Tuesday, 16 December 2008

Global Economics and Local Cipollas

Even if nation states were on their way out, some governments seem to want to linger around. They are thrusting themselves onto the global arena with a whole new set of aspirations, quite detached from their original functions. And by doing so, they meet entirely new forms of appreciation by the World.

Some will be happy, it seems, to subject themselves to ridicule: the Polish government banning the ‘super-gay teletubbies’ was an instant classic. Or contempt: the US deluding itself into a ‘global policing’ function did not exactly meet widespread appreciation around the world. Or admiration: did you register what AUSAID, the Australian government’s aid agency, did in Indonesia after the tsunami? Or, sometimes, the combination of contempt, ridicule, and admiration: remember the French government’s attempt at the global Francophone television? (Or, in fact, remember the “French government’, as such?)

The interesting thing is that these New Government Actions are mostly independent of their respective societies. And as they are busy reinventing themselves, the national economies that they have been presiding over are gradually dissolving into the global economy.

It started so much grander… 

At the beginning there were the sovereigns. Those mighty times of rule-free orgies and joyous beheadings. The times when the sovereign was still truly sovereign on its own land. 

But then, a glitch emerged. Even if slowly. 

Land was less and less important, people mattered, their heads mattered (and, shocking, more at the end of their necks, rather than on the top of a spear). With all the new ways of moving around and difficulty in stopping them from doing so, the people turned out to be not-so-loyal subjects. Huh, hard times came for the sovereigns. They had to compete with each other! Efficiency mattered. And worst of all, I kid you not, it was not even clear any more who the sovereign was. Can you imagine that? Sick world!

And thus the ‘government service providing institutions’ were born in the place of the Mighty Sovereign. But it might still end on a sweet note. 

As the world economic crisis is taking its full shape, and the national government’s services are becoming less effective by the day, a new, global set of institutions will emerge. And thus, the newly underemployed national governments will face the choice of reducing their size or finding new roles. (This is not the first time in recent history. See the variation with which the newly formed Eurozone’s old, national central banks reacted to their sudden lack of tasks. Some downsized, some magnified past functions, some created whole new ones...) This will be the moment, for national governments to reassess the globally interesting positions they sit on. There are some things, thank heavens, that cannot emigrate. Mountains rich in ore, seas of oil reserves, or nice beaches, coral reefs and snowy slopes are difficult to drag away. (Although some do try: witness Dubai’s two-piste mini ski resort.)

It might be a long time before these are submitted to global level control (do you know who owns the larger Schlesswig-Holstein banks? That provincial government never really came to terms with German reunification, did it? And I am talking about the one by Bismarck and not by Kohl.) We already began to discuss the consequences of this coming phenomenon, when the increasing role of sovereign wealth funds came into our sights. But the real thing is yet to emerge.

It is not that bad, is it? It will, or at least should not be necessarily very different from city municipalities playing a role in a nation’s economy, providing say infrastructure services, and at the same time maybe being an important, but not dominant player on the local capital markets. 

But some of the global players of government origin might turn out to be Cipollas. Excessively large accumulated wealth (maybe in sovereign wealth funds, maybe somewhere else, such as in government controlled mining companies), combined with lack of transparency, lack of any form of external oversight, and power hungry power-hungries. 

The newly emerging global state functions (well, if they emerge at all) might just start off with an unexpected rouge opposition. 

Tuesday, 9 December 2008

Cornish Love - Off Global Economics...

(more from those equatorial forests of Cornwall)

We also collected some real gems:

One. In the village shop where we stayed, people were very friendly to me. Liz suggested that here it might be better to be a foreigner than a non-Cornish Brit… So there was this guy, the local baker, who wanted to show off his freshly baked bread to me, accompanied by the words: “I bet that they did not tell you at Immigration about how great the bread is going to be here”. Sure, they did!

Two. It was also in this village shop that I witnessed firsthand two 50+ men say in all seriousness to each other: “see you later alligator”, “in a while crocodile”. I kid you not: they were not joking. Even a bit grumpy. And thus was the true etymology of the term ‘corny' uncovered.

Three. Although the Enlargement of Europe is recent, Central Europeans are already making a mark on the local culture. I overheard the conversation of two eight-year-olds at a kids’ slide place: “I bet you are a Romanian!” It was not discovered whether the term was used in a positive or a negative context.

Four. But the best of all was the large poster hung on a house at the end of one of the small towns: “Love Sale Festival” (heart, heart, heart). I guess the recession has now officially spilled into all the sectors of the economy.


(notes from one other remote, exotic place, with strange people and customs: Cornwall)
In a Papuan rainforest location I recently witnessed a PR person bragging about how her company had really not done that much damage to the environment at all. In a field which had previously been a complex forest ecosystem on the equatorial, there now lies a grass meadow with grazing cows, right out of a Constable painting. And we thought that clichés were only harmful to the soul...
Now, in Cornwall, I am struck by how desolate the land is in the ‘mature economies’. The beautiful meadows, with the gorgeous rolling hedges (the latter - to be precise - can contain a surprising complexity of life in them), the cows and horses… It all seems so empty and destroyed compared to the real thing. Desolate, really, is the word. 
Csaba Aradi, the former director of the Hortobagy National Park in Hungary once played a little game with me. I - in my usual polite manner - asked him, why on Earth people are so interested in the flat barren land over which he resided. Hortobagy is a great plain. It was, I suggested, just grass and nothing. His response? He made me walk in a random direction, of my choice, for a random distance, also my choice, on this ‘empty field’. Then we kneeled down, and he made me count the species I could see within a circle of one-metre diameter. It took a while: there were a lot of species. Then we stood up, he made me choose another direction, and we walked just two metres. Kneeled down again, many distinct species again, almost none of them the same. The species diversity in this ‘flat, barren field’ was very high indeed. 
Now take Papua, the extreme version of ecological variation. You cannot say this slowly enough, for my mind to take it in. There are more than 2000 different orchids on Papua. Two thousand. More than 600 birds. Incredible. 61 different species of snakes. Some 2400 different fish. How many birds, or fish can I name? Or remember ever having seen? Including the zoo, the nature books, the Attenborough movies, and all my hikes altogether. I guess - I have seen quite a few – but it is maybe 300 max. Now Papua has double all the birds I think I have ever glanced at in life, on the screen or in books. Or fish: if I spent only a minute looking at each species, I would need almost two days of constant looking to get through them. (This is why people come up with silly comparisons -- the magnitude just cannot be felt through a number on the screen, albeit a four-digit one. The next thing I will do is calculate whether all the fish species lined up one after the other would actually reach the moon...)
And to top it all, you have more than 100 thousand insect species alone. Now, that is a lot of bugs.
Then look at the English landscape. Grass and grazing cows. That is two species. Well, grass is a little more complicated, so maybe a few more. And the weeds. And the crows. And… Er… There is also the fly, yeah? It is a desert.

This Guy Is Boring!

The emerging economic policy of the Obama administration can - at best - be described as  enlightened left wing policies, the kind that has been practised by the better of the European social democrats. The usefulness of these might be a revelation for the government-fearing US conservative elite, but economic policy innovation it is not.

There goes our hope for global leadership.

A vision about creating global policy institutions? Global regulatory framework? Global fiscal and monetary policy harmonisation? Leading the world to find a globally legitimate set of institutions, and thus transforming his enormous political capital into finding a global political channel to achieve all of these?


It would have taken a ‘world leader’ to create a new, global institutional framework with foresight, in preparation of what is coming, rather than always moving as the reaction to the latest immediate pressure. At this time, Obama is the only person who has the global clout to do that. All others who could have done it have either already burned their capital in futile actions, or are yet to emerge, but are still not on the horizon. And Obama is not doing it.

Now, we will have to wait for the global economy to slide deeper into recession, and then see how global governance innovation inevitably emerges as a response.  Expensive entertainment.

