Monthly Archives: October 2008
With financial meltdown seemingly averted, eyes are now turning to the ‘real’ economy, and the question of how deep will be the global recession precipitated by the abrupt ending of cheap credit. (We should have no doubt that cheap credit is over. Banks and hedge funds are now desperately trying to ‘de-leverage’, which means holding onto all the cash they can, while unwinding their ‘positions’ funded through borrowing. Cash is king, queen, and the whole royal family.)
What exactly is the ‘real’ economy? Can we say it is the economy where we work, the economy of production, the economy of fundamentals? As discussed previously, the global financial markets are largely divorced from the real economy insofar as 80% of trades are purely ‘technical’ (e.g. arbitrage, currency speculation) while only 20% are concerned with actual ‘investment’. This is one of the reasons why Susan Strange said that money has gone “mad”.
The world’s richest and most famous fundamental investor, Warren Buffett, has also warned against the madness of a market obsessed with prices and technicalities. Following his friend Ben Graham, Buffett characterizes the market as a fellow named Mr. Market:
Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his. Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him. Mr. Market has another endearing characteristic: he doesn’t mind being ignored. If his quotation is uninteresting to you today he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you. (The Essays of Warren Buffett, p64)
Rather than focus on the ‘technical’ factors of market behavior, Buffett prefers to focus on the fundamental characteristics of the businesses in which he owns a stake. He wants to intimately understand their products, accounts, business models, and management. In this he follows the example of John Maynard Keynes, whom Buffett praises, quoting a letter that Keynes wrote in 1934:
As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence . . . . One’s knowledge and experience are limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence. (Essays of Warren Buffett, p82)
Although the investment philosophy of Warren Buffett compares favorably with the madness prevalent in the market, there are nevertheless many important ‘fundamentals’ which he overlooks. For example, Buffett describes Coca-Cola as a “wonderful” business (ibid. p30). This remark is very revealing about the ‘real’ economy, because the ‘real’ economy makes no distinction between those companies whose products and practices are harmful and those whose are helpful. Instead the focus is purely on the bottom line, profit and loss.
I would like to propose that we divide the ‘real’ economy into two broad categories: the productive and destructive economies. The job of investors, consumers, workers and governments should be to look beyond mere profit and loss at the actual effects which companies and their activities have on the world. We should support those which are productive, and boycott those which are destructive.
There are some companies which fall clearly into one or other of these categories, and some which are more ambiguous. Clearly we should all boycott weapons and tobacco companies, although unfortunately the British and American governments provide enormous public subsidies to weapons companies.
One ‘industry’ which is clearly destructive is gambling, yet its revenues — a frightening £55bn in the UK last year — are included in Britain’s GDP. Surely this figure should be subtracted, not added! However, the Department of Culture has gone so far as to say that it “sponsors” the gambling industry.
Government sponsorship indeed seems to be the effect of the Gambling Act 2005, which loosened the regulations applied to gambling, despite the fact that there were already 300,000 gambling addicts in this country (of whom 40% have suicidal tendencies). The act was passed in the face of a report by Professor Griffiths, professor of gambling studies at Nottingham Trent University that the effect of the bill would be to increase the number of addicts by between two and four times. As we move into recession we are likely to see gambling become more of a problem: a recent survey shows a link between gambling and urban deprivation.
The point is that notions of the ‘real’ economy are meaningless if considered in isolation from physical and mental well-being. No matter how profitable a company, if its effect is to damage well-being then its revenues and profits should not be counted as part of our national ‘product’. Instead, attempts should be made to warn people away through taxation, advertising bans, publicity compaigns, clear labelling, denial of premises and so on. This is the strategy which is now, belatedly, being pursued in the UK with regard to cigarettes. Better late than never.
After a hard day’s forage
Two bears sat together in silence
On a beautiful vista
Watching the sun go down
And feeling deeply grateful
Though after a while
A thought-provoking conversation began
Which turned to the topic of
Then one bear said,
“Did you hear about Rustam?
He has become famous
And travels from city to city
In a golden cage;
He performs to hundreds of people
Who laugh and applaud
The other bear thought for
A few seconds
Then started weeping.
(‘Two Bears’ by Hafiz, trans. Daniel Ladinsky)
To whom will we bow tomorrow? I lived in England from 2003 till 2007. During that time Iceland changed a lot. In a society that used to be almost without any class distinction, all of a sudden there was a group of extremely rich people. Private jets, Elton John and 50cent at birthday parties and so forth.
