mazzucato and coogan Mallaby and ferguson
This has happened before.
The current financial crisis has only one parallel: the Wall Street Crash of 1929 and subsequent Great Depression of the 1930s, which crippled the future of an entire generation and set the stage for the horrors of the Second World War. Yet the economic meltdown could have been avoided, had it not been for the decisions taken by a small number of central bankers.
In Lords of Finance, we meet these men, the four bankers who truly broke the world: the enigmatic Norman Montagu of the bank of England, Benjamin Strong of the NY Federal Reserve, the arrogant yet brilliant Hjalmar Schacht of the Reichsbanlk and the xenophobic Emile Moreau of the Banque de France. Their names were lost to history, their lives and actions forgotten, until now. Liaquat Ahamed tells their story in vivid and gripping detail, in a timely and arresting reminder that individuals - their ambitions, limitations and human nature - lie at the very heart of global catastrophe.
Lords of Finance: The Bankers Who Broke the World By Liaquat Ahamed Penguin, 576 pages, $32.95 FT Bookshop price: £16 When the history of the current financial crisis comes to be written, the battle of the index entries will surely be won by central bankers not politicians. The name Bernanke will appear on many more pages than Bush, King more often than Brown, and Trichet will trump even Sarkozy. Most of the time, central banks strive to be dull places; the people who run them relish their obscurity. But when crisis strikes, the limelight shines. The last great liquidity crisis to hit the global financial system happened 94 years ago, at the end of July 1914. It paralysed the wholesale money market, closed the world’s stock markets for months and necessitated unprecedented government intervention in the banking system. Rightly, this is where Liaquat Ahamed begins. A semi-retired investment manager, Ahamed set out to tell the story of the four dominant central bankers of the inter-war period. He cannot have foreseen how timely his book would be. Unlike most works on the origins of the Great Depression, Lords of Finance is highly readable – enlivened by vivid biographical detail but soundly based on the literature. That it should appear now, as history threatens to repeat itself, compounds its appeal. Ahamed’s four central characters are Émile Moreau, governor of the Banque de France; Montagu Norman, governor of the Bank of England; Hjalmar Schacht, president of the German Reichsbank; and Benjamin Strong, governor of the Federal Reserve Bank of New York. By 1926 they constituted “the most exclusive club in the world” but in 1914 they were largely unheard of. Norman was a partner at the British affiliate of US merchant bank Brown Brothers. Neurotic and prone to bouts of mental collapse, he lived in a large, gloomy house off Holland Park, surrounded by furnishings of his own design, listening to Brahms and dabbling in spiritualism. With his long ginger beard, he looked more like a boulevardier than a banker. At the other extreme was Schacht, a Hamburger who affected the stiff gait of a Prussian reserve officer, complete with bristling moustache, high celluloid collar and fierce glare. In 1914 he was rising through the ranks of Dresdner Bank. Of the four, Benjamin Strong was the furthest advanced: president of the powerful Bankers Trust Company, an offshoot of the financial empire of JPMorgan. His troubles were purely personal: a first wife who committed suicide and the onset of the tuberculosis that ultimately killed him. Moreau, meanwhile, was a happy, healthy civil servant whose career had taken a wrong turning. Having served as chef de cabinet to the scandal-prone finance minister Maurice Rouvier, Moreau was sidelined at the Algerian central bank. The war and its traumatic aftermath transformed all their careers. An architect of the Federal Reserve System, Strong accepted the governorship of the New York Fed in 1914. Norman joined the Bank of England in 1915 and became governor five years later. Schacht had a less good war but re-launched his career in 1923, when hyperinflation had rendered the German currency worthless: having successfully introduced the new Rentenmark currency, he was appointed Reichsbank president before the year was out. Two and a half years later, political crisis propelled Moreau into the top job at the Banque de France. The task facing these four men wasn’t small. After the first world war, victors and losers alike were saddled with immense foreign debts; all the European currencies had depreciated to varying degrees. The myriad new trade barriers made it ever harder for debtors to earn hard currency from exports. Outwardly, as Ahamed shows, the central bankers seemed to co-operate. Their frequent peregrinations across the Channel and the Atlantic attracted febrile press speculation. (So over-attentive were the reporters that Norman even took to sailing under an assumed name, “Professor Clarence Skinner”.) Friendship flourished between them; “Dear Strong” and “Dear Norman” became “Dear Ben” and “Dear Monty”; Norman made a point of cultivating Schacht. The exception was Moreau, whom Norman couldn’t resist insulting and who declined when Strong invited them all to New York in 1927, a year before his untimely death. Yet for all their communication, the four failed to reach an optimal resolution of the world’s financial problems. Strong encouraged Norman’s quasi-religious faith in the restoration of the gold standard, and helped finance the British return to the prewar dollar exchange rate. Yet Strong never allowed the gold standard to work as it was supposed to, systematically counteracting (“sterilising”) the effect of gold inflows on the American money supply. Meanwhile, Moreau intervened against the franc so the French currency was undervalued, ensuring export surpluses and the rapid growth of the Banque de France’s reserves. Schacht, on the other hand, obsessed about flows of hot money into Germany and the continuing burden of reparations on the German balance of payments. The result was that what we would now call “global imbalances” were not reduced, even when economic conditions were relatively good. When Wall Street bubbled and then burst in 1928 and 1929, the Europeans wholly underestimated their own vulnerability. Norman saw the Wall Street crash as a boon for sterling, claiming the “credit” for having caused the New York sell-off by raising British interest rates the previous month. By the summer of 1931, however, it was dawning even on Norman that the world economy was falling off a cliff. With massive bank failures on both sides of the Atlantic, it became clear that the Lords of Finance had bungled things. “Unless drastic measures are taken to save it,” he wrote to Moreau’s successor at the Banque de France, “the capitalist system throughout the civilised world will be wrecked within a year.” (With a characteristic flourish, he went on: “I should like this prediction to be filed for future reference.”) Such apocalyptic fears were not new. As early as November 1918 Strong had warned Norman of a coming “period of economic barbarism which will menace our prosperity”. The irony was that their favoured prophylactics had, in combination, made the apocalypse more likely. By 1931 the capitalist system was on its knees, and democracy with it. Schacht was soon flirting with the rising star of the German right, Adolf Hitler; he later served as his economics minister. As the world teeters on the brink of another great financial cliff, we can only hope that the modern-day Lords of Finance will co-operate to better effect. I suspect none has much time for bedtime reading these days. But should Messrs Bernanke, King and Trichet need a reminder of what can go wrong when central bankers achieve only the semblance, but not the reality, of co-operation, Lords of Finance is the book they should read. As a matter of urgency, a Chinese translation should also be sent to Zhou Xiaochuan, governor of the People’s Bank of China. Niall Ferguson is a contributing editor of the FT and author of ‘The Ascent of Money: A Financial History of the World’ (Allen Lane)