Wednesday, 26 November 2008

The Other Crisis

When the economic storm had hit us, 10 weeks ago, we were all looking for parallels from the past. Are there similarities with the burst of the dot.com bubble, in 2001. This is really different here, we said. But there are general lessons, no? And we listed those. 

Then things turned worse, the storm became a crisis. We started to revisit, first the 1997-98 Asian / Russian / Brazilian crisis. "How different was that! This time it is going to, rather than coming from the emerging markets." We lingered around this thought for a couple of days. 

However, as the term 'bleak' started to become an insufficient adjective, we were increasing turning to the previous meltdowns. The lessons from 1992, and then 1988, and even 1981 suddenly looked very relevant. Then, we went even further back in time. The prospect of a worldwide economic contraction coupled with expensive commodities were always a brill cue for plunging into the oil price shocks of the 1970's.

As the previously unthinkable kept happening, the bad news did not stop flowing in, it was no more denial any more. The comparison must be with the 'biggest shock ever'. And thus, Great Depression historians suddenly see their business prospering (one of them even became Obama's top economic advisor). 

But why stop at the 20th century? Why not the 16th century's Spanish gold inflation? Or how about the Greeks, or the Romans? 

A friend of mine, Philip Kay will speak on the financial meltdown in the Republican Rome. This Friday, in Oxford. Rome 88 BC. The abstract of the talk, coming directly from Philip is as follows:

"In 66 B.C. the Roman orator, Cicero, delivered a speech, the De Imperio Cnaei Pompeii, in which he argued that Pompey the Great should be given the military command against Mithradates VI, king of Pontus, a kingdom on the Black Sea coast of modern Turkey. In the speech he reminds his audience of the disasters which befell them 22 years earlier in 88 B.C. when the same Mithradates invaded the Roman province of Asia (situated on the western coast of what is now modern Turkey). According to Cicero, this invasion caused the loss of so much Roman money that credit was destroyed at Rome itself. He says:

'For then, when very many people lost large fortunes in Asia, we know that there was a collapse of credit at Rome, because repayments were interrupted. It is indeed impossible for many individuals in a single state to lose their property and fortunes without involving still greater numbers in their ruin. Defend the Republic from this danger; and believe me when I tell you –what you see for yourselves—that this system of monies (pecuniae), which operates at Rome in the Forum, is bound up in, and is linked with, those Asian monies (pecuniae Asiaticae); the loss of the one inevitably undermines the other and causes its collapse.'

This passage is remarkable in its contemporary tone. Substitute US sub-prime for 'the Asian monies' and the UK banking system for 'the system of monies which operates in the Roman Forum' and it could have been written about the current credit crisis.

I will argue this Friday that, in second century and early first century B.C. Rome, increased inflows of bullion combined with an expansion in the availability of credit to produce a massive growth in Rome's money supply. This increase in the supply and availability of money in turn resulted both in a major increase in Roman economic activity and, eventually, in the credit crisis which Cicero describes."

If you are hooked, here is Philip's exact title and address: 
Philip Kay will speak on: 'Financial Meltdown in Republican Rome'
Time: Friday, 28 November at 5.00 p.m.
Place: The Stelios Ioannou School for Research in Classical and Byzantine Studies
66 St Giles, Oxford OX1 3LU, +44 (0)1865 288391
(Philip Kay is a Supernumerary Fellow of Wolfson College, Oxford)

Sunday, 16 November 2008

The Pilot of the Nduga

(A report from Wamena, the capital of the West Papuan highlands.)

I have a new friend. He is Papuan, from the Nduga tribe. He is 22. And he wants to be a pilot.

His name is Samuel.

We met at the Jayapura airport. I had to stand around for hours, and in my boredom, started to circle around the departure lobby. There was a young, very university student looking Papuan guy with a girl, also very student looking, obviously a couple. (On a side note: why is it that people in similar positions look exactly the same around the world? Why is a water engineer dressing into exactly the same clothes in Budapest and in California? Why are bureaucrats in the planning department of the economic ministry look and behave exactly the same in Moscow and Brasilia? The clothes? Ok, maybe there is some common culture. The behaviour? Okay, they have to think about the same things. But the hair?) We smiled at each other, Samuel and I. Then again. Then as I was to pass by them for the third time, he had put his hand out, and announced that his name was Samuel. 

We talked the next hour and half.

He spent his early childhood in a little village in the middle of the Highlands. The challenges implied here are enormous. The Papuan highlands reach five thousand meters, on the equatorial. Translation: extremely difficult terrain, constant torrential rain, you live in tiny little huts, in the middle of a forest full of dangers, the next nearest village is half a day away, no electricity, no water, no roads at all, no telecommunication, no school, no healthcare whatsoever, just you, your family, and a few other families. That’s it. You help grow veggies, and look after the pigs. And play a lot. (It sounds rather pleasant, no?)

And then two events came. First, his dad organised that the village would build an elementary school. Second, and “African-American missionary” came to a neighbouring village, and told my friend, Samuel, that he had used to be a pilot. Samuel always wanted to fly a plane, the only transportation he had seen. There was no way, he could ever do that. But that black missionary told him that you see, here I am, black people can be pilots, too. 

My friend finished elementary school. Then had gone to high school. He had to walk three days to get to his school in the big town. Through the forest. Rain. Danger. Barefooted. Nowhere friendly to sleep. Age ten. Then three days back. Then again.

He finished high school. Had gone to senior high in the provinces capital. Then he got into a pilot school in Jakarta. He finished in May. Looked up on the internet that the best commercial pilot training is in New Zealand. He applied. He got in. Now he is looking for scholarship, and I have no doubt that he will somehow, through the impossible, get it. (Nobody is giving pilot training scholarships, especially for Papuans. But if you happen to sit on one, there is no better place for this money to go to -- I’ve got his email.)

I asked him what the people in his village need. Amazingly, he gave me a ten minute structured talk about priorities. First the landing strip, so that people do not have to walk to get the essentials. Second, healthcare. For little kids keep having diarrhoea, and it takes way too long to get to the town, and some of them die on the way. Third, education. The teacher in the school left, and the school closed. He had his chance, but what about his baby brothers and sisters? Fourth, economic development. People need to get access to the market, and have the technology to use the land and the forest without destroying it. (How many 22 year olds could give a priority list like that at a moments notice?)

He said that if he is going to get a scholarship, he will save enough on it to send his brother to medical school in America, for the second thing that his village needs is a doctor, after a pilot. 

The Papuan Highlands is the last place on Earth which is more or less untouched. Before I came here, I thought I would have trouble discussing global issues with people who share with me a cultural heritage from 45 thousand years ago, and nothing since. I thought the question of integration of global culture and economy would be something I would have to think about based on what I hear from them. Instead they are dictating the solution while I type.

We had one more specific topic. He raised the issue of how much economic development can go against leaving the environment intact. I started to explain that the ecological environment is a system, etc., but he cut into my sentence. “I know it’s a system. And of course, it’s unique. I grew up there. You come to my village, and I show it to you. My tribe will look after it for you.” Well, but who is going to pay price of looking after, then, I asked. He did not even blink: “You are the development economist, you figure it out.”


At the end, I asked him about Obama. You have not seen a bigger grin.

