How the Market Made Us Stupid
(Financial crises in the United States
and Japan are about to teach the world
an awesome lesson: the money-go-round must be regulated)
by Will Hutton
Four trillion dollars is a lot of money. It
is the entire annual output of Britain and France put together. It
is also the amount American investors in high-tech
shares have lost over the past 12 months - and
that's before their losses in the rest of
the stock market. The entire rickety American economic
success story has rested on a crazy stock
market boom so that even taxi drivers were trading in
dot.com stocks and running up unparalleled
levels of debt because they felt so wealthy. Now they are
left, like the rest of America, with the debts
and worthless stocks.
And the crisis in the American financial system
is matched by one in Japan. Japan's massive
financial bubble burst 10 years ago and it
has yet to clear up the financial detritus. The banking
system is racked by up to $350 billion of
bad debts, but the banks' capacity to ride the financial hit is
undermined by the downward plunge of the Japanese
stock market because their own capital is
invested in the shares of other banks - a
double whammy which already means many are technically
bankrupt. And if we take seriously the hint
from Japanese finance minister Kiichi Miyazawa that
Japan might be the first major state since
the war to unilaterally write down the value of its national
debt, its financial system has to be regarded
as on the brink. For the world to have one calamity
would be bad enough; to have two simultaneously
is more than careless.
It is eerily reminiscent not of the kind of
recessions of the post-war period - which have been painful
enough - but of the recessions up until 1930,
as Larry Summers, the outgoing US Treasury
Secretary, has said. Japan and the US have
in their different ways made the cardinal error; they
allowed their stock markets to become too
intertwined with their overall financial system, reinventing
the impulses that made nineteenth and early
twentieth century recessions so vicious. What made
those recessions last twice as long as post-war
recessions was that they were accompanied and
reinforced by bank and stock market collapses.
In Britain there is no longer any folk memory
of what it means for a bank to go bankrupt, but as
recently as the 1880s major banks could go
bust, sending local economies into tailspin; firms lost
their credit lines and workers and consumers
their savings. In the US the experience was no less
raw. The New York stock market began to have
national importance as early as the mid-nineteenth
century, and its ups and downs rippled out
across the national economy. Banks were no more stable
than the strength of the city or town in which
they traded, and if one went down others followed like
nine-pins. As the pace of industrialisation
and urbanisation quickened in Europe and the US,
workers could be suddenly thrown out of work
by equally sudden contractions of credit lines and
investment funds. The 1930s slump was the
last of the great stock market and bank-induced
economic collapses.
The great success story of the 50 years that
followed, led by liberal and social democratic
politicians, was to tame these wild forces.
A mixture of regulation, credit control and state
intervention in the banking system stabilised
the financial system while welfare states helped
underwrite the risk to ordinary workers and
give them buying power that contributed to stabilising
demand.
But as the consequences of the irrationalities
of stock market gyrations and wild bank-lending - the
consequence of applying free market economic
principles to finance - were forgotten, so the
reasons for the regulations were forgotten
too. Know-nothing politicians of the Right, their intellectual
acolytes and financier paymasters lobbied
increasingly for 'deregulation' and 'liberalisation'. Bit by
bit the controls came off. In the US, Rooseveltian
financial reforms of the New Deal were scrapped
over the 1980s and 1990s as hindering the
competitiveness of US banking. American finance now
has all the 'freedoms' it had in the nineteenth
century, taking us back to the same wild capitalism.
My hunch is that the world is about to learn
an awesome lesson; the conservative theorists were
wrong and the liberal Keynesians right. The
information technology revolution may have constructed
a new economy, but it is one that has ancient
parallels. IT could never have got off the ground so
quickly without stock market finance, but
it had the impact of making an already febrile and irrational
investment community even more stupid, speculative
and herd-like than usual as it chased what it
imagined were new pots of IT gold.
Moreover, IT has been one of the reasons it
has been so hard to regulate finance, with the borders
between banks and the stock market becoming
so much more porous; banks may be bigger but
their disastrous nineteenth century-type exposures
to stock market losses have been reinvented. To
be effective regulation had to become smarter,
faster and more international, but in the current
environment building the essentially left-of-centre
coalitions that might effect such regulation has
been difficult.
So we are where we are. In the US, rather
like the 1920s, the stock market boom spawned a
massive misallocation of savings as Americans
abandoned caution and played the markets. They
have been duped into running up a scale of
personal debt rarely witnessed. Worse, the prospect of
easy profit has created a new populism in
which stock ownership and speculation are portrayed as
democratically enfranchising - while progressive
politics, with its instinct to contain and regulate
finance, is cast as against the best interests
of the people.
Unravelling stock market bubbles is always
painful when the linkages have been allowed to infect the
entire financial system; the ordinary credit
lines that lubricate the wider economy become polluted by
what has happened in the stock market. In
this respect Japan presents a warning. The losses go so
deep that policy interventions such as lowering
interest rates and reducing taxes are much less
effective than they were in the immediate
post-war period. The US has a market structure that
means it will get the adjustment over more
quickly and radically than Japan - but that means any
recession will be compensatingly more intense.
Europe will not escape the fall-out - but it
is in a much stronger position precisely because its stock
markets (except in Britain) have a much less
central role in its financial system. And despite some
wobble under fire from ignorant American critics
and their British poodles, Europe has maintained a
regulatory structure that retains that insulation.
As that realisation grows, the European Union will be
seen as a safe haven. And Britain will be
glad to be a member of a club in which economic activity is
not seen as the by-product of a casino.
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