Adair Turner Between Debt and the Devil-Money, Credit, and Fixing Global Finance (2016)

Adair Turner
Between Debt and the Devil-Money: Credit, and Fixing Global Finance (2016)
 

The devil is in the details (and debt somewhat) by Kelechi Okoye-Ahaneku

“The cycle of manias and panics results from pro-cyclical changes in the supply of credit…Money always seems free in manias.”

Adair Turner through his book “Between Debt and the Devil” goes into minute detail to explain the true nature and underpinnings of a thing we like to call debt. First of all what is debt you say? Debt is not something that we the general pubic have a good general understanding or grasp of what it is or of what it entails. We have a basic premise and understanding but nothing of true depth and magnitude. Adair Turner a man that has been chairman of Britain’s financial Services Authority in 2008 during the global financial crisis, whom of which you could very much argue is a man who is best applicable to explain to us, the general public something that is truly central to our way of life here in the West.
Turner uses the notions that had already been laid down by Charles Kindleberger that booms and busts that result in the greatest economic harm are driven by “procyclical” credit supply, with a rapidly growing and easily available supply of credit in the boom, followed by a dearth of credit in the subsequent downswing. It seems in Turners eyes that the potential for irrational exuberance exists in all asset markets, but when it’s financed by debt, severe economic harm arises from it.

With that Turner goes on to assert that in the decade leading up to the 2007-08 crisis, private credit grew rapidly in almost all advanced economies: - In the US at 9% per year, in the UK at 10% per year, in Spain at 16% per year. In most of all advanced nations it grew faster than nominal GDP; as a result, private leverage (which is the ratio of private credit to GDP) significantly increased. Turner continues to assert that a 10-year pattern was a continuation of the far longer term 60-year trend of increasing real economy leverage. When you look at total UK private-sector leverage grew from 50% in 1964 to an astonishing 180% by 2007: - whilst in the US it grew from a humble 53% in 1950 to an outstanding 170% in 2007.

The crazy thing is that in all of this proliferation of numbers in relation to the levels of debt doesn’t just stop at advanced economies where high debt levels are somewhat expected. These exuberant levels of debt are even displayed in more developing economies. Turner goes on to highlight that the trend of an increase in private. Nations like South Korea’s private leverage grew from 62% in 1970 to 155% before the Asian financial crisis of 1997: it is now even higher at 197%. Continued from that fact the ratio of Chinese debt to GDP has grown from 124% in early 2008 to more than 200% today. These numbers are insane when you realize that these levels of leverage are proliferate all over the world, with most if not all nations having similar levels.

Well, it seems from the outset that debt is one of the threats to the wellbeing of any economy, well it is to a large extent. Nonetheless debt/debt contracts/ credit whilst looked at with suspicion, in many ways provide the needed sustenance of any economy, especially advanced, post-industrial, free market capitalist economies. Using Craeber as reference, Turner states that debt has been around as long as money has been around, Craeber even argues for even longer. Turner states how Islam prohibits usury, whilst medieval Christianity was deeply suspicious of it. Aristotle in his well famed writing “The Politics” described lending as a “most hated sort” of way to accumulate wealth. These suspicions are understandable; however, it seems that modern economic theory sees debt/debt contracts as vital to spur economic growth. Moreover, according to Turner, it is precisely their fixed nature-the fact that the returns to lenders are largely independent of the success of the business project that makes them valuable.

 Turner also highlights that the earliest days of the Industrial revolution, capital accumulation in fact involved a major role for debt capital markets and banks as well as equity markets. With this it is also paramount we understand that economic theory provides good reasons for believing that without debt contracts, capital mobilization would be more difficult.

With equity contracts, the return to investors varies with the success of the business projects being financed. Turner deliberates and emphasises that what is important here is that these results are unknown in advance to entrepreneurs or investors. Once projects are completed entrepreneurs or business managers know for more about the true results achieved than even the investors themselves. This results in equity contracts having investors face risks that they themselves cannot even control.  Whilst in contrast to equity contacts, debt contracts offer a return that is specified in advance and is fixed as long as the business project does not actually fail. As a result, they support capital mobilization from sources who would be unwilling to find investment projects if all contracts had to take an equity form. This benefit would be delivered by debt contracts that take a simple “direct” form, with an investor holding bonds issued by companies.