Monday, 3 November 2008


(A pre-note on Obama’s victory speech, scribbled down in Kuala Lumpur)
A few years ago, well, exactly four, Liz and I were invited to a posh dinner on what happened to be the night after the US elections. The organiser was a good friend, who rushed up to me as we were looking for our seats, looking rather anxious. Tamás - she said - I beg you, please, please, no scandal tonight… As it turned out, we were seated next to an elderly Florida Republican couple, who were full of their recent electoral victory. (They were also partially deaf, which, coupled with the news that they financed the concert the next day, I found - shamefully - very funny. Oh those lovely trills of the violin, the nuanced pianissimo of the flute! Ah!) The reason I bring them up here is that they spent the entire evening banging on and on about how we, non-Americans, had nothing to do with their election, so we should just, plainly, shut up. It was none of our business. Full stop. (They probably said ‘period’.)
Oh irony! Now they will have the chance to vote for the First President of the World. (Unlikely as it is that they will use the opportunity...)
Over the past 18 months or so I have asked so many emerging market economists around the world about Obama’s chances. Now that he is almost there, it might be interesting to recount the universal answer: “That would be amazing. But there is no way it will happen.” The excitement, together with a hushed-worry, has reached an incredible intensity by now. There is very little debate about the real merits of the policies in question, outside the US. But as much as Obama, and Obama’s chance, have become more than the story of a politician in his home country, he has also become the symbol of the non-wealthy world. Tim Russert in his famous reaction to Obama winning the primaries said that he would love to teach history to inner city kids the next day, a point that could be widened to 90 percent of the world’s schools. The World will be a different place Wednesday morning. Or at least the World will think of itself differently Wednesday morning. Which amounts to much the same thing. 
And thus, it is surprising that there is very little analysis these days about the impact of this political opera on the non-US part of the world. Ironically, the US is possibly the most Obama-sceptic place on Earth, even as it elects him to be president. (Bar Iran, of course, if polls of these kind can be trusted at all.)
Yet there is an important policy upshot of Obama’s victory. He will be able to push through almost anything, at least at the beginning. First, he is rather likely to have a Congress and a Senate that will (a) do what he wants, and (b) perhaps even be filibuster-proof. Second, much of the rest of the world sees him as its leader. Unlike the way my Floridian table companions saw it four years ago, then, and to a much larger extent now, much of the world really does have a say. Their ‘votes’ are not counted, but the action of choosing is there, and that could give Obama a mandate on the global level. Obama will be able to push through a global agenda if he wants. Third, the hunger for sensible global leadership was palpable during much of Bush’s second term.  Now though, the global economic crisis presents an issue where new leadership could really make a difference. This offers a space into which Obama, the new political leader of the World, as opposed to merely the political leader of the superpower of the World, could move. 
The time-window will be very short, though. For someone from whom so much is expected, disappointment on specific policy positions could quickly erode political capital. There is no omnipotency in real life. 
This is why I will pay a lot of attention to what Barack Obama, the First President of the World, will say when he makes the very first speech in which he can say something. Tuesday night, American time. 

Sunday, 2 November 2008

Off for a while

I am going to be on an lengthy trip for a month now. Blog posts will
be patchy.

Monday, 27 October 2008

Sisyphus’s Next Job

Comedy in Three Acts

Dramatis Personae

Problem, son of Old Habits, in love with Global System

Solution, king of Cheap Talk, a.k.a Good Enough

Trouble, cute little Goodfellow, messing with the World

Governors, presidents, ministers, all kinds of further support. Running around the stage at high velocity, in random directions. Some without head attached.

Act I. Regulation

Scene 1. Financial sector rules
(Problem and Solution stand facing each other. Trouble enters, happy.)

Solution: Increase regulation.

Trouble: Increased regulation within the old regulatory framework would only work if an isolationist approach was adopted at the same time. This would cause major inefficiency in the global economy. It would mean the end of ‘global finance’.

Without isolation of the national financial sectors, systemic risk would ‘flow’ to the weakest regulatory regimes. Overall global risk would not be contained, nor would the impact on the national economies. 

Solution: Globally harmonised financial sector regulation. Agency: OECD (you get harmonised as you enter the rich-club), IMF(emphasis on extending the harmonisation umbrella to emerging markets, as well).

Trouble: Lack of enforcement creates incentive to cheat by national governments: free riding on the global stability while boosting financial sector at home.

Solution: More than harmonisation. Global regulatory body with enforcement capabilities.

Problem: There is no existing mechanism to either create such an authority, or to supervise it.

Scene 2. Dynamic regulation
(A large paper-maché puppet falls from the sky. As it lands, it breaks into three pieces and bursts into fire.)

Problem: The set of rules is only part of the effective regulation that creates the framework that channels financial sector activities. Not only the way the rules are enforced is part of any regulatory regime, but also the active and reactive supervision coming from the government and the central bank. 

Any regulatory rule is fully defined only by the framework of dynamic leverages.

Solution: Harmonise the dynamic regulation, as well.

Trouble: It is impossible to harmonise non-conventional intervention, which is the essence of successful central bank crisis management. Game-changing solutions, by definition, cannot come from the game itself. 

For instance, the Brazilian central bank beat the 1998 attack by using unconventional, previously taboo tactics, such as going against particular hedges of the attackers, and thus forcing them to take an unacceptable level of risk. In essence, they stopped the possibility of leveraging, through unexpected through-market tools.

The non-static, active part of any regulatory regime is directly geared towards monitoring and managing systemic risk. Thus the essence is the immediacy and out-of-the-box solutions.  

Solution: A global rapid-reaction central bank committee facilitating harmonised reaction.

Problem: This would never work unless all monetary policy is co-ordinated on a global level.

Act II. Monetary Policy

Scene 1. Interest rate
(A human sized musical note marches through the stage, singing in whispering voice.)

Problem: The market is unable to recover from a systemic shock.

Solution: Monetary policy intervention by individual central banks. If the markets fall due to capital flight, hike rates a lot. If the market falls due to recession fears, cut rates a lot.

Problem: The algorithm will not work. When everyone is having troubles in a full global contagion, both rapidly changing capital flows and recession are lurking. There is no clear equilibrium in the world-wide rate game. Monetary chaos is certain.

Trouble: Thus national level monetary policy action is ineffective both in managing the global economy directly, and in providing leadership through expectations.

Solution: One-off interest rate move harmonisation would provide ‘leadership’ in crisis.

Trouble: Expectations can only refer to future policy measures by existing institutions. Or, at least, institutions perceived to exist. Therefore, one-off interest rate move harmonisation makes sense only as a harmonised expectations management exercise within the national economy framework. One-off moves, thus, cannot move expectations, unless they contain an implicit promise of future harmonisation of policy.

Problem: Thus, one-off, ad hoc solutions as a rule cannot possibly fill the global policy vacuum.

Solution: Institutionalised interest rate harmonisation among at least the leading central banks. Move all rates at the same time, in a harmonised fashion.

Trouble: A half-point cut has very different effects in different monetary environments. Thus harmonisation of rate moves makes sense only if the interest rates are allowed to be different. Only the timing is harmonised, but the moves are independent (even if ‘discussed’). but in this case, not much has changed. There is still no effective global policy.

Solution: Global universal interest rate set by a body with global statute.

Trouble: There are two issues with a single rate for the entire global economy. First, the global economy’s needs in terms of crisis management are very different from the monetary policy demands in the post-crisis world. Effective crisis management means, as argued above, a strong and credible common action, frozen in, that is a global monetary policy authority that can promise future action credibly. For normal times, however, the universal intervention, whose promise is the key to sorting out the crisis now, is too early for the world economy. The needs of the different parts of the world are wide ranging.

Solution: An institution that covers only part of the global economy. Merging the Fed, BoE, BoJ, and the ECB would not be unthinkable, and would cover around 65% of the world economy. Throw in a couple of others, like the Reserve Bank of Australia, or the Swedish Riskbank etc., and the ratio goes up to 75%. That could be a good start.

Problem: Talk about the institutionalisation of a programmed conflict with China.

Solution: Good point. However, if the crisis becomes deep enough to generate the political will for such harmonised global action, then the establishment of a strong and lasting institution in this fashion is not entirely impossible. Political constraints are agenda-defined. As the agenda changes, so does the strategy space.

Trouble: There is a second major issue with the single global interest rate, though. The currencies.

Scene 2. Exchange rate
(A group of currencies, of mixed age, start trembling in the background. The wind blows.)

