Robert Peston, 26th February, St Peter’s College, Oxford
Main causes of the financial crisis:
1. Global economic imbalances (i.e. some countries carrying persisting trade surpluses, and other deficits). The last year that the UK didn’t have to borrow for it’s consumption from the rest of the world was 1983.
2. Leverage in the banking sector and debt (enabled by incentives and regulator naivety) - Before the crisis debt in the UK was 500% of GDP
The UK policy response to the crisis included:
- Quantitative easing
- Higher capital ratios
- Household debt reduced from 163% of GDP to 140%
- Bit of EU economic reform
… basically the status quo has been regulated. Peston is surprised that the ambition for reform has been so modest. He thinks we should have nationalised and broken up the banks back in 2008.
The situation now:
- Too big to save (let alone fail) is still with us (Ringfencing means that in the case of bank failure the resolution process might save tax payers’ money, but even the details of this reform haven’t been agreed/ finalised.)
- Basel capital rules still in place (even thought they encourage gaming) - they’re just more complex.
- China still not a consumer economy
- House prices are rising in the UK, and the ratio of earnings to house prices is high.
- Interest rates are very low and Peston expects they will remain so until the election as if they rose then tens of thousands of people would go bust, which would be a political nightmare. BIS estimates that a 3% interest rate could lead to loss of 25% of GDP in the UK.
- UK productivity lower than competitors and worsening.
- UK public debt still high. To get it down to 60% GDP (as agreed should be the limit for all EU countries in the Maastricht Treaty), the UK needs more austerity than even Spain or Greece.
We now have genuine growth in the UK, but 5/8 of it comes from household consumption. Trade and investment have made just a small difference. The Office of Budget Responsibility sees consumption as the driver of growth for next few years too.
Peston thinks the recovery won’t last past the next election.
- US recovered more quickly because less reliant on the banks. In the US 80% of loans are provided by the markets/ investors and 20% is provided by banks. In UK/EU the ratio is more like 20:80.
- No nation now has the power to control global capital markets. When we unleashed the global capital markets, we should have thought about creating some sort of global regulator.
- Concerned about China, where debt is now 200% GDP, lending is up to $15 trillion, and Japan’s Prime Minister compares his country’s relationship with CHina to that between England and Germany in 1914.
Andy Haldane, Oxford Martin School, 4th February 2014
Key lesson from the financial crisis: We need to manage the financial system as a system.
But this lesson has not been taken to the international system.
E.g. US tapering (slowing the rate at which they put money into the economy) The US made this decision based on the impacts on their own country, despite there being direct financial spill overs on the rest of the world. The impact has been negative in Emerging Markets, where the cost of borrowing has increased as a result. The problem is that actions are taken in an individual country’s interests rather than for the system as a whole.
The problem of spillovers is greater than at any time before because:
- Global integration (as measured by cross border trade and financial integration) is at levels never seen before
- Financial integration is 10x that of trade
Integration is a double edged sword – it can improve risk sharing, but increase risk spreading too. The incidence of financial crises will increase, as will their impact/scale.
Interesting questions to explore:
- Does integration enhance growth and productivity? Can you have too much?
- Does the global financial system have sufficient insurance? If not, then which mechanisms make most sense?
4 superficially positive things about the state of insurance:
- Improved composition of capital flows (there’s more foreign direct investment and equity, and less debt)
- Higher absolute scale of FX reserves
- Higher absolute IMF resources
- Higher absolute regional/ national resources e.g. European Stability Mechanism
Reasons to be doubtful of these though…
- International reserves as a share of external liabilities has decreased, and holdings are concentrated in the hands of those who least need them.
- Resources as a share of potentially required resources have fallen
Where do we need to go next?
- Improved multilateral surveillance
(The IMF currently conducts surveillance, including spillover reports (that cover the impact of national & international policy on the global financial system), but they put most effort into “Article IV” – which is an annual assessment of individual countries. It is questionable whether the IMF is the right institution to be tasked with “ruthless truth-telling” too.)
- Improved debt structuring
- Improved capital flow/ macro prudential management
(The IMF has reversed its position on controlling capital flows. Now we need rules on when and how this should happen because this is currently happening nationally in an uncoordinated way.)
- Improved multilateral facilities
See my write up of Huw Pill’s talk at Oxford University, for OXONIA, here. Huw Pill is the Chief European Economist at Goldman Sachs.
This seminar for OXONIA, which took place on Wednesday 15th February, was made possible by the generous benefaction of Oxford Economics.
Martin Wolf presented the key ideas behind his third book entitled “The shift and the shocks: prospects for the world economy”. He described the exceptional, and unexpected current global economic situation, and explored how it might progress. In doing so, he exhibited an impressive understanding of the global macroeconomy.