Turner further highlighted that the development of “fractional reserve banks” also played an important role in enabling economic development. Using Walter Bagehot, whom wrote in 1878 argued that Britain’s more developed banking system compared with that of much of continental Europe, enabled wider pools of savings to become “borrowable” by entrepreneurs, rather the merely hoarded. Also, the economic historian Gersehercken argued that investment banks in the late 19^th century Germany played a role as important as industrial technologies in driving economic growth.

Turner then pinpoints that it’s not surprising that empirical studies have found evidence of a beneficial effect of financial deepening that measured as either the ratio of private debt to GDP or that of bank assets to GDP as countries progress through the early stages of economic growth. Turner goes even further that even in emerging countries like India, a strong case can be made that the extension of banking into small towns and rural areas would facilitate capital formulation by small and medium enterprises, which would not occur if capital accumulation required either equity or direct debt contracts between investor and entrepreneur.

All in all, as we all know with debt/credit, it garners many problems to economies, some of these fatalistic in nature. Most notable of these problems are deflationary debt effects, lost confidence in credit supply, ignorance of risks linked to debt and unstainable debt contracts. All these problems have amalgamated to become something of even greater concern that have caused havoc to economies all over the world. It indeed comes with its problems, but it also comes with its benefits as well as Turner has duly pointed out. We must find a balance to how we access credit as a means of prosperity but also armed with the knowledge that too much of credit/debt is not a good thing. At all.

Rethinking Capital Mobility, Re-Regulating Financial Markets; Watson (1999)

Poppy Harris

Watson’s paper aims to offer a challenge to the economic orthodoxy of the view of capital as a ‘hyper-mobile’ entity as a result of globalisation or, in others words, rejecting the ‘logic of no alternative’ purported by the classical neo-liberal dogma that has permeated global economies since the fall of Bretton Woods.

The West has tailored a view of capitalism whereby if the market cannot (or, indeed, is not ‘allowed to’) reach a global equilibrium, capital will naturally relocate to newly emerging lower-cost economies, since capital is inherently instinctive towards maximising profit and will move to do so. This has led to the view that states are unable to regulate their own economic spaces, or impose their own “distinct national identity upon capital” since capitalism transcends borders. Moreover, upon this orthodox view of global state interrelations and global capital movements, states are considered to not have the capacity act autonomously in regard to domestic economic policy. The logic of this argument suggests that economies are exporting capital at the expense of domestic capital and consumption.

To what extent is this the case? It appeared at the time of writing (1999) that domestic consumption was satisfied by domestic capital. Furthermore, Watson used the example that investors were holding stocks in their home country stock-markets with US at 94% of home-country investment and UK at 82% suggesting that capital is not as mobile as the spatial theory suggests. Of course, this needs re-visiting in light of when the article was written and the huge leaps that globalisation has made since 1999.  

Therefore, rather than explaining capital shortage in the West with these ‘logic of globalisation’ arguments, Watson suggests that it is instead the result of the neoliberal regime “providing a range of incentives for rationally-acting, profit-seeking capital investors to concentrate an ever-larger proportion of their investment in financial assets”. Capital has not relocated as is often understood; investment in production has been scuppered due to the widening gap between finance and the real-world economy, contra to the original aim of the financial industry to exist to regulate these differences. This has resulted in large capacity gaps in many Western economies (the difference between the actual output of an economy and its potential output).

