The Intelligent Conversationalist Read online

  As already alluded to, but worth reiterating at every opportunity should someone try to tell you what the economy is going to do, the “profession” of economics is notoriously bad at predicting recessions. Your local “walk-ins welcome” psychic would probably be more reliable.

  Thus most economists failed to predict the worst international economic crisis since the Great Depression of 1930s—our very own credit crunch.

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  WISE WORDS

  If all economists were laid end to end, they would not reach a conclusion.

  —George Bernard Shaw

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  SOCIAL SURVIVAL STRATEGY

  Argument: “I’m with Galbraith, the only function of economic forecasting is to make astrology look respectable.”

  All “professionals” tend to be bluffing—nobody really has a clue when it comes down to it. This phrase is brilliant as it shuts up any blustering business buffoon.

  Crisp Fact: “The term capitalism was actually coined by its critics, primarily Karl Marx.”

  It can take a critic to cement an idea in the mainstream—better to be talked about than not at all.

  Pivot: “The ‘profession’ of economics is notoriously bad at predicting recessions. Know any good psychics? I’m trying to decide whether to invest in the markets or not.”

  Everyone has a stance on psychics. Some will think them fakes, some will blush (so you know they’re ashamed to have one on speed dial), and others will be fishing out their phones to send you contact details for their favorites. A mischievous way to change the topic.

  CHEAT SHEET 7—A QUICK GUIDE TO THE CREDIT CRUNCH (C. 2008) AND EUROGEDDON (STILL GOING)

  BACKGROUND BRIEFING

  A credit crunch is a reduction in the general availability of loans (or credit). Suddenly it gets very hard to meet the conditions required to get a bank loan. And we in the early twenty-first century had a crunch to call our very own. Warren Buffett, a man who we will see in Cheat Sheet 8 is normally proven right in all matters financial, called the crunch poetic justice.

  Banks looked insolvent, credit availability declined, investors got freaked—so global stock markets crashed. International trade declined, economies across the globe slowed, and many countries went into recession. We looked financial Armageddon in the face. And although the sky hasn’t fallen on our heads, arguably Europe still hasn’t fundamentally recovered, and can American millennials really pay for the baby boomers’ lengthy retirements and all their Social Security and Medicare? Are Americans entitled to entitlements and can they afford them?

  A credit crunch is usually accompanied by a flight to quality by lenders and investors, as they seek less risky investments (often at the expense of small- to medium-size enterprises). Hence the subsequent strength of the dollar and gold at the end of the naughties. Yes, back to the United States (even though, as we shall see, that’s where the problems started) and gold again.

  The causes and effects of our credit crunch will be argued about for decades to come, especially by all the economists who failed to predict it (back to Galbraith’s quote from earlier about economists and astrologers). However, there were basically two reasons for our gigantic mess.

  CAUSE 1. THE US HOUSING BUBBLE

  The crisis was triggered by the bursting of the United States housing bubble, which peaked in 2006. High default rates (people not paying up) on subprime (risky) loans and adjustable-rate mortgages (ARMs) began to increase quickly thereafter.

  Borrowers had been encouraged to assume big mortgages in the belief that the housing market would continue to rise and that interest rates would remain low. When this began to change, defaults increased and the whole thing snowballed.

  Basically, credit rating agencies and investors failed to accurately price the risk involved with mortgage-related financial products. And where America led, the rest of the world followed, because we now live in a global society, so bankers in Britain and beyond were busy extending credit to people who shouldn’t have had it. The phrase to throw in at dinner parties and job interviews here is global contagion. That is why so many people around the world spent so much time worrying about the financial stability of Iceland, then the PIIGS (no, not about the supply of bacon for your BLT, but Portugal, Italy, Ireland, Greece, and Spain), and then the entirety of Europe and the world.

  CAUSE 2. GOVERNMENTS

  Now, you must note, as a well-read individual, that the crisis was not just Wall Street’s fault. History has shown that markets are not self-correcting. Give a banker an inch, he’ll take a mile, and boom and bust will follow. It’s lawmakers’ responsibility to rein these banksters in. That’s the point of GOVERNING. Hence Glass-Steagall was invented.

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  KEY TERM: GLASS-STEAGALL

  There are (or should be) two types of banks: investment banks (for gamblers—i.e., Gordon Gekko types) and commercial banks (where you have your checking and savings accounts). After the Wall Street crash of 1929 leading to the Great Depression of the 1930s, Congress put a firewall between investment and commercial banks: the Banking Act of 1933, or as it’s commonly known, the Glass-Steagall Act. Gordon Gekko could lose everything and you wouldn’t. This firewall helped to lead to the largest sustained period of economic growth in American history.

