by Dr. Angelika Brinkmann
In October 2008, the U.S. Congress passed a 700 billion dollar rescue plan of banks; European countries followed suit and moved with rescue initiatives of their own. The Netherlands and Luxemburg took partial control of the struggling Fortis bank and Germany guaranteed a loan to Hypo Real Estate Holding before finally moving to take control of the bank at the end of May 2009. On June 1st, 2009, the formerly largest car company in the world, General Motors, filed for bankruptcy.
We are in a period of profound changes in national and international economic systems and financial policies. This article argues that the economic crisis resulted to a great extent from the absence of a Third World War. This allowed for a new set of state and financial practices developed by leading states in the context of a flourisinhg international business after 1989. In the course of the last twenty years, these practices were universalized in the financial system, setting new standards for risky financial behaviour. These developments make us aware of changed processes in governmental decision-making. This essay reviews the contributions of three aspects: 1) previous historic incidences 2) the role model of verification and compliance in setting a new global financial architecture 3) business expansion of auto industry and financial markets due to an abundance of time.
The essay concludes that a solution lies not only in the restructuring of financial markets but in the redirection of economic policy.
Manhattan Transfer
There are a lot of sophisticated financial explanations of what went wrong, but there is also this: Among the U.S.'s 100 top political donors since 1989 there are 10 of the U.S. biggest banks and investment firms. Together with their employees they donated approximately 170 million dollars. Among those who gave generously were AIG, Fannie Mae and Freddie Mac [Center for Responsive Politics, http://www.opensecrets.org]
So they got what they wanted: more freedom and less regulation. Some of the financial meltdown can be attributed to laws that allowed the financial sector to engage in all sorts of innovative and risky behavior, and the absence of laws that even monitored such behavior.
Giving the financial sector its way undoubtedly helped fuel the rising stock market and expand homeownership. But when a housing bubble developed and it came to pull back, many lawmakers and regulators were too busy listening to big donors to see beyond what CEOs, bankers and their lobbyists were telling them. Maybe this is one reason why the obvious signals of perils were overlooked.[ For a detailed analysis see e.g.: Charles R. Morris: The Trillion Dollar Meltdown. Easy Money, High Rollers, and the Great Credit Crash, Philadelphia: Perseus Books, 2008; another opinion can be found at: Michael Dooley/Peter Garber: Global imbalances and the crisis. A solution in search of a problem, 21 March 2009, http://www.voxeu.org/index.php?q-node/3314]
Once upon a Time
Robert Malthus (1766-1834) was the first to present a universal and perpetual dilemma: he maintained thaht the prospects for permanent improvement in the condition of the mass of society in all countries has been placed in a precarious balance by an unequal race between the share of production growth. Malthusian has become part of our vocabulary, used in scientific and popular debate on the problems of population growth in the Third World, as well as by environmentallist who treat the balance between population and exhaustic resources as a global problem.
One of his earliest conclusions, which Malthus drew from his findings was a denial of the right of the poor to relief under the English Poor Law, thus indicating criticism for social policies which equated poverty with moral failing. A fear of falling in the social scale appeared to replace the opportunity to rise as the leading motive of men in society. Mass poverty and inequalities existent between rich and poor were seen as an indelible part of the human condition, capable of being remedied only by forms of individual prudence and self-help unlikely to be available to the majority of society until their living standards had already risen.
The principle which he enunciated with such conviction is a universal one, capable of explaining the past, present, and future condition of mankind.
He had not discovered this principle – the idea that population expands up to available subsistence was something of an eighteenth-century commonplace.
The problem of growth has dominated history since the 1960s as it has dominated political economy.
John Maynard Keynes published “The General Theory of Employment, Interest and Money” in 1936, more than 150 years after Adam Smith's “An Inquary into the Nature of causes of the Wealth of Nations”.
Several classical and neoclassical economists shared the vision that free play of markets is enough to ensure the full employment of resources and their optimal allocation. The economic crises suceeded one another during the entire nineteenth century and up to WWI 1914-18. The workers' uprising in the 19th century - in particular the events of 1848 and the Paris Commune of 1871 -, the Russian Revolution in 1917, and then the workers insurrections experienced by several European capitals as the war drew to a close seemed to confirm, for several, the visions of Marx and his disciples.
The crisis went on after the war. The stock market euphoria, evident in particular in the United States in the second half of the 1920s, became increasingly severe. The entire world was then ravaged by the great depression, which manifested itself in plummeting economic activity, rising unemployment and the broadening of poverty and misery. The world of economists was affected manyfold by this situation.
After WWII, Ludwig Erhard, the German Minister for Economic Affairs, conceived and set in motion the 'social market economy', characterized by a general confidence in the market mechanism. It required the State to ensure that progress was to benefit the society as a whole. Wilhelm Röpke, the main representative of the Freiburg School after the death of Walter Euken in 1950, gave his support.
But this much praised social market economy is better known as the “Rhineland” model. According to Frits Bolkestein, the Rhineland model “may be seen as a regulated market economy with a comprehensive system of social security.Government, employers organisations and labour unions consult each other about economic goals and on the policy instruments to be used.” [Frits Bolkestein: The Dutch Model. The high road that lead out of the Low Countries. The Economist, May 22nd, 1999, p. 97] This system combines a welfare state with a so-called “consultation economy”. [ibidem] “Rhineland participants in the economic process (widely known as 'stakeholders') try to achieve a harmony of interests. In such a stakeholder economy the primary goal is not the maximisation of short-term profits for the benefit of the shareholders. The main concern is a sustainable, stable and continous growth.