Solution: Universal interest rate with flexible exchange rate regimes would work. A global authority, with some straightforward decision-making mechanism, decides about the interest rate level. Exchange rate regimes stay in the current, mostly flexible framework.

Trouble: If capital flows stay largely free, then the presence of a flexible exchange rate would substantially weaken the impact of the interest rate move. The consequence would be a world economy that still had the effective interest rates varying across currency regions. Thus each currency would end up with its own interest rate engineered from futures. This would substantially diminish the ability of any global monetary policy to control the global economy.

Solution: Quasi currency union with universal interest rate.

Trouble: Either the currency levels are regularly administered -- but then what’s the point? It would be the same, but less effective than the market set flexible rate - or currency exchange rates are set in stone, but then…

Solution: ...common global currency, universal interest rate.

Problem: There is no political will anywhere around the world to create either a common monetary authority or a global currency union. This direction is entirely unrealistic. It belongs to Fantasyland. You might as well waste your time writing a blog about it.

Act III. Fiscal Policy

Scene 1. National treasuries competition
(Tropical forest. A number of beautiful plants climb high rapidly, with colourful flowers. All in parasitic relationships with the trees)

Problem: You can’t have monetary policy without some fiscal policy constraints: competing national treasuries would destroy the policy of any global monetary policy authority. Under a common monetary policy umbrella the inflationary impact of any individual governments deficit would be reduced substantially. Consequently the real rates would need to be kept much higher than management of the private sector would require to stave off the overspending impetus of national governments.

Solution: Cover the bad end of the tail: have a shared insurance umbrella for governments in trouble -- this would make crisis management of monetary policy easier.

Trouble: Not exactly incentive-compatible, is it? Anyway, an insurance umbrella would only limit the global damage arising from singular overspending. The bigger trouble is that if the global central bank was to set a policy for growth in normal times, this would translate into an incentive to overspend by all governments. The aggregate effect would be too lax fiscal policy on the global level.

Solution: Limit fiscal policy excesses. Implement a set of straightforward rules to which all government budgets should adhere.

Trouble: There are major difficulties with this. To start with, this is a political impossibility, for budgetary constraints would need outside policing if to be effective. That would require a level of transparency that many national governments will not sign up for under any situation.

Solution: Have a similar limited global core fiscal policy as in the monetary policy case. The countries that are listed in that 75% of the global economy are all democratic, and thus have largely transparent government accounting. Policing the budget rules would not take that much new intrusion into state secrets.

Scene 2. Global treasury
(The forest opens to a beautiful equatorial lake. With slow, almost animated movement, a group of crocodiles slides into the water.)

Trouble: This transparency argument is based on a myth, that the democratic, western governments have transparent budgetary accounting. Just take the example of what happened to Belgium after submitting itself to ECB scrutiny. What we learned was that before the setup of the Eurozone, the numbers that we were shown were mostly cooked. Or take Italy. Or Greece. This would not be an isolated problem of only a few governments. 

By the way, Eurozone. The second trouble with the pre-set fiscal rules is that they might allow overall limitation of fiscal excesses, and thus more or less effective monetary policy, but still impede any dynamic setting of fiscal policy. The Maastricht rules serve as a quasi-minister of finance, but a very rigid one. Thus there is no system-level fiscal policy. National governments find themselves facing an incentive structure to push to the limit of the rules. The management of the economy then becomes ineffective.

Solution: Actively harmonised global fiscal policy. Limits regularly adjusted to global economic climate, some ongoing decision-making mechanism is needed, as opposed to one-off setup at the beginning.

Trouble: This is not global fiscal policy, this is globally constrained national fiscal policy, what happens to global costs and spending? At least the cost of global institutions has to be covered in some way where the organisation is not hostage to the year-to-year budgets of national political processes.

Solution: Global treasury: tax framework, global treasury revenues, global government services.

Problem: There will never be political will for this. Any legitimate setup would need some kind of minimum harmonisation of the political system and thus political values, at least among the leading global regions. No chance.

Epilogue: The Case For Global Economic Authority

Thus is the argument towards the creation of a set of institutions that would generate and implement global economic policy. At the heart is the observation that neither global regulation, nor global monetary policy can be set without efficient, institutionalised decision-making mechanism, and enforcement. Arguably, if this crisis is truly a global crisis, then there will not be a ‘solution’ until a credible global policy framework emerges.

However, there is no political will at the moment to support the rise of such global policy institutions, and anyway they could not be effective without at least some kind of fiscal policy harmonisation, which would require a politically impossible intrusion into each other’s budgetary processes.

Trouble: Wouldn’t this mean that there’d be a global government that would be tempted to intervene in a host of other issues?

Solution: Like global warming, the relationship with the Biosphere, cultural diversity, etc?

Trouble: Yes… And also global government policing… Do we want that? Seriously.

(Exit all. The World wanders in, talking to herself in low voice. After a short while, she exits looking confused)

Tuesday, 21 October 2008

The Birth Of The New Global Capital?

(Notes from Abu Dhabi and Dubai)
I didn’t plan for this. There I was, arguing for an overarching crisis. That a tsunami was coming. That the outer islands had already been hit, and that we could see that enormous wave coming towards the beach. No one was to be spared. Can’t you see, people, it will hit us all? There will be no dry land left. Run for your lives!

The past five weeks looked good for us, Armageddon-types. 

And then suddenly, there it is. A place that could convincingly be the Winner of The Crisis. Two new-born cities on the coast of the Arabian Peninsula. To my utter surprise, I have started to suspect not only that the Twin Cities of the Gulf could survive the meltdown relatively unharmed, but also that they might even gain spectacularly from it. 

First, the obvious: although Dubai has considerable debt, neither rescheduling, nor financing should be a problem, as long as it can find the right words for a difficult conversation with the Older Brother. The rivalry with Abu Dhabi will give way to co-operation, which will display the fact that the two centres are, in reality, on the way to becoming one.

This One City is sitting on an accumulated wealth in the magnitude of the US bail-out package, even if you correct the latter with a ‘reality-multiplier’ (a.k.a. ‘the second bailout package’...). This is coupled with an exceptionally strong development dynamic, cash-financed in large part, and thus unaffected, or at least not directly affected, by the financial meltdown. 

Financial centres that weather the current crisis without a systemic meltdown will see their reputation gain. There is nothing more confidence-building than the history of stability amidst the storm. Imagine ocean liners about to cross the Atlantic, after a gigantic storm. You probably wouldn’t want to take a small boat. Nor the enormous ship that almost sank, even if it has all the luxury in the world. How about that nice, medium sized vessel almost unmoved by the winds, waves, and storm?

Stability will pay off nicely in the post-crisis world.

Second, the coming global regulatory overhaul is very likely to favour a financial centre with pre-existing buzz and relatively large size, but lack of high gearing. Agile and flexible regulatory response teams, could enable Abu Dhabi-Dubai to make the most of the inevitable global clampdown. Special Purpose Vehicles might be out, yet the need for ‘effective solutions’ will be all the same.

The point is that the regulator here does not need to worry about the global systemic effect. The supervisor needs to be seen to sign up for the to-be-emerging global regulatory protocols, make sure that the local system does not melt down, and then offer the maximum flexibility. The rising global New Rule Book will probably take a multi-tiered form, leaving ample room for local manoeuvring. Both the history and the attitude of the emerging ‘United Emirati Centre of Global Finance’ suggests that the appetite will be there to go in this direction. 

Third, the talent flow will be staggering. The meltdown of the other economic centres of the world will result in a lot of well educated and experienced professionals finding themselves on the street. They might as well find their way to this sunny oasis of opportunity. The human capital shortage in the Gulf may well be a thing of the past. 