Mallaby
More Money Than God: Hedge Funds and the Making of the New Elite, by Sebastian Mallaby, Bloomsbury RRP£25, 496 pages In the Soviet Union, the economy was run by the bureaucrats and their five-year plans. In capitalist economies, the job of allocating capital – picking which industries and businesses to fund, and which to let go to the wall – has been done by commercial banks, investment banks and, most recently, hedge funds. These freewheeling money managers shift cash rapidly between countries and companies, taking advantage of flaws in markets in ways that frequently produce eye-popping returns – and less frequent, but equally spectacular, implosions. Governments across the developed world are now trying to turn back the clock. No one is suggesting five-year plans, although the Chinese dictatorship is eyed with envy by some in the recession-ravaged west. But a concerted effort to undermine hedge funds and give governments more of a say in capital decisions is under way. Sebastian Mallaby’s contribution to this debate will not be appreciated by Angela Merkel, the German chancellor, or Nicolas Sarkozy, the French president who recently backed Merkel’s efforts to restrict short-selling, a tool wielded to deadly effect by hedge funds to make money from falling prices. In More Money Than God, Mallaby, a fellow at the US Council on Foreign Relations and a Washington Post columnist, argues that not only should hedge funds not be blamed for the world’s economic woes, they should be actively encouraged. The book sets out a warts-and-all history of hedge funds, focusing on the great names of the industry, starting with Alfred Winslow Jones. This former communist activist and friend of Ernest Hemingway stumbled on the money-making model in 1949, and claimed inspiration from Phoenician traders to justify taking a 20 per cent cut of profits. In his wake came some of the great names who dominated investing in the later part of the 20th century and the start of the 21st: Michael Steinhardt, George Soros, Julian Robertson, Stanley Druckenmiller, Paul Tudor Jones, Bruce Kovner, John Paulson and Ken Griffin. Many of their tales are already well told; several have multiple books dedicated to their exploits. But Mallaby manages to dramatise even heavily raked-over incidents, such as Paul Jones’s anticipation of the 1987 stock market crash, or George Soros’s successful assault on the Bank of England in 1992. He gets into the minds of the traders (“All I want to do is kill myself,” one minion told Michael Steinhardt after a losing investment; “Can I watch?” came the reply), and adds extensive historical and academic context without interrupting the highly readable narrative. Hedge fund managers may be attracted by Mallaby’s twin conclusions: “Governments must encourage hedge funds”; and “Don’t regulate” (he would relax this decree for the very largest, leveraged funds). But the stories he tells of how hedge funds made money could equally be used by German and French critics to support their calls for a clampdown as they negotiate final details of new European rules. Insider trading, market abuse and straightforward fraud leap out of the pages, from the very first days through to the recent arrest of Raj Rajaratnam, founder of US hedge fund Galleon Group. As Mallaby says of Rajaratnam, accused of running an insider trading ring, “He had no amazing special sauce, but he had a lot of special sources.” Mallaby makes clear that hedge funds are, at best, as pure as the driven slush. But he makes no apologies. “The case for believing in the industry is not that it is populated with saints but that its incentives and culture are ultimately less flawed than those of other financial companies,” he argues. For anyone unconvinced, he puts a lot of weight on the fact that during the recent crisis hedge funds managed to collapse – at the rate of 1,500 a year in 2008 – without government bail-outs. They were small enough to fail, unlike the too-big-to-fail banks. All the common critiques of the industry are addressed, from the trend-followers’ tendency to amplify market moves to hedge funds’ failure to consider liquidity issues (an expensive lesson for several of these latter-day masters of the universe). There are two points of weakness in Mallaby’s argument. First, he fails to deal effectively with the claim that hedge funds are too expensive. This is not just a matter of social envy. In the discussion of the best method of allocating scarce capital, the cost of the system chosen – the fees, in the case of hedge funds – is clearly an essential consideration. Mallaby attempts to contrast the industry standard fee of 2 per cent of assets a year and 20 per cent of a fund’s profits with investment banks paying half of turnover to staff. But revenue at a bank is a tiny fraction of assets, and even if it were comparable to hedge fund fees, which it is not, critics of hedge fund fees are hardly likely to be won over by comparisons with clearly overpaid investment bankers. Second, he skates over the problem of crowded trades, when all the hedge funds are doing the same thing. This is one of the major concerns of regulators: while no individual hedge funds may (for now) be too big to fail, a large number of simultaneous failures of small funds could take down a bank and start a new crisis. Picking holes in the argument is really an aside to this splendid account of the ups and downs of an industry in which few of the twenty-something hedge-fund wannabes know their history. They, and meddling politicians, should read this book before they are condemned to repeat it.
Who really creates wealth in our world? And how do we decide the value of what they do? At the heart of today’s financial and economic crisis is a problem hiding in plain sight.
In modern capitalism, value-extraction is rewarded more highly than value-creation: the productive process that drives a healthy economy and society. From companies driven solely to maximize shareholder value to astronomically high prices of medicines justified through big pharma’s ‘value pricing’, we misidentify taking with making, and have lost sight of what value really means. Once a central plank of economic thought, this concept of value - what it is, why it matters to us - is simply no longer discussed.
