Friday, November 21, 2008

An Open Letter to President-elect Obama

Mr. President

In case you have wondered why the economic crisis continues to get worse in spite of all the medicine in the world from the best experts in the world, the reason is simple: we have the wrong diagnosis (that this is a liquidity crisis) and we are therefore administering the wrong medicine.

You will not only be tempted to put the interests of the USA first, you may well consider it your duty to do so.

However, from your Administration, a fresh impetus towards open markets would be most welcome. The alternative to free trade is protectionism, which will ineluctably result in conflict - or War.

The parallels to the end of the previous phase of globalisation, in 1873, are chilling.

Lead us not towards the same mistakes. Lead us towards a form of capitalism which includes the possibility of a humane future for everyone in the world by means of a global level playing field for capitalism.

The Achilles' heel of the current phase of globalisation was the WTO's deliberate avoidance of a level playing field in terms of health, safety, environment, pensions - indeed, minimum standards in virtually all areas. I admit that the problem was compounded:
_ because of the pre-existing tendency to debasing money ("inflation"); and,
- because of legalising the possibility of gambling with money meant for other purposes, without requiring anyone even to keep track of who was betting how much - and indeed whether they even had the money with which to bet.

The result is that the world faces an unprecedented crisis whose true dimensions are being systematically ignored or underplayed.

The heart of the global problem is not currency misalignment or inter-bank liquidity or toxic assets - these are all important, but the key challenge is the derivatives/hedge funds/ credit default swaps (CDS) industry, whose global overhang is $1,144 Trillion (or 1.14 Quadrillion). That is as much as 23 times the total quantity of actual wealth in the world - Global GDP only amounts to some $50 Trillion. Even if we mark such trades at 5% of their value, as is usual, that still makes these trades roughly equal to world GDP.

In other words, the mass of outstanding CDS/Derivative/ Hedge Funds cannot be supported by all the money that all the governments in the world can provide. As there is no registration of such deals, no one knows who holds how much of these "acid assets", no one knows who will be required to cough up massive sums of money at what point, and whether such a person will have the capacity to pay or borrow such massive amounts. That is why not even banks trust other banks, let alone companies or individuals.

Moreover, in view of the current low appetite for long-term bonds, it is not at all clear whether even governments will be able to raise the quantities of money that have already been promised by them. So it is possible that some 30 countries are already bankrupt or well on the path to bankruptcy.

Much more innovative and substantial action is therefore needed. Any analysis of the contemporary phase of globalisation (the last 20 years or so) shows that our global economic system suffers from alarmingly large booms and busts. These may be inevitable, but intelligent ways are well established in the research literature for smoothing both booms and busts. High growth is always politically attractive, but it is much more important for growth to be sound, otherwise the illusion of so-called growth is quickly exposed as being hollow.

Here, therefore, are some key proposals:

1. As the purpose of CDSs was to provide insurance, and it is clear that insurance cannot in reality be provided by these at present, all CDSs should immediately be declared illegal, and the challenge of the actually-existing non-insurance should be met by government commitments to provide minimum insurance, but no more - that is, insurance that would enable all companies that were "going concerns" (say, at the end of September 2008) to continue trading. The initial amounts invested, provided those were before say 30 December 2007, could be returned to the original investors. The consequences for governments and for companies need to be worked out in detail but those could be good broad principles on which to act, essentially unwinding as safely as possible the huge industry which should never have come into being in the first place, at least on this sort of scale.

2. Derivatives and hedge funds have two purposes: (a) to provide insurance and (b) to provide speculative gain. The first function should, in accordance with item 1, also be taken over on a similarly minimum basis by governments, while all hedge fund and derivative activity which was oriented towards speculative gain should be immediately declared illegal, and compensation should be provided to the extent of returning the amounts originally invested.

3. All future speculative financial activity (hedge funds, derivatives, CDSs...) should be regulated by means of (a) standard templates (developed by the financial services industry) which provide transparency, measurability, gradeability and accountability, and (b) registration on, and sale exclusively through, recognised exchanges. At least seven global exchanges need to be established and maintained by law: competition is an important principle to uphold, specially when the scale of activity is so enormous.

4. The different types of financial activity (insurance, commercial banking, retail banking, investment banking, asset management...) should be separated by new global laws, so that speculation cannot be carried out with money originally supplied for other purposes. Certainly leveraged betting should be banned.