Karel Van Miert, the former EU Competition Commissioner and a true advocate of social market economy could agree to that. During his term he had several critical encounters with the German government regarding company mergers and the fixed book price agreement to name but a few.
The Grapes of Wrath?
In his 1939 Pulitzer Prize-wining novel John Steinbeck described a roaming, homeless society. But even the infamous tent cities near Sacramento, made public on U.S. Television cannot deny the fact that this is not quite like 1929. Starting in 1929, the U.S. Economy shrank for four consecutive years. In 1940, the economy was still smaller than in 1929 before the stock crash. Unemployment in the 1930s was staggering, in 1933, e.g., the number was 24.9%. Today, it is nearing 10% in the U.S. Recent analysis indicates that world industrial production, trade and stock markets are diving faster now than in the Great Depression. But the authors also note that stock markets show some improvement due to better political response. [Barry Eichengreen/Kevin H. O'Rourke: A Tale of Two Depressions. 4 June, 2009, http://www.voxeu.org/index.php?q=node/3421]
There is no formal definition for recession, but it is generally agreed to mean negative economic growth, lasting more than a few month (at least two consecutive quarters is an often-used measure). A depression is an order of magnitude worse. In the 1930 depression, which lasted a decade and was ended only by a world war, the stock market fell by almost 90%. Then, U.S. citizens were so strapped that even spending on basic needs such as food and medicine declined.
The plan to buy 700 billion dollars in troubled assests from financial institutions generated a wave of public outrage and political manoevering that nearly derailed the deal. A similar debate ignited in Germany. At issue: whether to help automaker Opel and department store chain Arcandor. But is it correct to speak of this situation as a 'tsunami' or 'Pearl Harbor' (Warren Buffet)? The first is a natural catastrophy and the latter an attack of one country on another. The financial market crisis affects most countries simultaneously and has seen a long built up over the years with warning signs put aside. It resembles more a classic dramatic situation: either way the turn could mean disaster. It is not clear if the plans conceived by the various governments will work. Nor is it certain that economic trouble will ensue if governments fail to act. The bailout money represents about half of what the U.S. Government will spend on Social Security, Medicare and Medicaid combined in 2009. It is also a temporary move with the government spending money to acquire loan portfolios and warrents to buy stock, which it intends to sell when economic conditions improve. In terms of its ultimate cost, tax payers should get much of their original investment back and some think they might even profit.
There is nothing unique about government interventions into credit markets. One very similar action was the savings -and-loan bailout assessed by Congress in 1989 in which the government spent about 124 billion in taxpayers' dollars to buy and resell distressed assets of failing thrifts.
The present situation is precarious but it is not a disaster, like a tsunami or Pearl Harbor. Precarious is not the same as disaster. The next chapter shows history knows similar events.
Boom and Gloom
An extraordinary analysis by Simon Shama, The Embarrassment of Riches (Berkely and Los Angeles: University of California Press, 1988) describes prosperity problems of 16th century Dutch Republic. The republic was an island of plenty in an ocean of waste. Its artisans, even its unskilled workers and its farmes enjoyed higher real incomes, better diets and safer livelihoods than anywhere else on the continent. Replacement from immigration, moreower, ensured that Amsterdam suffered nothing like the depressed conditions of Venice, which lost a third of its population to the terrible plagues of the 1630s. The country's riches seemed unvulnerable to the scourges that fell upon the rest of the world with merciless intensity.
“Capital begot capital with astonishing ease,and so far from denying themselves its fruits, capitalists reveld in the material comforts it bought. At midcentury there seemed no limit, certainly no geographical limit, to the range of its fleets,and the resourcefulllness of its entrepreneurs. No sooner was one consumer demand glutte or exhausted than another promissing raw material was discovered, the supply monopolized, demand stimulated, markets exploited at home and abroad. Would the tide of prosperity ever ebb?” (Shama, p.323)
And he further explains that that was just the problem. If the Dutch ever imagined their ruin was not at the hands of some neighboring predator pawn but at their own. “They could be the authors of their own undoing simply by overdoing things. Their ministers tirelessly reminded them of this, of the example of Israel where are the corruption of Baal had been the herald of disaster. So riches seemed to provoke their own discomfort, and affluence cohaibted with anxiety.” (p.326)
“The predicants would not stand idly by while the Golden Calf was erected amidst Isral's tent. Far from endorsing finance capitalism, the Dutch general synods did their level best to proclaim their disapproval.
Bankers were excluded from communion by an ordinance of 1581, joining a list of other shady occupations, like pawnbrokers, actors, jugglers acrobats... Their families shared the taint and were only permittted to join communion after a public profession of distats for daling in money. It was not until 1658 that the States of Holland persuaded the curch to withdraw the humiliating prohibition on “Lombards”. While bankers remained under the presumption of usurions practica, Dutch Calvinism did consider the possibilty that a Christian merchant might not be a contradiction terms.” (p. 330)
The next chapter discusses the effects of war and non-existing WWIII on the present situation.
War ...
Mankind has always warred with itself. Ever since recorded history began there are records of war. The reasons for wars are as many and as varied as mankind has been able to invent, ranging from the need for more slaves, more minerals, more oil, more land through the desire of one religions, political, business or national group to foster its own brand of system upon another people.
World War II, the greatest war at sea, on land and in the air, is estimated to have caused at least 55m deaths, approx 35m wounded people and 3m missing. Civilian casualties have never been higher; between 20-30m were civilians: 7m Russians, 5.4m Chinese, 6m Jews, 4.2 mio Polish, 3.8m Germans.