It seemed half of the population wanted to work in banks (that was the great gold cage everyone wanted to get into). I found it amazing that very few seemed to ever consider whether it was a good thing to go after as much money as you could possibly get your hands on. The people who followed that maxim were hailed as heroes, courageous vikings. I think oligarchs is the modern term.
Of course not everyone thought in this way.
What has happened now is a combination of many things. A government that hasn’t been doing its job of looking after the citizens, a lack of regulation of financial businesses, naiveity and greed. Greed is probably the biggest factor.
Many people have been warning that this might happen for some time now, both in Iceland and England. It looks as if they were hushed up (at least some reports were) so the party could go on for as long as possible. Who’s responsible for this hush up? The ones that gained from it. The 20 people or so that now are hiding outside of the country. Hanging on to their golden cages. As well as the politicians who wanted to enjoy the good times as well.
“We acted as if there was no tomorrow, so now there isn’t going to be one”
as my friend Kurt Vonnegut said when talking about the state of the planet.
The group of 20 or so people (oligarchs) who owned the lot, seem to have left the building, taking with them as much as they can save of their billions, or trillions. Sorry I’m getting quite confused with these big numbers.
This is a very sad situation. The consequences are not yet fully known. It looks very serious. It will ruin the foundations of our society and enslave future generations to a huge debt.
You have to remember there are only about 300,000 people here to pay this bill. And this bill is huge. The bank owners had set up branches all over Europe and the Icelandic government (i.e. Icelandic tax payers) is responsible for paying the deposits back to the people of these countries. That includes England.
A lot of people in Iceland have lost all their savings, including my sister, thousands of regular folks have. Old people and young who were convinced by the bankers to put their money in bonds and funds that were perfectly safe!
We have the problem with our currency as well. You can’t buy any currency now unless you’ve got a flight ticket. Icelanders abroad can’t cash any money through foreign banks. All imports have, or are about to, come to a halt. Icelandic businesses around the world have lost all credibility and have to pay cash in all transactions.
The krona has fallen to I don’t know where — no one knows now I think.
The government is desperately trying to get a huge loan from Russia. Iceland will then probably support their efforts of gaining control of the North pole and its resources. Well, I guess we will ‘support’ them on every matter and every whim. Maybe Canada would take us under its wing. Then we will of course ‘support’ them in all their actions and policies.
There is also the problem with Mr. Gordon Brown. He has used anti-terrorist legislation to freeze the assets of Icelandic banks. He declares the Icelandic state as bankrupt and so forth. Some people claim that with his remarks and actions he has ruined Kaupthing, the only bank which was still standing in Iceland. Kaupthing was the biggest Icelandic company and the loss because of this is tremendous.
The politicians all try to save their faces and keep themselves and their party number one. It’s so important to stay in power, to hold on to fame and the golden cage. The Icelandic PM and the British PM point their fingers and say to their people “Look at those islanders and see how they are treating you. But don’t worry, I’ll play tough and look after you. Just remember to vote for me in the next election.”
Our reputation has been ruined. That hurts all Icelanders deeply. Honor, reputation and independence is very important to this nation. I’m not sure if it affects the oligarchs though, they might have slightly different priorities.
I feel very sad and sick to my stomach about the way people behave. I feel for the people who are without any security now, and I feel for the people who are managing to hold on to their golden cages.
You could say that in a sense the Icelandic society has been shot right between the eyes.
It is in no way extreme to say that our independence is at stake in this situation. We might not be able to afford such a luxury any more. That breaks my heart.
I’m quite fortunate in a sense not to have any property and never to have had any. I’m also very fortunate to live among farmers and people up north who have always lived on modest means and know how to survive in this country.
This is a very basic description of the situation. The nation is in a state of shock. No one knows what will happen next. Will we have our health care, our education system and so forth?
Will we have to bow to the East or West in the future?
In her book ‘Casino Capitalism’ (1986) the respected political economist Susan Strange wrote:
“The great difference between an ordinary casino which you can go into or stay away from, and the global casino of high finance, is that in the latter we are all involuntarily engaged in the day’s play. A currency change can halve the value of a farmer’s crop before he harvests it, or drive an exporter out of business. A rise in interest rates can fatally inflate the costs of holding stocks for the shop-keeper. A takeover dictated by financial considerations can rob the factory worker of his job. From school-leavers to pensioners, what goes on in the casino in the office blocks of the big financial centres is apt to have sudden, unpredictable and unavoidable consequences for individual lives. The financial casino has everyone playing the game of Snakes and Ladders.”