Yet, argues Mariana Mazzucato in this penetrating and passionate new book, if we are to reform capitalism - radically to transform an increasingly sick system rather than continue feeding it - we urgently need to rethink where wealth comes from. Which activities create it, which extract it, which destroy it? Answers to these questions are key if we want to replace the current parasitic system with a type of capitalism that is more sustainable, more symbiotic - that works for us all. The Value of Everything will reignite a long-needed debate about the kind of world we really want to live in.
Who creates value? Who extracts value? Who destroys value? If we mistake those who do the second or third for those who do the first, or mistake those who do the first for those who do the second or third, we will end up with impoverished and unhappy societies, in which plunderers rule. Many advanced western countries, in particular the US and Britain, have already reached that state, according to Mariana Mazzucato. The consequences of this, including soaring inequality and declining growth are already visible, argues the author, a professor at University College London and sometime adviser to political parties and international institutions. We need to change course, she insists, in this challenging and stimulating book. Among other things, we need to re-think the relationship between markets and governments; make a clear distinction between creators of wealth and those who merely extract it; embrace bolder collective ambitions, notably a shift to a greener economy; and spend on the future, instead of embracing a sterile and counterproductive austerity. The book is a successor to The Entrepreneurial State, in which Mazzucato argued that government has played a powerfully innovative role in the modern economy. This book’s big point is that it is far too easy for those operating in the market economy to get rich by extracting economic value from those who add it, not by adding it themselves. An obvious example is the way the financial sector generated a huge increase in household debt in the years leading to the financial crisis of 2007-09. This funded zero-sum competition to buy the existing housing stock at soaring prices. Its legacy included a huge crisis, a debt overhang, weak growth and political disenchantment. Yet, for those who created, manipulated and sold this debt, it was a gold mine. This represented value extraction and destruction. Government, not private businesses, created many of today’s most fundamental technologies — including the internet and the global positioning system Much the same picture can be seen in asset management, with its excessive trading, exorbitant fees, lack of transparency, poor stewardship and conflicts of interest. This financial sector, together with the “shareholder value maximisation” that economists have promoted, has had a malign effect on the corporate sector as a whole, argues Mazzucato, by encouraging excessive pay and also, partly to that end, manipulation of stock prices in preference to long-term investment. That it is hard to see much wider economic benefit from the massive increase in the relative size and influence of finance over the past half century seems self-evident. Today, many western economies are, after all, burdened by high levels of private debt, high inequality and low rate of productivity growth. If this is success, what might failure look like? It is not just finance that is in the dock. Mazzucato also attacks what is going on in more obviously beneficial sectors of the economy, such as information technology and pharmaceuticals. One of the problems here, she argues, is the award of overly generous or simply unjustifiable rights to intellectual property, such as the patenting of things found in nature or of trivial business processes. No less important is the emergence of concentrated monopoly power in a small number of huge online internet companies, such as Google and Facebook, whose very size and omnipresence makes them the only rational choice for potential users. Mazzucato does not only refer to activities whose benefits are exaggerated, if not entirely misstated, by the immense rewards of the people and institutions engaged in them, such as financial engineering. She also notes the significant activities of a sector too often assumed to generate no economic value: government. Government does more than enforce justice and provide security, she argues. It builds infrastructure, educates the young, maintains the population’s health, finances fundamental research and has often promoted economic development directly. The US government, not private businesses, created many of today’s most fundamental and transformative technologies: the internet and the global positioning system are two spectacular examples. A fundamental thesis of the book, however, is that mistaking value extraction for value creation, and vice versa, has its roots in the errors of economists. A lengthy section duly discusses the history of the idea of value in economics, from the mercantilists of the 17th century, to the classical economists of the 18th and early 19th centuries, and then the marginalists (or “neoclassical economists”) of the later 19th and 20th centuries. The classical economists, notably Adam Smith, David Ricardo and Karl Marx were, she notes, concerned about the distinction between those who created value, those who merely moved it around and those who lived parasitically on the efforts of others (such as aristocratic landowners). Those were both economic and moral distinctions. Neoclassical economists, however, such as Léon Walras, Stanley Jevons and Alfred Marshall, with their marginal revolution and idea of equilibrium, eliminated these distinctions: under the subjective theory of value, price is simply the best indication of (marginal) value: what is expensive is, at least at the margin, valuable. The choices people make are the only determinant of value. The economists’ focus on what is produced and distributed in the market has two further consequences, argues Mazzucato — government is, by assumption, unproductive, even parasitic, and household labour disappears from sight. These assumptions were carried over into the new system of national accounts developed in the 1930s and 1940s, from which our measure of “gross domestic product” was born. I understand why Mazzucato engaged in the lengthy (and itself interesting) disquisition on the history of theories of value. It might have been enough, however, to note that there are good reasons for believing in the pervasiveness of defective and rigged markets in actual market economies, as opposed, to simplistic models of them. Nevertheless, she does make a crucial point: what we value is a social decision and some of what we now value — complex finance, for example — are more a justification for value extraction than a plausible source of additional value. What is not measured does not count. But what is measured does. Mazzucato offers the reader an account of how value is attributed to the activities of banking. Its added economic value is currently measured by the cost of “financial intermediation services indirectly measured” — in other words, by the spread it charges between the cost of borrowing and the rate of interest on lending. The bigger that spread, by assumption, the more value banks are supposedly creating. This is to confuse a cost with a benefit. In Mazzucato’s view the evident failings of our economies are a consequence of our inability to distinguish among activities that create, redistribute and destroy value. This, in turn, emboldens value extractors (such as pharmaceutical companies that charge whatever the market will bear); it frightens off non-market actors, including bureaucrats, who might have been able to help create value; and it encourages policymakers to believe market solutions, such as the UK’s flawed private finance initiative, are