International capital flows are supposed to be good for two reasons. First, they divert capital to where it can be invested most productively, enhancing efficiency and growth. Second, they help diversify risk. As regards the first benefit, helping rich country consumers borrow and consume is not what we typically think of as a productive investment. As regards the second benefit — well, the less said the better, really.
In a widely noticed article in the FT, Nouriel Roubini has argued that capital flows are now creating major asset bubbles outside the US, as investors exploit the weakening dollar to borrow at negative interest rates and invest the proceeds overseas. If he is right, then central banks are faced with an impossible dilemna. Outside the US, if they raise interest rates to prick incipient bubbles they jeopardize the recovery, and/or attract even more capital inflows. Inside the US, raising interest rates clearly places the recovery at risk.
I understand where Wolfgang Münchau is coming from when he calls for interest rates to be raised sooner rather than later, but having seen the world economy edge away from the precipice, I am not keen on measures that would bring us closer to it yet again.
If the problem is indeed being caused by ‘the mother of all carry trades’, as Roubini suggests, then throwing a few bucket-fulls of sand into the wheels of international finance seems to me to be a far less risky way of trying to deal with it. International capital flows have been associated with enough crises to be going on with these last few years.
20 replies on “The benefits of financial globalization have been oversold”
Roubini’s views obviously warrant serious respect given his role in calling the global housing meltdown, but I wonder if he has presented any hard evidence in support of the carry trade hypothesis. I didn’t see any in the FT piece.
I haven’t looked at other commodity prices, but crude oil prices since the start of the year are parallelling the rapid growth of early 2007 that topped out at $147/bbl in July 2008 with even less of a rationale in the fundamentals. During that 18 month period regulatory agencies and many commentators pooh-poohed the contention that it was been driven largely by huge volumes of speculative, unregulated OTCs trades and the impact of index funds. Since then, wiser counsels have prevailed, but the ability of speculators to evade the subsequent limited increase in reporting requirements has not been diminished. Fortunes were lost in the credit crunch, moral hazard rules supreme since taxpayers in the develoepd world have proved pliant patsies and no lessons have been learned, so its business as usual.
No amount of sand in the wheels will prevent the masters of the universe finding another wheel to spin unless every – and that means every – national jurisdiction is on board.
For a dissent from Roubini
Check out David Goldman’s blog on the Asia times
Our understanding of dynamics systems, and how we design ourselves into difficult no-win situations hopefully has improved in recent times. Our understanding of these dynamic systems has to continue to improve into the future, otherwise we will pay a significant penalty in terms of all kinds of systems we create.
I was reading a nice article about ventilation in buildings today. I found one funny piece at this web page.
Scroll down to the part about ‘Stack effect: slow, steady, and bigger with height’ to see the point the author is making. As people on the lower floors of a high rise building adjust their environment to suit them, it messes up things for people at the top of the building. Basically, the author compares a high rise building to being like a gigantic chimney in terms of air movements.
Using the above idea of ventilation in tall buildings as a model, I will attempt to describe a similar dynamic underway in our financial system, between the banks at the top of the building trying desperately to manage risk, while the people on the lower floors try to work out their situation as best they can themselves. In other words, we need better overview of the entire system to understand the problem.
Apologises for the length of what follows, but it might demonstrate a concept of movement of savings, risk and capital within a single vertical economy like that in Ireland. With deposits renting the ground floor space as it were. The bankers taking the penthouses.
The trouble I believe, (I know I have a very naive and simplistic view of the world of economics) is a mis-diagnosis of the problem in western economies. We are being told constantly that people in western societies do not save any more. Indeed, too much saving as seen in the UK these days, is deemed to be a bad thing and people are encouraged not to stop spending altogether.