Since the 1980’s, in the name of the so-called “free market”, governments around the world have made it easier for high-rollers to play in the global casino of high finance. In doing so they have argued that they are respecting the fundamental human ‘right’ to make millions, and they have claimed that the market is a force for innovation.
What we clearly understand is that there is always a trade-off between different peoples’ rights. As Susan Strange implies, the ‘right’ of certain people to play at the casino can severely impact the right of other people to eat, to afford healthcare, or to send their children to school.
There is a need to evaluate the relative importance of different people’s rights. If politics were healthy this evaluation would be performed on the basis of whose ‘right’ is more fundamental, and clearly the rights of those who wish to eat, study and get well should be considered more fundamental than the rights of those who wish to become multi-millionaires through unproductive speculation.
Unfortunately the political systems of the western democracies are not healthy. They are plagued by lobby groups representing ‘special interests’, including the financial industry which has put all of our futures in peril. They will seek to preserve their right to gamble, jeopardizing the rest of the world’s right to produce, plan, save, etc. We need to use the democratic tools at our disposal to prevent this.
The argument that deregulated financial markets are a force for innovation has been shown to be false. Their only ‘innovation’ is the creation of ever more complex financial products and derivatives, which even those who buy them fail to understand. Actual innovation, in terms of the productive ‘real’ economy, is severely stunted by these inveterate gamblers.
Another philosophical issue underlying the current financial crisis is the collective inability of our financial institutions to discern value. Lacking discernment they bought huge quantities of complex assets that turned out to be worthless, and now they require the tax-payer to bail them out.
One of the complex financial instruments whose actual value the banks failed to discern is Collateralized Debt Obligations (CDO’s). Sub-prime mortgages were packaged up as CDO’s and bought by the banks, creating the toxicity which the Paulson plan aims to hoover out of the US system, and which is undermining the British banking system so much that it needs to be partially nationalized at a cost of at least £50bn.
Banks were spectacularly unable to discern the actual value of CDO’s, and the risk which attached to them. With the absence of discernment, the herd mentality dominated the financial markets, first in the form of greed as banks bought and sold the toxic assets in great quantities because everyone else was doing it and earning fat bonuses, and now in the form of fear as inter-bank lending has completely dried up, with no bank trusting another.
For me, an interesting analogy is provided by the Australian aboriginal Achilpa tribe. The tribe possesses a sacred pole which connects heaven and earth:
“During their wanderings the Achilpa always carry it with them and choose the direction they are to take by the direction towards which it bends. This allows them, while being continually on the move, to be always in “their world”, and, at the same time, in communication with the sky . . . For the pole to be broken denotes catastrophe; it is like “the end of the world,” reversion to chaos. Spencer and Gillen [two anthropologists] report than when the pole was broken, the entire clan were in consternation; they wandered about aimlessly for a time, and finally lay on the ground together and waited for death to overtake them.” (from ‘The Sacred and The Profane’, Mircea Eliade, pub. Harcourt Brace (1959))”
The last sentence is an apt description of the current behaviour of financial institutions.
The human race’s unique nature is to be simultaneously in communication with the ground and the sky, earth and heaven. This is the meaning of the Taoist yin-yang symbol, where yin represents earth, yang represents heaven, and the human race’s job is to keep the two in harmony. Another way of saying the same thing is that human beings are composed of spirit and body, and that health and well-being, individually and collectively, come from correctly aligning body to spirit.
To relate such considerations to the financial crisis might invite derision from some quarters, yet it is precisely the correct alignment of spirit and body, heaven and earth, which enables us to discern value in the world. Without a spiritual axis there is no way to discern the beautiful from the ugly, the good from the bad, the valuable from the worthless. Without a spiritual axis all we are left with is the herd mentality: we blindly follow the rest of the herd and when that fails we lie on the ground waiting to die.
If any more proof were needed of financial wheeler-dealers’ inability to discern value or beauty, look at the current success of Damian Hirst, who cannily sold his remaining stock of embalmed sharks while the hedgies still had some money left. Look to the art market for the next set of ‘assets’ to be revealed as worthless, and for the next herd to lie on the ground bleating. Fortunately the tax payer won’t be required to bail them out.
There are bigger ‘philosophical’ issues at stake than the systemic issues affecting the financial system. One important issue that receives little discussion within the mainstream media is ‘productivity’, and how little the global financial system, as currently organized, is concerned with maximizing human productivity and creativity. This is not a trival issue, as in fact the entire purpose of economics should be to deploy resources in the most effective way to enable and facilitate human productivity and creativity.