There is no way of judging with any confidence what the process of fighting a nuclear war would be like. The magnitude of the destruction, the confusion, the psychological pressures on decision makers, the difficulty of making judgments about what was actually happening, and the problems in reestablishing any sort of civil or military order would all be incomparably greater than any that have ever been experienced by political and military leaders in past conflicts. The illusion of an atomic bomb being the ultimate weapon died in the first weeks of the Korean War. [David Halberstam, The Coldest Winter. America and the Korean War, New York: Hyperion, 2007, p. 149]
A strategic war that involved a massive attack on urban industrial areas would be unimaginably catastrophic. Any scenario for a thermonuclear war is improbable. But they existed for much of the 60s,70s, and 80s because military planners had to provide plans for all eventualities that are sufficiently serious, and reasonably possible, even if they are improbable. Therefore, U.S. Strategic doctrine evolved from massive retaliation to graduate response to a countervailing strategy.
Under the countervailing strategy adopted by the U.S. Government in 1980, the U.S. sought to maintain military (including nuclear) forces, contingency plans, and command-and-control capabilities to convince the Soviet Union that they could not secure victory, however they may define it, at any stage of a potential war. In essence: the U.S. was looking for a situation in which the Soviet Union would always lose more than they could reasonably expect to gain from either beginning or escalating a military conflict.
...and Peace
Whereas in agricultural ages land and natural resources were considered the most important production factor; those who had land were rich and powerful and those who had not were poor. Over a period of time, people started adding more capital to this process of producing goods and services. Historians like Fernand Braudel describe in vivid detail what happended toward the end of the Middle Ages in regions like Northern Italy and in Flanders.
In his “Material Civilization and Capitalism” Fernand Braudel maintains that the economic movements that succeeded one another from the Middle Ages to the Industrial Revolution were really only accidents, sometimes violant and even 'creative' in the structural history of merchant capitalism. He concentrates on the financial and monetary conjuncture because it is the money market (short-term credit) that lies at the heart of the capitalist “strategies”. Conjuctural movements repeat themselves and resemble one another. He cites the example of the credit boom at Florence in the early Renaissance, at the Genoese exchange fairs, and at Amsterdam in its golden age.
Braudel discounts the possibilities of accumulation of fixed capital and durable goods in the age of merchant capitalism, and consequently of economic growth in the modern sense.
In those societies, production had begun to exceed the immediate needs for consumption, even though they were not rich. A tiny portion /part of the population began to accumulate savings which then translated into production process not so much into the lifestyle of the land-based elite/powerful (merchants). Results were: Longer voyages with bigger ships, machines were introduced in the production of textiles and slowly replaced the workshop of an medieval merchant.
This new mix of production factors was accompanied by dramatic inventions in technology, i.e. Johannes Gutenberg's printing press. Both these developments increased output.
At the beginning of the 1930s, many economists as well as artists and other intellectuals left Hitler's Germany and those European countries where his ideas flourished. Keynes was 30 years old when WWI broke out. He became an important figure in the negotiations which marked the end of that war. Disagreeing with the nature of the reparations imposed on Germany as part of the Treaty of Versailles, he resigned from the British delegation and wrote The Economic Consequences of the Peace in three month. In it, he sketched a new liberalism.
For Keynes, “the political problem of mankind is to combine three things: economic effeciency, social justice,and individual liberty”. [JMK IX, p.311]It was largely in the 1920s that Keynes developed the propositions later called Keynsian policies in a form which furthermore were more radical in a way that would prevail afer the war (insisting, for example on the importance of public investment). A Treatise on Money (JMK V-VI), Solvency II
Demand for capital increased quickly and exceeded available savings. It turned into a special production factor and at the same time the most critical factor for success in the production of goods and services. Capital began to command the maximum remuneration. The consequences for society: Those who had capital were rich and powerful; those who had not were poor. Thus, with the rise in importance of capital as an decisive production factor led to the modern commercial company.
For heads of companies, their top managerial priority became the optimization of capital, i.e. making the maximum use of it to remain competitive and assuring the greatest return of its remuneration – to maintain access to it.This process lasted until shortly after WWII. Slowly but steadily, starting in the 1950s, unsurpassed accumulation of capital became the rule.
Today, growth in the sense of more is no longer the key, but rather change and restructuring. The term globalization describes the crisis of shareholder capitalism and its negative impact on labor markets, wages and work force (qualifications). Workers are confronted with the shock of not only losing their economic existence, but also their traditional role and their identitiy. The accelerated economic change resulted in a dramatic change of society as well. But society should not ignore the individuals' obligation to endeavor for themselves. The individual and his or her work power, however, cannot alone be burdened with the risks of a globalized market. [Reinhard Marx: Das Kapital. Ein Plädoyer für den Menschen.München: Pattloch, 2008, p. 298; Reinhard Marx is Archbishop of Munich and Freising. He shares his last name with the famous philosopher, but not his opinions. Yet, the title of the book plays with Marx' most famous publication, the capital, added by a supplement. “The Capital. An Appeal for Man.]
Brave New World
On June 5, 1947, U.S. Secretary of State, George C. Marshall, suggested the European Recovery Program (ERP). It was directed to give financial help to European countries torn by war, including Germany, and also to stop the spreading of communism.The agenda that the Marshall Planners had in mind shared a commitment to economic growth. The idea of growth made up one component of the New Deal concept. This idea was both a goal in its own right and the key to social harmony, to the survival of private-enterprise capitalism and to the preservation of political democracy.
