Ken Rogoff conquered the New York Times again.
- Eye of the storm
- The broken eggs of China's business omelette
- Future Shuk: When markets are no longer just emerging
The economics professor from Harvard starred on the front page of the business section last week as having predicted the financial crisis in China, as an expert on financial crises in general, and as being completely unsurprised by the global financial blood bath.
Rogoff is indeed an important and especially serious economist. But the spotlight trained on him and his ilk reminded me of an interview with him at the height of the last financial crisis, in January 2009. He predicted then that the dramatic increase in United States government debt would, as taught by economic dogma, lead to a historic high in the interest rates at which the government borrowed – toward 7%. At the time, the market rate of interest on U.S. government bonds was about 4%. Now it’s about 2%.
We don’t mean to pick on Rogoff and needle that he, the expert on financial crises who published a book explaining that huge debt is the main source of crisis, erred so badly in his assessment of the most central development in the American capital market following the increase in debt. It isn’t personal – this goes far beyond Rogoff. The true ability of the experts, the economists, the analysts and the politicians to understand what’s happening in the world capital markets and supply good forecasts is diminishing, partly because the financial world is so vast and complex, and also because most of these experts have incentives to supply positive prognoses.
At the heart of the global downturn in the financial markets this last month is China, which is not only the world’s second-biggest economy, but also the least transparent. China has a very weird type of capitalism: On the one hand it encourages private enterprise and private investments around the world, on the other hand the government is massively involved in the economy and in the financial markets.
The Chinese do not believe in the free flow of information, not when it comes to politics and not when it comes to the economy, either. Its main newspaper, The People’s Daily, didn’t even tell readers last week about the downturn, preferring to cover economic developments in Tibet. The economic data Beijing publishes is suspected of being biased. Nobody knows the exact extent of debt in that gigantic economy and how much of it is good.
China is an extreme – its economy bears huge influence on the rest of the world and the information on it is distorted. But why pick on China? In the aftermath of the U.S. financial crisis, it turned out that most of the market players had very little information about the risky mortgages. We can be sure that come the next financial crisis, a lot of information hiding in the balance sheets of the banks and giant companies in China and the U.S. will come to light.
As for this latest crisis, the pundits counsel “not to panic.” In practice, these experts have no clue what will happen. For most, media coverage is mainly a marketing opportunity.
Some years ago we suggested that the regulator require the business, press, finance, TV and bank analysts to append a warning, like on cigarette packs, to their reports and shows: “Reading and watching the news, analyses and financial reports could damage your financial health.” The regulator ignored our suggestion.
Meanwhile, as a growing portion of the public’s capital and savings gets placed in the Israeli and global capital markets, the flood of analyses, recommendations, guides, tips and forecasts just keeps mounting.
The problem with the tidal wave of information, especially during market downturns, is threefold: 1. Most of the experts have no idea what will happen in the market in the short, medium or long run. Their main weapon is an authoritative tone of voice and jargon. 2. Most people quoted in the media have a business model and incentives to be very optimistic, or very provocative. The incentive to provide real, serious service to the public is low, if any, as the public has a very short memory. 3. Most of the public isn’t equipped to understand the complicated financial markets. Even experts usually only know their corner.
If this flood of information is so useless, why does it survive? Because it’s easy stuff to sell, mainly when the markets rumble. On the one side are sellers hawking their brands and products, on the other are confused, frightened investors.
An occupation with the daily noise of the markets, the rises and falls and “surprising” news isn’t just attractive and easy to market, it makes the whole thing look serious, professional and authoritative. It’s also the best way to avoid looking at hard questions, structural basic questions that the players in the financial markets hope you never ask and mainly, they hope the regulators never ask. Such as:
1. Does corporate governance at the big companies in China and the developed economies like the U.S. and Europe enable investors to truly oversee the company managers? Or are most investments made through investment companies (portfolio management, funds) with no real incentive to oversee the companies’ governance?
2. Does the competition between investment managers motivate them to supervise the companies whose securities they buy for their clients? Or is supervising the companies expensive, complicated and unpleasant, so why would they?
3. There are tens of trillions of dollars in the global pension system. Is it efficient in resource allocation, assuring that all those pensioners will retire in comfort, or is it built chiefly to assure the needs of the money management system and the big listed companies?
4. Is the monetary policy of the world’s central banks, including China’s – namely bottom-crawling interest rates and injecting money into the markets every time a crisis arises – serving investors in the long run or mainly the banks themselves? Could these low interest rates merely be putting off the crisis in order to avoid dealing with structural problems?
5. Are the central bankers heedful of the needs of the public or do most of them live in the clique of politicians and bankers and tycoons? Note that not a single person in the U.S., not a regulator or banker or politician, has been called to take account for the last crisis, which begs the thought that the decision makers feel they won’t pay a personal price even if they make some horrible cock-up.
6. What proportion of the “value” that the gains on the financial markets created in recent years was driven by economic growth, and what share is the result of financial inflation thanks to the low interest rates, cheap credit, overcharging consumers and feeble regulation?
7. How able are nations to deal with these questions given their existing policy tools, with finance a global industry, with companies registering where it suits them, with capital flowing freely, with arbitrage between regulation and tax regimes, and with more and more power in the hands of the multinationals?
These questions are unlikely to be asked, and the experts are likely to continue to coo at the public, “Don’t panic,” “remember that investments are for the long run,” and “buy in the dip.” That’s all very well if the markets recover. But that is to ignore the reality that the world economies face. The great financial crisis of 2008 has led to no soul-searching at all; apparently much worse has to happen before somebody gets up and asks the really hard questions.