As a partnership, then, Abu Dhabi-Dubai could emerge as a winner. If on the other hand the cities prefer to go it alone though, one has a far greater chance of success than the other. Despite the mass denial among Dubai entrepreneurs, the global crisis would be certain to hit them, big time. Credit crunch is already there. There are doubts that Dubai alone has enough to back its banking sector. Abu Dhabi does. The collapse of tourism will hit Dubai badly. Abu Dhabi, being at the early phase of the sector’s development will hardly feel a mosquito bite. The inevitable fall of global transportation will hit the Dubai port. Abu Dhabi, again, will stay mostly unaffected. The ill-conceived manufacturing projects will inexorably be weeded out. The Dubai audacity of unfeasible electronics production will be trumped by the sensible oil-industry support manufacturing projects of Abu Dhabi. It is very unlikely that this advantage will not be turned into hard positions. As the FT pointed out yesterday, it is going to be a tough conversation.

Yet, the potential is there. The Twin Cities of the Gulf might take a new role, this time as the capital of the post-16-September World. Or at least one of them.

Wednesday, 8 October 2008

Me And My Friend, Alex

“With knots, the best is to use a hatchet,” - he used to say. “Just as it is coming towards you, large and complicated. Dark, and sometimes frightening.” Yes, it happened even to him. Only occasionally, though. “Just cut it right through. That’s all you can do. But, that will take any of them down.”

He was good at knots.

What the world’s governments are doing is using Lilliputian scissors on the knot of the world’s new Gordium. And they can’t even decide which side to start. They may eventually get there, and cut through the systemic entanglement of global finance, but it will cost time and rivers of sweat.

Or in other words: capital markets and banking activities have come to a halt anyway. The bit that is left is mostly desperate attempts of finding cover. There is zero ‘normal’ activity left in the financial sector of the countries that the contagion has already reached. All the rest spend their entire time jittering.


Suspend all activities. Stop the knot knotting. [sorry]

Then comes the hatchet. Unwind all positions. Take your time. Clear positions. Clear multiple accounts. Clear entities. We should each have one figure at the end.

You will say that this will require a price for each position, which is impossible. Well, yes and no. It will be impossible to do it fairly, but it is too late for that anyway.

You will say that the ‘hatchet technique’ will not work for the derivatives. Yes, it will not be perfect. But is there a viable alternative?

And meanwhile in the other room…

Design the new, post-knot regulatory system. Try to be a bit more sensible than before. Maybe look at the tried-solutions of some other countries. To give you a hint, I would start with the places that are rich, and highly banked, that have sophisticated capital markets, and so on, but at the same time are NOT in trouble. If the intersection of their regulatory rules has elements, there you are, you have got a starting point. (You might even be surprised about how non-empty that set is going to be.)

Then everyone can take their post-hatcheting figures, and start the game again. With the proviso that the number is strictly positive. As for those with a red number next to their names, this is the time for government led social solidarity to provide that proverbial net.

We are going this way, anyway. The wave of bail-outs allow the financial sector to unwind itself, arguably making more mess, while the prices are as artificial as ever. The new rules will come in, but will be affected by the ad hoc, spur of the moment, immediate urgencies rather than the long term rationales behind the would-be perfect new regulation. At the same time, the non-transparent clearing will make any social protection very costly, and likely to be perceived as unjust.

When dealing with knots, the Greek pros cannot be beaten.

Tuesday, 7 October 2008

The Song of the Earth

Mahler 1908. The triumph of the individual becoming one with the Earth. Death is merely part of the cycle of Life. One’s Life. Any particular one’s life, and the lives of all of us, individual ones. The highest point reached by human civilisation. The world was becoming interconnected and global, savouring the fruits of rapid economic growth after decades of innovation. New technologies created exciting new ways of life, while art and music thrived on the waves of ideas and thought coming from the other side of the Globe. The “World drunk with eternal love and life” was in sight.

Mahler did not turn out to be an accurate oracle: the highest point happened to be a peak. The Short Century was to be about something other than the love affair between the individual and the Earth. And in it “the earth breathing full of peace and sleep” was a mere dream amidst the terror.

The Century passed. The history of listening to The Song of the Earth through the era of upheaval, the social oppression of the individual, and World’s unhappiness create a backdrop in which the height can now be envisaged as a peak, and we know that the future is not necessarily a straight path from the past.

The horrors of the wars and dictators of the 20th century could, perhaps, have been avoided with foresight. Probably not. Wisdom and leadership need a history of failures. They had no Globe to look back on, the History of the World had been merely a collection of national narratives. For us, it is very different.

Unlike our peers 100 years ago, we can conceive the precipice. And we have the association base that the abstract ‘hope’ needs to manifest in action.

We have the Earth now. Our dreams are still the same. The Song of the Earth may turn out to be prophetic. This time.

“Everywhere and forever the distance shines in bright and blue.”

(Notes from 1 October, Budapest Festival Orchestra playing Mahler’s Das Lied von der Erde, SBC, London, with the super-human voice of Christianne Stotijn, conducted by the genius, Ivan Fischer. )

Friday, 3 October 2008

The Tiger

My Dear Friends, People of Denial. You amaze me.

Don’t you ever wonder why your Explanations and Explications, your Wisdom of Experience, your Expert Authority are so cheap, useless, and empty? These days.

Do you ever suspect that the world financial meltdown might reflect something more than ‘greedy CEO’ contracts encouraging “risk-taking culture”? (Wasn’t ‘greed’ meant to go with being a corporate leader, anyway? Isn’t risk-taking culture the essence of a sophisticated financial sector? Isn’t every word about CEO compensations pure populism?)

Do you really think that the financial engineering of super-highly leveraged derivatives could bring down the entire global economy even if it were under-regulated? Wouldn’t existing policy tools be able to deal with the intermingled mess if something else was not looming in there? (Something large, dark, and unknown...) Wouldn’t you need something more to explain why the over-packaged non-transparent risk bundles have not been sorted out in the last 18 months, since we have known for sure that they are around?

Isn’t it that our assessment of ‘risk’ comes from a particular framework? Notably the same one where Your Infinite Wisdom originates? Isn’t it that pricing risk essentially relies on a particular understanding of the entire system? Isn’t the problem really with our current definition of ‘the entire system’?

Aren’t all of these excuses really denials about the need to go and discover that large, dark, unknown Something?.

Could it be that our perception of what the ‘system’ is, and what we imagine about the ‘way-it-works’ are wrong. In other words. That we have been modelling a different ‘economy’ to the one that is really out there, and we have been mistaken about how it moves, reacts, behaves? If so, we would be screwed, wouldn’t we? We would have incorrect ideas about what the risks really were, and we would price them incorrectly. And when the inevitable troubles came, it would be impossible to pick an effective instrument to sort them out.

Huge piles of incorrectly priced risk bundles and inadequate policy tools? That’s what that would mean.

We are screwed.

It is as if we were vets, and an animal was brought in, in urgency. We rush it to the operating theatre, and get down to saving it. Only gradually occurs to us that we have got the species wrong. “Professor, shall we opt for the sedatives after all? I am not sure if bunnies should have teeth of this size.”

Tuesday, 30 September 2008

Expectations Bail-Out

What is a bail-out?

It’s just a promise.

A government bail-out of a private company is a promise to provide assistance such that some socially important function of the company can survive without discontinuity. The most often used form is short-term liquidity provision during bankruptcy. However, the ‘assistance’ could be provided in many other forms than mere cash (e.g., procurement orders). You, as the government, do this so that some vitally important products or services are not disrupted, or so that the reallocation of a large part of the labour force does not burden the social security system, etc. Typically, it is a systemic function provided by the private sector that you want to save.

The point here is that the bail-out is usually not immediate. It is a promise for future action. It is the promise itself that provides the stability. Frequently, the delivery is not needed or is not regarded as important when it actually takes place.

When a government offers a large pile of future cash, as in the case of the embattled Paulson Plan now, what is really promised is not the same as the number cited. It is only a “huge number”. It is managing expectations: it serves as a guarantee that the government will provide all the cash necessary to reduce the disruption to an acceptable level.

