[wordup] Bernard Hickey - The free market god doesn't exist

[Adam Shand]

I've been fortunately to meet Bernard a couple of times and hear him
speak at New Zealand's yearly "Kiwi Foo Camp".  I really like what he
has to say, he seems thoughtful, genuine and full of hard earned
common sense.

Source: http://www.nzherald.co.nz/politics/news/article.cfm?c_id=280&objectid=10676862
Via: http://www.facebook.com/profile.php?id=100000723323081

The free market god doesn't exist

By Bernard Hickey
9:30 AM Wednesday Sep 29, 2010

I feel like a priest who has been wrestling with his belief in god and
has now decided god does not exist.

It's time for me to recant and to say what I've been thinking for
months: the economic god of completely free markets and capital flows
is not worth believing in anymore and we must look for other things to
believe in and do.

I think New Zealand needs to have a debate about capital controls,
about foreign ownership of assets, about measures to control our
currency and about being openly nationalistic rather than
internationalistic about our economic policy.

I think the Global Financial Crisis and the preceding decade of
debt-driven instability in global capital markets and trade flows have
demonstrated the failure of the economic model most New Zealand
policymakers have adhered to for nearly 3 decades.

I think we need to rethink the way we run monetary policy, the way we
allow foreign ownership of assets, the way we encourage savings, the
way our financial institutions are regulated and change the things we
are aiming for.

We should debate more specific controls on who owns what assets,
whether monetary policy should still use the Official Cash Rate to
focus on inflation alone, and whether banks should still be free to
lend however much they want to whomever they want.

But first some background because this is not something that has come
out of the blue. I've been thinking about this for a while.

'Mea culpa'

I used to believe in the primacy of markets and economic freedom.

I used to believe that New Zealand's interests, and the world's, were
best served by completely free movement of capital and trade.

I railed against the tariffs and the exchange rate controls of the
mercantilists and protectionists.

I argued in favour of unfettered free trade with China.

I despised the 'Think Big' policies of the Muldoon era and all the
import licenses and exchange rate controls that went with them.

I believed the reforms of the late 1980s were ultimately good for New
Zealand and if only we had gone a little bit further and a little bit
faster we would have been OK.

I believed a free-floating exchange rate and the removal of tariffs
and other trade barriers was a good idea. I believed in the law of
comparative advantage and how encouraging companies to specialise the
means of production in different countries ultimately made everyone
wealthier.

I pointed to the amazing reduction in the number of people living in
poverty in China as proof of what free trade can do.

I thought the 'Great Moderation' between 2002 and 2007, where interest
rates and inflation was low while growth was high, was real.

But I think many of those beliefs are now wrong.

The Great Moderation was a Great Fraud

It's clear now that the explosion of global capital flows and low
interest rate debt over the last decade was a direct result of those
unfettered capital flows.

The 'Great Moderation' was actually a Great Fraud perpetuated by
financial engineers in Manhattan and London who targeted massive short
term bonuses by creating financial instruments that gave the
appearance of reducing risk, but actually massively increased risk.

These investment bankers exploited all sorts of holes in financial
regulations and in the way pension funds are allocated to enrich
themselves at the expenses of middle and under classes in developed
countries. The created a long term mess for short term gain. They
privatised profits for themselves and socialised the losses for us
all.

They worked in tandem with the managers of often publicly listed
multinational corporates who specialised their operations in different
countries, often moving manufacturing and services to lower wage
economies in an endless hunt to lower costs and increase profits
(often for their own personal benefit).

This seemed like a good idea at the time and even seemed noble,
spreading the wealth around. But all it did was reduce real wages for
the middle and under classes in developed economies, who then promptly
borrowed more to keep spending as if they were richer. It was a recipe
for instability.

All this debt-fuelled consumption growth in the developed world that
was funded and supplied by savings and production surpluses in the
developing world.

It could not last. Like any Ponzi scheme, eventually the debt keeps
rising until the interest bill overwhelms the ability of the borrower
to pay.

Once asset values start falling then we find out who has been swimming naked.

This exposure and collapse of a giant fraud is what we have seen in
the last two years. It has expressed itself in the usual way.

Now the fallout

Financial crisis has followed financial crisis. Banks have gone bust.
Savings have been wiped out. Economies have gone into deep recession.
Ponzi schemers have been put in prison.

Currencies have swung wildly. Unemployment rates have risen. Asset
prices (both property and share prices) have plunged.

Governments have tried to put their fingers in the dyke to stop their
economies being wiped out after the collapse of the levee walls. They
are trying and failing.

Firstly, governments rescued those same banks that had engineered the
explosion of debt. Private debt was transferred into public hands to
try to save the system. The bankers were allowed to keep going,
generating bonuses for themselves. Now the publics in those countries
where this happened in the biggest way are waking up, albeit in a
messy way.

However, this didn't stop the inevitable implosion. It just delayed
and extended it.

Now investors are rightly worried that governments may not be able to
afford the extra debt taken on to keep their economies pumped up after
September 2008 and the toxic debt they took on that the banks couldn't
handle.

The financial systems in many of these economies remain broken, but
more importantly, households know they have too much debt already and
won't borrow more to spend like they were. The great de-leveraging has
begun and nothing can stop it.

So the tide really is going out and now we're discovering the
underlying structure of the global economy is flawed.

Black Swans

Emerging economies such as China want to industrialise in a
mercantilist way, holding down their currencies to subsidise producers
at the expense of consumers.

The global economy is now dependent on production and saving in one or
two parts of the world, China and Germany, offset by consuming and
borrowing in other parts of the world, America, Britain, Southern
Europe, Australia and New Zealand.