I don’t know nearly enough about western economies other than Ireland to comment. Indeed, the world is a far bigger place than I know enough about. But from my experience here in Ireland, I know that people do not trust the plain vanilla bank deposit as a safe way to store their wealth anymore. People seem to believe, or have been taught that investing the money in some form of asset is a much safer way to go about saving. In other words, peoples’ money is removed from deposit accounts and moved into other forms of wealth storage. Indeed, to buy an asset outright may require additional monies, and banks often extend loans to people to purchase assets.
People in the west seem to feel this is the only safe way to operate. All faith seems to be lost in having money sitting in a bank balance. The banks in turn are forced to operate using risk models and deposits far below 5% as recommended by Larry Fish in the United States.
During our recent asset bubble in Ireland, the common perception out there was, you weren’t working hard enough, unless you were leveraged to the hilt. That somehow you were slacking off a bit, unless you had huge loans. I don’t know where that attitude came from. My guess, is that people are better educated nowadays and have better careers and that has given them a huge appetite for extending themselves. Education and advancement of one’s career are very good indeed. But perhaps we were more stable when people had less education and more savings in the bank.
The banks were better off, because they weren’t forced to delve into higher mathematics and operate sophisticated risk modelling. All too often, these days the element of ‘greed’ is being attributed to the asset bubbles like the one we experienced in Ireland. But no one I have read to date, tries to argue a case, that maybe greed had little to do with it. I talk to life long savers every day and their attitude is strange to me now. They cannot seem to wait to move their money out of deposit form and into the acquisition of assets. That is the mild form of the western impulse for security of one’s wealth in modern times. The more aggressive form, is simply where one leverages those savings a few times more, if one is young enough, against the supposed couple of decades of a working life one may enjoy. One acquires the asset earlier in life, in order to have it as a store of wealth as one grows older.
In other words, it is a different formula from the olden days, where one accumulated more ‘wealth’ in the form of deposits in a bank as one grew older. Those deposit forms of wealth were extremely useful for banks to boost their stablity. But it becomes more difficult for ordinary people to leave their accumulated wealth in deposit form in a bank, the more of these ‘asset bubbles’ we see in our western economies. The trouble with economic analysis, is the person who moves their money from deposit form to asset form, a second home or whatever, they are no longer labelled savers anymore. They are labelled as non-savers. But in reality they are still trying to be savers, but rather savers in a different way.
I do not believe that the western economic problem is lack of saving – but rather it is too much impulse to save, in the form of assets. This is where we get the volatility in house prices from as the volume of trading in those assets increases exponentially.
@ BrianO’H: Check out the FIRE economy at iTulip.com. Search archives. It will take you, perhaps, two-three days to read all the relevant pieces. Knowledge of the current ‘bust’ was being flagged by 12 different commentators as early as 2002 – NR included, and any of us 5 Sigmas who took the time to read their blogs.
If you have PLENTY of time, got to suddendebt.com – probably the best blog on the subject. Gets the message over in short order – no waffle! Its a scary place!
If you really have LOTS of time try: Richard Bookstaber: A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation. Brilliant!
The solution to the current global bust: Default all debts. Start from scratch. If this is not done, we will end up in a bad predicament. If your leg is gangrenous – you lop it off! Else you die! Choose.
@Brian O’Hanlon – “I know that people do not trust the plain vanilla bank deposit as a safe way to store their wealth anymore.”
That’s only fairly recently (since last year) but I agree with a lot of what you say about the primitive drive to invest in so-called assets. Prior to 12-18 months ago, people were more likely to put their money into a deposit (cash) account as interest rates seemed ‘OK’ but mostly because too many ordinary punters have been burned over the years buying unit-linked/stockmarket-linked investments etc. and oddly enough, when there’s a problem their stockbroker/life office doesn’t even answer the phone because they’re too busy dumping their own stuff to bother with mere customers.
The irony is that those investments are described as “asset-backed” in the glossy marketing literature of financial services companies. ROFLMAO.
Having worked in that area for many years you will have to excuse me if I view it with a somewhat cynical eye.