And this is the problem here.

The power to make such a promise can come from three sources.

First, the government may sit on enough cash to deliver. This is by far not the case now. None of the Western governments have much cash, especially compared to the size of their financial sectors (although there are small exceptions, like Norway). If they had, the power behind the bailout promise would come from their ability to cover the entire system. When the government offers cash on hand, it is essentially playing on expectations based on unrealistic assumptions about the ability of governments. Playing on omnipotence can get you only so far.

Second, the governments can promise future tax revenues, say by announcing that the money needed for the bailout would be borrowed first, and then the repayment needed would be raised from the tax base. However, the indebtedness of most western governments is substantial. That of the US is so large that it would not be able to get membership in the Eurozone. Thus raising the kind of money needed to fully back the financial sector would be impossible. Furthermore, what would be the source of new loans in a global financial crisis? From whom would you get that kind of money?

Finally, and most importantly, a future tax-revenue-based bail out in the magnitude of the annual GDP is unrealistic, to be euphemistic. (One year of US GDP could cover only around one-fourth of the US financial sector, and then the global linkages have not come in yet). You cannot promise to save the entire economy from collapse by promising money that you will collect in the future from the same entity. Thus the implicit promise of a full government guarantee, plays on the assumption that only a partial guarantee will really be needed.

Which leads to the third source of power:

The power of the bail-out promise could come from the government’s singular ability to change the rules. This reads something like this: “I do not have enough money to buy you out. And I cannot possibly promise to raise enough money from you in the future to buy you out now. But I could promise to change the rules under which you operate. Then I could claim that you will be in better condition in the future. If you do believe this then, arguably, you will be in a better condition. Then I can promise to raise taxes from the healthy-you in the future, and thus I can even promise to back you up with money now…”

This argument is entirely based on the assumption that there is a way to change the rules such that the current chaos is sorted out, and not repeated in the future. Hence all the sudden talk of socialism. That would change the rules, that is for sure. Some people might even believe in it. But you would need a mass change in the way western societies view themselves for such an expectations-bail out to work.


All of these expectations are based on a framework of thinking which is rapidly going out of date. Since 16 September we have been re-evaluating what is possible.

Which brings us to the ultimate question: can the US government, or any government, credibly promise to deliver systemic solutions now? Doesn’t this crisis, which is still in its early days, reveal that there is a need to replace the national level economy-management toolbox with global policy institutions? Could any local solution be a remedy even for the short term?

Monday, 29 September 2008

Europe’s New Golden Age? Fat Chance!

Europe could become the centre of the world, simply by not screwing up. Europe is big and loves government. But it will miss its chance for want of revolution.
When in globalisation, huge and mature is the best. The size of the European economy relative to that of the world makes it the largest economy on Earth that is both mature and integrated. The consequence: Europe possesses internal demand that could bridge over a global recession. 
Some emerging market people talk about China or Brazil being able to do the same. But this is a dream. Neither of these countries has made sufficient progress in economic transition to achieve a structure that could produce the necessary demand dynamics. As we have seen in numerous emerging markets before, hopes for a long-lasting domestic dynamo vanish shortly after the export impetus dries up. When things looked good, it was not that external demand had truly diminished in importance, it merely looked that way. Furthermore, despite the impressive expansion so far, neither of these countries is big enough to withstand a crisis. China is the size of Germany.  Brazil is the size of Canada. In comparison: the EU is larger than the US, Canada and Mexico put together. 
Furthermore, Europe’s potential to integrate its neighbourhood is much stronger than is the case for other regions. The number of people on the labour market with at least secondary-level education in Europe and its neighbourhood is more than double that in North America, for instance. At the same time, regional integration on a level even remotely similar to that in Europe is out of the question for decades in East or South Asia for obvious political reasons. Witness the ASEAN’s hopeless efforts at policy harmonisation. 
So Europe could be the dominant global region. If only there was a policy-making body to ensure that...
You must love your government. The European approach to governance makes it well-placed to withstand a global economic storm. Now is the time when it should perform at its best. 
Although, there are quite a few versions of the ‘European model’, the main theme is always the same, based on the notion of collective responsibility among independent individuals. 
The pure version is the semi-socialism of Scandinavia. The four North-West European countries have the largest presence of the state in the private economy of any other country group north of the 10,000-dollar annual income per capita mark. (Their tax revenue share of GDP is a staggering 47% as opposed to the rest of Europe’s 36% and the non-European OECD countries’ 29%.) But, crucially, their large state works: in the ‘institutions’ bit of the World Competitiveness Index, the four Scandinavian countries occupy four of the top eight slots. Markets and socialism clearly can form a good team. 
The rest of Europe acts out a series of variations on the pure case: lingua-etatist France, inflexible but strong Germany, the would-be socialist Mediterranean, the dreaming-of-being-different Britain, and the large-state-rampant-corruption new kids in Central and Eastern Europe. Still, even the UK, which sees itself as closest to the US model, will at one point have to come to terms with the reality of having strong state involvement. (Just as a passing example: the nationalisation of Northern Rock was swallowed much more easily than the US’s Fannie Mae and Freddie Mac a couple of months later. The temporary outrage subsided in seconds on the etatist-side of the Atlantic.)
European economic history is evidence that strong government - if done badly - may translate into non-performing economies. But if done well, it can create a framework in which the private economy thrives. Moreover, and critically for the current crisis, it can provide buffers against external shocks. It is, you could argue, to the latter form that Europe’s economic management needs to converge. And - there it is, or would be - the world’s new economic leader born.
Or maybe not...
A sclerotic pensioner with the identity problems of a teenager. A couple of years ago I was invited to moderate a roundtable discussion on the ‘European social model’. I wouldn’t have subjected myself to the pains of discovering the meaning of this concept, had the conference not taken place in one of the most beautiful Mediterranean villages, in Turkey. (I would have brushed up on the Inquisition for that…)
So when my friends called to say they needed a last-minute replacement chair, I signed up right away, although I did not know anything about the topic. (Shameless, I know.) I spent the following two weeks learning about the origin of the concept of the ‘European social model’. What I found was complete intellectual chaos. There is no common element - zero overlap in the 15 or so different definitions that are in use. The term does little more than fill the vacuum left by the absence of real common identity. It is empty. 
The elites that created the EU, an otherwise sensible project, failed to design a way to react to a crisis like this. There is no EU-level institution that could deliver the kind of governance that would make the European economy live up to its global potential. The current EU is a decrepit, ineffective and largely illegitimate body, more like a labour-union committee than a source of global leadership or cutting-edge governance. 
As we learned in the Central European transition countries, it is much easier to build brand new institutions than reform the old ones. The temptation is to ‘mend’ the system rather than truly reform it. Re-form it. ‘Mending’ means more regulation on top of the overbearing current regime, it means larger state French-style rather than re-thinking the content of governance Scandinavian-style. 
The institutional scleroticism of the unfinished EU calls for complete overhaul. But, for that, we would need a way to decide what ‘Europe’ is. In a legitimate way, in the form of Demos Kratia.
Funny how the European society, arguably the origin of globalisation, manages to react to the global challenges with the worst combination of age and youth.  It is as sclerotic as an elderly pensioner, but with the identity problems of a teenager.  Wisdom and dynamism would be a much more promising combination.

Thursday, 25 September 2008

The quiet contagion

The World’s complacency is deafening.

The ‘explanations’ coming in from around the Globe take a surprising range of forms. All kinds of factors, all kinds of reasons, why that one country, that one region, or even that one city will be spared by this crisis. The denial is the only common element.

For instance...

No, China is fiiiinnnne. More of a problem is the domestic slow-down, if anything, really. But you know what, we’ve been worried about overheating so long. A bit of slow-down is great.

Or: Australia has an excellent banking regulatory system, unlike the US. This is not going to hit us here. We are not worried.

Or: Ah, Japan is a different case. The Americans’ crisis is more of a buying opportunity.