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  In 1980 Ronald Reagan was elected, which brought in a culture of deregulation culminating in the repeal of Glass-Steagall in 1999. To put it simply: Gordon Gekko was now allowed to use your cash to make bets. And yes, the repeal happened under Bill Clinton, a Democratic president. But you should always blame the tearing up of the rule books on Alan Greenspan (chairman of the US Federal Reserve, 1987–2006) instead of Clinton, as Greenspan was really the “brains” behind it. To make matters worse, the regulatory framework that governments (apart from Canada’s) had for the financial markets did not keep pace with financial innovation, such as the increasing importance of the shadow banking system.

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  KEY TERM: THE SHADOW BANKING SYSTEM

  • Like mercantilism and capitalism, this term was invented after the practice started.

  • The shadow banking system consists of nonbank financial institutions that play an increasingly critical role in providing credit across the global financial system.

  • Many institutions and vehicles resembling shadow banks emerged in American and European markets between 2000 and 2008.

  • Famous examples of shadow institutions include private equity companies, hedge funds, and mortgage brokers such as Countrywide Financial. Countrywide Financial was naughty in many ways, including allegedly giving politicians favorable mortgage rates as well as in essence screwing its clients. In 2006 it was the US’s biggest single mortgage lender, financing 20 percent of all mortgages. By 2008 it was failing miserably and was bought by Bank of America.

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  Shadow institutions were not subject to the same safety and soundness regulations as depository banks (which after the repeal of Glass-Steagall weren’t that strong anyway). This is to say, shadow institutions didn’t have to keep as much money in the metaphorical vault relative to what they borrowed and lent, what is known as capital requirements. Therefore they could have a very high level of financial leverage—a lot of debt relative to the liquid assets available to pay immediate claims. This is fine and means a lot of money can be made—unless there is a Mary Poppins moment, where the little boy in the bank screams, “Give me back my money!” and we all want our money back at the same time.

  The shadow banking system has been blamed for aggravating the subprime mortgage crisis and helping to transform it into a global credit crunch. After Glass-Steagall was repealed and as the shadow banking system expanded to rival or even surpass conventional banking in importance, politicians and government officials should have realized that they were re-creating the kind of financial vulnerability that made the Great Depression possible. And they should have responded by extending regulations and the financi
al safety net to cover these new institutions.

  But oh no, they didn’t. Politicians encouraged financial vulnerability. The government wanted to give people the opportunity of home ownership, so (through Fannie Mae, Freddie Mac, etc.) it lowered the requirements to get a mortgage. Banks just followed their lead.

  And then there was—and still is—Europe. The argument can certainly be made that Eurogeddon was started by the crisis in America. The United States sneezed and Europe caught a cold so bad that it threatened the whole world’s financial well-being. Unfortunately the banking regulations in Europe were even looser than those in the United States, so while America produced most of the toxic mortgages and securities, they were bought by European institutions.

  These institutions needed their own series of bailouts, and they didn’t own up to the extent of their insolvency, which slowed Europe’s recovery. There’s also been the “small” problem of certain European governments’ level of spending. Added to which, there’s a fundamental problem in Europe. The euro. It is of flawed design.

  The euro is a classic case of “marry in haste, repent at leisure.” Economic union without political union can’t work, so divorce is always in the background (for example, the Grexit—Greek exit).

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  NOTEWORTHY NUGGETS

  • The European Union (EU) is comprised of twenty-eight member states, which when put together make the EU, with a population of around 500 million people, the largest economy in the world.

  • At time of going to press, nineteen of those countries are members of the Eurozone, nations that use the euro.

  • The Eurozone is the world’s second largest economy, with a population of around 340 million.

  • Euro coins and banknotes entered circulation on January 1, 2002.

  • The euro is used daily by several hundred million Europeans. As of 2013, more than 210 million people around the world, including 182 million people in Africa, use currencies pegged to the euro.

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  Still at a loss? If at a highbrow drinks party, throw in the word Greece after Glass-Steagall and then take an elaborate sip of your beverage. People will nod and mutter and then focus on the nearest canapé.

  WHY IT MATTERS TODAY

  The best analogy of the crisis is a medical one.

  When someone has a heart attack, there are two vital stages in saving them. The first is the initial lifesaving shock treatment. With this crisis, governments and central banks responded with unprecedented fiscal stimuli, monetary policy expansion, and institutional bailouts. It really did get all very dramatic; think, say, of an episode of the medical drama ER when George Clooney was still on it. On September 18, 2008, Federal Reserve chairman Ben Bernanke met with key US legislators to propose a $700 billion emergency bailout. He supposedly told them: “If we don’t do this, we may not have an economy on Monday.” Cue TARP.

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  KEY TERM: WHAT IS TARP?

  • TARP is America’s Emergency Economic Stabilization Act (also called the Troubled Asset Relief Program). Bernanke’s bailout was signed into law on October 3, 2008.

  • Note that TARP occurred under the Republicans’ watch.

