David Gordon on Mervyn King: Central Bankers are Losing Faith in their own Alchemy. Cobden

Mervyn King is the British Ben Bernanke. An eminent academic economist, who now teaches both at New York University and the London School of Economics, King was from 2003 to 2013 Governor of the Bank of England. In short, he is a very big deal. Remarkably, in The End of Alchemy he frequently sounds like Murray Rothbard.

King identifies a basic problem in the banking system that has again and again led to financial crisis.

“The idea that paper money could replace intrinsically valuable gold and precious metals, and that banks could take secure short-term deposits and transform them into long-term risky investments came into its own with the Industrial Revolution in the eighteenth century. It was both revolutionary and immensely seductive. It was in fact financial alchemy — the creation of extraordinary financial powers that defy reality and common sense. Pursuit of this monetary elixir has brought a series of economic disasters — from hyperinflation to banking collapses.”

How exactly is this alchemy supposed to work?

“People believed in alchemy because, so it was argued, depositors would never all choose to withdraw their money at the same time. If depositors’ requirements to make payments or obtain liquidity were, when averaged over a large number of depositors, a predictable flow, then deposits could provide a reliable source of long-term funding. But if a sizable group of depositors were to withdraw funds at the same time, the bank would be forced either to demand immediate repayment of the loans it had made, … or to default on the claims of depositors.”

Readers of Rothbard’s What Has Government Done to Our Money? will recognize a familiar theme.

Many have sought to salvage the alchemy of banking by resorting to a central bank. By acting as a lender of last resort, a central bank can bail out banks in need of funds to satisfy anxious depositors and thus avert the danger of a bank run. The alchemy of transforming deposits into investments can now proceed.

Though he was one of the world’s leading central bankers, King finds fault with this “solution.” A local bank can be rescued by getting money from the central bank, but the process generates new problems. Thomas Hankey, a nineteenth-century Governor of the Bank of England, pointed out some of these in response to Walter Bagehot, the classic defender of the central bank as the lender of last resort:

[i]f banks came to rely on the Bank of England to bail them out when in difficulty, then they would take excessive risks and abandon “sound principles of banking.” They would run down their liquid assets, relying instead on cheap central bank insurance — and that is exactly what happened before the recent [2008] crisis. The provision of insurance without a proper charge is an incentive to take excessive risks — in modern jargon, it creates “moral hazard.”

Given the dangers of financial alchemy, what should we do about it? Again, King strikes a Rothbardian note. He writes with great sympathy for one hundred percent reserve banking.

Even though the degree of alchemy of the banking system was much less fifty or more years ago than it is today, it is interesting that many of the most distinguished  economists of the first half of the twentieth century believed in forcing banks to hold sufficient liquid assets to back 100 percent of their deposits. They recommended ending the system of “fractional reserve banking,” under which banks create deposits to finance risky lending and so have insufficient safe cash reserves to back their deposits.

Like Rothbard, King calls attention to the insights of the nineteenth-century Jacksonian William Leggett. King cites an article of 1834 in which Leggett said:

Let the [current] law be repealed; let a law be substituted, requiring simply that any person entering into banking business shall be required to lodge with some officer designated in the law, real estate, or other approved security, to the full amount of the notes which he might desire to issue.

King may to an extent resemble Rothbard; but unfortunately he is not Rothbard; and alert readers will have caught an important difference between King’s idea of one hundred percent reserve banking and Rothbard’s. King’s notion, unlike Rothbard’s, still allows banks to expand the money supply. The “liquid assets” need not be identical with the deposits: they need only be easily convertible into money should the need arise to do so.

King’s own plan to “end the alchemy” allows for substantial monetary expansion. He calls his idea the “pawnbroker for all seasons (PFAS)” approach. This is a form of “liquidity” insurance. Banks would have to put up in advance as collateral with the central bank some of their assets. This would act as a “form of mandatory insurance so that in the event of a crisis a central bank would be free to lend on terms already agreed.” So long as the insurance had been paid, though, the central bank would still bail the bank out in a crisis by giving it more money. Contrast this with the plan suggested in the quotation from Leggett, in which if a bank could not redeem its notes, depositors could proceed directly against the bank’s assets. This allows no monetary expansion; and Rothbard’s plan is of course more restrictive still.

