Showing posts with label markets. Show all posts
Showing posts with label markets. Show all posts
Friday, 10 July 2009
Thursday, 7 May 2009
High stakes, low finance
Chasing Alpha: How Reckless Growth and Unchecked Ambition Ruined the City's Golden Decade
by Philip Augar
272pp, Bodley Head, £20
Fool's Gold: How an Ingenious Tribe of Bankers Rewrote the Rules of Finance, Made a Fortune and Survived a Catastrophe
by Gillian Tett
352pp, Little, Brown, £18.99
Meltdown: The End of the Age of Greed
by Paul Mason
192pp, Verso, £7.99
The Crash of 2008 and What It Means: The New Paradigm for Financial Markets
by George Soros
288pp, Public Affairs, £9.99
Gordon Brown will not think it, but in the politics of credit crunch he is a lucky man. His speech at the Mansion House on Wednesday 20 June 2007, days before he took office as prime minister, is one of the greatest political and economic misjudgments among postwar politicians. Yet very few have read or even recollect it. But then his political opponents, outbidding him at the time in their slavish praise of the City, have even more embarrassing quotes on the record. They are hardly in a position to attack him.
"This is an era that history will record as a new golden age for the City of London," Brown intoned. "I want to thank all of you for what you are achieving." Just weeks later the financial catastrophe burst, creating the "great recession" and leaving the UK taxpayer with a one-sided exposure of £1.3 trillion in loans, investments, cash injections and guarantees to the banking system, of which over £100bn may be lost for ever. Brown went on to hymn the City's "creativity and ingenuity" that had enabled it to become a new world leader. In language so purple it could make a cardinal blush, he praised London's invention of "the most modern instruments of finance" - the very instruments that were to bring it and the western banking system down.
Invoking Adam Smith, Brown declaimed: "The message London's success sends out to the whole British economy is that we will succeed if, like London, we think globally ... and nurture the skills of the future, advance with light-touch regulation, a competitive tax environment and flexibility." He even managed to boast that, after financial and accounting scandals in the US such as those that brought down Enron and WorldCom, which led the American government to introduce new regulatory reforms, "many who advised me, including not a few newspapers, favoured a regulatory crackdown. I believe we were right not to go down that road."
The boastfulness, the wholesale endorsement of the philosophy that was to bring the world to the economic edge and the sheer ignorance are painful to read - tribute to the way the bankers completely pulled the wool over the eyes of the political and regulatory establishment in one of the greatest heists the world has witnessed. The IMF now calculates that there are $4.1 trillion of losses in the world financial system, less than half of which has been formally written off. Without massive government support, the scale of the banking collapse that would have followed such losses would have induced a global depression. Even as it is, world trade will this year decline by 9%. Alistair Darling's budget has already passed into legend as the most depressing since the war. The credit-crunch-ravaged, post-recession British economy will be unable to shoulder the size of the current British state. In the most challenging decade since 1945, a way has to be found of shrinking its size while still finding new ways to grow and alleviate mass unemployment.
It is a disaster, or, as BBC Newsnight's Paul Mason would have it, a financial Krakatoa. It is the economic and financial story of our times, and he, the Financial Times journalist Gillian Tett and financial author Philip Augar have all been inspired to write "crash" books. Each is gripping and revelatory, with sometimes breathtaking quotes or new facts, and each adds a different dimension to our understanding of the crisis. Their subtitles tell of greed, recklessness and catastrophe - and all three writers are as good as their promise. What has happened to finance and the financial system since London's Big Bang in 1986 is an astounding story of ideology, greed and lack of restraint - sanctioned by our politicians who, like Brown, marvelled at the apparent results without beginning to understand how they were achieved. Moreover, they built regulatory systems to suit the bankers' interests. You might have hoped that politicians of the left would have been savvier and more suspicious of the bankers' claims. One of the tragedies of New Labour is that the party leadership bought the story so completely - Brown becoming as much of a zealot for free-market financial innovation as the free-market fundamentalist neocon Alan Greenspan, whose knighthood he organised.
The books leave no doubt that it is the bankers and their greed who were the authors of the crisis. True, there were dollars spilling out of Asia and the Gulf in huge volumes in the 2000s, and low interest rates created an appetite for taking risks. But bankers seized the opportunity to lend unprecedented amounts on ever smaller amounts of capital, with the risk apparently abolished by the invention of new financial instruments and tradeable insurance contracts. This is Tett's original contribution. Her blow-by-blow story of how these were developed during the 1980s and 90s, and the motivations of those who did it, is an impressive piece of detective work. She pulls back the curtain on a closed, unaccountable world of finance - a "silo in its own right detached from society". My only cavil is that I wish she could have got as much access to top British bankers as she got to American ones, and in particular those in JP Morgan: her locus is too much New York.
That is made good by Philip Augar, a former investment banker who has made it his mission to reveal the systemic and destructive way that British finance works. He understands both the people and the processes - and Chasing Alpha is his best book yet. He even devotes a chapter to Brown's Mansion House speech. Together, he and Tett make it clear beyond peradventure that it was the structure of the financial system that created the havoc, and that it was firmly embedded in the intertwined London and New York markets from the 1980s onwards. Similar-scale dollar surpluses in the 1970s did not create such financial problems; but that was before the Thatcherite and neoconservative revolutions.
In 1933 Senators Glass and Steagall, prompted by Roosevelt, had sponsored the Glass-Steagall Act, prohibiting investment bankers betting deposits on the buying and selling of tradeable financial securities that can create huge losses. Banking and investment banking should be separate. For 50 years the act kept American banking honest. But after Mrs Thatcher decided in 1986 that banks could own stockbrokers and market-making stock jobbers in her new anything-could-go casino City of London - the "Big Bang" - American banks complained to the US central bank, the Federal Reserve, that they could do things in London not possible in New York. Paul Mason explains how in 1987 the Fed relaxed Glass-Steagall to allow 5% of a bank's deposits to be used for investment banking, further relaxed to 25% in 1996. The act's abolition in 1999, which opened the floodgates for today's financial catastrophe, was inevitable - even if it cost the banks $300m in lobbying fees.
Tett shows how the regulators rolled over in another core area. In the late 1990s they accepted the banks' argument that their alchemy in creating collateralised debt obligations (bundling up income-generating assets of varying quality into one security) and then insuring against the risk of default (credit default swaps) both merited the triple A credit scores the credit agencies were awarding and, crucially, needed less capital to stand behind them. By 2000 the stage was set for what was to follow: investment banks having balance sheets 30 times or more larger than their core capital, refinancing as much as a quarter of their trillions of dollars of liabilities every day from the so-called wholesale money markets, and lending/investing in a range of highly risky financial instruments. The system could not insure against its own systemic failure. It was an edifice built on sand: $1 trillion of sub-prime debt had been bundled into various categories of structured, tradeable debt; when American house prices began to crumble in 2007, the whole interlinked pyramid came crashing down.
Mason's first three chapters are a page-turning account of September and October of last year, when it did look as though the American and British financial systems were about to collapse - the fateful weekend in September when Lehman Brothers went bust and America's top insurance company AIG only survived courtesy of an $80bn loan, and later, in early October, when Britain's RBS and HBOS were hours away from implosion. Mason, I think correctly, emphasises the highly risky way some British commercial, and other, mortgage lenders had become reliant on the money markets to support their lending, so that RBS and HBOS were in an analogous position to the US investment banks Lehman and Bear Stearns, both of whom went bust. At the root of the crisis were the interaction of money market-financed balance sheets, too much consequential borrowing and the new "weapons of mass financial destruction".
Mason is refreshingly clear-eyed about the operation of today's finance-driven capitalism - and angry. It wasn't only that the banks and insurance companies campaigned to have the law changed to serve their interests with such disastrous results. Sometimes, as with AIG, they began to transgress the law. AIG admitted in 2005 that it had faked $500m of transactions to fool the auditors, and "misclassified" another $3bn to inflate its profits. I have no doubt that there are more instances that may never come to light. Britain has insured £585bn of bank loans. It is hard to believe that every penny of bad debt on such a scale was just honest misjudgment. Do we believe that the British were angels and the only frauds American?
