Sinister aspects to the humbling of the experts
When rich people lose a lot of money, they seek to blame someone else
Tuesday 06 October 1998
But assessing just how serious the trouble has become is extraordinarily difficult, because the mood of both stories is changing with lightning speed. We'll leave the President's plight to one side and focus instead on the world economy.
In some ways what's happening is nothing new - we have had sharp falls in market confidence many times before. The hard thing is to gauge whether a market correction (to use the standard euphemism) leads to economic disaster. Put another way, is this 1929 or 1987?
The change of mood among Americans in the space of just three months is remarkable. Three months ago recession was something that happened elsewhere. The very possibility would be denied by leading economists in the main US financial institutions. The London view that US shares were dangerously overvalued was dismissed as ridiculous. Goldman Sachs, perhaps the most bullish of the US houses, chose this moment to decide to float its shares.
Now the fall in the market has destroyed wealth on a gigantic scale: shares of the big banks, particularly investment banks, have fallen by up to two-thirds. Go to any of the many bankers' cocktail parties here and you hear the comments that this or that bank is in deep trouble.
When rich people lose a lot of money they seek to blame someone else. So expect blame to be loaded on to officialdom: the G7 finance ministers, the central bankers, the regulators and so on. You will hear a lot more of this in the weeks to come. As the world of officialdom has been pretty ineffectual - calling for strong co-operative efforts and then doing nothing - there is a certain justice in this criticism. But that should not obscure the plain fact that the experts were wrong. What was needed was judgement, not Nobel prizes in mathematics.
As well as being wrong, they have also been sloppy. Not only are the rumour mills churning out stories of bad judgement; they are also spilling stories of incompetence. Every commercial bank in the world has spent the last month combing its accounts to find out what it has lent to whom in case it can unearth some bad debts it didn't know about.
I hadn't fully grasped quite how sloppy some banks had become in the fat years. We all know now that Barings' risk management was gravely flawed, and how it discovered this the hard way. It seems likely now that many other banks have been almost equally cavalier, particularly in the management of their derivatives positions. I was told that some positions on which banks are losing money were not even examined by the banks' normal risk assessment teams because they were assumed to carry no risk at all.
Some stories of banking errors have emerged. UBS, the second-largest bank in the world, has just seen its chairman and some senior executives resign. That episode has been reasonably well handled: the problem was swiftly disclosed and the people responsible behaved decently and honourably. Expect much, much more to come out in the coming months, and do not assume it will be handled equally well.
You may think that this humbling of the experts is good clean fun, and in a way it is. But there is a sinister aspect to it. If the world's banks are seriously frightened - which they are - this is liable to lead to a loss of confidence in the banking system in general. Japan apart, that has not happened yet. If the Japanese disease proves contagious, the ability of the rest of the world economy to recover will be gravely undermined.
Aside from the humbling of the bankers, what else is new? Two things stand out from these Washington meetings. The first is that shoring up the world economy will be an ad hoc, piecemeal patching operation. Not only is there no grand plan (which may be no bad thing), but we cannot assume that the G7 will behave in a co-ordinated and competent way. There is a sense of denial - not of the scale of the dangers, for everyone is aware of that - but rather of the ability of the finance ministries to deliver.
The best example is the position of the Japanese. Much play was made of the acceptance by Japan of the strong statement of the G7 and its assurance that it would take measures to boost the economy and fix the banking problems. But of course the Japanese cannot do anything, partly because they don't know what to do and partly because even if they did, they couldn't get the legislation through parliament.
I don't dismiss the various plans and programmes being discussed through the autumn, for a lot of the work is very useful. But in the short run the markets have to work on the assumption that the authorities will be fairly ineffective - and hope that this assumption is wrong.
The other thing that has become very apparent is that different regions of the world will not only continue to experience very different economic conditions, but the ability to recover will depend crucially on the solidity of the local banking system. Regions with strong banks will be able to sustain their economic growth, or recover it, reasonably swiftly, while those with weaker banks will remain in trouble.
After 1929 there was the global problem of a collapse in world trade and a surge of protectionism, but the countries which recovered best were those with strong banking systems, while those which recovered most slowly were those with weak ones.
Despite the temptation to draw parallels with past market plunges, I'm not sure that either 1929 or 1987 (when a market collapse was swiftly reversed) are the best models for what might happen over the next few years. I'm inclined to think that the 1870s might be a better model, the start of what was called - until the 1930s came along and stole the expression - the Great Depression.
It was not a depression in the 1930s sense that world output plunged. Actually it grew, bumpily but quite well. It was a depression in the sense that world prices fell for two decades until the gold rushes of the 1890s. This mix of growth during a period of falling prices is not within our experience. If it happens again, solid banking systems become enormously important and bond markets flourish, as they are doing now.
One other thing: it was a period of generally very low nominal interest rates. If the Bank of England does cut rates this week, it could be the start of a long, long trend. Yes, the world economy is in trouble, and some bits of it will remain in trouble for another three years, maybe more. But we should not assume that deflation means disaster - just a difference, and a difference to which we will all have to adapt.
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