How has this happened? Watson appears to argue that political economy has been too preoccupied with the spatial mobility of capital at the expense of its functional mobility. It is these two distinctions he continuously refers to in support of his argument. Spatial arguments maintain that capital will move across nations, transcending borders in search for the optimal maximisation of profit. A functional understanding, by contrast, should be understood as the impediment of investment flows into production, standing in contrast to a free-flowing understanding of capital. Viewing capital through the lens of spatiality presupposes that at some point it will always “touch down” in distance places. Looked at through functional mobility, we are forced to assume that finance capital does not touch down at all. A lack of this understanding can, and has, have serious implications for policy-makers.

Watson uses the example of derivative markets to defunct the spatial model of capital movement. The very existence of derivative markets, he suggests, are an example of the limitations of this argument. The spatial argument is based upon an understanding of capital’s ability to assess all available market options, placing itself where it will earn the highest premium. Taken to its logical conclusion, this would impact “upon domestic money supplies in such a way so as to eliminate the interest rate differentials which triggered the [movement] in the first place”. With such an understanding, we are forced to believe that domestic interest rates will be ‘policed’ by “speculative activity towards an international average”. However, he points out that derivatives markets exist in the first place because this international convergence failed to materialise. Uncertainty needs to exist to some degree for these sorts of markets to be viable.

Since the fall of Bretton Woods, interest rates have increased due to a loosening of capital control. A growing desire for liquidity meant that capital costs increased as a result, which affected small to medium-sized firms the most. Moreover, financial transactions were mobile in terms of geographical location (crucially also meaning they were outside the control of governments), which led to lowered transaction costs and thus the financial flow appeared to grow, whilst not being passed into the hands of production. For a shift to changing incentives from holding capital as money to holding capital as productive assets, new regulations of the market regime need to emerge in the form of a new set of interventions. This, he argues, will have the effect of “ending the notion of competitive austerity”. As it stands, governments attempt to market their workforces cheaply due to the supposed alternative being capital will leave for far-flung cheaper lands. These short-cuts in regards to labour and production costs have resulted in a relative fall in wages for the average worker. Only in regulating the flows between finance and production capital can the difference between the financial sector at large and the real-world economy begin to be stabilised.

Limits of transparency

Finance, the Modern-Day Babel

In “The limits of transparency”, Jacqueline Best shifts the focus from economic “uncertainty”, by emphasizing the importance of the term “ambiguity” in the determining of past and present financial institutions. Though she agrees on the importance surrounding the concept of uncertainty, she stresses that ambiguity is one of the main factors behind the dissolution and evolution of financial structures. Financial regimes have changed over time in their measures of choice that sought to minimize ambiguity, such as in the postwar era where it was regulated through managing capital and exchange rates. In recent decades, economists have argued for a more liberalized take in the quest for stability. Transparency and liquidity are believed to increase stability, as the market self-regulates and rids itself of ambiguities. The current state of affairs, stems from policy maker’s argument that the lack of information has been to blame for financial instability. Crisis has come about due to a lack of transparency and circulation of precise information. Best agrees with the paucity of information, but insists that transparency isn’t the “solution” to ambiguity. She proposes that the acknowledgement of ambiguity can contribute significantly to financial improvement.

She divides ambiguity into three categories:

·       Technical ambiguities

·       Contested ambiguities

·       Intersubjective ambiguities

Each one of those confirming different aspects inherent in the concept of ambiguity. Mostly they comprise a political and cultural spectrum, which create ambiguous policy’s. One aspect is the intersecting of finance with politics. Many fiscal policies are based on multiple interests, who fail to accommodate political differences. Best argues that there isn’t a simple solution and answer to economic issues, therefor understanding ambiguity can prove to be an asset. However, politics need to be considered, otherwise imbalances cannot be treated. This proposition is paradoxical to the neo-liberal point of view that separates the economy from politics. The neo-liberal point of view deems the economic machine rational enough to self-regulate itself and firm enough to rebuttal a crisis.  To resolve these ambiguities is a constant process of renegotiation. A swinging pendulum between temporary rigidity and looseness. Best is able to shed light on the true complexity behind international economic proceedings, which will continue to increase through further expansion and growth. It is important to see the big picture but details are able to clarify financial misuse and misunderstandings.