George Soros, successful hedge fund entrepreneur and famous beneficiary of the pound's expulsion from the European Exchange Rate Mechanism, has been trying for decades to explain that the axioms of free-market economics do not apply to the financial markets. Brown and Greenspan were always wrong to believe that free financial markets would tend to optimal outcomes. Rather, markets feed on themselves, so that financial values have a permanent tendency to swing between boom and bust - they are never rational. The crash of 2008, Soros explains, was an accident waiting to happen. Recovery will require regulation that compels banks to carry more capital and lend more judiciously. But until the international financial system is fairer to the less-developed countries on "the periphery", the core of the world economy will always be at risk of being flooded by hot money fleeing from that risky periphery.
This quartet of books indict modern finance. They cannot be read without wishing for something different. Yet even now I am not sure that the politicians and officials get it. The support for British banks is disgracefully one-sided. The taxpayer will lose at least £50bn, if not £100bn, but there has been no concomitant willingness on the part of the bankers to restructure their business model - or accept that their pensions, bonuses and pay should be seriously qualified. They want to get back to the glory days, and if once in every 30 or 40 years the rest of us suffer recessions and a £100bn bill while they make personal fortunes - so be it. It is not a fair bargain. These books set out why, and how it could be changed.
• Will Hutton is executive vice-chair of the Work Foundation
by Philip Augar
272pp, Bodley Head, £20
Fool's Gold: How an Ingenious Tribe of Bankers Rewrote the Rules of Finance, Made a Fortune and Survived a Catastrophe
by Gillian Tett
352pp, Little, Brown, £18.99
Meltdown: The End of the Age of Greed
by Paul Mason
192pp, Verso, £7.99
The Crash of 2008 and What It Means: The New Paradigm for Financial Markets
by George Soros
288pp, Public Affairs, £9.99
Gordon Brown will not think it, but in the politics of credit crunch he is a lucky man. His speech at the Mansion House on Wednesday 20 June 2007, days before he took office as prime minister, is one of the greatest political and economic misjudgments among postwar politicians. Yet very few have read or even recollect it. But then his political opponents, outbidding him at the time in their slavish praise of the City, have even more embarrassing quotes on the record. They are hardly in a position to attack him.
"This is an era that history will record as a new golden age for the City of London," Brown intoned. "I want to thank all of you for what you are achieving." Just weeks later the financial catastrophe burst, creating the "great recession" and leaving the UK taxpayer with a one-sided exposure of £1.3 trillion in loans, investments, cash injections and guarantees to the banking system, of which over £100bn may be lost for ever. Brown went on to hymn the City's "creativity and ingenuity" that had enabled it to become a new world leader. In language so purple it could make a cardinal blush, he praised London's invention of "the most modern instruments of finance" - the very instruments that were to bring it and the western banking system down.
Invoking Adam Smith, Brown declaimed: "The message London's success sends out to the whole British economy is that we will succeed if, like London, we think globally ... and nurture the skills of the future, advance with light-touch regulation, a competitive tax environment and flexibility." He even managed to boast that, after financial and accounting scandals in the US such as those that brought down Enron and WorldCom, which led the American government to introduce new regulatory reforms, "many who advised me, including not a few newspapers, favoured a regulatory crackdown. I believe we were right not to go down that road."
The boastfulness, the wholesale endorsement of the philosophy that was to bring the world to the economic edge and the sheer ignorance are painful to read - tribute to the way the bankers completely pulled the wool over the eyes of the political and regulatory establishment in one of the greatest heists the world has witnessed. The IMF now calculates that there are $4.1 trillion of losses in the world financial system, less than half of which has been formally written off. Without massive government support, the scale of the banking collapse that would have followed such losses would have induced a global depression. Even as it is, world trade will this year decline by 9%. Alistair Darling's budget has already passed into legend as the most depressing since the war. The credit-crunch-ravaged, post-recession British economy will be unable to shoulder the size of the current British state. In the most challenging decade since 1945, a way has to be found of shrinking its size while still finding new ways to grow and alleviate mass unemployment.
It is a disaster, or, as BBC Newsnight's Paul Mason would have it, a financial Krakatoa. It is the economic and financial story of our times, and he, the Financial Times journalist Gillian Tett and financial author Philip Augar have all been inspired to write "crash" books. Each is gripping and revelatory, with sometimes breathtaking quotes or new facts, and each adds a different dimension to our understanding of the crisis. Their subtitles tell of greed, recklessness and catastrophe - and all three writers are as good as their promise. What has happened to finance and the financial system since London's Big Bang in 1986 is an astounding story of ideology, greed and lack of restraint - sanctioned by our politicians who, like Brown, marvelled at the apparent results without beginning to understand how they were achieved. Moreover, they built regulatory systems to suit the bankers' interests. You might have hoped that politicians of the left would have been savvier and more suspicious of the bankers' claims. One of the tragedies of New Labour is that the party leadership bought the story so completely - Brown becoming as much of a zealot for free-market financial innovation as the free-market fundamentalist neocon Alan Greenspan, whose knighthood he organised.
The books leave no doubt that it is the bankers and their greed who were the authors of the crisis. True, there were dollars spilling out of Asia and the Gulf in huge volumes in the 2000s, and low interest rates created an appetite for taking risks. But bankers seized the opportunity to lend unprecedented amounts on ever smaller amounts of capital, with the risk apparently abolished by the invention of new financial instruments and tradeable insurance contracts. This is Tett's original contribution. Her blow-by-blow story of how these were developed during the 1980s and 90s, and the motivations of those who did it, is an impressive piece of detective work. She pulls back the curtain on a closed, unaccountable world of finance - a "silo in its own right detached from society". My only cavil is that I wish she could have got as much access to top British bankers as she got to American ones, and in particular those in JP Morgan: her locus is too much New York.
That is made good by Philip Augar, a former investment banker who has made it his mission to reveal the systemic and destructive way that British finance works. He understands both the people and the processes - and Chasing Alpha is his best book yet. He even devotes a chapter to Brown's Mansion House speech. Together, he and Tett make it clear beyond peradventure that it was the structure of the financial system that created the havoc, and that it was firmly embedded in the intertwined London and New York markets from the 1980s onwards. Similar-scale dollar surpluses in the 1970s did not create such financial problems; but that was before the Thatcherite and neoconservative revolutions.
In 1933 Senators Glass and Steagall, prompted by Roosevelt, had sponsored the Glass-Steagall Act, prohibiting investment bankers betting deposits on the buying and selling of tradeable financial securities that can create huge losses. Banking and investment banking should be separate. For 50 years the act kept American banking honest. But after Mrs Thatcher decided in 1986 that banks could own stockbrokers and market-making stock jobbers in her new anything-could-go casino City of London - the "Big Bang" - American banks complained to the US central bank, the Federal Reserve, that they could do things in London not possible in New York. Paul Mason explains how in 1987 the Fed relaxed Glass-Steagall to allow 5% of a bank's deposits to be used for investment banking, further relaxed to 25% in 1996. The act's abolition in 1999, which opened the floodgates for today's financial catastrophe, was inevitable - even if it cost the banks $300m in lobbying fees.
Tett shows how the regulators rolled over in another core area. In the late 1990s they accepted the banks' argument that their alchemy in creating collateralised debt obligations (bundling up income-generating assets of varying quality into one security) and then insuring against the risk of default (credit default swaps) both merited the triple A credit scores the credit agencies were awarding and, crucially, needed less capital to stand behind them. By 2000 the stage was set for what was to follow: investment banks having balance sheets 30 times or more larger than their core capital, refinancing as much as a quarter of their trillions of dollars of liabilities every day from the so-called wholesale money markets, and lending/investing in a range of highly risky financial instruments. The system could not insure against its own systemic failure. It was an edifice built on sand: $1 trillion of sub-prime debt had been bundled into various categories of structured, tradeable debt; when American house prices began to crumble in 2007, the whole interlinked pyramid came crashing down.
Mason's first three chapters are a page-turning account of September and October of last year, when it did look as though the American and British financial systems were about to collapse - the fateful weekend in September when Lehman Brothers went bust and America's top insurance company AIG only survived courtesy of an $80bn loan, and later, in early October, when Britain's RBS and HBOS were hours away from implosion. Mason, I think correctly, emphasises the highly risky way some British commercial, and other, mortgage lenders had become reliant on the money markets to support their lending, so that RBS and HBOS were in an analogous position to the US investment banks Lehman and Bear Stearns, both of whom went bust. At the root of the crisis were the interaction of money market-financed balance sheets, too much consequential borrowing and the new "weapons of mass financial destruction".
