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A sermon for the converted and modestly informed,
This review is from: The Gods That Failed: How Blind Faith in Markets Has Cost Us Our Future (Paperback)'The Gods What Failed' (sorry, changed title to reflect the failing educational standards under New Labour). In parts a bit waffly, in an attempt to fill out the book. Also irrelevant as soon as written were the passages that were no more than an on-going dialogue with other journalists and economists. 'Fantasy Island' was much better.
What's good about the book is the description of the 1997-2007 UK economy: how the apparent stability was entirely dependent on an inherently unstable process: asset, particularly house, prices rising relative to earnings, financing the equity withdrawal that was necessary to maintain consumption growth.
The pleas of bankers for government intervention, after they have advocated 'small' government for decades, is ridiculed repeatedly and deservedly.
Some of the authors' conclusions are sensible: squeezing tax havens; a real commitment to reduce money laundering; breaking up banks so that no one bank is considered 'too large to fail'; splitting retail and commercial banking from investment banking.
It would also be interesting to know how the passage on useless white collar public sector jobs went down with Elliott's colleagues at the Guardian, the Guardian readership (including many who fill said posts) and the commercial section at the Guardian, which earns lots of money from advertising these jobs.
There are, however, lots of things wrong in the book or else simplified to the point of being misleading. It is all very well to criticise fractional reserve banking. However, you have to then consider the alternative. Full reserve banking means banks matching loans to deposits, not just in magnitude but in term, ie a bank with deposits of $10m on call, $5m on 3 months and $1m on 1 year would have loans limited to $10m on call, $5m for 3 months and $1m for 1 year. This wud negate the important role that banks have played in economic growth of borrowing short-term and lending long-term. Under full reserve banking long-term interest rates wud be much higher and business investment lower. This is the reason why fractional reserve banking, not full reserve banking, has been practised thruout the capitalist era.
It is also just wrong to say that commercial banks can create money out of nothing. They can only increase lending, if the the central bank increases the supply of central bank reserves to the banks. Admittedly the possible increase of bank lending is a multiple of the increase in the supply of central bank reserves to the banking system. However, the central bank is ultimately in control. If it wants it can withdraw reserves and force the banks to cut lending. If you don't believe me, just consider this. If banks can create money out of thin air, why don't they just do so now and in that way solve their problems? They don't because they can't.
The problem was that some central banks do not pay attention to the money supply and bank lending figures. The Bundesbank did and due to its continuing influence the ECB still does, albeit to a lesser extent. The Fed does not. The Fed even stopped publishing M3 data - presumably because it provided critics with ammunition. It is staggering that the authors do not discuss this.
There is also another reason why the authors don't discuss full reserve banking further. Under full reserve banking, there is no need for a central bank and no need for government intervention in the banking system. For this reason full reserve banking is strongly advocated by the 'austrian school' of economists, who are free market extremists! Monetarists in general, economists who believe that the best way to control inflation is thru managing money supply growth, are seen as right-wing. Leftie Elliott is understandably reluctant to advertise the company he keeps!!!
The essential problem in many economies has been too much lending chasing too few assets. The predictable consequence is asset price inflation. The question, which the authors don't address, is did the central banks not have enough tools to control bank lending or was there simply a lack of will? They may well have a point that the repeal of capital controls reduced the armoury of the central banks. However, the case does not prove itself, because undeniably central banks in the UK and the US ignored the monetary stats.
Equally all central banks could have prevented the creation by banks of off-balance sheet vehicles, a means of evading limits on lending imposed by capital requirements. The Bank of Spain did so. All the others could have done so. There was a lack of will.
The authors approach the discussion of Collateralised Debt Obligations (CDOs) and Credit Default Swaps (CDSs) from a false premise. These securities and contracts were not designed to ELIMINATE risk, as the authors suggest, but to offer tools to MANAGE risk. The authors are wrong to say that there was no demand for CDOs. There was - from investment managers, who wanted more return than that offered by US government bonds and who were prepared to manage the risks involved in holding these securities. It was a market that has functioned well for decades including thru two recessions. There was even demand for the high risk tranche - from investors with money to lose and an appetite for greater risk. The problem has not been the structure of CDOs, but the unjustified inflation of the prices of the collateral (houses in the US) and the lack of creditworthiness of many people being offered mortgages. Without the PC motivated sub-prime lending, without the mortgages offering teaser starter rates, without excessive bank lending on mortgages, the CDO market would have done just fine. A few high worth individuals, who read the economic cycle wrong, would have got burnt. Nothing more.
Turning to CDSs, what is wrong with being able to insure against a corporate default? Currently many corporate bonds are illiquid. Holders can't sell, if they become unhappy with the issuer. For that reason many investors don't buy corporate bonds in the first place. Being able to use CDSs allows a holder to manage the risk. More investors will consequently buy corporate bonds.
Likewise there are good reasons for securitising the future income on David Bowie's albums: an old man gets the full benefit during his lifetime (he couldn't otherwise benefit from sales after his death) and younger people get a long-term income stream.
Surprisingly for a left-winger, Elliott seems very nostalgic for the pre-Big Bang City and its caste system. For those who weren't there, it was a time when white male working-class traders sold securities to white male upper-class asset managers, the sales being brokered by white male upper-class brokers. Women could not walk across a trading exchange without receiving extreme sexual innuendo and a black or brown face was not to be seen anywhere.
Even the old chestnut of asset strippers, while not relevant to current problems, needs comment. Asset strippers thrived because they were able to buy shares that were hugely undervalued - the share price of the company was a lot less than the sum of the values of the parts of the company. Is it not good that companies are now more closely analysed, so that it is no longer possible to buy a company, split it up and sell the parts, thereby making a big profit? The modern equivalent, private equity funds, thrived only because interest rates were artificially low and equity prices were rising, i.e. only because central banks had taken their eye off the bank lending figures.