By focussing on growth it seemed possible to widen the area of collaboration and shrink the area of conflict between competing groups, in particular organized labor and organized capital. But actually generating growth required more than corporate collaboration between different functional groups or the integration of economies, the liberation of national market forces, and the organisation of transnational networks. It also required the modernization of production, the reforming of fiscal and tax policies and the willingness of the European business and government elites to raise the productivity of labor by more equitably sharing the benefits of growth with the working class.
The Marshall plan was a success if judged simply as a program to control inflation, resume trade, and restore production.
Westworld
“And the moral of that is – The more there is of mine, the less there is of yours.” Alice in Wonderland.
Have the basic conditions to achieve long-term business success changed dramatically? In the early 1980s, discussion started about the 'post-industrial society'. Who will have a place in the new society, or will there still be the same old procedure with different preconditions? Where will economic growth occur? Will it be services, bread-and-butter industrial products as well?
The term 'post-industrial society' has almost vanished, instead it is sais we have moved into the 'Information Age' and towards the 'Knowledge Society'. In Germany, the term 'leisure-oriented society' was widely used in the 1980s. These definitions do not, however, relieve us from our responsibility for the future.
These descriptions suggested implicated that the worst happening is the transition from one period to another. No drama, no problem is on the horizon. Nothing to worry about for industrial societies and well-established business. Companies that had been established 100 years ago have knowledge and time to absorbe new technologies. Technological changes mean challenging business frames/set.
But no matter what kind of business, there are some basics that rarely change: a business needs capital, : natural resources, labor and a promising business model. Over time though, these items do not have equal weight in the process of making something.. The balance between these basic factors can change in the production of goods.
The Big Chill
Changes in technology and the economy have complex cultural, social and political effects. Effects on how people are able to earn their living, on what they can buy, how fast they can move from place to place, in how easily they can transport things, in how they can dissiminate and acess information and ideas. The integration of economic activities via market resulted in globalisation. It is a precondition and consequence at the same time. In his last book, published posthumously, Mancur Olson argued that “we know that an economy will generate its maximum income only if there is a high rate of investment and that much of the reurn on long-term investments is received longafter the investmenst are made”. (Mancur Olson: Power and Prosperity; Outgrowing Communist and Capitalist Dictatorships, New York; Basci Books, 2000, p.25)
How could suggestions for the future look like? A market economy is still a useful structure to have for generating sustained increases in prosperity providing efficient oversight and regulation. Individual states remain one pillar of political debate and legitimacy. Supranational institutions gain their legitimacy and authority from the states that belong to them. But regimes need to be specific, focused and enforcable. A voluntary agreement, honesty in dealings, respect for contract, acceptance of dissent, investment for productive purposes, could be a starting point.
In the UK privatization of industries began in the early 1980s and than conquered the world. The WTO was created in 1995. It looked like the idea of an integrated world economy, founded on market relationships. The collaps of the Soviet Union between 1989-1991 appeared to confirm the global transformation in politics and economic policy. Francis Fukuyama proclaimed the end of history. What he probably meant was that a (liberal) democracy had proved to be the only way to govern and advance economy and society.
What it most likely not meant was that mistakes and crimes of the past could not be repeated one way or another in the future. Turmoil/Confusion could get the upper hand again. But we have choices in choosing a better or worse path.
The conventional knowledge of economic policy had undergone many revolutionary changes. The Keynesian belief in the ability to fine-tune economies to achieve given real autonomies had been shattered by the stagflation in the 1970s. It was replaced by the search for monetary stability. This was to result in a widespread adoption of inflation targeting. Exchange controls had been abolished by Margret Thatchers' government in the UK in 1979. The labor market of the U.S., like Germany's mostly represents the workers of the 'old economy'. This means import-threatened industries such as steel, textiles, manufacturing and clothing. As the late Mancur Olson, pointed out: only an “encompassing organization”, i.e. one that represents most of the economic interests in society, is likely to campaign for policies that raise overal incomes rathe than increase the incomes oftheir members at the expense of others. (Mancur Olson: The rise and decline of Nations: Economic Growth, Stagflation and Social Rigidites, New Haven, Conn. Yale Univ. Press. 1982)
States and markets are not in opposition to one another. The world needs a better globalisation (import) But this will only happen if, let's say, the G20 start a value discussion and address limited integration and poverty. An open society is important but it does not mean deragulated one. It means transparency and not: some countries are more equal than others ..and less selective.
Reliable information, trust, and transparancy are the backbone of a market economy. Ideally people in business should provide guarantees or should get themselves a reputation for honest dealing; they can employ credible professionals to certify the truth of what they say. Indepent regulators and rating agencies can help by certifiying the quality of a company's flows of work or products.
To shine a light on the potential problems ahead for financial market regulators, a look back into compliance and verification of arms control treaties can be helpful.
Trust but Verify
With regard to reglating financial markets, experience for verification and compliance in arms control offer some advise on where to look for complications.
Compliance and verification had to do to insure 'security' Today a broader approach is necessary.
The 1980s, especially the period from 1981-87, were dominated/plagued by problems of controversies about compliance with arms control agreements. From 1983 to 1987 the Reagan Administration published annual reports elaborating on charges of Soviet cheating.
In 1986, the United States even unilaterally ended its voluntary adherence to the SALT II (Strategic Arms Limitation Talks) limits on strategic nuclear weapons, referring to concerns about Soviet non-compliance.