5. In order to make rescues of companies by governments viable, no company's turnover should be allowed to grow to a size of more than 0.5% of the GDP of the country where it is registered. As soon as any company is within 20% of that range, it should be required by law to start planning to spin out parts of the company; if a company does not do so, the national authorities must intervene with such plans - which will in any case go into effect as soon as company size does arrive at the borderline.

6. Countries within the UN, the WTO, Bank of International Settlements (BIS) and other such global bodies should agree to avoid printing more money than is justified by their GDP. Debasing a currency can provide a short-term spurt to an economy, but sound money is essential if solid growth is to take place. Any country violating this principle should be considered to have disqualified itself from belonging to the community of civilised countries with whom trade is possible.

7. Financial institutions (FIs) currently lend 12 times (or more) of the amount they actually have in money deposited with them. The greater the proportion that they lend, the more vulnerable they are to lack of depositor confidence at any time, and the consequent possibility of bank runs. FIs may therefore not lend more than 6 times the amount of deposits they hold at any one time. The rate of credit growth should always be below the rate of GDP growth for every country within the BIS, WTO, and similar treaties. Whenever the rate of growth of credit in a country comes within 20% of the rate of its GDP growth, the amount FIs may lend should immediately drop to 5 times what they have in deposits. Contrariwise, when the rate of GDP growth slows to 2% or less, the amount that FIs can lend should be increased to 7 times what they hold in deposits. If the GDP growth rate drops to 1% or less, the amount that FIs can lend should be increased to 8 times deposits. The intention of such a policy is to be counter-cyclical and to be well within safety margins, so that it would be unnecessary for FIs to be rescued by governments. Variable lendable quantity is an important but ignored lever, in addition to the equally-important but highly-attended-to-lever of interest rates, in order to influence debt, economic activity and sound growth within the global economy.

8. Tax and other positive and negative incentives should be used to discourage credit-based growth for individuals, families, companies and countries. Instead, investment-based growth should be encouraged.

9. The current monopoly of currencies (Yen in Japan, Dollars in the USA, the Pound Sterling in the UK, et al) needs to be complemented by currencies which are specifically designed to be cycle-dampening. The literature on cycle-dampening currencies and the experiences with them around the world are well known.

10. As accelerating stock market activity over recent years has speeded short-termism, two classes of stocks (Long Term and Short Term) should be immediately deemed to have been created for all publicly-quoted companies, and all existing stock holdings should be immediately considered to have been divided equally into these two classes. New stocks may be purchased only in equal quantities of Short Term stocks and Long Term stocks. Short Term stocks can be traded at any time. Long Term stocks may be traded only once a year on the date of purchase. This will eliminate "day trading" and so slow down the rate of economic activity, but at the same time enable growth to be much more solidly and healthily based. The exact proportions of Short Term and Long Term stock issuable and purchasable can be varied by global agreement from time to time, say every 3 years.

11. The 100 richest families in the world may be required by law to invest (invest, not donate! - whether through existing vehicles or through vehicles that develop for the purpose) 2% of their total wealth in democratic countries that are Least Developed. In addition, the 1000 richest families in each country may be required to invest 1% of their wealth in micro-enterprises in their own country, or to funds devoted to that purpose. Note that the intention is not to encourage micro-lending at the sorts of scandalous rates that are considered acceptable; rather, the intention is to encourage micro-investment.

12. Regulatory arbitrage around the globe should be immediately prevented through global frameworks, global minimum standards and global approaches to health, safety, pensions, minimum income, environmental protection, and tax (for the last, minima and maxima can be established depending on the level of achievement of a country). If a level playing field cannot be established around the world straightaway, there should at least be rational and agreed principles on which different levels of playing fields are recognised and established from time to time.

CAVEATS: Whether or not any or all of these proposals find favour, the vast majority of people in the world would deem the following to be completely unacceptable:
- attempts to form a world government, and
- attempts to create a world currency.
This is because we view such things as constituting, or at least laying the foundation for a slide towards, global totalitarianism. The world has had 20 years of casino or jungle capitalism. On the rebound, there is a real danger that there will be a temptation to rush into authoritarianism.
Global stability and sound global growth are essential. But these can only continue on a secure footing if we conserve and nurture political, economic, fiscal, financial, business, social, religious, ideological and lifestyle freedoms around the world.

Yours faithfully
Prabhu Guptara Sphere: Related Content

1 comment:

vasjpan2 said...

You know what really disgusts me about all these complaints about short termism? If the newspapers cared, why don't they print five and ten year changes in their stock tables? If the unions and universities cared, their own institutional investing is the worst offender.