Kevin, low central bank interest rates are meant to encourage resources – including financial capital – to be channeled into riskier enterprise or assets. No surprise there, and certainly there should be no surprise for professional economists.
As even economic historians know, with one just policy instrument, there is only so much that can be achieved.
The “impossible dilemma” for central banks results from inappropriate policies or constraints on other fronts (and notably fiscal policies). I’d see it as the responsibility of the economics profession – even historians – to explain the issues.
I understand that this entry is just part of a blog. This forum is strongest when entries rely on solid analysis.
I have no idea what “throwing a few bucket-fulls of sand into the wheels of international finance” might mean in reality. It doesn’t sound helpful. Some populists seem to believe that the economy can make do without banks or without capital flows. Yet there will be no economic recovery without a recovery in the financial industry as well. We can argue over how to engineer that. But it is the responsibility of the profession not to kindle the fires of economic populism.
Sorry Ciaran, I assumed that everyone knew what throwing sand into the wheels of international finance meant. It is of course a reference to the Tobin tax.
I was seeing the problem a little differently. I’m definitely not saying I disagree; I’m intrigued rather, as I hadn’t considered your points. It’s why I love coming here — to get shaken out of my own circular thoughts.
My initial opinion may very well shift as I digest your points. That position is as follows (sorry for the length):
As Joseph mentioned above, interest rates were recently quite low, especially compared to historical trend. Holding a deposit is perforce less attractive. People were urged and instructed to look for higher growth in their savings. In the US (where I’m from) in the Nineties, the combination of stagnating wage growth, low interest rates and poor job security were the fuel for regular punters to start thinking of risking more. Early stages of a bubble look innocuous and pretty sweet to someone knowing that they will not have enough for retirement if they don’t take a risk. I think stagnating incomes had a lot to do with middle-class people turning to credit more and more, once it became fairly cheap.
Also, deposits are not as desirable to banks as loans are. They make more fees, for one; for two (and if I’m wrong on this someone correct me) the necromancy of accounting allows banks to use the whole loan as an asset, not just the portion that’s been paid. And when a loan goes onto the asset side of the ledger, poof! Lotsa money just appears out of nowhere. The money stock is increased in a way that doesn’t encourage inflation (remember, moderate rates of inflation are actually somewhat beneficial to the debtor and detrimental to the creditor). I think (again, you smart people can correct this) the M1 measure of money stock has decreased as a proportion of the total as a result – M1 being the actual jingly-foldy stuff.
The problem I see with accounting in this fashion is that it seems like smoke-and-mirrors to an ordinary householder like me; I can’t borrow against anything but my equity, whereas the bank can borrow against my whole mortgage (coupled with a fortune-telling called my credit rating). But that value is a future gain. So they are magically pulling future wealth into the present and declaring it to be in da house. But in the crunch, when that future wealth seemed not to be a sure thing anymore, Elvis left the building. If I am correct in all this, the wealth listed on banks’ books was this “air money” to begin with, never really there. They a) claimed our future earnings plus interest, b) convinced themselves and everyone else that we were all so good for it that c) it was as good as in their hands now.
What NAMA and other similar vehicles are for is to get those future earnings back on their books some other way. But in the end, it seems our politicians are making sure that we’re still good for it. Even though the fortune-teller Madame Fitch says we’re not so.
SSIA had an influence in flooding the market with credit, don’t we think? It was necessary for TPTB to replace the capital “lost” to the Revenue Commissioners, once the DIRT collection was underway.
BPW is correct. Capitalism allows mistakes and helps us to learn from them. Making bigger debts to recapture losses sounds like the worst sort of gambling to me!
Ciaran O Hagan
The financial industry exists to take OPM and then finally, to cause bubbles! It is a Ponzi scheme. Look at the derivative “industry”! Sell on the risk and pocket the commissions always leveraging to the max. Financial industry is a scam pure and simple. The tragedy is that the suckers often never learn and blame everything but the bubbles!