Or: Hey, the Brazilian economy is taking off. The momentum is domestic. Maybe the export markets will get rattled a bit, but there won’t be much lasting effect.

The first thing you learn in the emerging markets business is to suspect arguments about exceptionalism. If everyone is making such arguments amidst a global crisis, that should sound alarms.

My forecast is that there will be a slow, quiet contagion. For a while the (primarily US) policy alternatives will dominate the agenda. A lull of complacency will come in. We will hear a lot about the situation-being-not-so-bad.


Can you assume that this crisis is not going to impact consumer confidence in every place on Earth with a TV? If you are to decide to buy a new car now or delay, what would you do? How about real investment? Would you jump into a new venture at this moment? Or, would you finance one? If you were a retailer, what inventory strategy would you go for? Would you pile up as much as possible, leaving orders for more, or rather risk running out of the current stock first and see how people react to the new realities?

At one point, the hit to the real economy will become undeniable, and the global macroeconomic elite’s hope-bubble will burst.

This might be a good point to recall that the first life-boats to leave the Titanic were two-thirds empty, for lack of interest…

Tuesday, 23 September 2008

A week-old blog

What do you think?

It was the second day of the crisis when I started this blog. A week ago. It now has six postings, somewhat varying in style and depth. It would be rather useful for me if you gave me feed-back. Its direction, the topics, everything. Please.

Monday, 22 September 2008

Newtonian gamble

It is 1947. The Cold War is starting. A group of defence strategists get together to figure out how to best tackle it. They start with the analysis of the world war finished only two years earlier. They focus on details, where, of course, the devil lives. Weapons, or in general ‘military technology’ is all based on Newtonian mechanics. That is, the weapons that count. Or rather, the weapons that have counted so far. The world war was fought and won with arms from the pre-Einstein age. The two nuclear bombs, used at the very end, did not have much military effect. 

How large a mistake that would have been. To form the defence strategy of the 1950’s ignoring the reality of weapons based on quantum mechanics.

This is the recurring thought I have had reading the end-of-week press digesting last week’s ‘turbulent events’. Certainly, some regulatory armoury proposed in-line with the old thinking might still be appropriate. (Just as Newtonian mechanics does not contradict relativity theory, but is merely a sub-case -- and anyway you can use it to efficiently calculate the trajectory of the defence rockets that are to take down the incoming nuclear warhead-carrying missiles.) Most other ‘Newtonian ideas’ miss the point. For instance, it makes no sense to call for the regulation of executive pay. Do the politicians and their economic advisors (surprisingly from both ends of the political spectrum) really think that the current global meltdown is due to the contract structures of CEO’s? Even if they did encourage a risk-taking attitude?

At the start of last week, it looked as if the coming days were to bring the worst that could come, but would also lead to an entirely new world: the rise and definition of a global-economy-management institutional framework. It has happened to some extent. The US treasury secretary (who overnight has become the fiscal policy opinion leader of the world) is calling for semi-harmonised global treasury action, but with operations staying strictly on the national level. However, the big opportunity to change the intellectual framework and to look ahead has been largely missed. 

Apart from some calls for new thinking in the tsunami of analyses, there is not much that is filtering through. The particular actions, although they look brave (or brash), are products of the old framework. And, mostly, they are attacked or supported with the narrative of the past. 

Furthermore, the actions focus solely on the problems that have surfaced so far. The benevolent observer could argue that by saving the US financial system, global financial contagion can be stopped. Even if it comes at an exorbitant cost to be paid in the future in terms of cash, as well as the mess the uncertainty about ‘rules’ will make. If the world financial system is saved, the argument may go, the real economy impact will be small, while global contagion will be halted. 

People with a more diabolical approach to life would suggest that the wished-for buffering of sectoral and global contagion relies even more on containing the collapse in appetite for risk than on a direct cash injection. The sigh released by the markets at the end of last week is based on the axiom that the government, in particular the US government, is a risk-free institution. But isn’t what happened that the systemic risk coming from the potential collapse of several large actors in the economy has been reduced by shifting the risk onto the level of the entire system? Making the assumption that the system - the framework in which the individual actors operate - is unquestionably stable is an intellectual cheat.

Just as the Cold War turned out to be about perceptions of the two sides’ nuclear abilities, it seems that the perceptions of the global economic framework might turn out to be as important as the national-level regulatory weaponry. It is time to move beyond the era of Newtonian regulations if we are ever to reach the global economics theory of relativity.

Saturday, 20 September 2008

Hugging China

Here is a question to you. If you were a geopolitical strategist working for the Chinese government, what would you be thinking about the global banking crisis?

First, your country’s exposure in US capital markets has just been dealt a substantial blow. Clearly, pulling out now is not an option, the drag on the market would be insufferable. (However, the US government bailout implies a free ride for you, as well.) 

Second, your speech writing tasks just got easier. Just as the rules have gone, so has any possibility of credible American lectures. Pretence international selflessness gives way to blatant national selfishness. At least one aspect of economic diplomacy just got easier.

Third, your global strategy space has widened considerably. There is a ripple across the meagre international policy architecture. The depth of this ripple as well as the lightning speed with which it has opened up, creates an appetite for designing global institutions. The previous status quo that so many newly emerged economies, first of all China, had outgrown is now in question across the board. It is the perfect time to push through your own reform agenda. 

Furthermore, the relative positions could not be more favourable for you. Your domestic economy has little direct exposure now, even though the long term Chinese buffers are probably substantially overestimated. (We will learn a lot about the internal dynamics of the Chinese economy the next months.) What might be more important is that your new allies, developing countries with inefficient economies but a lot of natural resources, will be hard hit, and would welcome a ‘global insurance pool’, otherwise known as a short term umbrella in exchange for access to assets. 

A combination of these would create a formidable Chinese negotiating position. If China were in alliance with many developing former Western-affiliated countries (Indonesia, and many states in Sub-Saharan Africa come to mind), it will have the flow of raw materials insured. The financial blow to the Chinese state assets will not have a direct impact in all, but the full-meltdown scenarios. The domestic real economy will be on a dynamo for a while, even if a slowing one. And any basis for western arguments against China’s ‘influence’ on its currency has just been blown up.

In short, China will feel little impetus towards playing a constructive role in building up the new global institutions the West will suddenly be so enthusiastic about. Maybe this is the moment to throw open arms, and give China a big, warm hug.

Thursday, 18 September 2008

The Cacophony

The closer you are the more worried you are.

The analysing is almost as frantic as the markets, but there is clearly no agreement even about the basics. Neither on causes, nor on consequences.

The regulation-optimists. A.k.a. the ‘ultimate-denial-people’. The more political function you have, the more likely you are to be here.

The regulation-optimists see the current crisis as primarily caused by lack of adequate regulation. Thus, the solution is to have more of it. As if ‘regulation’ was a type of custard of which you pour more if you want. There is little consensus in the substantive discussion about the details of what is being proposed. The only recurring theme is that it should have been less easy to lend. Really? So all the financial innovations that would allow structuring risk should be out of the window? Is the argument really against sophistication? Oh, no, comes the answer, it should have been less easy to lend to risky people. I see, so your argument is like reacting to a mass highway accident by turning rusty old cars into horse-drawn carriages, while keeping all the Ferraris.

The ‘this will pass’ semi-optimists. The more academic your are, the more likely your argument goes in this direction.

The study of economic history provides a comfortable backdrop against which what is happening now is not necessarily that unique. You are probably using the phrase “yes, that is correct, but history would suggest that…”. And, of course, you can also point to the - historical - fact that market people and politicians always overreact in times of crisis, always ignoring the lessons of the past. It is very difficult to argue against you, for (a) the facts of the past are on your side, and (b) people did try to claim at every crisis in history that their one was special.