In her books ‘Mad Money’ and ‘Casino Capitalism’ Susan Strange (1925-1998), former Professor of Economics at Warwick University, describes the degeneration of the global financial system. As late as the 1970’s, 80% of transactions in the financial markets were concerned with actual investment, and only 20% with speculation. However, by the 1990’s the ratio had flipped, with 80% of transactions being merely speculative, and only 20% concerned with actual investment.
As an example of a merely speculative transaction, consider a hedge fund such as Long Term Capital Management (LTCM) which failed in 1998, precipitating a financial crisis. Its ‘investments’ consisted of a myriad of transactions designed to exploit minor differences in asset prices around the world, a practice known as ‘arbitrage‘. If a particular bond or security was selling a penny cheaper in Tokyo than New York then LTCM would try to exploit this difference. Although such transactions may be profitable, they are in every other respect completely useless. They are not genuine ‘investment’ in any sense. They do nothing to direct the world’s resources towards ‘production’.
The global financial markets are awash with such types of meaningless transactions. Money is racing around the world, crossing borders, fleeing across fibre-optic cables at the speed of light, solely in order to generate profits. Currency speculation is an obvious example. Neo-conservatism has deregulated international capital flows, while on the other hand the movement of people between countries is restricted (very tightly in the case of people from poor countries who want to move to rich ones. No such barriers for their money or resources). Minor tweaks to this speculative system, such as the Tobin Tax which would impose a tiny tax on currency trades, have been resisted.
The measures which we are seeing goverments adopt in the face of the current financial crisis, such as the Paulson plan in the US or the nationalization of Northern Rock and Bradford & Bingley in the UK, do nothing to address the real issue that the global financial system is fundamentally wrong and immoral, failing to direct resources where they are needed, in fact the opposite. These measures are designed merely to get the existing financial system back on its feet so that it can continue with ‘business as usual’.
What is needed of course is a sane economic system which puts people before profits. Although this may sound radical it is in fact very simple and sensible, as in fact nobody at all — not even one person — is benefitting from the system as it currently stands. Some may protest that mega-rich hedge fund traders (‘hedgies’) are benefitting, but an academic study of hedgies reveals this not to be the case. Commenting on this study psychologist Oliver James writes that the hedgies
had high levels of depersonalisation (feeling detached from one’s surroundings) and a staggering two-thirds were depressed. There were similarly high levels of anxiety and sleeplessness. The more they earned, the more likely they were to have these problems. Twice daily, they consumed both alcohol and an illegal substance (mostly cocaine). For relaxation, they chose solitary pursuits: jogging, masturbation and fishing were common.
For anyone familiar with sane theories of economics, such as the work of E. F. Schumacher or Erich Fromm, these findings are not surprising. The exercise of our productive and creative talents is at the heart of being human, and merely pushing money around in the pursuit of profit is not productive and does not contribute to human welfare. Just like an assembly line worker or a fast food server, hedgies are likely to suffer from ‘alienation’. Observing workers in the automobile industry in the 1940’s, Peter Drucker wrote:
For the great majority of automobile workers, the only meaning of the job is in the pay check, not in anything connected with the work or the product. Work appears as something unnatural, a disagreeable, meaningless and stultifying condition of getting the pay check, devoid of dignity as well as of importance. No wonder that this puts a premium on slovenly work, on slowdowns, and on other tricks to get the same pay with less work. No wonder that this results in an unhappy and discontented worker — because a pay check is not enough to base one’s self-respect on. (‘Concept of the Corporation’, The John Day Company, New York, 1946, p179, quoted ‘The Sane Society’ by Erich Fromm)
The syndrome of alienation that Drucker describes is common whether we are at the top, middle or bottom of the current economic pile. On the other hand, if the nature of work is properly appreciated and applied
it will stand in the same relation to the higher faculties as food is to the physical body. It nourishes and enlivens the higher man and urges him to produce the best he is capable of. It directs his free will along the proper course and disciplines the animal in him into progressive channels. It furnishes an excellent background for man to display his scale of values and develop his personality. (by J. Kumarappa, quoted ‘Buddhist Economics‘ by E. F. Schumacher)
In order to put economics back on track, to make money serve people rather than the other way around, and to help make productive work available for all, it is essential that there should be political will. To a large extent we have been duped into believing that economics is a science which follows natural laws like physics or chemistry, whereas really economics is tightly constrained by the role given to it by politics. The fact that sick economics has taken over is testament to an absence of political will and effort on all of our parts. Governments and citizens now have an opportunity to put that right.