Marise is correct. But Marise does not follow the extension that all these loans eventually stop. That is the bursting of the bubble. Roubini merely points to the new bubble!
Guilty as charged, I didn’t mention the particulars of th Ponzi’s collapse. This time, it seemed like when the banks ran out of middle-class, more credit-worthy suckers to enterthe pyramid, they created sub-prime. For them, the loan train stopping was the end of the party. Now it looks like investors, still yearning for the good old days of huge returns, are running around looking for either safety (and not finding much) or the Next Big Thing.
I attended a workshop on ‘universal design’ this weekend organised by the National Disability Authority of Ireland, Trinity college and the RCA Helen Hamlyn Centre in London. A lady from the Royal College of Art in London, Julia Cassim showed one slide in her presentation, which described the population demographic in decades past as being like a pyramid. All of the young people being the largest segment at the bottom. She noted how this shape has change and now the bulge has pushed further upwards to around the neck or bust area.
The workshop was all about design of the environment and design of products which fit around the requirements of this new older population majority. Julia Cassim made the quite obvious point, that the older market should not be ignored. Many products are aimed at the youth culture, because designers assume that is where the money is. But that is a mis-perception and designers should re-evaluate at their potential marketplace.
I saw 5 no. different projects explained during the workshop presentation. Of course, none of them were financial products aimed at the older person. The design workshop had a justified claim to being multi-disciplinary. It was multi-disciplinary in the fact the 5 no. teams contained members from many of the different design, architecture and engineering professions. But I couldn’t help but think a whole big part of the problem facing older people was omitted in the challenge. Sure, getting around a city if you are in a wheelchair, partially or fully blind, or otherwise challenged in terms of physical mobility is a design challenge. But another part of the design challenge where older people is concerned is to do with the financial area.
I was watching Prime Time the other evening and Joan Burton of Labour, Richard Curran of the Sunday Business Post and Michael McGrath of Fianna Fail. It suddenly occured to me that the debate about NAMA has been framed in terms of the taxpayer. I have challenged deputy Burton since on this, and she has given me some very logical explanations of why the Irish taxpayer is seen to be the party most at risk. I am sure that Karl Whelan and others would agree with this focus on the Irish taxpayer as crucial in the debate on Ireland’s national recovery. But part of the debate should also focus on what Julia Cassim talked about – that large ‘bust’ in the population demographic today, where a huge portion of the wealth is tied up with that older majority. How is the financial and economic system going to deal with that?
It is similar in a way to Kevin O’Rourke’s original point, that of globalisation. This notion of the savings of many of the poorest on the globe suddenly appearing within the global capitalist system. Our track record in dealing with that challenge hasn’t been good. We should be looking at Ireland and the aging population to ascertain what is the best way for the older people to use their savings.
See also, Philip’s Lane’s earlier blog entry: The Housing Bubble and the Windfall in the Tax Revenues, I where I scribbled down multiple posts, to try and articulate some of the problems I see, in the perception of bank depositors of cash they might have stored in banks for a very long time.
“the necromancy of accounting allows banks to use the whole loan as an asset, not just the portion that’s been paid.”
I wrote something at my designcomment blog a while back about ‘Push and Pull’. I tried to describe a sort of dynamic process, where there was too primary forces acting upon property developers in unison. A lot of people focus on the first force, which was to ‘push’ credit towards developers. But a force acting upon developers which was equally as strong and really tipped the construction industry way out of balance in Ireland, was the ‘pull’ force at the back end of that system. Whereby the square meters of let-able floor area, was converted into a product which the markets promptly gobbled up. Many people asked me, how did that ‘pull’ system work.
Well in many cases, it was no more sophisticated than the fact an Irish developer could put forward the projected future rental of his completed project as collateral for getting more credit out of the system.