The return-to-decoupling semi-pessimists. If you have a strong exposure in China or the Gulf, the idea probably has already crossed you mind. (Russia, with perfect timing, ruled itself out of the oh-no-we-are-immune club.)

The concept of decoupling, very badly defined most of the way, was rather fashionable up until around a year ago. It started with the revival of the ‘global regions’ notion, and ended up using macroeconomic variable clustering. After the fifteen-weeks of fame, however, the idea-bubble had burst, being pointed out that intra-regional trade patterns in East Asia were just catching up to the global level of integration, and macroeconomic convergence is actually the opposite of decoupling. Now, the idea is coming back again. Although the arguments tend to be mostly emotional (“please, please, let something stay safe, I will be good, I promise”), at least we will have the ultimate test of the hypothesis.

The armageddon type. The closer you are to action, on the markets, or in media, or in policy, the more likely you are to be in this category. Disturbingly, that is true within the armageddon group itself: the most worried people are the ones who really see what is happening.

Soldiers tell you that people who get hit by a bullet will most often go into a state of disbelief. Although you have seen this happen to others, you just do not believe that it is happening to YOU. This denial seems to be the only general characteristic of the reactions now. People seem to ‘get’ what happened so far, but the improbable nature of these events make forecasting the consequences emotionally difficult. However, those who are closely involved with sorting out the crisis, and in that are making up new rules, and trying to invent new policy tools, have no choice but to come to terms with the depth and width of the trouble. They are talking about actual banks that will come next, rather than the generalities of financial contagion. They are discussing the collapse of actual countries rather than pondering if the ‘world economy could turn into recession’. Very worrying.

To sum up, imagine that you are rushed to the hospital, you don’t feel well, and a bunch of doctors come up to you. The first one says, oh, no problem, a bit too much running around with wet hair, perhaps; we will sort you out now, and then you just have to make sure you put a hat on from now on. The second one ponders that, well, you do have a nasty flu, but in the past you survived all of them, no? Nothing to be worried about. The third one announces that although, for some odd sounding reason, they will have to chop a leg and and arm off, the good news is that you will have two limbs left. And then comes the fourth, who turns out to be a specialist on your rare virus, examines you thoroughly, and then she comments on how interesting tomorrow’s dissection will be.

Wednesday, 17 September 2008

Rules versus discretion…

This is the end of market capitalism as we know it. 
Imagine this, someone asks you a week ago, to assign a probability to the Fed taking 80% share of AIG and thus the most important central bank of the world effectively nationalising the largest insurance company. Would you have just laughed? Or would you have bothered to actually say less than 1%? Or would you have got bogged down in giving a lecture on the main principles of economics, and explained - probably slowly - the idea behind rules versus discretion? 
Clearly, somebody got very scared yesterday. They did halt the immediate meltdown with one bold move. But they also considerably upped the stakes.
Short term worry one. Large. This move implies the promise of nationalisation of the entire US economy in a meltdown scenario. Not only participation in the risk pool is not voluntary any more, but the state now chops off the end of the distribution. Although a systemic collapse has been averted, at least for the time being, uncertainty about the framework in which the risks are being priced has increased considerably. Not only are we on a sailing boat out at sea in the middle of a big storm, but at the same time, someone is shaking the entire Earth. A whole new meaning to ‘choppy waters’. 
Short term worry two. Very large. This week we have seen the unthinkable. So, here is an ‘unaskable’ question: is the Fed large enough to deliver the implicit guarantee it made? What happens if the gamble of nationalising AIG does not pay off? There are a lot of signs, and even more rumours, about a host of other ‘immediate’ collapses. How much can the Fed and the US government pretend to be merely a clearing house and bankruptcy manager before the markets start discussing the limit to which the Fed can, rather than wants, to go? What would that do to risk perceptions? 
Long term worry. Gigantic. Rules are out of the window. In fact the concept of ‘rules’ is out of the window. Ad hoc solutions may be necessary in an emergency, but they nevertheless form expectations and change the perceived rulebook. How high can a pyramid of impulse actions be built before it collapses? This may seem a secondary worry now, given that the world has not yet sunk into abyss by mid-week, an achievement in itself, but will form very hard constraints in building up the post-crisis institutions. 
Global worry. Unknown magnitude. How much implicit global risk has the Fed taken on? Where is the legitimacy and mandate for that? What will the ultimate backers, the US taxpayers say about it? How adequate will the Fed’s implicit global economic management be for the rest of the world, either country by country, or - more importantly, for the entire global economy? There are strong arguments that what is unfolding now is the first truly global crisis. It’s not very likely that the unilateral approach from the US would be more successful in dealing with, say, global security issues. 
The last few days have changed the way we think about market economies. Systemic mispricing of risks, and thus collapsing financial institutions, could themselves be attributed to the globalisation of the effective economic systems in which these risks occur. We thought that new, global models would solve the problem. Now, the very foundations of the discipline of economics are being altered. Up until the rise of ‘unified macroeconomics’ the debate was between the proponents of a large state and those of a small one. In the past two decades this has given way to a new narrative, about what the state does irrespective of its actual size. Governance, institutional competition, and quality of government services are what mattered. This was, in a way, a downgrading of the state. You are not sovereign any more. You have to be smart. You have to compete for people and capital. What the Fed has done, the most unlikely institution to do so, has put the role of the state at centre-stage again. 

Tuesday, 16 September 2008


It is very interesting to see how the narrative about the current crisis, which in my view is clearly a global one, stays on the national level. This is true for the policy makers, the media, as well as the investment banking chatter. Part of the reason is that the institutions that could do something about it are on the national level, such as central banks, treasuries, as well as regulatory bodies. However, that is perhaps the problem: current regulation, monetary and most of the fiscal policies operate on the national level. And not only the legitimacy and the mandate come from local rather than global entities, but the intellectual focus, the data, and the models stay there too.

As a consequence, we tend to overemphasize the national at the expense of learning about the global. While things were looking bright, prices tended to go up, and risk aversion was at historical lows, this did not matter. It was only a few scarecrows scratching their heads. Now, amidst the crisis, this limitation might impede effective intervention.

It seems that although there is a general recognition about ‘new economy’ and ‘globalisation’, the economics profession, as one, comes to terms with the new reality with a considerable lag. Thus, we keep discussing localised effects, either in geographic or in sectoral sense, rather than getting down to dealing with it on the global level. In the old times, when, say, a national economy recession took place, the economics profession did not have separate solutions for only part of the country, or a few sectors. The entire economic system was modeled, with the sub-national regional or sectoral dynamics making the analysis more refined, but only as part of the overall model or policy.

Now, it's as if we only focused on parts of the global economy, trying to figure out the dynamics of only that part, while ignoring the rest. If the global economy really is a system, this is not very likely to work.

The perfect day to start a global economy blog

Today is the perfect day to start a global economy blog. This could be the very first truly global crisis. So far all previous economic and financial crises were limited geographically or in sectoral width. Most emerging markets had been closed, and the relationship network among mature economies was too loose for a crisis to really impact all. Even the 1929-1933 meltdown or the two oil shocks of the 1970’s were reaching only part of the globe. This is not the case any more.

Will the entire banking sector get affected? Just look at the list of the banks that are dead worried now. They are not only ALL the large international banks, but also - of course - ALL the medium sized regional banks, as well. There is no large region or country with a financial sector of any sophistication in the world that would have been left insulated by today’s shock.

Will it spread to the rest of the economy? It already has. Liquidity is the staple for the entire economy (well, at least the monetised bit). But, maybe more importantly the risk appetite is gone. Funny how we have been laughing at the ridiculous levels of love of risk in the past years, and now there is NONE left.

I bet the biggest problem now is that the information systems of the ‘investment banking community’ (if there ever was anything community like about investment banks…) are not good enough and fast enough to reveal the extent of the damage that the folding of Lehman brings, as well as the danger lying in WaMu, AIG, and the host of others everyone is talking about. A lot of running around this week.