The world economy has changed significantly in the last 200 years. In the 19th century there occurred what Kenneth Pomeranz called the “great divergence”, which saw the Western world advance ahead of Eastern countries. Japan and the east Asian “tiger countries” then saw converging growth in the early 20th century and more recently, in the late 20th/early 21st century, convergence spread to the Asian giants, like China. Today, growth across the globe is diverging again but in the mirror image to the 19th century.
The rate of growth in the emerging economies is staggering, suggesting that their GDP is going to double every 12 yrs. The most striking case is China, who since 2007 has seen aggregate GDP rise by 60%. Chinese GDP per head has continuously risen, as a share of US GDP per head (at PPP), since the 1980s from 3% to 16% today. This is in contrast to the other six largest emerging economies who have faced fluctuating or less rapid increases in GDP per head, relative to the US, during the same time period. What makes the situation so interesting, and unprecedented, is that, since 2007, the developed economies have been mainly stagnant.
In the long run, Wolf finds it hard to believe that this ‘catch up’ by the emerging economies won’t continue, provided the world avoids huge shocks. That’s not to say, however, that the process will be smooth because China is vulnerable to its excessive reliance on investment, and its high dependence on exports and property bubbles. If China’s growth did slow, the impact on commodity exporters could be substantial.
The impacts of the shift in global economic activity have so far been strong. The labour supply shock, which has lowered the relative wages of the relatively unskilled in high income countries is ongoing. Whilst there was initially a disinflationary shock as China lowered world prices for manufactures, an inflationary shock followed as demand for raw materials soared.
The impact on the pattern of saving was unanticipated; emerging economies have increased savings whilst the richer countries have decreased the amount they save, and there have been huge flows of capital from poor countries to the West. Wolf argues that the “savings glut” is evident from the negative real interest rates in the UK and US. Unfortunately, the low interest rates distorted the price of risk and debt, and the financial sectors failed to use the capital productively, contributing to an almighty financial crisis. The emerging world now holds $10trn of investment in “borderline bankrupt states”.
A large and enduring economic collapse has ensued and a dramatic rescue pursued: the liabilities of the core financial system have been nationalised, fiscal policy is on a war time footing and the extent of monetary policy, in the form of quantitative easing, is without parallel. Unfortunately, most of the Western countries’ GDP remains below pre-crisis levels, their public debt is set to increase until at least 2015, and whilst some countries’ 10 year government bond yields remain low, other countries’, like Italy’s and Spain’s, are high.
At the broadest level, the global situation can be described, according to Wolf, as the interaction of two huge events: 1) the secular shift in location of economic activity, and 2) the collapse of a generational expansion in private and public sector leverage in high income countries.
Wolf sees the eurozone crisis as a microcosm of the global crisis; a currency union that fell where these two events intersected. For, whilst there are current account imbalances, Europe (like the world) is roughly in balance as a whole, and the core of the eurocrisis is not fiscal but the result of the interaction of a balance of payments problem with financial crises. Huge debt stocks did played a part in creating liquidity problems for sovereigns though.
At the moment the situation looks dire. Across the world countries are facing falling growth, and in Europe some countries face negative growth, which raises doubt that the countries of Europe can help each other. Wolf identified four immediate global challenges:
1) Accelerating de-leveraging in private sectors of over-leveraged countries,
2) Rebalancing the world economy to give over leveraged economies export led growth, which is necessary when their private sectors run huge financial surpluses,
3) Reducing fiscal deficits without killing recovery,
4) Avoiding excess in emerging countries despite easy financial and monetary conditions.
The question everyone wants to know the answer to is: How’s it going to play out? Wolf’s prognosis is mixed, and lamentable for Europe. He envisions that the US will be the most dynamic of the big economies. In high income countries, inflation will fall, growth will remain weak, and the short term official interest rates will remain low for a long time. Countries with their own central banks will have low long term bond rates but many eurozone countries will not and the chance of the eurozone breaking up is significant. Emerging countries are likely to grow quickly but the chance of crises exists there too.
Marloes Nicholls, seminar coordinator
Oxonia is hosting two very topical lectures later this month. As usual, I’ll be covering the events and so, if you can’t make it, i’ll point you to the reports when they’re up on the website.
Martin Wolf (Financial Times): The Shift and the Shocks: the State of the World Economy
Oxford University Economics department,
15th February, 5pm.
Jean Pisani-Ferry (Director of think tank Bruegel and professor of economics at Universite Paris-Dauphine): The Crisis of the Euro Area
Oxford University Economics department,
22nd February, 5pm.
