A physicist, a chemist and an economist are marooned on a desert island. Their only food is a can of beans that has just been washed ashore. The physicist suggests using the sun’s rays to melt the can. The chemist suggests using seawater to erode the can. The economist’s solution? “Let us suppose we have a can-opener…”
We are now four years into a global financial crisis. The search for solutions goes on. But we cannot solve a problem unless we understand it. We also need to avoid making the same mistakes that got us here, which is where the economists come in. Ahead of any other interest group, economists should own up to the failings of their own profession and their contribution to the crisis.
The rot set in early. In the 1870s, Frenchman Léon Walras, who had already failed as an engineer, banker, journalist and novelist, took up economics. At the time, the study of physics was highly regarded. So it was only natural (to Walras) to adopt some of its principles wholesale. The problem was that the laws of physics are unsuitable for the study of the economy, largely because the economy, as the Austrian school of economics reminds its students, is us. Human nature is not precisely forecastable. Yet this did not stop the adoption of scientific principles and models into the realm of economics. Overconfidence in such flawed models played a key role in the evolution of the banking crash.
Having partly contributed to the disaster, mainstream economists are now pouring petrol on the fire by continuing to back inappropriate solutions – not least, the adoption of further Keynesian monetary stimulus. At the risk of stating the blindingly obvious, printing more money does not create wealth – it merely reduces the purchasing power of existing money. Western governments are now pursuing a futile race to the bottom, a competitive currency devaluation battle that nobody can win. The only rational response? Shelter in gold until the storm abates.
But economists have not acted alone. They have provided intellectual cover for their primary sponsors, the bankers. Nassim Nicholas Taleb, the author of The Black Swan, recently suggested – and it’s hard to disagree with him – that the best way to secure the financial system is to eliminate bankers’ bonuses and instead pay them in line with civil servants: “Consider that we trust military and homeland security personnel with our lives, yet we don’t give them lavish bonuses. They get promotions and the honour of a job well done if they succeed, and the severe disincentive of shame if they fail. For bankers, it is the opposite: a bonus if they make short-term profits, and a bail-out if they go bust.”
Of course, banks have a role to play in the modern economy, but that role is all about offering safe custody and interest to depositors and facilitating the ethical extension of credit to deserving borrowers. It is definitely not about the sort of casino banking that has brought the industry into disrepute. The financial crisis boils down to a seizure of control by economic agents. In theory, banks are not owned by their staff, but by their shareholders. Yet a powerful coterie of executive insiders has claimed effective ownership – note, for example, the 89% of its revenues that investment bank UBS is paying its staff. All well and good, but what about the poor, long-suffering shareholder? One answer, of course, is for institutional shareholders to be more proactive in reminding the banks to whom they are answerable. The system cannot mend itself without an understanding that agency risks run deep.
No survey of the guilty parties in the crisis would be complete without including the politicians – the ultimate regulators of the banking system. But here the waters get muddied. If we hold our political leaders to account for having capitulated to the bankers in their direst hour, we are chastising ourselves. It is voters who have perpetuated the economic policies of recent decades, policies of jam today, the attendant issuance of yet more debt, and the distant prospect of taxes tomorrow to pay for it all. Greece is not the cause of the eurozone’s debt problems, but merely a symptom of a broader political failure. With everyone narrowly pursuing their own vested interests, a culture of entitlement has spread throughout the Western economies like cancer. The day of reckoning has now arrived, and governments are starting to fall.
Pretty quickly one comes to the Murder on the Orient Express conclusion: in the banking crisis as to whodunit, we all did it. But rather than stew in an atmosphere of perpetual distrust, the answers are clear. Reform the banking sector that, as taxpayers, we now largely own. Abolish banking bonuses. And if our current political leaders aren’t up to the task, we will elect ones who are.
• Tim Price is director of investment at PFP Wealth Management. He also edits The Price Report newsletter. Contact: 020-7633 3637.
Category: Market updates