Having come so close to Rothbard, why does King shrink from the final step? Why does he still allow room for monetary expansion? He fears deflation.

Sharp changes in the balance between the demand for and supply of liquidity can cause havoc in the economy. The key advantage of man-made money is that its supply can be increased or decreased rapidly in response to a sudden change in demand. Such an ability is a virtue, not a vice, of paper or electronic money. … The ability to expand the supply of money in times of crisis is essential to avoid a depression.

But if the demand for liquidity suddenly increases, when the monetary stock is constant, cannot falling prices for goods satisfy the demand? King, here following Keynes, is skeptical. “Wage and price flexibility does help to coordinate plans when all the markets relevant to future decisions exist. But in practice they do not, and in those circumstances cuts in wages and prices may lower incomes without stimulating current demand.” Prices may keep falling indefinitely.

Other possibilities of coordination failure also trouble King, and underlying them is an important argument. Following Frank Knight, he distinguishes between risk and uncertainty.

Risk concerns events, like your house catching fire, where it is possible to define precisely the nature of that future outcome and to assign a probability to the occurrence of the event based on past experience. … Uncertainty, by contrast, concerns events where it is not possible to define, or even imagine, all possible future outcomes, and to which probabilities cannot therefore be assigned.

We live in a world of radical uncertainty, and thus we cannot be sure that relying on market prices to adjust to changes in the demand to hold money suffices to avert catastrophe. It is for this reason that resort to monetary expansion sometimes is needed.

This argument moves altogether too fast. It does not follow from the fact that Knightian uncertainty prevails widely that one must take seriously the possibility that prices and wages would fall indefinitely. In a situation of uncertainty, we cannot, by hypothesis, calculate probabilities; but this does not require that we take outlandish possibilities as likely occurrences that must be averted by the government. Some reason needs to be given for supposing that prices will continue to fall indefinitely. Why would entrepreneurs not be able to correct the situation, without resorting to monetary expansion? We are not faced with a dichotomy between exact mathematical calculation, in the style of an Arrow-Debreu equilibrium, and blind groping in the dark.

King himself acknowledges that in the American depression of 1920 to 1921, no resort to the government was needed.

The striking fact is that throughout the episode there was no active stabilization policy by the government or central bank, and prices moved in a violent fashion. It was, in the words of James Grant, the Wall Street financial journalist and writer, “the depression that cured itself.”

It is encouraging that King cites the Austrian economist James Grant, but he draws from his work an insufficient message. “The key lesson from the experience of 1920–21 is that it is a mistake to think of all recessions as having similar causes and requiring similar remedies.” In view of the manifold invidious consequences, fully acknowledged by King, of government intervention, should we not rather emphasize the need to rely on the unhampered market? King nevertheless merits praise for coming close, in his own way, to many Austrian insights.

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China’s liquidity flood stirs memories of the Mongols and Mao

When Marco Polo went to China he discovered something better than alchemy. Rather than turning base metals into gold, he marvelled that the Chinese were creating money out of paper. But what the 13th­century Venetian traveller could not know was how perilous a paper currency would prove for the country that invented it.

At intervals in their history, Chinese rulers have succumbed to the temptation to pay off spiralling debts simply by rolling the money printing presses. Inflationary scourges ravaged dynasty after dynasty, with both the

Mongols and Mao Zedong’s Communists seizing power in a country eviscerated by depreciated paper.

Such episodes sound uncomfortable echoes for Beijing as it wrestles to control its latest bout of monetary exuberance. The current tussle to ward off a financial crisis pits the world’s most powerful authoritarian system against the propensity of money to resist control as it seeps and flows like water through unattended apertures.

China’s problem this time is not inflation, at least not yet. It is rather that Beijing has again sent its printing presses into overdrive, creating what is almost certainly the biggest pool of domestic liquidity in history to help stimulate its economy and finance a crushing debt burden. The danger is that if the renminbi loses value internally or gushes out of China, a wave of unpaid debts could precipitate a crisis.

The dimensions of China’s liquidity splurge are startling. Ousmène Jacques Mandeng, formerly with the International Monetary Fund, has calculated that between 2007 and 2015 China created 63 per cent, or $16.1tn, of the growth in the world’s supply of money.

