky “derivatives” could total up to US$600-trillion, or 10 times the world’s GDP.
Last fall, Washington was told by AIG and Lehman Brothers that the world had gone bust. Thanks to trillions in bank bailouts, and shotgun marriages, total collapse was averted.
Months later, there are positive signs. Consumer confidence has a pulse, at long last, though this has yet to translate into spending. Some 53 million people have lost their jobs worldwide and governments are in hock to the tune of trillions. Innocent victims include the world’s poorest nations and their citizens, including those who ran their fiscal and monetary houses in a responsible way.
Wall Street’s recklessness, and in some instances criminality, has destroyed credit, which continues to afflict third-party, real-economy businesses from Detroit (which already had problems) to retailers and most others.
The fix will take years, require international co-operation and wasn’t the fault of government or the rest of us. So the next time some Wall Streeter or financial-sector apologist is blabbing about how reregulation will kill capitalism, just remember it was capitalists, so-called “champions” in pinstripes, who nearly destroyed free enterprise by driving it into a wall.
June 24th, 2009
The blunt fact is that the economic recoveries that have been rapid and seen fast growth in employment are those that ended when a central bank, following strongly restrictionary policies to fight inflation, eased off and significantly lowered interest rates. No such lowering of interest rates is possible this time—interest rates are already as low as they can possibly go. So I can see no reason to anticipate a rapid recovery and rising employment when the cliff-diving stops. And I do not understand why the Obama administration is following policies that presume such a rapid recovery—a V rather than an L for the shape of the recession—is not just possible but probable.
How Far We’ve Come from Last December – Brad DeLong, Free Exchange
June 19th, 2009
Last week, General Motors began the fourth largest bankruptcy proceedings in history, joining the many other large and venerable companies that have sunk to the bottom during this economic crisis. In fact, eight of the 20 largest bankruptcies have happened during the last two years of crisis. Our latest Transparency is a look at the biggest sinking ships in business history.
A collaboration between GOOD and Always With Honor.
Transparency: The 20 Largest Bankruptcies in History – Good Magazine
June 16th, 2009
It’s one thing for President Obama to face off against Fox News, the right-wing radio empire and Republican congressional leaders whose names are unfamiliar to much of the public. It’s quite another to confront organized business.
That’s why last week’s announcement by the U.S. Chamber of Commerce of a new “Campaign for Free Enterprise” could be one of the year’s most consequential political developments. Now the real resistance to Obama begins.
As long as the global economy was crumbling, business held back and even welcomed the infusion of hundreds of billions of government dollars to prop up the system. Business leaders, like everyone else, were frightened to death. They welcomed Big Government’s exertions to keep the banks alive and gin up consumer purchasing power.
It is an odd tribute to the short-term success of Obama’s recovery effort that the business lobbies now feel free to return to the old-time religion of bashing government and singing the praises of the unfettered marketplace. You might expect the corporate guys to show a little gratitude to the government that bailed them out. But that’s never been their way. They’d rather pretend that the past nine months were a bad dream.
Thus the Chamber’s new offensive. In his statement announcing its campaign, chamber President Thomas J. Donohue tried to brush past the recent unpleasantness as quickly as possible.
Obama and the Politics of Short Memories – E.J. Dionne, Washington Post
June 16th, 2009
President Obama has officially begun the era of bigger big government by proposing to go on a multitrillion dollar borrowing spree that risks doing to the “full faith and credit of the United States” what excessive borrowing during the housing bubble did to private credit.
Under his budget plan for America’s future, spending will average 23.7% of GDP for at least a decade (a whopping 20% higher than in 2000-08).
Near-record deficits increasing at record rates will push the public debt of the U.S. beyond the economy’s plausible capacity to pay — 70% of GDP by 2012, heading quickly to 82% of GDP in 2019 and on pace to be astronomically higher soon thereafter.
The Avalanche
American families over the last year have already lost 8% of their net worth — in part as a result of inept government meddling, past and present. For many of the same reasons, they are also buried under a mountain of mortgages and private-sector debts gone bad. On top of that, if the president has his way, they will soon be hit with more than a 100% increase in public debt (from $8 trillion this year to $17.3 trillion in 2019).
Furthermore, the Treasury (and taxpayers) will soon have to begin repaying to Social Security more than $5 trillion in payroll tax revenues that the government had taken from the trust fund and spent for earmarks and other purposes.
Even without the Obama surge in debt — and taxes to pay it off — taxpayers face the prospect of 60% to 70% income-tax rates in the future to pay for $48 trillion in unfunded liabilities under existing entitlement programs. Now the president plans to burden the economy’s limited taxpaying capacity with a universal health care entitlement.
Foreigners purchased two-thirds of the Treasury debt sold during 2004-08 — and now own 50% of U.S. public debt.
Scholars at the Peterson Institute for International Economics warn that the “net foreign debt” position of the U.S. is becoming unsustainable.