necessarily superior to ones introduced by governments. What I would have liked to see far more of, however, is a probing investigation of when and how governments add value. The US government, for example, has played an extraordinary role in innovation, especially through the Department of Defense and the National Institutes of Health. Yet how far is this really relevant to countries with more limited economic and scientific resources? How can one ensure that governments do add value rather than merely extract and waste it? In her enthusiasm for the potential role of the state, the author significantly underplays the significant dangers of governmental incompetence and corruption. Nevertheless, the book has three significant strengths. First, Mazzucato pushes us to get away from the simplistic creed that markets are always good and governments always bad. Second, she offers the Left a positive goal of prosperity-inducing innovation rather than a sterile and ultimately destructive politics of resentment and redistribution. Finally, she forces us to ask ourselves what adds value to society and how to create an economic and social order that promotes that. The book itself adds value by forcing us to confront these points. The Value of Everything: Making and Taking in the Global Economy, by Mariana Mazzucato, Allen Lane, RRP£20, 384 pages
Paper Promises: Money, Debt and the New World Order, by Philip Coggan, Allen Lane, RRP £20, 304 pages History is a battle between creditors and debtors over the nature of money. The former want sound money and the latter want easy money. That is Philip Coggan’s thesis in his new book, Paper Promises, and it leads naturally to an explanation of the current credit crisis, along with all the great financial crises of the 20th century. Crises occur, in the Coggan view of history, when debtors fail to repay. At this point, because their interests have been reflected in the very nature of money, the financial system itself must be reformed. This happened in the 1930s, when the Great Crash led to the end of the gold standard, and again in the stagflationary 1970s, with the end of the Bretton Woods agreement. We are now living through another such crisis. Its resolution remains unclear but none of the available routes is palatable. Either the world must suffer through prolonged stagnation or see a massive default, or the accumulated debts of the past four decades must be inflated away. But the identity of the country around which the next financial system will be built is not in any doubt. That will be the world’s largest creditor, China. Coggan points out that the system always hinges on the greatest creditor, just as the US led the world during the Bretton Woods era and Britain led in the gold standard era. As for the repeated bubbles and crises of the past four decades, they can be traced to the ease with which money can be printed following the end of the last Bretton Woods tie to gold, and to the unprecedented growth of the financial sector, both in absolute size and in its share of the economy. These are bold and confident historical abstractions. But they do not seem so when reading the book. Coggan, a former Financial Times journalist and my predecessor as regular writer of the FT’s “Long View” column, covers the terrain with characteristic calmness and objectivity, avoids over-simplification, and laces his arguments with his trademark erudition. His references are wide-ranging. Shylock’s loan to Bassanio in The Merchant of Venice comes up. So do the family finances of the Forsytes in The Forsyte Saga (they lived off consols, a form of perpetual UK government debt). And so do the South Sea islanders who once threw a chest of gold into the sea, thinking it worthless, and kept on looking for precious cowrie shells, the basis of their own financial system. Most of all, William Jennings Bryan, the turn-of-the-century populist who ran three times for the presidency, functions as the book’s hero, or anti-hero. Ever since he made it his rallying call that Americans must not be “crucified on a cross of gold”, his spirit has lived on; debtors, Coggan points out, have always passionately campaigned for adulterated money. The writing is clear and concise. It is aimed at lay people, not professionals. The extremely technical concepts that necessarily arise in discussing the credit crisis are carefully explained from first principles. The alphabet soup of acronyms, from SIVs to CDO Squareds, is blissfully lacking. Finally, the book is free from the shrieking ideology that afflicts virtually all contemporary debates over money. Indeed, it offers a clear explanation of the fresh ideological divisions that have arisen over how to deal with the crisis. The US now has powerful populist impulses on both sides of the political divide, with the libertarians (or creditors, in the Coggan view) of the Tea Party on one side and the leftists (or debtors) of Occupy Wall Street on the other. Beneath the passionately held principles, a division of the populist movements into defenders of debtors and creditors makes sense. The first call for a “Tea Party” came from a commentator on CNBC railing against the Obama administration’s plan to give aid to “losers” who could not repay their mortgages; while Occupy’s founding principles rail against “an unfair global economy that is foreclosing on our future”. Paper Promises shows that both Occupy and the Tea Party have real reason to be angry. Indeed, either side could cite large chunks of Paper Promises in its favour. Coggan is clear that doing away with the dollar’s peg to gold in 1971 gave governments the power to create money at will, that they abused it, and that this created the bubbles of the past four decades. This is a central narrative of the Tea Party. Yet he is scornful of Ayn Rand, the libertarian philosopher much beloved by Tea Party followers, and is clear that the growth of the financial sector in the past generation was a harmful development. He suggests the financial sector “has become what economists call a ‘rent-seeker’, charging excessive prices for its services”. That might be thanks to lack of competition, as implicit guarantees from governments make it hard for new banks to enter the market, or it might result from banks’ own deliberate lack of transparency. And plainly the Occupy movement, representing debtors, does have a point. The chances of our minimising what Coggan rightly argues is an inevitable dose of severe pain would be much greater if people on both sides of this latest debtor-creditor divide could approach the problem in his own well-informed and dispassionate way. However, I fear many people who should read this book will not do so, because its ultimate message is not uplifting. Coggan’s prediction is that the crisis can only be resolved by some combination of “inflation, stagnation and default,” which will drive a crisis “at least as severe as the one in 2008”. As for the future, Coggan has the honesty to admit that he cannot foresee it. But his central prediction, of the ultimate ascendancy of China as the world’s greatest creditor, is both hard to dispute and unlikely to be popular. After patiently examining and dismissing various possibilities, such as systems based around a Chinese “renminbi standard” or IMF “special drawing rights”, he suggests the most likely new system will revolve around capital controls, exchange rate pegs and “financial repression” – measures to force creditors to lend to governments at cheap rates. “Something will turn up but it may take 10 or 15 years and it will not necessarily be to the west’s liking. A new order will emerge. And, like so many of the goods sold in western supermarkets, it will be made in China.” Paper Promises lacks either an upbeat conclusion or a narrative to support the prejudices of one side or the other. This might not help sell copies but it is all the more reason why the book should be taken very seriously.