I presume this is where the upward only rent review legal clause came to be important. It had the effect that it released a lot of finance back to the development community, as they were adding together all future rental income from a property. But the legal clause of upward only rent review, did not address the issue of shopping centre we read about in the newspaper today, such as the CHQ centre in the Dublin docklands with 40% vacancy rate. It would be interesting to know if the CHQ facility had been put forward as collateral on any other loans the DDDA has outstanding.
“So they are magically pulling future wealth into the present and declaring it to be in da house.”
That is what has happening within most of the major Irish property development firms. This is the reason why so many property development firms were in a rush to develop commercial real estate. It was a race on to see who could pull as much future wealth down onto their balance sheet as fast as they could. The fact there might be a demand or no demand for the commercial real estate was only a secondary consideration. The main goal was to secure the land and build on it, so you could use your future rental income as collateral. People often wonder why there is so much vacant commercial real estate around the place.
It had nothing to do with the fact that Irish builders were so stupid they couldn’t calculate what likely demand was in the market. They were more than well aware of what demand was. But it was an effort to see how much more leverage one could create for oneself by development net meters squared of space. That is the way the financial system is set up to work with ‘property’ today. We need to re-configure it radically, so that speed of construction is less favoured in the equation – and that other elements like quality, sustainability and energy independence generate more wealth than speed of construction.
If you have the time to read the green building advisor explanation of ‘air flows’ in high rise buildings it provides a useful model for thinking about what is happening in our economies in the western world – from a dynamic point of view, where the action of the party occupying the lower floors has an effect on those up at the highest level penthouses. In rational terms, this shouldn’t be so, as the rent the tenants in the penthouse pay should preclude them from any involvement whatsoever, with those on the lower floors paying the lower rents. But in terms of system dynamics nothing is entirely separate from something else. I believe the green building advisor explanation of air flows is a useful way to think about the economy in this dynamic sense.
Basically, the behaviours of the people on the lowest floors, the most un-sophisticated people using the simplest of ‘mental models’ to assess their risk position, do something at the lower level like turning up their thermostat. The people at the top level have to open a window, which accelerates the cooling effect at the bottom, so the people at the bottom turn up their thermostat yet again. The whole thing accelerates and gains its own behaviour – everyone gets ‘pissed off’ as the Green building advisor article said.
“the people in the penthouse apartments get all they’re burps and farts delivered into the penthouse suite.”
The people at the bottom, they get the freshest air of all, even though they pay the lowest rents.
My reading of all of this is, as the behaviour of depositors changes at the bottom, to get hold of something real, something physical in the form of bricks and mortar because of a fear they have or their retirement and their savings difficulties – this requires the bankers in the penthouse, to engage in more sophisticated leverage and risk calculation to try and ‘re-balance’ the system. An air conditioning system is all about finding a balance to the system. My understanding, is there is a huge amount of science involved, and a lot of it has to do with cybernetics. The same kind of theory which enabled James Lovelock to come up with this idea of Gaia and our green planet.
This is the systems view and most people don’t think in that way when trying to deal with dynamic, fluid concepts such as our economy. I will be so bold as to suggest that economics students at UCD or other universities should study air condition-ing or other natural phenomenon to obtain some grasp of the dynamic systems view. It is essential to designing products in the world as we move forward. John Thackara’s book ‘In the Bubble’ is one very good reference on how to use a systems view.
I downloaded the following book from a link at a wikipedia page on system dynamics not too long ago. It describes in one section, very well, the process of trying to balance an air conditioning system.
THE SYSTEMS APPROACH
Fresh Solutions to Complex Problems Through Combining Science and Practical Common Sense
Simon Ramo, Ph.D. and Robin K. St.Clair, Ph.D.
Simon Ramo and Robin St. Clair book, was actually at the systems engineering, rather than the systems dynamic wiki page.
The salient conclusion that James Lovelock came to about the global balance in terms of Gaia, was that the globe attempted for a while to resist the changes we enforced upon it. But eventually it simply gave up trying to balance the system, and instead it jumps suddenly to a different state of equilibrium where it feels comfortable. It is irrelevant to the Gaia system, that change in state might have consequences for the human inhabitants. Lovelock reckons the planet has done this several times in the past.
