Sunday, May 30, 2010

Will Capitalism survive from immoral behaviour?

The OECD ministerial meeting (27-28 May) includes in its final declaration the following statement: 'The depth and breadth of the crisis has demonstrated the need to strengthen our commitment to fundamental principles of propriety, integrity and transparency. Our future growth and stability should be based on a commonly shared set of principles underpinning international economic and financial transactions'.

Launched as a concept by the Italian G8 Presidency in early 2009, the Global Standard aims to develop a set of common principles and standards for propriety, integrity and transparency in international business and finance.

In the G8 Declaration "
Responsible Leadership for a Sustainable Future" adopted at the L'Aquila Summit, G8 Leaders agreed on the objectives of a strategy to create such a comprehensive framework, the “Lecce Framework”, and to "make every effort to pursue maximum country participation and swift and resolute implementation".

The significance of this declaration is not only rhetoric. It is much more profound if we look from a historic perspective. Capitalism wants to build a moral society from immoral behavior. Political leaders are afraid of the consequences on the public opinion of the financial meltdown caused by the banks gambling with other people's money. In the US, part of the middle class has lost their houses as they could not pay back their mortgages.

In fact, some blame Wall Street for its greed, hubris, and stupidity. But free market economists will argue that this has always existed. Russell Roberts, a professor at George Mason university in Washington argues that " public policy decisions have perverted the incentives that naturally create stability in financial markets and the market for housing".
Free market supporters will support the idea that markets are always efficient and that new regulations are harmful. They prefer non binding rules such as the ones discussed in the OECD framework, with some exceptions such as the offshore places.

Capitalism is to blame because it is unstable and when crises occur, unemployment rises and inequalities tend to grow dramatically. This is Keynes' philosophical conclusion of his General Theory** in defining the foundations of an 'ethical' economy: "The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes" .

  *Chapter 24. Concluding Notes on the Social Philosophy towards which the General Theory might Lead

Saturday, May 15, 2010

Markets should become reasonable

Markets are not abstract entities. Behind the 'invisible hand', there are entrepreneurs as well as speculators who seek to invest to get a higher return. Long term investors promote the public interest whilst speculators will seek short term gains. We should therefore distinguish between markets which correspond to real economic activities, such as commodity markets, and 'fictional' markets, as derivatives, which are organised like a casino. Making money quickly gambling on fluctuations of the market is intolerable and immoral because it rewards greed, not economic risks.

Keynes wrote in his 'General Theory' *(p159): 'When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done'. ¨[...] It is usually agreed that casinos should, in the public interest, be inaccessible and expensive.

Today, the debt market has become a battlefield. It has turned into pure speculation: financial investors buy and sell sovereign debt bonds for their clients; they gamble on default risks of States on debts that they don't own. There are some good reasons to limit the operation of markets to the reality of goods and services. Ms Merkel has decided to ban short selling operations for public debt market. But this initiative will be effective if it is applied consistently by all countries, in particular by the United Kingdom, the largest financial haven in Europe. So it is likely that this will be vetoed by the new government which will want to protect their hedge funds and other instruments alike.

Furthermore, the European Union should ban financial speculation operated via sophisticated computer systems which are able to detect in some fractions of second market fluctuations worldwide. More than 40% of financial transactions are operated in that way, which bring huge and quick gains for the investors.

The US Senate has adopted recently a bill** for financial regulation to' protect consumers and investors from financial abuse' and pledges for enhanced international cooperation. The G-20 will have to agree on measures to increase transparency and regulation of financial markets.

But if we want to put an end to a casino economy, not simply because it is immoral or irrational but also because it is not economically viable nor socially desirable, we also need to set the right institutions to orient markets gradually towards the genuine aims of the economy. As Keynes put it (p 157): 'there is no clear evidence that the investment policy which is socially advantageous coincides with that which is most profitable. It needs more intelligence to defeat the forces of time and our ignorance of the future than to beat the gun'.

* J.M.Keynes (1936), The General Theory of Employment, Interest and Money, in The Collected writings of John Maynard Keynes, Vol.VII, Mac Millan - Cambridge University Press for the Royal Economic Society 1973


Thursday, May 6, 2010

The domino effect

The big issue today is whether the debt crisis will spread to other vulnerable countries such as Spain and Portugal. In the decade since the introduction of the euro, the economies on the continent have become increasingly interwoven. With cross-border banking and borrowing, many countries on the periphery of Europe owe vast sums to one another, as well as to richer neighbors like Germany and France.
This means that there is a domino effect. I quote here the New York Times (2 May) :

The first domino is Greece. It owes nearly $10 billion to Portuguese banks, and with Portugal already falling two notches in S. & P.’s ratings and facing higher borrowing costs, a default by Greece would be a staggering blow. Portugal, in turn, owes $86 billion to banks in Spain; Spain’s debt was downgraded one notch last week.
The numbers quickly mount. Ireland is heavily indebted to Germany and Britain. The exposure of German banks to Spanish debt totals $238 billion, according to the Bank for International Settlements, while French banks hold another $220 billion. And Italy, whose finances are perennially shaky, is owed $31 billion by Spain and owes France $511 billion, or nearly 20 percent of the French gross domestic product.'

The whole euro system is in danger. There are no simple solutions, but maybe we should think about a plan B on debt restructuring as suggested by N.Roubini (FT 30 April) if things go wrong. We can bail out Greece, but not all euro area countries.

Saturday, May 1, 2010

The Euro will be saved only by true EU cohesion

    A recent note from Citigroup to its clients warned that the Euro area risked falling apart if the EU member states did not unite at a financial and political level. The biggest financial services company in the world informed its investors that the threats to the single currency will persist even after the crisis in Greece. According to Citigroup, the Euro area does not stand a chance of survival if the member States do not unite in respect to the economic and political measures. “The EU must take a stand and decide whether it wants to become “the United States of Europe” or a patched blanket of independent countries”, shows a note sent by the chief-analyst of Citigroup, Tom Fitzpatrick, quoted by Bloomberg.
    As negotiators are discussing a three year loan to Greece that could amount to as much as €120 billion in total - after euro area states and IMF agreeing earlier his month to provide up to €45 billion- the question arises about a risk of contagion to other countries. Portugal is seen as the country most likely to follow Greece; Ireland too is seen as vulnerable after its government published the euro area's largest budgetary deficit in 2009, at over 14 per cent of GDP; Spain became the latest euro area economy to suffer a credit rating downgrading. As contagion from the Greek debt crisis appeared to be spreading rapidly, markets have reacted strongly causing a rise in bond yields and a tumble in stock markets.
    Current talks are designed to create an 'ad hoc' support mechanism for Greece, despite difficulties in the other euro area countries. However, the European Commission will come forward with proposals in May, intended to set up a crisis resolution which tighter rules for fiscal discipline will be built inorder to prevent moral hazard. 
    The German debate is revealing about the lack of cohesion in Europe. Opponents to rescue Greece ask on the basis of legal arguments - the no bail out clause in EU Treaty- for Greece to exit temporarily the euro area . As W. Munchau pointed out (FT 25 April),' the argument is full of legal hypocrisy'. Greece cannot in fact exit the euro area without leaving the European Union. So, if Germany blocks the loan package, Greece will be in a default situation and will put several German, French and Swiss banks at risk due to the size of their holdings of Greek debt. 
    Euro area countries must prevent a fire from spreading to the entire European economy. If your neighbor's house is burning, you have a moral obligation to help him. Cohesion should prevail over the narrow interests of the euro area countries . If Europe acts as a united block, it can defeat market fundamentalism and save the euro.