The current financial crisis has only one parallel: the Wall Street Crash of 1929 and subsequent Great Depression of the 1930s, which crippled the future of an entire generation and set the stage for the horrors of the Second World War. Yet the economic meltdown could have been avoided, had it not been for the decisions taken by a small number of central bankers.
In Lords of Finance, we meet these men, the four bankers who truly broke the world: the enigmatic Norman Montagu of the bank of England, Benjamin Strong of the NY Federal Reserve, the arrogant yet brilliant Hjalmar Schacht of the Reichsbanlk and the xenophobic Emile Moreau of the Banque de France. Their names were lost to history, their lives and actions forgotten, until now. Liaquat Ahamed tells their story in vivid and gripping detail, in a timely and arresting reminder that individuals - their ambitions, limitations and human nature - lie at the very heart of global catastrophe.
Lords of Finance: The Bankers Who Broke the World By Liaquat Ahamed Penguin, 576 pages, $32.95 FT Bookshop price: £16 When the history of the current financial crisis comes to be written, the battle of the index entries will surely be won by central bankers not politicians. The name Bernanke will appear on many more pages than Bush, King more often than Brown, and Trichet will trump even Sarkozy. Most of the time, central banks strive to be dull places; the people who run them relish their obscurity. But when crisis strikes, the limelight shines. The last great liquidity crisis to hit the global financial system happened 94 years ago, at the end of July 1914. It paralysed the wholesale money market, closed the world’s stock markets for months and necessitated unprecedented government intervention in the banking system. Rightly, this is where Liaquat Ahamed begins. A semi-retired investment manager, Ahamed set out to tell the story of the four dominant central bankers of the inter-war period. He cannot have foreseen how timely his book would be. Unlike most works on the origins of the Great Depression, Lords of Finance is highly readable – enlivened by vivid biographical detail but soundly based on the literature. That it should appear now, as history threatens to repeat itself, compounds its appeal. Ahamed’s four central characters are Émile Moreau, governor of the Banque de France; Montagu Norman, governor of the Bank of England; Hjalmar Schacht, president of the German Reichsbank; and Benjamin Strong, governor of the Federal Reserve Bank of New York. By 1926 they constituted “the most exclusive club in the world” but in 1914 they were largely unheard of. Norman was a partner at the British affiliate of US merchant bank Brown Brothers. Neurotic and prone to bouts of mental collapse, he lived in a large, gloomy house off Holland Park, surrounded by furnishings of his own design, listening to Brahms and dabbling in spiritualism. With his long ginger beard, he looked more like a boulevardier than a banker. At the other extreme was Schacht, a Hamburger who affected the stiff gait of a Prussian reserve officer, complete with bristling moustache, high celluloid collar and fierce glare. In 1914 he was rising through the ranks of Dresdner Bank. Of the four, Benjamin Strong was the furthest advanced: president of the powerful Bankers Trust Company, an offshoot of the financial empire of JPMorgan. His troubles were purely personal: a first wife who committed suicide and the onset of the tuberculosis that ultimately killed him. Moreau, meanwhile, was a happy, healthy civil servant whose career had taken a wrong turning. Having served as chef de cabinet to the scandal-prone finance minister Maurice Rouvier, Moreau was sidelined at the Algerian central bank. The war and its traumatic aftermath transformed all their careers. An architect of the Federal Reserve System, Strong accepted the governorship of the New York Fed in 1914. Norman joined the Bank of England in 1915 and became governor five years later. Schacht had a less good war but re-launched his career in 1923, when hyperinflation had rendered the German currency worthless: having successfully introduced the new Rentenmark currency, he was appointed Reichsbank president before the year was out. Two and a half years later, political crisis propelled Moreau into the top job at the Banque de France. The task facing these four men wasn’t small. After the first world war, victors and losers alike were saddled with immense foreign debts; all the European currencies had depreciated to varying degrees. The myriad new trade barriers made it ever harder for debtors to earn hard currency from exports. Outwardly, as Ahamed shows, the central bankers seemed to co-operate. Their frequent peregrinations across the Channel and the Atlantic attracted febrile press speculation. (So over-attentive were the reporters that Norman even took to sailing under an assumed name, “Professor Clarence Skinner”.) Friendship flourished between them; “Dear Strong” and “Dear Norman” became “Dear Ben” and “Dear Monty”; Norman made a point of cultivating Schacht. The exception was Moreau, whom Norman couldn’t resist insulting and who declined when Strong invited them all to New York in 1927, a year before his untimely death. Yet for all their communication, the four failed to reach an optimal resolution of the world’s financial problems. Strong encouraged Norman’s quasi-religious faith in the restoration of the gold standard, and helped finance the British return to the prewar dollar exchange rate. Yet Strong never allowed the gold standard to work as it was supposed to, systematically counteracting (“sterilising”) the effect of gold inflows on the American money supply. Meanwhile, Moreau intervened against the franc so the French currency was undervalued, ensuring export surpluses and the rapid growth of the Banque de France’s reserves. Schacht, on the other hand, obsessed about flows of hot money into Germany and the continuing burden of reparations on the German balance of payments. The result was that what we would now call “global imbalances” were not reduced, even when economic conditions were relatively good. When Wall Street bubbled and then burst in 1928 and 1929, the Europeans wholly underestimated their own vulnerability. Norman saw the Wall Street crash as a boon for sterling, claiming the “credit” for having caused the New York sell-off by raising British interest rates the previous month. By the summer of 1931, however, it was dawning even on Norman that the world economy was falling off a cliff. With massive bank failures on both sides of the Atlantic, it became clear that the Lords of Finance had bungled things. “Unless drastic measures are taken to save it,” he wrote to Moreau’s successor at the Banque de France, “the capitalist system throughout the civilised world will be wrecked within a year.” (With a characteristic flourish, he went on: “I should like this prediction to be filed for future reference.”) Such apocalyptic fears were not new. As early as November 1918 Strong had warned Norman of a coming “period of economic barbarism which will menace our prosperity”. The irony was that their favoured prophylactics had, in combination, made the apocalypse more likely. By 1931 the capitalist system was on its knees, and democracy with it. Schacht was soon flirting with the rising star of the German right, Adolf Hitler; he later served as his economics minister. As the world teeters on the brink of another great financial cliff, we can only hope that the modern-day Lords of Finance will co-operate to better effect. I suspect none has much time for bedtime reading these days. But should Messrs Bernanke, King and Trichet need a reminder of what can go wrong when central bankers achieve only the semblance, but not the reality, of co-operation, Lords of Finance is the book they should read. As a matter of urgency, a Chinese translation should also be sent to Zhou Xiaochuan, governor of the People’s Bank of China. Niall Ferguson is a contributing editor of the FT and author of ‘The Ascent of Money: A Financial History of the World’ (Allen Lane)