Mason is refreshingly clear-eyed about the operation of today's finance-driven capitalism - and angry. It wasn't only that the banks and insurance companies campaigned to have the law changed to serve their interests with such disastrous results. Sometimes, as with AIG, they began to transgress the law. AIG admitted in 2005 that it had faked $500m of transactions to fool the auditors, and "misclassified" another $3bn to inflate its profits. I have no doubt that there are more instances that may never come to light. Britain has insured £585bn of bank loans. It is hard to believe that every penny of bad debt on such a scale was just honest misjudgment. Do we believe that the British were angels and the only frauds American?
George Soros, successful hedge fund entrepreneur and famous beneficiary of the pound's expulsion from the European Exchange Rate Mechanism, has been trying for decades to explain that the axioms of free-market economics do not apply to the financial markets. Brown and Greenspan were always wrong to believe that free financial markets would tend to optimal outcomes. Rather, markets feed on themselves, so that financial values have a permanent tendency to swing between boom and bust - they are never rational. The crash of 2008, Soros explains, was an accident waiting to happen. Recovery will require regulation that compels banks to carry more capital and lend more judiciously. But until the international financial system is fairer to the less-developed countries on "the periphery", the core of the world economy will always be at risk of being flooded by hot money fleeing from that risky periphery.
This quartet of books indict modern finance. They cannot be read without wishing for something different. Yet even now I am not sure that the politicians and officials get it. The support for British banks is disgracefully one-sided. The taxpayer will lose at least £50bn, if not £100bn, but there has been no concomitant willingness on the part of the bankers to restructure their business model - or accept that their pensions, bonuses and pay should be seriously qualified. They want to get back to the glory days, and if once in every 30 or 40 years the rest of us suffer recessions and a £100bn bill while they make personal fortunes - so be it. It is not a fair bargain. These books set out why, and how it could be changed.
• Will Hutton is executive vice-chair of the Work Foundation
Monday, 30 March 2009
Keynes is innocent: the outcome of Bretton Woods was not his plan
Poor old Lord Keynes. The world's press has spent the past week blackening his name. Not intentionally: most of the dunderheads reporting the G20 summit that took place over the weekend really do believe that he proposed and founded the International Monetary Fund. It's one of those stories that passes unchecked from one journalist to another.
The truth is more interesting. At the UN's Bretton Woods conference in 1944, John Maynard Keynes put forward a much better idea. After it was thrown out, Geoffrey Crowther - then the editor of the Economist magazine - warned that "Lord Keynes was right ... the world will bitterly regret the fact that his arguments were rejected." But the world does not regret it, for almost everyone - the Economist included - has forgotten what he proposed.
One of the reasons for financial crises is the imbalance of trade between nations. Countries accumulate debt partly as a result of sustaining a trade deficit. They can easily become trapped in a vicious spiral: the bigger their debt, the harder it is to generate a trade surplus. International debt wrecks people's development, trashes the environment and threatens the global system with periodic crises.
As Keynes recognised, there is not much the debtor nations can do. Only the countries that maintain a trade surplus have real agency, so it is they who must be obliged to change their policies. His solution was an ingenious system for persuading the creditor nations to spend their surplus money back into the economies of the debtor nations.
He proposed a global bank, which he called the International Clearing Union. The bank would issue its own currency - the bancor - which was exchangeable with national currencies at fixed rates of exchange. The bancor would become the unit of account between nations, which means it would be used to measure a country's trade deficit or trade surplus.
Every country would have an overdraft facility in its bancor account at the International Clearing Union, equivalent to half the average value of its trade over a five-year period. To make the system work, the members of the union would need a powerful incentive to clear their bancor accounts by the end of the year: to end up with neither a trade deficit nor a trade surplus. But what would the incentive be?
Keynes proposed that any country racking up a large trade deficit (equating to more than half of its bancor overdraft allowance) would be charged interest on its account. It would also be obliged to reduce the value of its currency and to prevent the export of capital. But - and this was the key to his system - he insisted that the nations with a trade surplus would be subject to similar pressures. Any country with a bancor credit balance that was more than half the size of its overdraft facility would be charged interest, at a rate of 10%. It would also be obliged to increase the value of its currency and to permit the export of capital. If, by the end of the year, its credit balance exceeded the total value of its permitted overdraft, the surplus would be confiscated. The nations with a surplus would have a powerful incentive to get rid of it. In doing so, they would automatically clear other nations' deficits.
When Keynes began to explain his idea, in papers published in 1942 and 1943, it detonated in the minds of all who read it. The British economist Lionel Robbins reported that "it would be difficult to exaggerate the electrifying effect on thought throughout the whole relevant apparatus of government ... nothing so imaginative and so ambitious had ever been discussed". Economists all over the world saw that Keynes had cracked it. As the Allies prepared for the Bretton Woods conference, Britain adopted Keynes's solution as its official negotiating position.
But there was one country - at the time the world's biggest creditor - in which his proposal was less welcome. The head of the American delegation at Bretton Woods, Harry Dexter White, responded to Keynes's idea thus: "We have been perfectly adamant on that point. We have taken the position of absolutely no." Instead he proposed an International Stabilisation Fund, which would place the entire burden of maintaining the balance of trade on the deficit nations. It would impose no limits on the surplus that successful exporters could accumulate. He also suggested an International Bank for Reconstruction and Development, which would provide capital for economic reconstruction after the war. White, backed by the financial clout of the US treasury, prevailed. The International Stabilisation Fund became the International Monetary Fund. The International Bank for Reconstruction and Development remains the principal lending arm of the World Bank.
The consequences, especially for the poorest indebted countries, have been catastrophic. Acting on behalf of the rich, imposing conditions that no free country would tolerate, the IMF has bled them dry. As Joseph Stiglitz has shown, the fund compounds existing economic crises and creates crises where none existed before. It has destabilised exchange rates, exacerbated balance of payments problems, forced countries into debt and recession, wrecked public services and destroyed the jobs and incomes of tens of millions of people.
The countries the fund instructs must place the control of inflation ahead of other economic objectives; immediately remove their barriers to trade and the flow of capital; liberalise their banking systems; reduce government spending on everything except debt repayments; and privatise the assets which can be sold to foreign investors. These happen to be the policies which best suit predatory financial speculators. They have exacerbated almost every crisis the IMF has attempted to solve.
You might imagine that the US, which since 1944 has turned from the world's biggest creditor to the world's biggest debtor, would have cause to regret the position it took at Bretton Woods. But Harry Dexter White ensured that the US could never lose. He awarded it special veto powers over any major decision made by the IMF or the World Bank, which means that it will never be subject to the fund's unwelcome demands. The IMF insists that the foreign exchange reserves maintained by other nations are held in the form of dollars. This is one of the reasons why the US economy doesn't collapse, no matter how much debt it accumulates.
On Saturday the G20 leaders admitted that "the Bretton Woods institutions must be comprehensively reformed". But the only concrete suggestions they made were that the IMF should be given more money and that poorer nations "should have greater voice and representation". We've already seen what this means: a tiny increase in their voting power, which does nothing to challenge the rich countries' control of the fund, let alone the US veto.
Is this the best they can do? No. As the global financial crisis deepens, the rich nations will be forced to recognise that their problems cannot be solved by tinkering with a system that is constitutionally destined to fail. But to understand why the world economy keeps running into trouble, they first need to understand what was lost in 1944.
by George Monbiot
The truth is more interesting. At the UN's Bretton Woods conference in 1944, John Maynard Keynes put forward a much better idea. After it was thrown out, Geoffrey Crowther - then the editor of the Economist magazine - warned that "Lord Keynes was right ... the world will bitterly regret the fact that his arguments were rejected." But the world does not regret it, for almost everyone - the Economist included - has forgotten what he proposed.
One of the reasons for financial crises is the imbalance of trade between nations. Countries accumulate debt partly as a result of sustaining a trade deficit. They can easily become trapped in a vicious spiral: the bigger their debt, the harder it is to generate a trade surplus. International debt wrecks people's development, trashes the environment and threatens the global system with periodic crises.