One major tool/Mittel for resolving compliance problems arising from SALTII and ABM(Anti-Ballistic-Missile) Treaties was the Standing Consultative Commission. It was created to serve as the main institutional model for dealing with compliance issues. It worked ziemlich/mostly/pretty effectively to the satisfaction of the United States and the Soviet Union in the 1970s. [ Strobe Talbott, “Endgame. The Inside Story of SALT II, New York: Harper&Row, 1979, p.144] This was not the case in the 1980s.
In order to avoid problems made, it is important to find out why these problems occurred:
If violations did occur, why? Where treaty provisions not adequate enough? Where treaty provisions ineffective because they did not serve as a roadblock to stop nations from accused cheating?
In 1988, all of a sudden, the compliance problems vanished between the U.S. and the Soviet Union. One reason: Improvements regarding the Krasnoyarsk radar. They included halting constructions and ultimately dissmanteling it. Expert analysis also showed that many accusations of cheating by both governments were not sufficiently substantiated. [Gloria Duffy, “The Sources of Soviet Compliance Behaviour”; James A. Schear, “Compliance Diplomacy in a Multilateral Setting”; in Micheal Krepon/Mary Umberger,eds., Verification and Compliance: A Problem-Solving Approach, London: Macmillan, 1988]
The most important reason for improvement: In 1988 the arms control process tok a major step forward because on December 8, 1987 President Reagan and General Secretary Gorbachev had signed the INF (Intermediate Nuclear Forces) Treaty.
While the emphasis on compliance problems emerged in the period of 1981-87, the underlying process of 'de-escalation' that led to the signing of the INF-Treaty was well under way. In 1985, then-president Mikhail Gorbachev of the Soviet Union made his famous speech which came to be known as suggesting glasnost and peristroika. In 1987 then-president Ronald Reagan visited the city of West-Berlin and made his famous remarks at the Brandenburg Gate: “Mr. Gorbachev, tear down this wall. Open this gate.”
So the compliance disputes ended upruptly only on surface, but rather subtly, because the political relationship and climate between the superpowers underwent a transition.
In the early 1980s the United States had developed a tendency to make unilateral judgements about the attitude of the Soviet Union towards compliance, avoiding the existing dispute-resolution procedures. In the end both countries recognized that it was in their mutual interest and in the interest of continuing to develop an arms control regime and to go back to the established mechanisms to resolve compliance disputes. This presented an opportunity to resolve disputes over the interpretation of agreements to the appropriate channels.
Types of dispute are difficult to predict because future language of a treaty cannot be designed '100% verifiable'. But as the history of compliance disputes in the 1980s demonstrated, disagreement often occurs over the limitation of aspects which create uncertainty on one side about the intentions of the other party's behavior. Then, an often heard phrase stated that verification is not a technical, but a political problem. It seems that those disputes over compliance errupted due to a freeze in the political climate between the two countries. This suggests that an overall 'friendly' or open climate is more important than the actual wording of a treaty.
Sunset Boulevard
It has been twenty years since the fall of the Berlin Wall.
We are concerned about a declining trust in banks, politicians, and priests as well as scientists and the future at large. This is not a new sentiment. Since the 1990s it reflects the political, social and economic realities of an increasingly interdependent, global world. This renewed sentiment comes on the heels of the massive, somewhat catalysmic social, political and financial upheavels in the world's political scene, two of the most significant being “the fall of the wall in 1989 and the demise of the Soviet Union. Such periods of uncertainty understandably lead to reflections on the breakdown of trust.
The core elements in trust relations are uncertainty and vulnerability. In solving problems of trust, people select strategies that reduce uncertainty and vulnerability. Trust issues are assembled under a broad umbrella of concepts linked closely to the underlying notions of uncertainty and vulnerability. Insureance is a particularly effective technique for managing vulnerability under uncertain conditions. You can have insurance but it does not stop you from having an accident.
The period between 1989 and 2001 has been the age of experiment. It looks like it will be a permanent or longer experimental situation. We cannot regulate an experimental situation. But we can look to the natural sciences for ideas. Experiments in the natural sciences have known and unknown elements; if one setting fails, a new set-up will try to generate 'better' results. But we learn during the process and we gain experience and knowledge.
Although we may be as vulnerable to our neighbors as we have always been, we are probably more often profoundly ignorant about their intentions and competence. In such circumstances, the distrusting strategies of contemproary societies (insurance, guarantees, deposits, deversified portfolios of goods and relationsships) nevertheless make high levels of interaction possible. Distrust should not be confused with trust. Distrust in an important ways is a minimax solution in which peole try to control losses. They may hope that others will behave honorably, but they have no reason to expect that to be the case. Caution allows people to begin in tentative and relatively safe ways to collect information, construct appropriate institutions and norms, and build social relationsships with enough past and history to trust one another. Distrust is the first tentative step toward trust.
The Real Menace
On May 19th, 1999, the long awaited Star Wars prequel, Episode I – A phantom menace hit movie theaters around the world. At about the same timethe Economist business magazin ran a cover story “Economy Wars: The real menace, starring Alan Greenspan, inflation fighter.” The article credits the Federal Reserve and its Chairman with an overall satisfiying role in inflation management. But it also goes on to question the form of productivity growth, whether it is sturctural, cyclical, temporary, or permanent. [Return of the Dread-I?, The Economist May 22nd-28th 1999, p.59-60]
Financial systems perform several essential functions. They mobilize savings (for which outlets would otherwise be far more limited), they allocate capital (to finance productive investment and permit people to spend temporarily above their current incomes market-driven financial arrangements.