Mallaby
More Money Than God: Hedge Funds and the Making of the New Elite, by Sebastian Mallaby, Bloomsbury RRP£25, 496 pages In the Soviet Union, the economy was run by the bureaucrats and their five-year plans. In capitalist economies, the job of allocating capital – picking which industries and businesses to fund, and which to let go to the wall – has been done by commercial banks, investment banks and, most recently, hedge funds. These freewheeling money managers shift cash rapidly between countries and companies, taking advantage of flaws in markets in ways that frequently produce eye-popping returns – and less frequent, but equally spectacular, implosions. Governments across the developed world are now trying to turn back the clock. No one is suggesting five-year plans, although the Chinese dictatorship is eyed with envy by some in the recession-ravaged west. But a concerted effort to undermine hedge funds and give governments more of a say in capital decisions is under way. Sebastian Mallaby’s contribution to this debate will not be appreciated by Angela Merkel, the German chancellor, or Nicolas Sarkozy, the French president who recently backed Merkel’s efforts to restrict short-selling, a tool wielded to deadly effect by hedge funds to make money from falling prices. In More Money Than God, Mallaby, a fellow at the US Council on Foreign Relations and a Washington Post columnist, argues that not only should hedge funds not be blamed for the world’s economic woes, they should be actively encouraged. The book sets out a warts-and-all history of hedge funds, focusing on the great names of the industry, starting with Alfred Winslow Jones. This former communist activist and friend of Ernest Hemingway stumbled on the money-making model in 1949, and claimed inspiration from Phoenician traders to justify taking a 20 per cent cut of profits. In his wake came some of the great names who dominated investing in the later part of the 20th century and the start of the 21st: Michael Steinhardt, George Soros, Julian Robertson, Stanley Druckenmiller, Paul Tudor Jones, Bruce Kovner, John Paulson and Ken Griffin. Many of their tales are already well told; several have multiple books dedicated to their exploits. But Mallaby manages to dramatise even heavily raked-over incidents, such as Paul Jones’s anticipation of the 1987 stock market crash, or George Soros’s successful assault on the Bank of England in 1992. He gets into the minds of the traders (“All I want to do is kill myself,” one minion told Michael Steinhardt after a losing investment; “Can I watch?” came the reply), and adds extensive historical and academic context without interrupting the highly readable narrative. Hedge fund managers may be attracted by Mallaby’s twin conclusions: “Governments must encourage hedge funds”; and “Don’t regulate” (he would relax this decree for the very largest, leveraged funds). But the stories he tells of how hedge funds made money could equally be used by German and French critics to support their calls for a clampdown as they negotiate final details of new European rules. Insider trading, market abuse and straightforward fraud leap out of the pages, from the very first days through to the recent arrest of Raj Rajaratnam, founder of US hedge fund Galleon Group. As Mallaby says of Rajaratnam, accused of running an insider trading ring, “He had no amazing special sauce, but he had a lot of special sources.” Mallaby makes clear that hedge funds are, at best, as pure as the driven slush. But he makes no apologies. “The case for believing in the industry is not that it is populated with saints but that its incentives and culture are ultimately less flawed than those of other financial companies,” he argues. For anyone unconvinced, he puts a lot of weight on the fact that during the recent crisis hedge funds managed to collapse – at the rate of 1,500 a year in 2008 – without government bail-outs. They were small enough to fail, unlike the too-big-to-fail banks. All the common critiques of the industry are addressed, from the trend-followers’ tendency to amplify market moves to hedge funds’ failure to consider liquidity issues (an expensive lesson for several of these latter-day masters of the universe). There are two points of weakness in Mallaby’s argument. First, he fails to deal effectively with the claim that hedge funds are too expensive. This is not just a matter of social envy. In the discussion of the best method of allocating scarce capital, the cost of the system chosen – the fees, in the case of hedge funds – is clearly an essential consideration. Mallaby attempts to contrast the industry standard fee of 2 per cent of assets a year and 20 per cent of a fund’s profits with investment banks paying half of turnover to staff. But revenue at a bank is a tiny fraction of assets, and even if it were comparable to hedge fund fees, which it is not, critics of hedge fund fees are hardly likely to be won over by comparisons with clearly overpaid investment bankers. Second, he skates over the problem of crowded trades, when all the hedge funds are doing the same thing. This is one of the major concerns of regulators: while no individual hedge funds may (for now) be too big to fail, a large number of simultaneous failures of small funds could take down a bank and start a new crisis. Picking holes in the argument is really an aside to this splendid account of the ups and downs of an industry in which few of the twenty-something hedge-fund wannabes know their history. They, and meddling politicians, should read this book before they are condemned to repeat it.
Who really creates wealth in our world? And how do we decide the value of what they do? At the heart of today’s financial and economic crisis is a problem hiding in plain sight.
In modern capitalism, value-extraction is rewarded more highly than value-creation: the productive process that drives a healthy economy and society. From companies driven solely to maximize shareholder value to astronomically high prices of medicines justified through big pharma’s ‘value pricing’, we misidentify taking with making, and have lost sight of what value really means. Once a central plank of economic thought, this concept of value - what it is, why it matters to us - is simply no longer discussed.