Even if the bond rating of Treasury obligations is not formally downgraded for risk, foreign investors may start to resist buying more U.S. debt and, if the situation gets worse, may start withdrawing from the U.S. economy the trillions of dollars of capital they have already lent us. Then what?
The current level of private saving in the U.S. is grossly insufficient to make up the shortfall. In fact, Washington is doing nearly everything possible to prevent Americans from adding to their savings.
In theory, the U.S. government can always pay its debts by increasing taxes, but the problem with taxes — and ultimately with big-spending government — is that tax increases harm the economy disproportionately and quickly reduce the economy’s taxpaying capacity.
Before she became the chairman of the president’s Council of Economic Advisors, Christina Romer demonstrated in a research paper prepared for the National Science Foundation in 2007 that it costs the private-sector economy $4 ($1 of tax and nearly $3 of economic damage) to provide the government with $1 to spend.
In a research paper published by the National Bureau of Economic Research in 2006, former CEA Chairman Martin Feldstein concluded that the private-sector cost of an additional dollar of income-tax revenues for the government is $2.50 ($1 of tax and $1.50 of economic damage).
Paying off Obama’s 10-year string of deficits that add up to $9.3 trillion with income tax increases of $9.3 trillion over 10 years would cost the private sector $23 trillion (Feldstein) to $37 trillion (Romer).
In effect, American families would over time lose an amount greater than an entire year of GDP — a blow far more severe than the damage being done to them by the current recession.
Dubious Direction
It is irresponsible stewardship for Obama and Congress to go on a borrowing spree that puts America in the same unsustainable position as an overstretched boomer with too much debt and too little income and whose only option is to refinance at higher costs just to pay the interest.
The responsible alternative is for Washington to spend less — a lot less. Otherwise, the next Washington-created bubble to burst may be the full faith and credit of the United States.
Christian and Robbins are, respectively, the executive director and the chief economist of the Center for Strategic Tax Reform (cstr.org) in Washington, D.C.
Obama’s Plan For a Debt-Ridden Future – E. Christian & G. Robbins, IBD
June 11th, 2009
Onetime presidential hopeful and current Republican congressman Ron Paul has an interesting piece of legislation wending its way through the US capitol. HR1206 calls for “a complete audit of the Federal Reserve and removes any significant barriers towards transparency in our monetary system” says Paul’s website.
This bill now has nearly 170 cosponsors, with support from both Republicans and Democrats. Senator Bernie Sanders has introduced a companion bill in the Senate S 604, which will hopefully begin to gain momentum as well. I am very encouraged to see so many of my colleagues in Congress stand with me for greater transparency in government.
Congressman Paul continues:
Fundamentally, you cannot defend the Federal Reserve and the free market at the same time. The Fed negates the very foundation of a free market by artificially manipulating the price and supply of money – the lifeblood of the economy. In a free market, interest rates, like the price of any other consumer good, are decentralized and set by the market. The only legitimate, Constitutional role of government in monetary policy is to protect the integrity of the monetary unit and defend against counterfeiters.
And indeed, continues:
Instead, Congress has abdicated this responsibility to a cabal of elite, quasi-governmental banks who, instead of stabilizing the economy, have destabilized it. It took less than two decades for the Federal Reserve to bring on the Great Depression of the 1930’s. It has also inflated away the value of our currency by over 96 percent since its inception. It has invisibly stolen from the poor and given to the rich through this controlled inflation, and now openly stolen through recent bank bailouts. It has predictably exacerbated the very problems it was meant to solve.
All of which we’d have been quite likely to dismiss out of hand, were it not for its relevence in light of an excellent essay from historian Simon Schama in last weekend’s FT, on the central-bank hating tendencies of President Jackson, and more broadly, the long and rich seam of bankphobia than cleaves through American history:
Jackson, who was in the White House from 1829-1837, was a new brand of politician in American life. No one would confuse him with the Virginian gentlemen-planters who had dominated high office in the early republic. He had been Indian fighter, scourge of the British and darling of the frontier crowds. But what really got his dander up was the Bank of the United States, the institution granted the monopoly to print paper money. The “Monster”, he declared at the height of his presidential knock-down battle with its president Nicholas Biddle, “wants to kill me but I will kill it”.
And destroy the Bank of the United States Jackson did, vetoing the Senate’s renewal of its charter in 1832 and running for re-election as the champion of People v Monster. The result of the liquidation of monetary regulation was predictable: wildcat speculation. Two months after Jackson left office in March 1837, the second of the great American financial meltdowns was under way (the first was in 1819). Another swiftly followed in 1839 under the administration of Jackson’s hand-picked successor, Martin Van Buren. On the eve of the civil war, Jackson’s wish for monetary decentralisation had come true beyond his wildest dreams There were 7,000 local currencies circulating in the republic and an epidemic of counterfeiting. It took Lincoln’s Banking Act of 1862, born of a desperate need for dependable credit to fight the war, for a modicum of monetary order to be salvaged from what Biddle had accurately prophesied would be monetary anarchy.
Jackson tapped into a pulsing vein of American insecurity about the moral character of money.