Victor Hugo, International Peace Congress, 1871
Dreams of a united Europe are old.
If you want to get to grips with the crisis - how it happened and why it’s so important - check out This American Life’s special podcast.
We’ve all heard about Germany’s world class manufacturing industry and strong export trade. Two events that took place earlier this year in July highlight just how far Germany is ahead of the UK.
1) Cameron’s pride at signing a £1.4bn trade deal with Chinese premier Wen Jiabao was quickly knocked when two days later Angela Merkel signed a £9bn deal and agreed on a target to increase trade with China to £178bn over the next five years.
2) The last remaining train maker in the UK, Derby based firm Bombardier, lost a UK government contract to the German group Siemens resulting in 1400 job losses, and this was just four months after Cameron visited the plant to boost morale.
Less well known is the fact that the German banking system is also radically different. Here in the UK, most people bank with the familiar high street banks (Barclays, HSBC, Lloyds TSB, Nationwide and RBS), but in Germany there are many smaller banks from which people choose to banks with. David Boyle has written about this in a recent report for the new economics foundation on local banking: “In the UK, over 80 per cent of mortgages are in the hands of the top five banks, as are over 80 per cent of Small and Medium Enterprises (SME) accounts. In comparison, 70 per cent of the German banking sector is in small or community banks.”
The benefits of the German system are strikingly apparent from the graphs below (excuse the poor pictures) which show that the small community banks were able to provide stable returns and access to credit during the financial crisis. Figure 2 shows that their return on savings remained fairly constant during the period of the financial crisis, whereas the rates commercial banks offered were much more volatile and plummeted in 2008. The big banks that most of us use in the UK are commercial banks. Figure 3 shows how local Swiss banks continued to provide credit at a constant rate throughout the crisis, whereas the commercial banks reduced lending considerably. This stability helped to shelter small businesses and individuals from the crisis. To be clear, they aren’t untouchable by economics crises but as David Boyle says, they “represent a stability and usefulness to the real economy that is almost entirely lacking in the UK”. In the UK small businesses are struggling to get loans.
I think the difference in performance between commercial banks and local community banks can largely be explained by their different structures of ownership and decision making. Commercial banks are usually public limited companies listed on the stock market driven to make profits for their owners, the shareholders, who can be anyone in the world. Decisions are often made by computers or sent to remote regional offices. Local community banks in Germany, on the other hand, are mutually owned which means that, instead of having shareholders, they have members who collectively own the business and are also its customers. The members are entitled to information on the business and to vote on important issues. Decision making is decentralised so that the branch manager has the authority to back his or her judgement (rather than obeying a computer algorithm). Furthermore, these banks are not purely profit driven, but have explicit social as well as economic objectives.
There are a large number of financial institutions (over 450) called credit unions all over the UK that could form the basis of a flourishing local community banking sector in our country too.
Credit unions are not-for-profit cooperatives owned and run by their members that focus on providing savings accounts and loans. Their main purpose is to provide credit at competitive rates and their social benefit lies in tackling financial exclusion (the fact that many people cannot get loans from the big banks) and liberating communities from loan sharks. They are by no means just for the “poor” though - apparently there is a credit union for people who work in the City! As a saver, you can put your money in a credit union and know that it will be used in the local community. About 25 credit unions also offer current accounts. Rest assured that credit unions offer precisely the same government guarantee as the high street banks.
In North American and Canada 40% of people are members of a credit union, whereas in the UK about 1% of the population are. Hopefully new legislation that comes into effect in early January will begin to broaden the services they can provide and help credit unions to compete with other banks.
Each credit union is slightly different because it is run by its members and for their particular local community. You can find out more about credit unions, and search for your local one and the services it offers on the Association of British Credit Unions’ website.
"Like an organ ofthe human body, the financial system calls most attention to itself when it malfunctions. But in normal times, is the financial system like the human heart, circulating essential capital throughout the economy? Or is it like the appendix, doing little when healthy but devastating when ill?"(Christina Wang)
Conventional measures of how much the financial sector contributes to the economy indicate that the financial sector contributes up to twice as much to the economy than the average of all US firms. These measures, one might say, portray finance as being the heart of the economy.
Christina Wang explains why these measures are misleading, mainly because they fail to discriminate between the cases when a bank is providing a service and when they are just taking on more risk. She discusses her research that tries to measure the risk-adjusted value-added of the financial sector to the economy. She finds that the conventional measure overstates the ‘true’ value-added of banking by 100%, and by her measure “banks look like the average of all US firms. In fact, banks appear to generate slightly lower returns”!
This research uses US data but Andrew Haldane from the Bank of England has conducted similar research for the case of the UK (The contribution of the financial sector: miracle or mirage?).