I found Larry Elliott and Dan Atkinson’s book The Gods That Failed on the credit crunch and the build-up to it to be both interesting and amusing. The book uses the colourful analogy of the ancient Greek gods on Mount Olympus when considering the powerful forces of the international financial markets. They are portrayed as capricious gods who promised wealth and prosperity to people and nations if only they would sacrifice their business regulations, welfare states, nationalised industries, trade union rights and progressive taxation systems to it. They have failed to deliver on this. Their ‘servants’ – the wealthy businessmen, traders, journalists, academics, politicians and opinion-formers – who promote this ideology as portrayed as the ‘New Olympians’, living on Mount Olympus distant from the sufferings their favoured policies have inflicted on mere mortals down on earth.
The key points in the book are that the economic growth in Britain and the US over the past decade and a half has been mainly caused by consumer spending. This consumer spending has been sustained, to a significant degree, by taking on more and more debt. People’s consumption has been growing faster than their incomes. This may be partly because people are becoming more acquisitive but, also, because incomes for those on average and below-average earnings have not been growing as fast as they were in the 1945-73 period.
The low interest rates of the period since the early 1990s have also encouraged two things. It has encouraged asset price bubbles as people are more able to borrow large sums of money to buy property since the interest payments are low. Also, the low rate of interest has tempted institutional investors into more risky investments as part of a ‘hunt for yield’.
The financial markets have also developed more and more advanced systems for lenders to pass on their loans to others. Mortgages can be packed into mortgage-backed securities, collateralised debt obligations and other such weird financial instruments. This makes it increasingly hard to calculate risk. It doesn't matter to a company if they have made a risky loan if they can then pass it on to another firm.
Additionally, the growth in derivatives and related instruments mean that holders of some financial instruments are not hedging but magnifying their potential gains and losses from any given movement of share or commodity prices. That is all well and good if, say, someone has bet on silver going up in price and it does. But, if they have bet on it going down in price, their loss is magnified in the event that it rises in price. They could be obliged to close down their futures contracts at a huge loss to themselves. Given that a lot of these speculators are not playing with their own money, but with the money of banks, pension funds and others then this has huge potential problems.
The authors also highlight the large trade deficits of the US and the UK. Although some aspects of the asset price and debt bubble are common to lots of countries, the UK and the US have the additional problem (that Japan and Germany lack) of a large trade deficit. That means they have to borrow money from, say, China in order to buy Chinese manufactured goods. The Chinese are lending us the money to buy their own exports. The oil-rich Middle Eastern states are doing the same, as is Japan.
In a sense, the economic boom of the 1990s and early 2000s has been artificially prolonged and exaggerated by us mortgaging our own future. There is only so long that China will be willing and able to lend the developed countries money to buy its products. As the UK and US get more indebted and more pressure falls on sterling and the dollar, the more likely it is they will fall in value. If so, the value of Chinese and Japanese assets in the UK and US falls. That will mean that they will more or less have to sell up – causing even further falls in sterling and the dollar. There is only so long that Chinese consumers will be willing to save a lot of their meagre just so that the nationalised banks and related enterprises of the Chinese economy can lend money to firms that then lend it to richer American consumers.
The book does launch a number of criticisms of the ‘Left’ – the core of it being that, because of its focus on ‘identity politics’ and ‘post-material’ issues – it has taken the eye off the ball and let the deregulation of the financial markets go unchecked. The book is written by the economics correspondents of the Guardian (Elliot) and Daily Mail (Atkinson). The Daily Mail’s dislike for the ‘nanny state’ is manifested in the chapter that talks of the increased public expenditure of the early 2000s contributing to growth but that this growth was not well-targetted. They seem to think that too much money was spent on employing people to deal with ‘equalities issues’ and to change public behaviour (e.g. health education, parenting classes, the smoking ban). There is perhaps some truth to the charge that, as parties of the left became more pro-market, they switched their radicalism to social issues. However, there is a danger of over-egging the pudding on this. After all, social issues are important as well and anyone who calls themselves progressive would not like to go back to an era when racism, homophobia and so forth were more socially acceptable. Also, although issues like anti-alcohol and anti-smoking campaigns may seem like a ‘nanny state’ matter it is legitimate for the state to wish to improve the health of the population. That should be part of its role to improve the general welfare.
The other respect in which the book does not take a ‘conventional’ left stand is in their desire for what they call an ‘independent middle-class’. They do mention that the tide of market forces has swept away trade union rights and job security for the working-class. They also mention that the ideology of deregulation means that the position of middle-class professionals such as doctors and lawyers and the position of small businessmen are challenged. They want to see the government making a greater effort to protect them – since they see an independent middle-class as an important part of civil society. From my point of view, that’s all well and good, but the priority must be to help those at the bottom of the pile more than them.
Their solution to the credit crunch and to prevent it from happening in the same way again is to put finance back in its cage. This was achieved prior to the 1970s and it could be done again. One key point they mention is the Glass-Seagall Act in the US in the 1930s. That existed for decades and separated out retail banking from investment banking and other more speculative activities. They think that should be reintroduced in the US and introduced here in the UK. That would stop problems in the financial markets directly affecting ordinary savers and borrowers so dramatically. In addition, certain credit and capital controls are suggested. This would make finance the servant of the real economy rather than vice-versa. The sticks suggested to make firms obey these new laws rather than evade them are making it clear to firms that limited-liability, trusts and fractional-reserve banking are privileges. The state could threaten to remove these privileges from firms that abuse them. Unlimited liability would definitely make company directors less reckless with their firm’s money.
The book also points out that the government could ask for all new financial instruments (CDOs, MBSs and other such devices) to be pre-approved. If an instrument has not been approved, then the courts would refuse to enforce contracts concerning it. There is always the danger of companies and individuals moving their money overseas but this is over-played. As Elliot and Atkinson point out, governments let them be too easily blackmailed by this threat. In practice, even if two Channel Islands or Cayman Islands companies come into dispute they will need to have the judgement enforced in the UK. Otherwise, how can a trust in these tax havens exercise control over a business with workers in the UK? After all, the productive economic activity of the world – on which a lot of the finance industry is parasitic upon – is based in large nation-states not in little tax havens. It is not the tax havens that produce the wealth of the world, but the efforts of workers throughout the globe. The governments of the lands that those workers live in can use their sovereignty to prevent profits from these activities seeping away into tax havens.
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