As Keynes recognised, there is not much the debtor nations can do. Only the countries that maintain a trade surplus have real agency, so it is they who must be obliged to change their policies. His solution was an ingenious system for persuading the creditor nations to spend their surplus money back into the economies of the debtor nations.
He proposed a global bank, which he called the International Clearing Union. The bank would issue its own currency - the bancor - which was exchangeable with national currencies at fixed rates of exchange. The bancor would become the unit of account between nations, which means it would be used to measure a country's trade deficit or trade surplus.
Every country would have an overdraft facility in its bancor account at the International Clearing Union, equivalent to half the average value of its trade over a five-year period. To make the system work, the members of the union would need a powerful incentive to clear their bancor accounts by the end of the year: to end up with neither a trade deficit nor a trade surplus. But what would the incentive be?
Keynes proposed that any country racking up a large trade deficit (equating to more than half of its bancor overdraft allowance) would be charged interest on its account. It would also be obliged to reduce the value of its currency and to prevent the export of capital. But - and this was the key to his system - he insisted that the nations with a trade surplus would be subject to similar pressures. Any country with a bancor credit balance that was more than half the size of its overdraft facility would be charged interest, at a rate of 10%. It would also be obliged to increase the value of its currency and to permit the export of capital. If, by the end of the year, its credit balance exceeded the total value of its permitted overdraft, the surplus would be confiscated. The nations with a surplus would have a powerful incentive to get rid of it. In doing so, they would automatically clear other nations' deficits.
When Keynes began to explain his idea, in papers published in 1942 and 1943, it detonated in the minds of all who read it. The British economist Lionel Robbins reported that "it would be difficult to exaggerate the electrifying effect on thought throughout the whole relevant apparatus of government ... nothing so imaginative and so ambitious had ever been discussed". Economists all over the world saw that Keynes had cracked it. As the Allies prepared for the Bretton Woods conference, Britain adopted Keynes's solution as its official negotiating position.
But there was one country - at the time the world's biggest creditor - in which his proposal was less welcome. The head of the American delegation at Bretton Woods, Harry Dexter White, responded to Keynes's idea thus: "We have been perfectly adamant on that point. We have taken the position of absolutely no." Instead he proposed an International Stabilisation Fund, which would place the entire burden of maintaining the balance of trade on the deficit nations. It would impose no limits on the surplus that successful exporters could accumulate. He also suggested an International Bank for Reconstruction and Development, which would provide capital for economic reconstruction after the war. White, backed by the financial clout of the US treasury, prevailed. The International Stabilisation Fund became the International Monetary Fund. The International Bank for Reconstruction and Development remains the principal lending arm of the World Bank.
The consequences, especially for the poorest indebted countries, have been catastrophic. Acting on behalf of the rich, imposing conditions that no free country would tolerate, the IMF has bled them dry. As Joseph Stiglitz has shown, the fund compounds existing economic crises and creates crises where none existed before. It has destabilised exchange rates, exacerbated balance of payments problems, forced countries into debt and recession, wrecked public services and destroyed the jobs and incomes of tens of millions of people.
The countries the fund instructs must place the control of inflation ahead of other economic objectives; immediately remove their barriers to trade and the flow of capital; liberalise their banking systems; reduce government spending on everything except debt repayments; and privatise the assets which can be sold to foreign investors. These happen to be the policies which best suit predatory financial speculators. They have exacerbated almost every crisis the IMF has attempted to solve.
You might imagine that the US, which since 1944 has turned from the world's biggest creditor to the world's biggest debtor, would have cause to regret the position it took at Bretton Woods. But Harry Dexter White ensured that the US could never lose. He awarded it special veto powers over any major decision made by the IMF or the World Bank, which means that it will never be subject to the fund's unwelcome demands. The IMF insists that the foreign exchange reserves maintained by other nations are held in the form of dollars. This is one of the reasons why the US economy doesn't collapse, no matter how much debt it accumulates.
On Saturday the G20 leaders admitted that "the Bretton Woods institutions must be comprehensively reformed". But the only concrete suggestions they made were that the IMF should be given more money and that poorer nations "should have greater voice and representation". We've already seen what this means: a tiny increase in their voting power, which does nothing to challenge the rich countries' control of the fund, let alone the US veto.
Is this the best they can do? No. As the global financial crisis deepens, the rich nations will be forced to recognise that their problems cannot be solved by tinkering with a system that is constitutionally destined to fail. But to understand why the world economy keeps running into trouble, they first need to understand what was lost in 1944.
by George Monbiot
Reform is in the air.
Joseph E Stiglitz is university professor at Columbia University, chairman of the UN Commission of Experts on Reforms of the International Monetary and Financial System and recipient of the 2001 Nobel Prize in Economics. He is also the author of Globalization and Its Discontents, The Roaring Nineties: Why We're Paying the Price for the Greediest Decade in History and Making Globalization Work: The Next Steps to Global Justice.
The financial crisis that began in America's sub-prime mortgage market has now become a global recession – with growth projected to be a negative 1.5%, the worst performance since the Great Depression. Even countries that had done everything right are seeing marked declines in growth rates, and even deep recessions. And much of the most acute pain will be felt by developing countries.
A UN commission of experts on reforms of the international monetary and financial system, which I chair, has just published its preliminary report. It focuses especially on the impact of the crisis on developing countries and the poor everywhere, which is likely to be severe. An estimated 30 million more people will be unemployed in 2009 compared to 2007. The increase could even reach 50 million. Progress in reducing poverty may be halted. The report warns that: "Some 200 million people, mostly in developing economies, could be pushed into poverty if rapid action is not taken to counter the impact of the crisis."
While this is a global crisis, responses are undertaken by national
governments, who quite naturally look after their own citizens' interest
first. Particularly invidious are protectionist measures, such as the US
"buy America" provision in its stimulus package. In fact, the World Bank
reports that 17 of the group of 20 countries have engaged in protectionist measures, after making a commitment not to do so in their meeting in Washington in November. By focusing on national, as opposed to global impacts, the global stimulus will be less – and the global recovery weakened.
While there is a consensus that all countries should undertake strong
fiscal stimulus measures, many developing countries do not have the
resources, and it calls for a concerted approach for additional funding,
both for spending and liquidity support for countries and corporations in
developing countries that are strained by the current credit crunch.
Developed countries should contribute 1% of stimulus spending; there should be an immediate issue of special drawing rights (SDRs), the "IMF money" that can be used especially to help those facing difficulties, and an expansion of regional efforts, such as the Chang Mai initiative in Asia.
It is important that any assistance be provided without the usual strings.
Conditions such as those which force developing countries to contract
spending and raise interest rates are counterproductive: the intent of the
assistance is to help them expand their economies, thereby assisting the
global recovery. Deficiencies in current institutional arrangements for
disbursing funds – for example, through the IMF – have long been noted, but the reforms so far are insufficient. Countries with funds are often reluctant to give money to institutions in which they have little voice, and which have advocated policies that they do not support; and countries are often reluctant to borrow, given the stigma associated with turning to these institutions. The commission urges the creation of a new credit facility, in which the voice of the new providers of finance and the borrowers are both better heard.
There are several important lessons to be learned from the crisis. One is
that there is a need for better regulation. But reforms cannot be just
cosmetic, and they have to go beyond the financial sector. Inadequate
enforcement of competition laws has allowed banks to grow to be too big to fail. Inadequate corporate governance resulted in incentive schemes that led to excessive risk taking and short sighted behavior, which did not even serve shareholders well.
The Commission recommends the establishment of a Global Economic
Coordinating Council, not only to co-ordinate economic policy, but to assess the economic situation, identify gaps in the global institutional arrangement, and propose solutions. For instance, there is a need for a Global Financial Regulatory Authority – without which there is a risk of regulatory arbitrage, undermining regulation, and creating a race to the bottom. There is a need for a Global Competition Authority – markets are global in scale. There is a need for a better way of handling defaults of countries, of which there may be several in this crisis. And there is a need for better ways of managing the many risks that developing countries face, especially with debt and capital account management.
