Whilst it is not my intention to drill down and get into specifics regarding the current crisis, whether we are on the right course or not, who is right, who is wrong or who is to blame for all of this (many people, all for very different reasons), I am struck by what has been mentioned elsewhere on this matter and how we, as humans, seemingly cannot learn from our mistakes or are blinded by our own ideological peccadilloes (myself included) and that we seem unable to solve problems with out creating even greater ones.
As we know, at the moment the vast majority of ‘developed’ economies are experiencing great turmoil, some of which is due in large part to the largess of private consumption and debt fueled by lax lending practices of banks (with government approval) who really should have known better (see Ireland and Spain for instance), some of which is due to nations not having effective controls in place regarding the denomination the loans its citizens take (see Hungary, October 25th 2008 the exchange rate with £Sterling was £1 = HF350, come January 1st 2009 thiS dropped to £1 = HF273) and then we have what started as a recession coupled with a banking crisis which started in the US thanks to sub-prime loans being securitised (given a AAA rating by ratings agencies and sold off to people who really didn’t understand the nature of the underlying assets underneath) manifesting itself into a sovereign wealth crisis as governments felt compelled in many instances to either bail out there national banks for fear that panic may spread if one of their banks were to fail or take on the debts of these institutions and place them effectively on national balance sheets (Spain and Ireland are great examples once again). Finally, we have the seemingly unending policy of ‘austerity’ across the ‘developed’ world,, whether forced (see Ireland, Spain, Portugal and the big one, Greece) or unforced (the UK) which does not appear to be creating many benefits for those countries where these measures are being imposed. In fact, it seems to be not only making a bad situation worse economically, it is clearly straining the social fibres of many countries where they are being imposed.
Many have said over the past number of years ‘we didn’t see this trouble coming’, and I am certain that they didn’t see this coming, however, the question has to be asked, why didn’t they see it coming? After all, we are often told that banks need to pay rather large remuneration packages to their elite staff as they are the best around and are in some ways, irreplaceable. As someone who has either worked with or met people who work in some of these institutions, I can say with my hand on my heart that yes, they are very intelligent and yes they are incredibly hard working people, however, they are working in such a manner where they are effectively siloed into very niche working practices and are not able to, or supposed to, see the wider picture. Now, we could criticise these working practices, and I do not doubt that some should be reformed, however, I believe that this is a rather piecemeal solution and one that does not go anywhere near the heart of our problem.
Some have noted that we have had plenty of notice of an oncoming financial crisis for years now. They point to the Savings and Loan Crisis in the 1980s or the collapse of Long Term Capital Management in the late 1990s as clear indicators, sign-posts if you will, of impending danger simply ignored by those making lots of money in the longest bull market in history, or by those in government charged with regulatory oversight. However, we carried on regardless, largely with the motto ‘if it ain’t broke, don’t fix it.‘
Ever since the crisis started, when Lehmann Brothers went to the wall and when the world appeared to be caving in everywhere, I decided that I really needed to get a better understanding of what was going on, after all, knowledge is power. Further, as someone who loved studying history when he was younger, having heard people compare what we are experiencing with the conditions the western world faced in the 1930s and the Great Depression, I took it upon myself to try and see if we are experiencing a phenomenon that no one could have predicted? Is the Great Recession due to a single design flaw in the economic model we have taken up here in the West, is it the fault of Globalisation as risk is no longer confined to within the borders of a nation (was it ever?), is it due to lax regulatory oversight, bad loans, ideology of those who created our economic model, graft, cronyism, too much regulation, government largess, economic illiteracy or all of the above?
What has really drove me to write is the fact that I was confronted with an assertion I particularly didn’t like but one I have been mulling over ever since; that there is a crisis with the ‘credibility of economics’. To be frank, I took this an accusation that some are questioning the very existence of economics itself as a discipline. But the more I discussed the matter with none other than Sammy McNally, the more I came to a certain conclusion; that the use of the word ‘economics’ in this instance was slightly misleading. That while our economies are clearly in much distress, economics hasn’t gone away you know. It also reminded me of the use of the word ‘politics’ within a work environment and that people who feel that they are not doing well in a job due to the influence of others would normally say something along the lines that ‘there is too much politics in my work, I hate it.‘ What I find funny and fascinating about such assertions is that there is ‘politics’ in every work place, it’s just when events do not appear to be going the way we like that we call it ‘politics’. Similarly, economics is something that existed for a very long time, however, now that we are faced with trouble in our economies there is all of a sudden a crisis in ‘economics’. Is it more rather the case that we are having a crisis with a specific economic model or way of life as opposed to with economics in general?
Below is a video from Nassim Taleb, author of ‘The Black Swan: The Impact of the Highly Improbable‘ who notes that he had been warning about how economists were not giving proper weight or diligence to the risks many banks were taking on. I have a lot of time from Taleb and his writings, I would especially recommend his novel and others as I found it to be thought provoking and allowed me to see risk in a very different way than I had before. Further, his thoughts on the current crisis have been very interesting though I wouldn’t agree with everything he has said on the matter. However, what I have found funny is his use of the word ‘economists’ and how they didn’t listen to him. After all, he too is an academic at NYU as well as someone who works in the private sector, he is in effect an economist too, though he also specialises in risk management.
To be frank, there is little I disagree with Nassim with in the above. He notes in his book, as both Sammy and I did in our discussions, that economics is a social science, not a pure science, that the problem economists have created is that they have placed all of their eggs in one basket by relying on mathematical models as economists suffer from professional envy as their discipline is a social science, not the real thing. These models have acted as something of a constraint in the thinking of many economists as they have proved to be too rigid and seemingly don’t rely on too large a data set.
If we compare this rather rigid and flawed thinking with say, reflexivity, we would be able to see why someone like George Soros, one of the main proponents of this theory, has continued to do well during the whole financial crisis.
However, this brings me on to the main thrust of this piece, and that is, while we have an economic crisis at the moment, and lots of people are clearly questioning ‘economics’ or the teaching of specific economic doctrines today, why are we not looking even further back in time, seeing what similarities there may be not just with the Great Depression, but what about before that? How about looking even further back to say the 1820s and the post-Napoleonic era? I know times have changed and we financial products have evolved as well as the markets in which they are sold, but I often wonder if people, even those who work in financial services, fully comprehend what it is they are dealing with and how these products and innovations came about.
With this in mind, I come to Niall Ferguson’s work with his book ‘The Ascent of Money‘ where he goes over the history of money, financial markets and why some things that we take for granted, such as government bonds, stock markets and wide spread home ownership, have come about and become part of the landscape. He tells us the history behind these developments, the problems they were to solve and the problems they have also created. And it is this book and the documentary series that accompanied it on Channel 4 in the UK, PBS in the US, that started to pique my interest in economics in general. Here, Ferguson discusses the content of the book and some of main points he deals with in the book, including the creation of bubbles and the behavioral economics of these phenomena, together with the constraints of slavishly using mathematical models without deviating from them when it is obvious that they do not have enough variables incorporated into them. Be warned, the discussion below with Harry Kreisler of UC Berkeley is close on an hour long but very interesting and worthwhile.
So, why are we not having a major discussion about economics in general outside the realm of the current, fairly narrow focus on specific levers we should be using to try and drag us out of our malaise. Why are we still locked in a politically motivated ideological debate as opposed to actually looking at what works by using empirical evidence instead of conjecture? Why are we not incorporating economics into the fabric of our day to day discussions? Who knows, but I’m sure like myself, you may have some opinions on the matter.