Financial markets suffer from inadequate information and obstacles to monitoring performance. For this reaon, financial markets are fragil. This is particularly true of banks. A world full of information and perfect competition is an illusion. The question remains whether sophisticated markets imply a certain degree of monopoly and instability and to what extent this risk requirement makes these markets successful. The ECB defines financial stability “as a condition in which the financial system comprising of financial intermediaries, markets and market infrastructures – is capable of withstanding shocks and the unravelling of financial imbalances, thereby mitigating the likelihood of disruptions in the financial intermediation process which are severe enough to significantly impair the allocation of savings to profitable investment opportunities.” [Financial Stability Review, Preface,
http://www.ecb.int/pub/fsr/html/index.en.html.] n order to meet regulatory goals in this aspect, the regulators need the equivalence of a 'flexible response' strategy.
So now, the Federal Reserve is supposed to play an important part as super-regulation agency. The Federal Reserve is an independent agency of the federal government; its charter is the Federal Reserve act of 1913 which vests authority over monetary policy in a board of Governers of the Federal Reserve system and a Federal Open Market Committee. In March 1951 the Federal Reserve's obligation to support bond prices at wartime levels was terminated. In 1953 all obligation to support bond prices ended, and the agency assumed its modern macroeconomic function.
A rather restrictive phase of slow money growth and high interest rates started with the appointment of Paul Volcker as Chairman of the Fed by President Carter in the summer of 1979. This development became even more obvious under the Reagan administration until the summer of 1982.
Banking regulators under the comptroller of the currency and the FDIC share responsibility with the Federal Reserve over matters of bank reglation affecting the debt. The Federal Reserve is basically a political body. One important aspect: what should the Federal Reserve Board look like?
To sum up: at one end of the financial market crisis and resolve is the consumer, the wish for credit and 'honest banking' (like James Stewart in the 1934 movie 'It's a wonderful life') and all those goals for 'good will' that human beings crave for. At the other end are private and investment banks who need to grow businesswise and therefore seek markets to expand with their products. The need to expand business is major cause for bankruptcy, especially for younger banks in the U.S.. For example, ANB Bank of Arkansas went bankrupt in 2008. It started writing high-risk loans in order to grow. Half its portfolio in 2005 was concentrated in risky contruction and land-development loans – a 300% increasw from 2004.[Pallavi Gogoi: Where were regulators when banks were failing? USAToday, June 17, 2009, overseas edition]
Let's make money
“What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage.” Adam Smith, 1776
“Most of us don't know,where their money is. However, one thing is for certain. It's not in the bank, to which we entrusted it. The bank and our money are already a part of the cycle of the global money market.” Let's make money, 2008
In his enlightening documentary, Austrian Filmmaker, Erwin Wagenhofer, describes in great detail the international developments of how we got to where we are today.
International business activity is not new. The transfer of goods and services across national borders has been taking place for thousands of years (think of Marco Polo for instance) Since the end of WWII, however, international business has transformed dramatically out of which emerged one of the most important economic phenomenon of the latter half of the twentieth century: The Multinational Corporation.
Over the past decades, increasing currency volatility has subjected the earnings and assets of multinational corporations, banks, and cross-border investors to large and unpredictable fluctuations in value. These currency problems have been exacerbated by breakdowns in and out of the postwar international monetary system established at the Bretton Woods Conference in 1944. The main features of the Bretton Woods system were the relatively fixed exchange rate of individual currencies in terms of the U.S. Dollar and the convertibility of the dollar into gold for foreign official institutions. These fixed exchange rates were supposed to reduce the riskiness of international transactions, thus promoting growth in world trade.
However, in 1971 the Bretton Wood system fell victim to the international monetary turmoil it was designed to avoid. It was replaced by the present system of rapidly fluctuating exchange rates, resulting in major problems and opportunities for multinational corporations.
The international monetary system refers primarily to the set of policies, institutions, practices,regulations and mechanisms that determine the rate at which one currency is exchanged for another. Today's financial reality is that money knows no national boundary. The dollar and in recent years the euro have become a world currency, with billions switched at the flick of an electronic blip from one corporation to another, from one central bank to another. International mobility has benefitted entities but at the same time has complicated the job of the Chief Financial Officer.
Capital moves around the world in massiv amounts at the speed of light; corporations increasingly raise capital simultaneously in several major markets. Labor skills in these countries no longer can be considered fundamentally different. The ability of corporations of all sizes to use these globally available factors of production is a far bigger factor in international competiteveness than broad macroeconomics. Contrary to the postulation of Smith and Ricardo, the very existence of mulitnational corporations is based on this international mobility of certain production factors. The value added in a particluar country – product development, design, prodcution assembly, or marketing depends on differences in labor costs and special national features, or skills.
There are market seekers and market forces; despite early types (Ford, Coca-Cola) the bulk of foreign direct investment took place after WWII. This investment was primarily a one-way flow from the U.S. To Western Europe untile the early 1960s. At that point, Western European and later Japanese firms have begun investing in the United States.
The existence of global competition and global markets for goods, services and capital is a fundamental economic reality that has altered performance profiles of governments and corporations world wide. Paradoxically, however, even as people are disturbed at the thought of their government losing control of events, they have lost faith in their governments ability to solve many of their problems.
We usually place money in people we trust: well-known business organizations, organizations regulated within our own jurisdiction or non-profit ones, sometimes our own government.