The other important commission recommendation concerns the creation of a new global reserve system. The existing system, with the US dollar as reserve currency, is fraying. The dollar has been volatile. There are increasing worries about future inflationary risks. At the same time,
putting so much money aside every year to protect countries against the
risks of global instability creates a downward bias in – aggregate demand – weakening the global economy. Moreover, the system has the peculiar property that poor countries are lending trillions of dollars to the US, at essentially zero interest rate, while within their country there are so many needs to which the money could be put. The Commission argues that a new Global Reserve System is "feasible, non-inflationary, and could be easily implemented".
After the East Asia crisis, there was much talk of reform, of a new global
financial architecture. But there was just talk; as the global economy
recovered, the impetus for reform faded. This is a more severe crisis. It
will last longer. Hopefully, this time, we learn our lesson.
The financial crisis that began in America's sub-prime mortgage market has now become a global recession – with growth projected to be a negative 1.5%, the worst performance since the Great Depression. Even countries that had done everything right are seeing marked declines in growth rates, and even deep recessions. And much of the most acute pain will be felt by developing countries.
A UN commission of experts on reforms of the international monetary and financial system, which I chair, has just published its preliminary report. It focuses especially on the impact of the crisis on developing countries and the poor everywhere, which is likely to be severe. An estimated 30 million more people will be unemployed in 2009 compared to 2007. The increase could even reach 50 million. Progress in reducing poverty may be halted. The report warns that: "Some 200 million people, mostly in developing economies, could be pushed into poverty if rapid action is not taken to counter the impact of the crisis."
While this is a global crisis, responses are undertaken by national
governments, who quite naturally look after their own citizens' interest
first. Particularly invidious are protectionist measures, such as the US
"buy America" provision in its stimulus package. In fact, the World Bank
reports that 17 of the group of 20 countries have engaged in protectionist measures, after making a commitment not to do so in their meeting in Washington in November. By focusing on national, as opposed to global impacts, the global stimulus will be less – and the global recovery weakened.
While there is a consensus that all countries should undertake strong
fiscal stimulus measures, many developing countries do not have the
resources, and it calls for a concerted approach for additional funding,
both for spending and liquidity support for countries and corporations in
developing countries that are strained by the current credit crunch.
Developed countries should contribute 1% of stimulus spending; there should be an immediate issue of special drawing rights (SDRs), the "IMF money" that can be used especially to help those facing difficulties, and an expansion of regional efforts, such as the Chang Mai initiative in Asia.
It is important that any assistance be provided without the usual strings.
Conditions such as those which force developing countries to contract
spending and raise interest rates are counterproductive: the intent of the
assistance is to help them expand their economies, thereby assisting the
global recovery. Deficiencies in current institutional arrangements for
disbursing funds – for example, through the IMF – have long been noted, but the reforms so far are insufficient. Countries with funds are often reluctant to give money to institutions in which they have little voice, and which have advocated policies that they do not support; and countries are often reluctant to borrow, given the stigma associated with turning to these institutions. The commission urges the creation of a new credit facility, in which the voice of the new providers of finance and the borrowers are both better heard.
There are several important lessons to be learned from the crisis. One is
that there is a need for better regulation. But reforms cannot be just
cosmetic, and they have to go beyond the financial sector. Inadequate
enforcement of competition laws has allowed banks to grow to be too big to fail. Inadequate corporate governance resulted in incentive schemes that led to excessive risk taking and short sighted behavior, which did not even serve shareholders well.
The Commission recommends the establishment of a Global Economic
Coordinating Council, not only to co-ordinate economic policy, but to assess the economic situation, identify gaps in the global institutional arrangement, and propose solutions. For instance, there is a need for a Global Financial Regulatory Authority – without which there is a risk of regulatory arbitrage, undermining regulation, and creating a race to the bottom. There is a need for a Global Competition Authority – markets are global in scale. There is a need for a better way of handling defaults of countries, of which there may be several in this crisis. And there is a need for better ways of managing the many risks that developing countries face, especially with debt and capital account management.
The other important commission recommendation concerns the creation of a new global reserve system. The existing system, with the US dollar as reserve currency, is fraying. The dollar has been volatile. There are increasing worries about future inflationary risks. At the same time,
putting so much money aside every year to protect countries against the
risks of global instability creates a downward bias in – aggregate demand – weakening the global economy. Moreover, the system has the peculiar property that poor countries are lending trillions of dollars to the US, at essentially zero interest rate, while within their country there are so many needs to which the money could be put. The Commission argues that a new Global Reserve System is "feasible, non-inflationary, and could be easily implemented".
After the East Asia crisis, there was much talk of reform, of a new global
financial architecture. But there was just talk; as the global economy
recovered, the impetus for reform faded. This is a more severe crisis. It
will last longer. Hopefully, this time, we learn our lesson.
Wednesday, 4 March 2009
Tuesday, 10 February 2009
Recession Britain: the great debate
Intermission nr2. Will Hutton is probably my favourite economic commentator. Last weekend he had an email exchange with the leader of the Conservative party, David Cameron, about the economic situation in the UK. It was published in the Observer and I'm reprinting it here.
* Will Hutton and David Cameron
* The Observer, Sunday 1 February 2009
Dear David
The Conservative party under your leadership has moved a long way - in both rhetoric and stated ends - and last Friday's speech in Davos, where you outlined your concept of capitalism with a conscience, is another landmark. I know you will say that Lady Thatcher was operating in different times with different needs, but I still don't think she would ever have wanted to say that markets must not trample over values that society holds dear, or to question the need for the profit motive always to triumph. You said: "If markets, and capitalism, and the activities of individual businesses, conflict with our vision of the good society and the good life ... you must speak out." Amen to that.
But "speaking out" is not enough. 2009 is going to be the toughest economic year since the war, and if Britain's GDP falls by more than 5% from its peak in 2007 by 2010 - now virtually certain - we move from the realms of recession to near depression. I recall Tony Blair when in opposition calling for stakeholder capitalism, in rather the same vein as you are calling for capitalism with a conscience, but in practice very little happened. The financial markets were allowed their freedoms, executive pay became more grotesque, society grew more unfair and the dynamics that have created the current mess were unleashed. Actions have to accompany words.
Obviously in the current crash actions are being forced on everybody that, as you acknowledge, would have been inconceivable 12 months ago. But although some of your suggestions - such as the £50bn National Loan Guarantee Scheme - have been innovative and ahead of the curve in addressing the vital necessity of getting credit moving again, I feel that you lack an organising theory to explain what happened and how it underpins your aim to put society before markets and repopularise capitalism. If you don't offer a coherent framework for reform, complete with some robust sticks and carrots, what you say sounds little more than opportunistic warm words.
I fear that, like Tony Blair, you shrink from the truth of the matter; that free and lightly regulated financial markets, upon which so much of our business elite's prosperity is dependent, have delinquent propensities for speculation and short-termism that profoundly damage the real economy. The crash of 2008-09, like 1929, is because once again we did not keep finance on a tight rein. You need to say this.
I consider this the heart of Keynesian economics, and adopting this root and branch would give you more bite and coherence. For example, Keynes was certainly a radical monetary activist, a believer that, in economic extremis, you might have to print money, as much as he was a deficit spender, so in one sense you are already moving in his direction. But he was also passionate about insulating as far as possible the real economy from the casino of finance, which he felt de-legitimised capitalism. He had no qualms about the state doing what the market could and would not. Confronted by today's acute shortfall of lending capacity because of the flight of foreign banks, he would simply have created - like Roosevelt - a network of state banks to make good the gap. Britain could launch, say, national infrastructure, housing and long-term investment banks. This massive new leverage, along with a new framework of company law, could kick-start " capitalism with a conscience".
It is this link between analysis and action that you need to give your position some spine. Keynesianism is an economic philosophy open to all parts of the political spectrum. Are you ready to go all the way?
Will
Dear Will
I understand why you want us to back up words with action, and to avoid repeating Tony Blair's mistake of raising expectations in opposition only to do little in office. I also agree with you when you say we need to "offer a coherent framework for reform". Let me try and reassure you on both points.