Yet, argues Mariana Mazzucato in this penetrating and passionate new book, if we are to reform capitalism - radically to transform an increasingly sick system rather than continue feeding it - we urgently need to rethink where wealth comes from. Which activities create it, which extract it, which destroy it? Answers to these questions are key if we want to replace the current parasitic system with a type of capitalism that is more sustainable, more symbiotic - that works for us all. The Value of Everything will reignite a long-needed debate about the kind of world we really want to live in.
Who creates value? Who extracts value? Who destroys value? If we mistake those who do the second or third for those who do the first, or mistake those who do the first for those who do the second or third, we will end up with impoverished and unhappy societies, in which plunderers rule. Many advanced western countries, in particular the US and Britain, have already reached that state, according to Mariana Mazzucato. The consequences of this, including soaring inequality and declining growth are already visible, argues the author, a professor at University College London and sometime adviser to political parties and international institutions. We need to change course, she insists, in this challenging and stimulating book. Among other things, we need to re-think the relationship between markets and governments; make a clear distinction between creators of wealth and those who merely extract it; embrace bolder collective ambitions, notably a shift to a greener economy; and spend on the future, instead of embracing a sterile and counterproductive austerity. The book is a successor to The Entrepreneurial State, in which Mazzucato argued that government has played a powerfully innovative role in the modern economy. This book’s big point is that it is far too easy for those operating in the market economy to get rich by extracting economic value from those who add it, not by adding it themselves. An obvious example is the way the financial sector generated a huge increase in household debt in the years leading to the financial crisis of 2007-09. This funded zero-sum competition to buy the existing housing stock at soaring prices. Its legacy included a huge crisis, a debt overhang, weak growth and political disenchantment. Yet, for those who created, manipulated and sold this debt, it was a gold mine. This represented value extraction and destruction. Government, not private businesses, created many of today’s most fundamental technologies — including the internet and the global positioning system Much the same picture can be seen in asset management, with its excessive trading, exorbitant fees, lack of transparency, poor stewardship and conflicts of interest. This financial sector, together with the “shareholder value maximisation” that economists have promoted, has had a malign effect on the corporate sector as a whole, argues Mazzucato, by encouraging excessive pay and also, partly to that end, manipulation of stock prices in preference to long-term investment. That it is hard to see much wider economic benefit from the massive increase in the relative size and influence of finance over the past half century seems self-evident. Today, many western economies are, after all, burdened by high levels of private debt, high inequality and low rate of productivity growth. If this is success, what might failure look like? It is not just finance that is in the dock. Mazzucato also attacks what is going on in more obviously beneficial sectors of the economy, such as information technology and pharmaceuticals. One of the problems here, she argues, is the award of overly generous or simply unjustifiable rights to intellectual property, such as the patenting of things found in nature or of trivial business processes. No less important is the emergence of concentrated monopoly power in a small number of huge online internet companies, such as Google and Facebook, whose very size and omnipresence makes them the only rational choice for potential users. Mazzucato does not only refer to activities whose benefits are exaggerated, if not entirely misstated, by the immense rewards of the people and institutions engaged in them, such as financial engineering. She also notes the significant activities of a sector too often assumed to generate no economic value: government. Government does more than enforce justice and provide security, she argues. It builds infrastructure, educates the young, maintains the population’s health, finances fundamental research and has often promoted economic development directly. The US government, not private businesses, created many of today’s most fundamental and transformative technologies: the internet and the global positioning system are two spectacular examples. A fundamental thesis of the book, however, is that mistaking value extraction for value creation, and vice versa, has its roots in the errors of economists. A lengthy section duly discusses the history of the idea of value in economics, from the mercantilists of the 17th century, to the classical economists of the 18th and early 19th centuries, and then the marginalists (or “neoclassical economists”) of the later 19th and 20th centuries. The classical economists, notably Adam Smith, David Ricardo and Karl Marx were, she notes, concerned about the distinction between those who created value, those who merely moved it around and those who lived parasitically on the efforts of others (such as aristocratic landowners). Those were both economic and moral distinctions. Neoclassical economists, however, such as Léon Walras, Stanley Jevons and Alfred Marshall, with their marginal revolution and idea of equilibrium, eliminated these distinctions: under the subjective theory of value, price is simply the best indication of (marginal) value: what is expensive is, at least at the margin, valuable. The choices people make are the only determinant of value. The economists’ focus on what is produced and distributed in the market has two further consequences, argues Mazzucato — government is, by assumption, unproductive, even parasitic, and household labour disappears from sight. These assumptions were carried over into the new system of national accounts developed in the 1930s and 1940s, from which our measure of “gross domestic product” was born. I understand why Mazzucato engaged in the lengthy (and itself interesting) disquisition on the history of theories of value. It might have been enough, however, to note that there are good reasons for believing in the pervasiveness of defective and rigged markets in actual market economies, as opposed, to simplistic models of them. Nevertheless, she does make a crucial point: what we value is a social decision and some of what we now value — complex finance, for example — are more a justification for value extraction than a plausible source of additional value. What is not measured does not count. But what is measured does. Mazzucato offers the reader an account of how value is attributed to the activities of banking. Its added economic value is currently measured by the cost of “financial intermediation services indirectly measured” — in other words, by the spread it charges between the cost of borrowing and the rate of interest on lending. The bigger that spread, by assumption, the more value banks are supposedly creating. This is to confuse a cost with a benefit. In Mazzucato’s view the evident failings of our economies are a consequence of our inability to distinguish among activities that create, redistribute and destroy value. This, in turn, emboldens value extractors (such as pharmaceutical companies that charge whatever the market will bear); it frightens off non-market actors, including bureaucrats, who might have been able to help create value; and it encourages policymakers to believe market solutions, such as the UK’s flawed private finance initiative, are necessarily superior