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  It is worth recalling in polite company that employment will lag behind the money markets. If they crash, unemployment will follow in time, and correspondingly, it will take time for employment to recover after the markets do. Therefore, after the crash in 1929 it was two years before unemployment reached its peak, and the same was true of our crunch.

  The second stage of heart attack treatment is, once the patient is stable on life support, to determine at what point you take the tubes out and in which order. When do you decide “That’s enough medicine”? If it’s too soon, then that’s another recession. If it’s too late, then the resulting deficit is, as the US chairman of the Joint Chiefs put it, a threat to national security (China buying up American debt, which it now holds lots of, etc.). Europe went all out with austerity measures; America not so much.

  What’s the solution? There are some fundamental flaws in how America’s politicians have ended up behaving. Financial regulations have been put in place since the crisis, such as the Volcker Rule (part of the Dodd-Frank Act), but as Senator Elizabeth Warren types are always reminding us, they are nowhere near as concrete as Glass-Steagall. There’s also the world. We now live in a global economy. When the BRICS (Brazil, Russia, India, China, and South Africa), the emerging national economies, are unstable, it will have ripple effects. Also, of course, Europe.

  Now, the problem for Europe is not the United States of Europe. It is the Disunited States of Europe. In Europe, the nineteen leaders of the Eurozone—and sometimes all twenty-eight leaders of the European Union—have to collectively come to an agreement on a decision. And then go home and sell that to nineteen—and sometimes twenty-eight—democracies. Europe literally and figuratively does not speak the same language. Thus these leaders were always behind instead of ahead of the crisis curve and always will be.

  Compare that to the United States of America, which when there’s a crisis like the credit crunch can come together. America also has a key weapon at its disposal: Not only is it the world’s reserve currency (it can basically borrow money cheaply, as it’s perceived as reliable) but the Fed can print as much money as is needed to finance its borrowing. The countries in the Eurozone do not have this power. Those that ran into big trouble, the PIIGS, do not have their own individual central banks that they can rely on to print money and buy their debts.

  Why didn’t the European Central Bank just print more money? Theoretically it could, but the Germans are very opposed to letting this happen. There are a multitude of reasons for this, from the historical—Weimar hyperinflation contributed to the rise of Hitler—to the belief that countries should not be bailed out for living beyond their means. This rankled within some European countries, especially Greece in 2015, for Germany received debt relief from foreign creditors after World War II. (Lack of debt relief after World War I helped contribute to the rise of Hitler in Germany.)

  The irony in all this is that if you take the Eurozone as one entity, it does not lack for resources. The problem is political: Member states are reluctant to finance each other. There is a moral hazard issue. Why should a German be liable for Greek debt, but then have no say in how Greece runs its affairs and spends German money? Note that since 1945, the main point of the European project was never again to leave an aggrieved Germany isolated.

  The euro is basically a political crisis that can be resolved only with greater fiscal and political union to complement the monetary union. However, getting countries to voluntarily give up their sovereignty is not exactly straightforward. Consumers, businesses, banks, and governments around the world are confidence players—that is to say, to get sustained economic growth they have to believe the system is solid. Can anyone truly say this about the Eurozone? This is where I stick my neck out and say that I’m not so sure.

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  WISE WORDS

  Some day, following the example of the United States of America, there will be a United States of Europe.

  —George Washington

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  TALKING POINTS

  • When in doubt, just say “the markets don’t like uncertainty.” Nobody can argue with and everyone can understand that.

  • Lehman Brothers, the fourth largest investment firm in America, was allowed to collapse in September 2008. There is still vigorous debate about this, with many believing it to have been a genuine error that played a huge part in the financial crisis playing out as it did.

  • Let’s look on the bright side of those predicting America’s demise and China’s rise. America’s downfall has been prematurely predicted before, with the 1980s and Japan. Which didn’t work out so well for the Japanese. Most countries (especially Europe) would love to have America’s “decline.” The USA’s share of global GDP was about 25 percent in 1969
—and according to the last figures your author was able to get her mitts on, still is. The Chinese government has to walk an increasingly fine line to maintain control in the here and now (globalization isn’t exactly a dictator’s friend—those within a closed society can compare their lot with other peoples’). And if China does end up ruling the world? They’ll probably have to do so in English—it’s way more rooted in global media and technology than Mandarin.

  • Canada was the only G7 country (the G7 is an informal bloc of industrialized democracies—Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States) to survive the financial crisis without a state bailout for its financial sector. This is because it had an uncomplicated and well-coordinated regulatory framework with capital requirements at its core that was innately suspicious of the rise of the shadow banking system.

   Canada has had no systemic banking crises since 1840. The United States has had twelve.

   There were some warning “flashes” about Canadian credit growing faster than it should be in 2014. But even if there’s a crisis, historically it’s still winning.

  • In regards to the 2008 financial crisis, the powerful sacrificed taxpayers to the interests of the guilty (who didn’t go to jail), full stop. Anyone who argues that this is incorrect is not someone you want to be hanging out with.