I'll start with the "organising theory", as you put it. You suggest we should go the whole way and embrace Keynesianism. As a Conservative, I'm naturally sceptical of embracing anyone's theory or ideology, although I agree that Keynes had many good ideas, in particular his emphasis on the dangers of the contraction of credit. Here in Davos you see this clearly right now: for example, a representative from the African Development Bank told me how the lack of credit is holding up the construction of roads, bridges and other infrastructure. So I think our plan for a National Loan Guarantee Scheme would actually achieve many of the long-term outcomes people associate with "Keynesianism".
But if by Keynesianism you mean a big fiscal stimulus regardless of the level of government borrowing, I don't agree. The reason is simple: because the government is already planning to borrow so much, if we borrowed a lot more now we'd actually make the recession worse. Why? Because we'd have to show how the extra borrowing was going to be paid back through tax rises. That would damage business and consumer confidence, which is in the end what will get the recovery going.
So if it's not full-blown Keynesianism, what is it? The way I explain it is progressive conservatism - that is, we think the best way to achieve progressive goals such as a fairer, greener society is through conservative methods, such as making sure that government lives within its means and decentralising responsibility and power. That brings me to your important challenge about backing up words with action.
I think a proper conservative approach to regulating capitalism is to understand that it's not about heavy regulation or light regulation, but about right regulation - appropriate for what you're trying to do. So in the most important regulatory failure before us - the failure to regulate financial services properly - the problem wasn't that the regulation was too light, it was that it was all wrong. There was no regulation at all of the things that really matter: the overall level of debt in the economy, and the financial risks that banks and other financial services companies were taking, linked to pay and bonuses.
So we've said we'll change that by giving the Bank of England back the power to regulate the level of debt in the economy, by requiring banks to keep more capital on their books in the good years, and by requiring financial services companies to be transparent about pay and bonuses, so investors and regulators can see what's going on. We will also levy a fee on City firms to pay for a beefed-up FSA that can afford to pay salaries that will attract people who are as smart as the firms being regulated.
In other areas, too, I think we're showing that we don't allow commercial interests to override our aims for society and the environment - and it's not just "warm words".
So, for example, on making the country more family-friendly, we have a number of specific policies to regulate corporate behaviour: giving all parents the right to request flexible working; shared parental leave, and compulsory equal pay audits for all companies that lose a discrimination tribunal. And, of course, on the environment we were the first to campaign for a climate change bill with legally binding carbon limits, and stood up to massive corporate lobbying to oppose a third runway for Heathrow.
I completely take your point that we won't succeed in putting society's needs above capitalism's needs with words alone, but what we've got to do is make sure the actions actually achieve the aims we want, and that's why I think that progressive Conservatism is the right formula.
David
Dear David
You pushed the boat out with an interesting and significant speech, but in the face of some challenges I feel you have retreated to your comfort zone - a litany of pre-announced policies.
Just to drive the point home. There is a massive simultaneous economic contraction going on across the industrialised west, which is particularly acute in Britain; the decline in GDP we confront is on a similar scale to the early 1930s. British public debt levels are relatively low. We know businesses and individuals do not make careful calculations about future liabilities such as future tax burdens, as you argue; if they did, there would not be a debt and credit crisis. The evidence is overwhelming that fiscal boosts work in highly depressed economic environments, which is why Dominique Strauss-Kahn, managing director of the IMF, urges them. Our resulting public debt would not be high. I think you are ill-advised to set yourself against fiscal expansion in what rapidly looks closer to a depression than a recession.
But we have to fix the financial system as well. The global financial crisis has deeper origins than merely a failure of regulation, important though that was. Shareholders did not hold managements to account for wild behaviour and even wilder pay. Financiers knowingly misled investors about the risk in their products. Even now many bankers do not accept their excess and their mistakes. On top, there was an avalanche of cash from the emerging economies which passed the contagion of hot money to the west. The market system as it stands failed and needs to be fixed.
I understand and sympathise with your call for a capitalism with a conscience. But there have to be deep reforms of the system to deliver it. Unless progressive conservatism persuasively addresses the heart of this crisis, it will be seen as nice but peripheral.
Will
Dear Will
I don't think you are right about the IMF and fiscal expansion - its position is actually the same as mine: fiscal expansion is great if you can afford it, counter-productive if you can't. Just what exactly did the VAT cut achieve except adding another £12.5bn to our ballooning national debt? But we'll probably just have to agree to disagree on that.
What concerns me more is that you think my response to the challenges you laid out was just retreating to a comfort zone of policies we've announced. It seems to me you're missing the big picture: that all those policies (and many more) add up to a vision for the country that connects the economy, society and the environment, and which aims to bring a new sense of responsibility to all three.
That's a change from the past decade or so, where we had booster capitalism tacked on to a failing welfare model. And it's a change from the 1980s, where we rightly had the spirit of enterprise, but on which we now need to build the sense of responsibility.
That word responsibility is really crucial for me: it's the golden thread that connects all our policies and positions. On issues such as executive pay and corporate greed, I agree we want business leaders to behave more responsibly. But I don't think that more statism is the best way to fix the excesses of the market.
Why? Because clever people will always find their way around rules; there will be unintended consequences, and you can too easily end up doing more harm than good.
There is an alternative. The sustainable way to achieve change is through people choosing to behave more responsibly. Now, that's not just a question of sitting back and hoping for the best, as some like to caricature it. We can lead change by changing the culture and, yes, the legal and regulatory frameworks within which people and businesses operate. That's what connects what we're saying about welfare reform, City regulation, carbon emissions, and our other reform plans. They're all about creating a more responsible society.
But I do know we can go further, and I especially want to apply our thinking on social reform - which is all about decentralising responsibility and power - to economic reform. I think that will provide us with a better balanced account of what progressive conservatism means.
David
Dear David
I'm no statist - I am a committed and passionate pluralist. That is what stakeholder capitalism, which I champion, is all about. So I like your "big picture" view of embedding responsibility; in cricket, batsmen should walk when they know they are out, rather than wait for the umpire's ruling, and the same spirit should imbue economic and social life. What is elusive is how you propose to get there, and whether you are going to use the philosophy as cover not to use state power when it is plainly vital.
Take fiscal policy. The IMF is warning that the world confronts a contraction in demand greater that at any time since the 1930s - a crisis of "historic proportions". To avoid a Great Depression scenario it has called on governments to organise timely and temporary fiscal boosts equivalent to 2% of GDP, together with aggressive monetary policy and actions to stabilise the banking system. All three policies are needed. Three IFS researchers (http:/www.ifs.org.uk/wps/wp0902.pdf) recently assessed the VAT cut and show it will raise real consumption by a powerful 1.2% this year - significantly more than even the Treasury predicted in the pre-budget report. This is a temporary fiscal boost from a country with a low public debt ratio to GDP - the " space" that Strauss-Kahn has urged governments to exploit.
Your distaste for the state is leading you into ideological opposition to a necessary economic policy. The strikes and walk-outs in Lincolnshire by energy workers over the use of foreign workers show how angry and fearful people are - and potentially highly protectionist. If you become prime minister, you will have to offer very anxious people security, confidence and optimism, otherwise we will be unable to keep our capitalist system free and open.
You will have to use the state constructively, and not just over fiscal policy. It can only be the state that can reconstruct the financial system shattered by its own weaknesses, and I would use the opportunity to make it more long-termist and more supportive of genuine wealth generation. Do you agree? This country will need to grow many more companies like Rolls Royce and Vodafone to rebalance the economy; it will be the state that needs continually to attend to our innovation and skills systems to support them. Do you agree? The state will also need to avert a potential environmental catastrophe. We certainly need better constitutional protections against state intrusion into our liberties. But the constitutionally constrained state is the guarantor of pluralism, stimulator of prosperity and agent of more responsibility. You are mistaken to characterise it ideologically as our enemy.
Will
Dear Will
It is not a hostility to the state that makes me oppose excessive deficits in the UK, but a dislike of irresponsible borrowing and the building up of debt that will threaten recovery and mean higher taxes.
A clear view, even if it is not a popular view, is what people should expect from me. On the issue of foreign workers, we also need straight talking. I told the prime minister not to borrow that inflammatory slogan from the BNP. It was cheap populism of the worst kind, and now he has been found out.