In the world of multinational corporations, dividends are by far the most important means of transferring funds from foreign affiliates to a parent company. Therfore, the compensational mechanism is called a 'Dividend' and not 'future tax' because it adds a positive notion to redirect money for a common cause. Dividend payments lead to liquidity shifts.
Not only the testing of boundaries can be observed in the financial sector but a more traditional one as well: the upheavel in the automobile industry. This will be detailed in the two following chapters.
From Tucker to Gran Torino
The stylish 1988 movie 'Tucker: A man and his Dream' tells the story of Preston Tucker (Jeff Bridges) who tried to build “the car of the future” in the 1940s, only to be crushed by the Big Three automakers and their political clout. In 1947, the Tucker car incorporated a rear air-cooled engine, disk brakes!, seatbelts!!, safety windows with shatterproof glass, fuel injection,and a central swivellable headlight. It looked sleek and futuristic. By 1947, 51 sample cars had rolled off the assembly line. Tucker priced the car at a mere $ 1000,--each; Detroit saw 'the writing on the wall'. Those 51 cars remained the only ones. Tucker died seven years later.
The Ford Gran Torino was built from 1968 to 1976. But at the time, the Chevrolet Chevelleand the Plymoth Road Runner were merely accepted. In the movie, a 1972 Gran Torino owned by car mechanic Clint Eastwood symbolizes the search for a symbol of lost American values.
Another most unusual example of vehicle production excentric was the Delaurean sedan in “ Back to the Future”. John Zachary Delorean (Jan 6, 1925-March 19, 2005 an American engineer, developper, Pontiac mustang); The Delorean Time Machine. In the back to the Future trilogy, the delorean time machine was the time travel tool of the moment plus an 'processor' car built for interior shots. According to wikipedia, in 1952 Colin Chapman founded the sports car company Lotus cars. Shortly befor his death he become involved in John Delorean's 'Delorean car company' ill-fated affair.
[http://en.wikipedia.org/wiki/Colin_Chapman][http://en.wikipedia.org/wiki/DeLorean_Motor_Company]
A new biopic about the excentric car maker is also in the making.[James Toback goes from Mike Tyson to John DeLorean, New York Times online edition, May 28, 2009 in: Carpetbagger Hollywood blog of NYT]
The situation had been very different at the beginning of the twentieth century for the auto industry. Whereas the risk today lies solemnly with the producer, the beginning of the century had the risk tilted more towards the consumer. To order a car was a question of trust not only in technology but also honesty of producer and dealer.
“By 1899, the year that Ranson E. Olds organized the Olds Motor Vehicle Company, eighty companies either were making or preparing to make automobiles of one kind or another. Unlike other consumer products, automobile makers never utilized small single-column ads. Quarter, half, and full-page ads appearred in trade journals during the last few years of the nineteenth century and gradually made their appearance in popular magazines in the 20th century. The rapid failure of automobile companies in the last years of the 19th century and early years of the twentieth not only make the public wary of placing orders which required deposits, it also led the public to a general suspicion about the stability of the entire industry.”[James D. Norris: Advertising and the Transformation of American Society 1865-1920, p.145]
Since none of the early automobile companies produced for future sales or carried stocks of vehicles, each vehicle was produced and assembled to order. Ads featured a photograph of the automobile the company promissed to deliver.
Whereas Ford would capitalize on the seeming paradox in American society of consumers seeking to achieve status by the consumption of identical mass-produced items.[ibid p. 161] But with America's entry into World War I, the automobile industry cut back its production and decreased its adverising. Ibid. p.165 But “By the 1920's we were a society of abundance in which consumption and spending became increasingly more important than the old virtues.”[ibid.p.XIII]
Rein, Gain &Automobiles?
On June 1st, 2009, GM, the century-old car manufacturer filed for bankruptcy. The plan of the Obama administration is to shrink the company once considered a symbol of economic might and dynamism. The intention is to reshape the auto industry, erase most of GM's debt and have it emerge leaner and stronger. It comes down to managed bankruptcy with the government help to ensure GM gets the credit needed for restructuring. In essence: automakers have to come to grips with reality. But at the moment, Congress is making business decisions and not Chrysler or General Motors. As important as it is to aim for a more competitive auto industry, political interference has to be kept to a minimum.
Like in Germany with automaker Opel, a subsidiary of GM, the U.S. Government has already interefered by not liquidating or phasing out either company. Instead it determined the scale of the needed cuts and how much taxpayer money it is willing to commit. Furthermore, the boards of both companies are reorganised and the CEO of GM has been ousted. This is where the interference should stop in order to make the plan working.
A cost-benefit analysis is needed here. Mistakes will be made in choosing which dealership to close. There seldom is fairness involved in business decisions. This issue is more about consumers than dealers. It is not so much about economic rights of dealers but a painful and necessary adjustment in the auto industry because of world wide excess production. Different lifestyles in urban areas and among younger people also call for changes.[Canzler, Weert/Knie, Andreas: Grüne Wege aus der Autokrise. Vom Autobauer zum Mobilitätsdienstleister. Heinrich Böll Stiftung Ökologie, Band 4, Mai 2009, p.15] The authors also note that mobility in rural areas will continue to rely on automobiles due to changes in demography. [ibid. p. 10]
The long-term prospective not only for GM but for other car manufacturers is to become smarter and smaller in order to make a tax-payer funded bailout an acceptable long-term investment. The big Three, and Opel, all make some good cars. But escpecially GM presents a prime example of having too mujch production capacity and too many product lines, to name a few. Like in banking, merging and scaling down should be a priority. GM already has proven it knows how to deal with excess capacity by cutting car line as it did with Oldsmobile in 2004.