to ones introduced by governments. What I would have liked to see far more of, however, is a probing investigation of when and how governments add value. The US government, for example, has played an extraordinary role in innovation, especially through the Department of Defense and the National Institutes of Health. Yet how far is this really relevant to countries with more limited economic and scientific resources? How can one ensure that governments do add value rather than merely extract and waste it? In her enthusiasm for the potential role of the state, the author significantly underplays the significant dangers of governmental incompetence and corruption. Nevertheless, the book has three significant strengths. First, Mazzucato pushes us to get away from the simplistic creed that markets are always good and governments always bad. Second, she offers the Left a positive goal of prosperity-inducing innovation rather than a sterile and ultimately destructive politics of resentment and redistribution. Finally, she forces us to ask ourselves what adds value to society and how to create an economic and social order that promotes that. The book itself adds value by forcing us to confront these points. The Value of Everything: Making and Taking in the Global Economy, by Mariana Mazzucato, Allen Lane, RRP£20, 384 pages
Paper Promises: Money, Debt and the New World Order, by Philip Coggan, Allen Lane, RRP £20, 304 pages History is a battle between creditors and debtors over the nature of money. The former want sound money and the latter want easy money. That is Philip Coggan’s thesis in his new book, Paper Promises, and it leads naturally to an explanation of the current credit crisis, along with all the great financial crises of the 20th century. Crises occur, in the Coggan view of history, when debtors fail to repay. At this point, because their interests have been reflected in the very nature of money, the financial system itself must be reformed. This happened in the 1930s, when the Great Crash led to the end of the gold standard, and again in the stagflationary 1970s, with the end of the Bretton Woods agreement. We are now living through another such crisis. Its resolution remains unclear but none of the available routes is palatable. Either the world must suffer through prolonged stagnation or see a massive default, or the accumulated debts of the past four decades must be inflated away. But the identity of the country around which the next financial system will be built is not in any doubt. That will be the world’s largest creditor, China. Coggan points out that the system always hinges on the greatest creditor, just as the US led the world during the Bretton Woods era and Britain led in the gold standard era. As for the repeated bubbles and crises of the past four decades, they can be traced to the ease with which money can be printed following the end of the last Bretton Woods tie to gold, and to the unprecedented growth of the financial sector, both in absolute size and in its share of the economy. These are bold and confident historical abstractions. But they do not seem so when reading the book. Coggan, a former Financial Times journalist and my predecessor as regular writer of the FT’s “Long View” column, covers the terrain with characteristic calmness and objectivity, avoids over-simplification, and laces his arguments with his trademark erudition. His references are wide-ranging. Shylock’s loan to Bassanio in The Merchant of Venice comes up. So do the family finances of the Forsytes in The Forsyte Saga (they lived off consols, a form of perpetual UK government debt). And so do the South Sea islanders who once threw a chest of gold into the sea, thinking it worthless, and kept on looking for precious cowrie shells, the basis of their own financial system. Most of all, William Jennings Bryan, the turn-of-the-century populist who ran three times for the presidency, functions as the book’s hero, or anti-hero. Ever since he made it his rallying call that Americans must not be “crucified on a cross of gold”, his spirit has lived on; debtors, Coggan points out, have always passionately campaigned for adulterated money. The writing is clear and concise. It is aimed at lay people, not professionals. The extremely technical concepts that necessarily arise in discussing the credit crisis are carefully explained from first principles. The alphabet soup of acronyms, from SIVs to CDO Squareds, is blissfully lacking. Finally, the book is free from the shrieking ideology that afflicts virtually all contemporary debates over money. Indeed, it offers a clear explanation of the fresh ideological divisions that have arisen over how to deal with the crisis. The US now has powerful populist impulses on both sides of the political divide, with the libertarians (or creditors, in the Coggan view) of the Tea Party on one side and the leftists (or debtors) of Occupy Wall Street on the other. Beneath the passionately held principles, a division of the populist movements into defenders of debtors and creditors makes sense. The first call for a “Tea Party” came from a commentator on CNBC railing against the Obama administration’s plan to give aid to “losers” who could not repay their mortgages; while Occupy’s founding principles rail against “an unfair global economy that is foreclosing on our future”. Paper Promises shows that both Occupy and the Tea Party have real reason to be angry. Indeed, either side could cite large chunks of Paper Promises in its favour. Coggan is clear that doing away with the dollar’s peg to gold in 1971 gave governments the power to create money at will, that they abused it, and that this created the bubbles of the past four decades. This is a central narrative of the Tea Party. Yet he is scornful of Ayn Rand, the libertarian philosopher much beloved by Tea Party followers, and is clear that the growth of the financial sector in the past generation was a harmful development. He suggests the financial sector “has become what economists call a ‘rent-seeker’, charging excessive prices for its services”. That might be thanks to lack of competition, as implicit guarantees from governments make it hard for new banks to enter the market, or it might result from banks’ own deliberate lack of transparency. And plainly the Occupy movement, representing debtors, does have a point. The chances of our minimising what Coggan rightly argues is an inevitable dose of severe pain would be much greater if people on both sides of this latest debtor-creditor divide could approach the problem in his own well-informed and dispassionate way. However, I fear many people who should read this book will not do so, because its ultimate message is not uplifting. Coggan’s prediction is that the crisis can only be resolved by some combination of “inflation, stagnation and default,” which will drive a crisis “at least as severe as the one in 2008”. As for the future, Coggan has the honesty to admit that he cannot foresee it. But his central prediction, of the ultimate ascendancy of China as the world’s greatest creditor, is both hard to dispute and unlikely to be popular. After patiently examining and dismissing various possibilities, such as systems based around a Chinese “renminbi standard” or IMF “special drawing rights”, he suggests the most likely new system will revolve around capital controls, exchange rate pegs and “financial repression” – measures to force creditors to lend to governments at cheap rates. “Something will turn up but it may take 10 or 15 years and it will not necessarily be to the west’s liking. A new order will emerge. And, like so many of the goods sold in western supermarkets, it will be made in China.” Paper Promises lacks either an upbeat conclusion or a narrative to support the prejudices of one side or the other. This might not help sell copies but it is all the more reason why the book should be taken very seriously.
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