But let me conclude by taking on what you say about the role of the state. I think we are in danger of misrepresenting each other. I have said that being clear about the limitations of government should not mean being limited about the aspirations of what I would like a government to achieve. A more balanced economy between north and south needs high-speed rail and we will get the private sector to build it. A more green economy needs an interactive smart grid and we will ensure it is created. A better balance between saving and borrowing and more assets for the poorest need long-term incentives to save, and we will provide them. Progressive ends delivered by conservative means.
But none of this will be possible unless we also make the state and state spending smarter and more efficient. Living within our means is an important conservative insight and will be essential if we are to succeed as a country. Any minister in any government I lead would always have to ask: how do we do this and save money? How can we involve the private and voluntary sectors rather than just sanction more top-down state action? And above all will this encourage responsibility and a more responsible society? Now that would make a real difference.
I've enjoyed this frank exchange of views on what I think is the key issue ahead of us. I passionately believe that, before we can move forward with confidence, political leaders must be honest about the mess we are in. The truth of how we got here has to be properly confronted. Then only through strong public finances and strong and honest leadership will we find our way out.
David
Tory Economics: The buzz words
Free trade
Major battleground of economic policy in the 19th and early 20th centuries. In 1846 Robert Peel fought a marathon parliamentary battle to repeal the Corn Laws - the tariffs on imports of corn that had driven up bread prices. Helped position Britain as a prime mover in the "first globalisation" that persisted until the first world war, but split Conservatives.
The gold standard
Winston Churchill's stint as Conservative chancellor was best remembered for his ill-fated decision to return to the gold standard that linked the value of money to government gold reserves in 1925, at the prewar exchange rate. Conventional wisdom said Britain had to prove its economic strength by rejoining; John Maynard Keynes argued against. Already struggling export industries crippled by overvalued exchange rate.
Postwar consensus
"Butskellism", the phrase coined for Conservative chancellor Rab Butler and Labour counterpart Hugh Gaitskell, who alternated in power in the early 1950s, was a cross-party postwar economic consensus. After Labour's landslide victory in 1945, both major parties moved towards a centre-left position, including acceptance of a welfare state, a strong role for unions and national ownership of many industries.
Monetarism
Margaret Thatcher took economic policy-making in a radical new direction. She embraced the "monetarism" of Milton Friedman and others, who argued that the key to battling inflation was to keep a firm grip on the supply of money. Thatchers's chancellors targeted size of money supply itself, and later value of pound, in an effort to beat inflation. Mass unemployment was regarded as "a price worth paying" to bring low inflation and economic stability.
Rolling back the state
Conservative economics in the 1980s and early 1990s also meant "rolling back" the state. Thatcher sought to cut public spending, privatise nationalised industries and liberate the City from capital controls.
* Will Hutton and David Cameron
* The Observer, Sunday 1 February 2009
Dear David
The Conservative party under your leadership has moved a long way - in both rhetoric and stated ends - and last Friday's speech in Davos, where you outlined your concept of capitalism with a conscience, is another landmark. I know you will say that Lady Thatcher was operating in different times with different needs, but I still don't think she would ever have wanted to say that markets must not trample over values that society holds dear, or to question the need for the profit motive always to triumph. You said: "If markets, and capitalism, and the activities of individual businesses, conflict with our vision of the good society and the good life ... you must speak out." Amen to that.
But "speaking out" is not enough. 2009 is going to be the toughest economic year since the war, and if Britain's GDP falls by more than 5% from its peak in 2007 by 2010 - now virtually certain - we move from the realms of recession to near depression. I recall Tony Blair when in opposition calling for stakeholder capitalism, in rather the same vein as you are calling for capitalism with a conscience, but in practice very little happened. The financial markets were allowed their freedoms, executive pay became more grotesque, society grew more unfair and the dynamics that have created the current mess were unleashed. Actions have to accompany words.
Obviously in the current crash actions are being forced on everybody that, as you acknowledge, would have been inconceivable 12 months ago. But although some of your suggestions - such as the £50bn National Loan Guarantee Scheme - have been innovative and ahead of the curve in addressing the vital necessity of getting credit moving again, I feel that you lack an organising theory to explain what happened and how it underpins your aim to put society before markets and repopularise capitalism. If you don't offer a coherent framework for reform, complete with some robust sticks and carrots, what you say sounds little more than opportunistic warm words.
I fear that, like Tony Blair, you shrink from the truth of the matter; that free and lightly regulated financial markets, upon which so much of our business elite's prosperity is dependent, have delinquent propensities for speculation and short-termism that profoundly damage the real economy. The crash of 2008-09, like 1929, is because once again we did not keep finance on a tight rein. You need to say this.
I consider this the heart of Keynesian economics, and adopting this root and branch would give you more bite and coherence. For example, Keynes was certainly a radical monetary activist, a believer that, in economic extremis, you might have to print money, as much as he was a deficit spender, so in one sense you are already moving in his direction. But he was also passionate about insulating as far as possible the real economy from the casino of finance, which he felt de-legitimised capitalism. He had no qualms about the state doing what the market could and would not. Confronted by today's acute shortfall of lending capacity because of the flight of foreign banks, he would simply have created - like Roosevelt - a network of state banks to make good the gap. Britain could launch, say, national infrastructure, housing and long-term investment banks. This massive new leverage, along with a new framework of company law, could kick-start " capitalism with a conscience".
It is this link between analysis and action that you need to give your position some spine. Keynesianism is an economic philosophy open to all parts of the political spectrum. Are you ready to go all the way?
Will
Dear Will
I understand why you want us to back up words with action, and to avoid repeating Tony Blair's mistake of raising expectations in opposition only to do little in office. I also agree with you when you say we need to "offer a coherent framework for reform". Let me try and reassure you on both points.
I'll start with the "organising theory", as you put it. You suggest we should go the whole way and embrace Keynesianism. As a Conservative, I'm naturally sceptical of embracing anyone's theory or ideology, although I agree that Keynes had many good ideas, in particular his emphasis on the dangers of the contraction of credit. Here in Davos you see this clearly right now: for example, a representative from the African Development Bank told me how the lack of credit is holding up the construction of roads, bridges and other infrastructure. So I think our plan for a National Loan Guarantee Scheme would actually achieve many of the long-term outcomes people associate with "Keynesianism".
But if by Keynesianism you mean a big fiscal stimulus regardless of the level of government borrowing, I don't agree. The reason is simple: because the government is already planning to borrow so much, if we borrowed a lot more now we'd actually make the recession worse. Why? Because we'd have to show how the extra borrowing was going to be paid back through tax rises. That would damage business and consumer confidence, which is in the end what will get the recovery going.
So if it's not full-blown Keynesianism, what is it? The way I explain it is progressive conservatism - that is, we think the best way to achieve progressive goals such as a fairer, greener society is through conservative methods, such as making sure that government lives within its means and decentralising responsibility and power. That brings me to your important challenge about backing up words with action.
I think a proper conservative approach to regulating capitalism is to understand that it's not about heavy regulation or light regulation, but about right regulation - appropriate for what you're trying to do. So in the most important regulatory failure before us - the failure to regulate financial services properly - the problem wasn't that the regulation was too light, it was that it was all wrong. There was no regulation at all of the things that really matter: the overall level of debt in the economy, and the financial risks that banks and other financial services companies were taking, linked to pay and bonuses.
So we've said we'll change that by giving the Bank of England back the power to regulate the level of debt in the economy, by requiring banks to keep more capital on their books in the good years, and by requiring financial services companies to be transparent about pay and bonuses, so investors and regulators can see what's going on. We will also levy a fee on City firms to pay for a beefed-up FSA that can afford to pay salaries that will attract people who are as smart as the firms being regulated.
In other areas, too, I think we're showing that we don't allow commercial interests to override our aims for society and the environment - and it's not just "warm words".
So, for example, on making the country more family-friendly, we have a number of specific policies to regulate corporate behaviour: giving all parents the right to request flexible working; shared parental leave, and compulsory equal pay audits for all companies that lose a discrimination tribunal. And, of course, on the environment we were the first to campaign for a climate change bill with legally binding carbon limits, and stood up to massive corporate lobbying to oppose a third runway for Heathrow.
I completely take your point that we won't succeed in putting society's needs above capitalism's needs with words alone, but what we've got to do is make sure the actions actually achieve the aims we want, and that's why I think that progressive Conservatism is the right formula.