In fact, in the unstable conditions of America in the 1830s, the paper of the Bank of the United States was by far the most dependable medium of transactions from Maine to Louisiana. But Jackson was convinced that unless the Bank perished, American democracy would always be infected by its machinations. What was at stake was the battle of rural and urban values for the economic soul of America. In some ways this was almost as momentous as the struggle between the slave south and the free north for it went to the heart of what America was supposed to be: a place where simplicity and transparency ruled in small moral communities, or a self-energising machine of unlimited economic growth and power: Field of Dreams or Citizen Kane?
Interesting times we live in.
America has a long tradition of central bank antagonism. (FT Alphaville)
May 28th, 2009
This recession is now the worst since at least 1958, which is as far back as the index of coincident indicators stretches back.
The Conference Board reported today that the index, which is intended to measure how the economy is doing on an overall basis, slipped a little in April. The decline was smaller than in previous months, and two of the four indicators edged up, which could be taken as a sign that the economy is at least getting worse at a slower pace.
As I noted last month, the index was nearing the 5.6 percent decline that it experienced in the 1973-1975 recession. Now it is down 5.7 percent.
One way to put that into perspective is that the decline so far in this recession is more than the maximum falls combined in the two previous recessions, in the early 1990s and then in 2001.
“..the decline so far in this recession is more than the maximum falls combined in the two previous receptions, in the early 1990s and then in 2001.” (Floyd Norris)
May 27th, 2009
The UK’s AAA-rating is at risk. (Bloomberg, MarketBeat, EconomPic Data, Zero Hedge)
Bye, bye miss american pie…..
Don’t wait…..buy Gold and Gold Mine Stocks!
May 25th, 2009
Looking north at statue of Cornelius Vanderbilt at the head of the ramp to en:Grand Central Terminal on a sunny late morning
A review at the NY Times: http://www.nytimes.com/2009/05/10/books/review/Kazin-t.html?_r=1&ref=books
Cornelius Vanderbilt spent little of his long life fretting over his image. If Americans were not grateful for the many steamships he built, the major railroad lines he integrated into a common system, the stock market panics he soothed and the Grand Central Terminal he constructed with his own millions, that was their fault, not his. Vanderbilt was the richest man in 19th-century America; at his death in 1877, he possessed, at least on paper, one-ninth of all the American currency in circulation. But like other corporate giants of his era and ours, he saw no reason to apologize for manufacturing and managing commodities everyone wanted and needed. “Vanderbilt was many things, not all of them admirable,” T. J. Stiles says in this perceptive and fluently written biography, “but he was never a phony. Hated, revered, resented, he always commanded respect, even from his enemies.”
That respect stemmed, in part, from how he earned his fortune. During the early years of the republic, most rich Americans had inherited their wealth from mercantile or planter ancestors. Like their fellow patricians across the Atlantic, they tended to equate good breeding with the right to rule. Vanderbilt left school at the age of 11. But as a self-taught, self-made entrepreneur, he had no equal.
Vanderbilt grew up on Staten Island, the son of ambitious farmers who were determined to profit from the commercial bounty being frantically pursued in the booming city across the bay. Cornelius routinely took his father’s boat to Manhattan and back; sometimes, he spent all night in the small vessel in order to grab the first job the next morning. By his 20th birthday, Vanderbilt had made enough cash to compete for trade up and down the coast. While a tiny number of men his age were leisurely studying the classics in Cambridge and Princeton, Vanderbilt became a prosperous “shopkeeper of the sea.” He was also one of the first Americans to learn to construct and operate steamships — the greatest innovation in transport since the invention of sail.
Vanderbilt erected a continental empire on his love and mastery of the age of steam. It was a perilous industry: captains eager to destroy the competition routinely pushed engines beyond their limits. Boilers exploded. Ships crashed into one another. Deaths were common. Vanderbilt often challenged other owners to races, piloting boats of his own design with ferocious cunning, if not always to victory.
But the Commodore (a name he cherished) accomplished his most impressive feats away from the steering wheel. By slashing fares and buying out rival firms, Vanderbilt achieved a near monopoly on steamship travel between New York and Boston. During the California gold rush, he hacked out a passage through Nicaragua to carry the forty-niners and their mail from ocean to ocean. Midway through the Civil War, he loaned his largest and fastest ship to the Union Navy to chase down Confederate raiders. Once victory was won, he switched his energies to the railroad business and soon controlled a network of lines that ran from New York to Chicago.
Like a great athlete, Vanderbilt lived to compete. As a septuagenarian, he still relished racing a team of fancy horses on the outskirts of Gotham. His “resolution is indomitable,” The New York Herald gushed. But Henry J. Raymond, the editor of The Times, introduced a new metaphor by likening Vanderbilt to a robber baron. Similar to the medieval German nobles who “swooped down upon the commerce” of the Rhine “and wrung tribute from every passenger that floated by,” Vanderbilt gained maximum profits by gaining maximum control of whatever market he entered.
Use the link to read the entire review.
May 9th, 2009