And there is also this: One very prominent GM car will get promotion and stay on people's mind: Bumblebee, the yellow Chevrolet Camaro turned Autobot from the Transformers movie series.
Reformers: Revenge of the befallen?
Like anyone in his right mind will be in favor of nuclear disarmament, so anyone will favor regulation of financial markets. But like with nuclear disarmament there should be a great deal of skepticism as to capacity and willingness of governments to achieve this in any fundamental measure. The history of disarmament in the 20th century has been a long, painful and trusting but mostly futile effort. As the saying goes: do one thing without letting go of the other.
Nuclear arms control has mostly been incomprehensible to laypersons which not only finds it parallels in the world of financial market products, it surpasses it. At least some people in the banking industry had trouble to understand and describe the products they were selling. As the wider public had scarce means of checking any of the facts of the accusations of compliance and non-compliance, what chance will there be to discover fraudulent financial transactions?
There were lots of imponderabilities in nuclear arms control like 'fractricide' (a warhead explosion destroying another one targeted in the same direction) meaning more to come and unresolved.Why rule this out for financial market products? In the words of the fictional mathematician Dr. Ian Malcolm , played by Jeff Goldblum in the 1993 movie Jurrasic Parc, that Chaos Theory teaches “Life cannot be controlled...Life finds a way”. What holds true in biotechnology surely works for financial products as well.
But like the peace dividend that never materialized because of a lack of definition (see article on this website) financial markets and its proponents no doubtedly will continue to develop and seek growth in ways that are unpredictable. There can be no Maginot line in regulation to perform the function the original was designed and maintained for. Somewhere between the financial strategist and the normal citizen, the G20 and other institutions must find a way for creative and sustainable solutions.
“Modern man might not be designed for contentment. The envious have inherited the earth.” [Gregory Clark: A Farewell to Alms. A Brief Economic History of the World.Princeton: Univ. Press, 2007, p. 16] It is important to define what one is for, not against. Greed is not enshrined as the motive-force of human behavior. But unlike Gordon Gecko would like to make us think, it is neither good, nor entirely bad either, but a sometimes useful motive force which can and should be channeled. To paraphrase the statement on verification: Regulating international financial markets is not an economic problem, it is a political challenge.
UP - The Future Dividend a mechanism for prosperity
This article is an elaboration of the theory that much of today's economic crisis lies in the absence of a Third World War. Contrary to the conclusion of a wide-spread belief it is not solemly mismanagement in the financial industry that led to the present situation. So there is no need for an elaborated blame game. We got here because we all would like to live long and prosper. The absence of war allowed for the expansion of industries world wide, but we are experiencing the problems of this horizontal growth at the moment. This is the time to discuss vertical expansion; meaning more education, better health care etc. The money has to come from a dividend of sorts and the G20 are the body to discuss.
Since the end of the 1960s the economic balance has altered slowly but continuously, and starting with the 1990s rather rapidly. There have been and will continue to be interminable arguments about the exact nature of how the crisis started. The modernization of financial market products in itself would not have guaranteed that the industrialized countries and their financial industries would have attained its related economic superiority. Like a weapons build-up did not assure the U.S. national security goals of minimizing the chance of a strategic nuclear conflict, the U.S. and the Soviet Union needed arms control and diplomatic measures as well. But these stood no chance of success in the absence of an adequate strategic arms program.
We have entered a period of human history where not only is the rate of change accelarating in political, social, and economic areas of domestic and international life, but where we are on the dividing line between epochs. The performance of existing policies to meet present and emerging needs must be carefully and creatively examined. Between 1000 and 1820, European real incomes per head rose about three times. Between 1820 and 1998 world population rose almost to being six times as high. In 1900 life expectancy was a mere twenty-six in today's developing world. It was sixty-four by 1999. Change is a pervasive qualitiy of governmental financial policy. Although no era is immune to dramatic changes in world affairs, we are living in a period with numerous remarkable examples. As of 1993 the countries of the European community have committed themselves to an integrated single market. The single currency Euro was introduced in banking as of January 1, 1999 and as into the large public as of January 1, 2002.
It can be argued that the fall of the Berlin Wall ended the twentieth century politically. If this is the case the 21st century politically started on September 11th, 2001. Industrially, the twentieth century ended on June 1st, 2009 with GM declaring bankruptcy. But when did the new industrial age start? Is there a starting point or is it rather a slow transformation process which has accelerated over the years? Was it the invention of the internet? Did that come to a slowdown or temporary halt with the dot-com bust in 2001?
The internationalisation of capital and trade has proceeded further than ever before in some respects; in others it is much more limited than before even though the technological basis for integration has advanced substantially. The biggest downside to date is in the transfer of capital and ideas to the developing world.
As of yet, a model of transformation philosophy does not exist. How long will it take? Maybe the decade that started after WWII will be a blip like the classic Industrial Revolution in England in 1760-1860. [ Clarke, p. 10] It took Moses forty years to lead the Israelites out of the desert. Half way through they asked: Why did you do this to us? These processes of transformation usually last at least about two generations. The end of the process could mean a mixture of profit and mutual obligation among people.
To start along this way, the actual circulation of capital flow has to correspond with the actual value of production goods. Next to dealingwith the financial crisis, the G20 have to start a discussion about their values. Like Peter Parker was told by his uncle: With great powers comes great responsibility. The G20 have to remember that with great wealth comes much obligation.
Both these approaches will be needed. Together, they may prevent the next financial crisis.
June 2009