David
Dear David
You pushed the boat out with an interesting and significant speech, but in the face of some challenges I feel you have retreated to your comfort zone - a litany of pre-announced policies.
Just to drive the point home. There is a massive simultaneous economic contraction going on across the industrialised west, which is particularly acute in Britain; the decline in GDP we confront is on a similar scale to the early 1930s. British public debt levels are relatively low. We know businesses and individuals do not make careful calculations about future liabilities such as future tax burdens, as you argue; if they did, there would not be a debt and credit crisis. The evidence is overwhelming that fiscal boosts work in highly depressed economic environments, which is why Dominique Strauss-Kahn, managing director of the IMF, urges them. Our resulting public debt would not be high. I think you are ill-advised to set yourself against fiscal expansion in what rapidly looks closer to a depression than a recession.
But we have to fix the financial system as well. The global financial crisis has deeper origins than merely a failure of regulation, important though that was. Shareholders did not hold managements to account for wild behaviour and even wilder pay. Financiers knowingly misled investors about the risk in their products. Even now many bankers do not accept their excess and their mistakes. On top, there was an avalanche of cash from the emerging economies which passed the contagion of hot money to the west. The market system as it stands failed and needs to be fixed.
I understand and sympathise with your call for a capitalism with a conscience. But there have to be deep reforms of the system to deliver it. Unless progressive conservatism persuasively addresses the heart of this crisis, it will be seen as nice but peripheral.
Will
Dear Will
I don't think you are right about the IMF and fiscal expansion - its position is actually the same as mine: fiscal expansion is great if you can afford it, counter-productive if you can't. Just what exactly did the VAT cut achieve except adding another £12.5bn to our ballooning national debt? But we'll probably just have to agree to disagree on that.
What concerns me more is that you think my response to the challenges you laid out was just retreating to a comfort zone of policies we've announced. It seems to me you're missing the big picture: that all those policies (and many more) add up to a vision for the country that connects the economy, society and the environment, and which aims to bring a new sense of responsibility to all three.
That's a change from the past decade or so, where we had booster capitalism tacked on to a failing welfare model. And it's a change from the 1980s, where we rightly had the spirit of enterprise, but on which we now need to build the sense of responsibility.
That word responsibility is really crucial for me: it's the golden thread that connects all our policies and positions. On issues such as executive pay and corporate greed, I agree we want business leaders to behave more responsibly. But I don't think that more statism is the best way to fix the excesses of the market.
Why? Because clever people will always find their way around rules; there will be unintended consequences, and you can too easily end up doing more harm than good.
There is an alternative. The sustainable way to achieve change is through people choosing to behave more responsibly. Now, that's not just a question of sitting back and hoping for the best, as some like to caricature it. We can lead change by changing the culture and, yes, the legal and regulatory frameworks within which people and businesses operate. That's what connects what we're saying about welfare reform, City regulation, carbon emissions, and our other reform plans. They're all about creating a more responsible society.
But I do know we can go further, and I especially want to apply our thinking on social reform - which is all about decentralising responsibility and power - to economic reform. I think that will provide us with a better balanced account of what progressive conservatism means.
David
Dear David
I'm no statist - I am a committed and passionate pluralist. That is what stakeholder capitalism, which I champion, is all about. So I like your "big picture" view of embedding responsibility; in cricket, batsmen should walk when they know they are out, rather than wait for the umpire's ruling, and the same spirit should imbue economic and social life. What is elusive is how you propose to get there, and whether you are going to use the philosophy as cover not to use state power when it is plainly vital.
Take fiscal policy. The IMF is warning that the world confronts a contraction in demand greater that at any time since the 1930s - a crisis of "historic proportions". To avoid a Great Depression scenario it has called on governments to organise timely and temporary fiscal boosts equivalent to 2% of GDP, together with aggressive monetary policy and actions to stabilise the banking system. All three policies are needed. Three IFS researchers (http:/www.ifs.org.uk/wps/wp0902.pdf) recently assessed the VAT cut and show it will raise real consumption by a powerful 1.2% this year - significantly more than even the Treasury predicted in the pre-budget report. This is a temporary fiscal boost from a country with a low public debt ratio to GDP - the " space" that Strauss-Kahn has urged governments to exploit.
Your distaste for the state is leading you into ideological opposition to a necessary economic policy. The strikes and walk-outs in Lincolnshire by energy workers over the use of foreign workers show how angry and fearful people are - and potentially highly protectionist. If you become prime minister, you will have to offer very anxious people security, confidence and optimism, otherwise we will be unable to keep our capitalist system free and open.
You will have to use the state constructively, and not just over fiscal policy. It can only be the state that can reconstruct the financial system shattered by its own weaknesses, and I would use the opportunity to make it more long-termist and more supportive of genuine wealth generation. Do you agree? This country will need to grow many more companies like Rolls Royce and Vodafone to rebalance the economy; it will be the state that needs continually to attend to our innovation and skills systems to support them. Do you agree? The state will also need to avert a potential environmental catastrophe. We certainly need better constitutional protections against state intrusion into our liberties. But the constitutionally constrained state is the guarantor of pluralism, stimulator of prosperity and agent of more responsibility. You are mistaken to characterise it ideologically as our enemy.
Will
Dear Will
It is not a hostility to the state that makes me oppose excessive deficits in the UK, but a dislike of irresponsible borrowing and the building up of debt that will threaten recovery and mean higher taxes.
A clear view, even if it is not a popular view, is what people should expect from me. On the issue of foreign workers, we also need straight talking. I told the prime minister not to borrow that inflammatory slogan from the BNP. It was cheap populism of the worst kind, and now he has been found out.
But let me conclude by taking on what you say about the role of the state. I think we are in danger of misrepresenting each other. I have said that being clear about the limitations of government should not mean being limited about the aspirations of what I would like a government to achieve. A more balanced economy between north and south needs high-speed rail and we will get the private sector to build it. A more green economy needs an interactive smart grid and we will ensure it is created. A better balance between saving and borrowing and more assets for the poorest need long-term incentives to save, and we will provide them. Progressive ends delivered by conservative means.
But none of this will be possible unless we also make the state and state spending smarter and more efficient. Living within our means is an important conservative insight and will be essential if we are to succeed as a country. Any minister in any government I lead would always have to ask: how do we do this and save money? How can we involve the private and voluntary sectors rather than just sanction more top-down state action? And above all will this encourage responsibility and a more responsible society? Now that would make a real difference.
I've enjoyed this frank exchange of views on what I think is the key issue ahead of us. I passionately believe that, before we can move forward with confidence, political leaders must be honest about the mess we are in. The truth of how we got here has to be properly confronted. Then only through strong public finances and strong and honest leadership will we find our way out.
David
Tory Economics: The buzz words
Free trade
Major battleground of economic policy in the 19th and early 20th centuries. In 1846 Robert Peel fought a marathon parliamentary battle to repeal the Corn Laws - the tariffs on imports of corn that had driven up bread prices. Helped position Britain as a prime mover in the "first globalisation" that persisted until the first world war, but split Conservatives.
The gold standard
Winston Churchill's stint as Conservative chancellor was best remembered for his ill-fated decision to return to the gold standard that linked the value of money to government gold reserves in 1925, at the prewar exchange rate. Conventional wisdom said Britain had to prove its economic strength by rejoining; John Maynard Keynes argued against. Already struggling export industries crippled by overvalued exchange rate.
Postwar consensus
"Butskellism", the phrase coined for Conservative chancellor Rab Butler and Labour counterpart Hugh Gaitskell, who alternated in power in the early 1950s, was a cross-party postwar economic consensus. After Labour's landslide victory in 1945, both major parties moved towards a centre-left position, including acceptance of a welfare state, a strong role for unions and national ownership of many industries.
Monetarism
Margaret Thatcher took economic policy-making in a radical new direction. She embraced the "monetarism" of Milton Friedman and others, who argued that the key to battling inflation was to keep a firm grip on the supply of money. Thatchers's chancellors targeted size of money supply itself, and later value of pound, in an effort to beat inflation. Mass unemployment was regarded as "a price worth paying" to bring low inflation and economic stability.
Rolling back the state
Conservative economics in the 1980s and early 1990s also meant "rolling back" the state. Thatcher sought to cut public spending, privatise nationalised industries and liberate the City from capital controls.
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