Considering that the western economy has this demographic change going on, considering the fact that so much of the financial system is based upon pulling future wealth in the present – given that most of the wealth has been captured by the older majority of the population now – I am really not surprised that the old models that seemed to work, do not work quite so well anymore. We are unable to predict where we are going, unable to balance the system as it were. We need to really go back to basics and find a way to understand the system.
Naturally, one of the ways to re-balance the system, is to put more incentives into making things that last over time, add value over time, and create more value over time. This I think is where the green movement and economics have to converge with one another, in some way. But we cannot expect to get very far with old pre-conceptions.
Enough said? B.
I always liked Derek Brawn’s explanation of re-gear-ing by developers in his comment here at the Sunday Tribune.
Derek describes a process in which wealth was tied up in a project and then released again, and possibly increased a number of times, by the process of development.
Apologises in advance for this other load of waffle, but there is an important connection I would like to establish between age demographics, asset backed saving and economic perception.
Here is a chimney or stack effect that might be operating within the economy and it is a self-reinforcing process that continues to accelerate. You have to see my earlier comments in Philip’s Lane’s earlier blog entry: The Housing Bubble and the Windfall in the Tax Revenues, to understand some of the background to this theory.
The people who hold cash on deposit in Ireland regularly ‘benchmark’ their holdings of wealth in deposit form, against having the same embedded in bricks and mortar. Hence, the obsession to talk about house prices so much in pubs, restaurants, cafes or wherever people of a certain age bracket meet up. As the price of homes increase, the perceived purchasing power of cash on deposit is perceived to drop relatively.
Hence the impulse to move money from deposit form and into bricks and mortar form. Of course, more competition for bricks and mortar, the higher its price goes. This puts increased pressure upon people to move their wealth out of deposit form and into bricks and mortar form. Very soon you witness a situation in which people all have 2 or 3 no. homes. These people might be of middle age and do not even need the extra homes. It is like a chimney effect.
But it put immense pressure on our banking system. Because, in order for first time buyers to compete in this market they are forced to obtain much more leverage from banking institutions. That is, many times their annual income rather than the traditional 4-5 times. The banks in other words are forced to do enormous amounts of residential mortgage lending, at a time when much money is flowing out of coffers from deposit form – to be transformed by the older savers into the safer bricks and mortar form.
This system does not work in reverse unfortunately. As the previous large depositors cannot exchange their expensive bricks and mortar now, and turn it back into deposit form. At a time when the banks need deposits more than ever, to address their problems of over-leverage to help out the first time buyers! It is the equivalent of trying to suck air back down the chimney.
The reason I went to the trouble of making another long post on this subject is simple. The typical family home is one of those ‘products’ that Julia Cassim of the Royal College of Art in London talked about which is aimed at the ‘youth market’. That is, a house to use Le Corbusiers old phrase, is a machine for living in. A machine basically, to act as a baby factory, to be very basic about it. But unfortunately, it is a product which the older demographic bulge is finding very attractive to store their wealth in.
To end this rant, I will share with you a story about ‘disposable nappies’. Disposable nappies were originally aimed at the top end of the market. At people with a lot of money who could afford disposable nappies. But unexpected to the large corporations, disposable nappies were quickly purchased by mums in the lowest income brackets. Because they faced all kinds of challenges in terms of not have washing facilities and time to use traditional re-usable types.
Unfortunately, the family home – the bricks and mortar in Ireland has become like the traditional nappy in reverse. It is aimed at one segment of the market, yet was purchased by the higher end of the market. There was one of the Fiat automobile models which went like that too. It was aimed at the lowest income bracket, but it was purchased and became a symbol of the Mercedes owning class, because they wanted a cheap, small disposable car basically, to go to the shops in.