This is fine as long as the savers have somewhere safe to put their
capital surpluses and the borrowers can keep borrowing. But it all
ends when borrowers run out of borrowing capacity and the savers lose
faith in the paper they're exchanging for the product they're
producing.

There are some short term fixes. One is to cut interest rates to zero
and hold them there forever. America is trying that right now. The
other is to try and win a race to the bottom in a game of competitive
devaluations. In a way they are the same thing. America, Japan and
Europe are all trying that right now.

All this specialisation and separation of production, saving,
borrowing and consumption in different parts of the globe has done is
make it more unstable.

The most convincing argument I've seen on this is from Nassim Taleb,
the author of the Black Swan, who says that financial and capital
systems need to have redundancies and inefficiencies built in to cope
with shocks, just as Mother Nature does. Here's his argument in a must
read piece in the New Statesmen.

We need some redundancy

Essentially, I'm saying we need to build some redundancy into the
systems for global trading and capital flows.

We need to realise that sometimes the system doesn't work. We need to
have something in reserve.

We need to accept that a completely free and unfettered system of
global multi-national capitalism driven by an elite of CEOs and
investment bankers will inevitably blow itself up in a frenzy of
borrowing, bonuses, short term thinking and self interest.

If we're not careful there will be the sorts of revolts, political
unrest and global tensions that sparks wars and revolutions. It's
happened before. To think it won't happen again is naive.

So what?

So what has this got to do with New Zealand?

Surely this is all going to happen independently of us and we just
have to open ourselves up and hope for the best.

We tried that and it failed. We increased our foreign debt by NZ$97.5
billion inside the last six years, but all that happened is our per
capita GDP actually fell over that period.

We borrowed from the free and easy and low interest rate global
capital flows to pump up asset prices and go on a spending spree. All
we have left for it now is some leaky homes, a big debt and a hollowed
out workforce.

We need to recognise that in a world of competitive devaluations,
growing trade tensions and nakedly selfish vested interests
(governments, multinationals and global investment banks) that we have
to defend ourselves and be just as nakedly nationalistic.

We have to assume, just as Marx pointed out, that free markets will
eventually overheat and blow up if we allow them free rein.

Income needs to be redistributed to offset the concentration of wealth
that naturally occurs in such a globalised, free flowing world of
capital. Ownership of assets needs to be monitored and controlled. The
growth of foreign debt needs to be restricted.

Consumers and bankers need to be saved from themselves.

That is what I think we're starting to see filter through to our
politicians from the grass roots upwards.

Stop the fudging and have a debate

The government's fudgey decision this week to give ministers
discretion to reject foreign bids for large tracts of farmland is the
first sign.

I'd much prefer we had a debate about this.

John Key is as aware as anyone that the inevitable result of these
dislocations of capital and the means of production, along with
competitive devaluations, is a global land grab for hard assets such
as arable land, mines and technology. Bits of paper don't cut it
anymore. No wonder the price of gold hit a record US$1,300/oz
overnight.

No wonder the Chinese want to buy our dairy producing land and
factories. Or the mines in Australia. (Interestingly the Australians
wouldn't let the Chinese buy the mines).

China likes free trade because it wants to build factories and sell
stuff to the rest of the world. It wants to own assets in other
countries that can provide it with the raw materials and food it needs
to keep that export machine going and employing workers from the
countryside.

But China will not allow others to buy those assets in its country. It
is point blank refusing to allow its yuan to appreciate quickly versus
the US dollar.

US politicians, under pressure from voters, are revolting against the
multi-national free trading system in a messy way, looking to impose
tariffs. The Tea Party movement, however flawed, is a reaction to the
failure of this global system and the way it has been distorted by
vested interests to transfer wealth from the middle classes to the
richest Manhattanites.

This is not going to stop and we can't ignore it.

America is trying to devalue and print its way out from under its
debt. Europe will eventually have to do the same, if only to stop its
single currency from exploding from within. China will not stop and
Japan is about to announce a massive new stimulus in the wake of its
second currency intervention inside a week.

Brazil has declared it is engaged in a currency war to try to stop its
currency from rising.

Brazil, like Australia and New Zealand, has a freeish floating
currency that is rising as others try to devalue and buy into
countries with hard rather than paper assets.

So what do we do?

The Reserve Bank of New Zealand has already taken a baby step down
this route to intervention to save ourselves. Its Core Funding Ratio
(CFR) essentially directs our big four banks to stop dipping into
these global capital flows and to fund much more of their lending from
local sources.

That has stopped the mad dash into property and higher debt, although
households have also worked out for themselves that the game is up.

The Reserve Bank could do a lot more. It could direct banks to have
maximum loan to value ratios. It looked at this in 2006. It could
require banks to put aside more capital for the 'wrong' types of
lending into housing and consumption.

Remember, that in the last two years of the crisis our banks have lent
more to households and to farmers against the value of property, but
lent less to businesses, Reserve Bank statistics show. Farm lending is
up NZ$7 billion to NZ$47 billion and household lending is up NZ$8
billion to NZ$181 billion, while business lending is down NZ$4 billion
to NZ$72 billion.

The government could consider limits on foreign ownership of major
assets and restrictions on profit repatriation.

Savings into New Zealand KiwiSaver funds and the New Zealand
Superannuation funds could be directed into New Zealand investments.

Much more could be done to protect ourselves and reduce the possible
damage from future booms and busts.

I don't have all the answers./I'm not saying we should throw out the
baby with the bathwater and return to Muldoon-era currency controls.
But other open trading countries, such as Singapore, have ways to
control their capital flows and exchange rates. Why shouldn't we?

I'd just like to have a debate and start looking for a new way to run
our economy.

Because the current way isn't working.