China now has more money coursing through the arteries of its economy than the eurozone and Japan combined — and almost as much as the US and the eurozone combined. Since the financial crisis, commentators have focused on the efforts of US, European and Japanese central banks to print money through “quantitative easing”, but China’s output has eclipsed them all.

Marco Polo would have been impressed. He noted with awe China’s capacity to print off as much money as it needed: “It may certainly be affirmed that the grand khan has a more extensive command of treasure than any other sovereign in the universe”.

But for China’s modern rulers, the effusion of liquidity presents as many problems as it promises to resolve. The main issue is that debts are piling up almost as fast as China generates money to service them, creating what Jonathan Anderson of the Emerging Advisors Group calls a “debt funding bubble”.

In his analysis, China’s crunch point will come when there is a disruption in the supply of money needed to pay total debts that amount to about 250 per cent of China’s gross domestic product, the highest level among any large emerging market.

Mr Anderson sees peril mainly in the form of a “madcap proliferation” of flaky financial institutions that lend out money they have raised by issuing debt. The potential for something to go wrong is considerable among a “chaotic hodgepodge of banks and non­ banks” that are fuelling China’s credit boom.

Officials also see another source of vulnerability. They fear that Chinese corporations and citizens will decide en masse that they would be better off taking their money abroad to buy companies or invest in gold, stocks or real estate. Such capital flight could sap the liquidity that is required to keep China’s bubble from popping.

These concerns explain Beijing’s plans to restrict outbound foreign investment. People familiar with the plans told the Financial Times that China intends to scrutinise acquisitions of overseas companies costing more than $1bn if they are outside the investors’ core business scope. Meanwhile, state­owned enterprises will not be allowed to invest more than $1bn on a single real estate transaction abroad. Gold purchases are also being curbed.

With outbound investments from Chinese corporations running at $150bn in the first 10 months of this year, up from $121bn last year, such outflows are increasingly being seen as part of a complex of problems that have also driven down China’s stockpile of foreign exchange reserves from almost $4tn in early 2014 to $3.12tn in October.

Outflows of even as much as $1tn may not seem too debilitating when set against China’s proven capacity to generate plentiful supplies of money. But the fact that Beijing is taking action reveals the knife­edge upon which Chinese policymakers are balancing.

So engorged with easy money have they become that Chinese banks are on average four times larger today than they were just eight years ago. But riskier still is the fact that several of its mid­sized banks rely for funding on so­called wholesale operations — a euphemism for issuing debt to re­lend.

The folly inherent in such a form of alchemy has been understood for at least 800 years. Ye Shi, a Song dynasty adviser, warned that issuing “kongqian” — or “empty money” that is not backed by assets — would stoke inflation and reduce people’s incomes. His emperor did not listen, triggering economic chaos that enfeebled China before the Mongol invasion.

Marco Polo noted with awe Chinese rulers’ capacity to print off as much cash as they needed

Democracy and Debt, Michael Hudson

Has the Link been Broken?
*This article appeared in the Frankfurter Algemeine Zeitung on December 5, 2011.

Book V of Aristotle’s Politics describes the eternal transition of oligarchies making themselves into hereditary aristocracies – which end up being overthrown by tyrants or develop internal rivalries as some families decide to “take the multitude into their camp” and usher in democracy, within which an oligarchy emerges once again, followed by aristocracy, democracy, and so on throughout history.

Debt has been the main dynamic driving these shifts – always with new twists and turns. It polarizes wealth to create a creditor class, whose oligarchic rule is ended as new leaders (“tyrants” to Aristotle) win popular support by cancelling the debts and redistributing property or taking its usufruct for the state.

Since the Renaissance, however, bankers have shifted their political support to democracies. This did not reflect egalitarian or liberal political convictions as such, but rather a desire for better security for their loans. As James Steuart explained in 1767, royal borrowings remained private affairs rather than truly public debts [1]. For a sovereign’s debts to become binding upon the entire nation, elected representatives had to enact the taxes to pay their interest charges.

By giving taxpayers this voice in government, the Dutch and British democracies provided creditors with much safer claims for payment than did kings and princes whose debts died with them. But the recent debt protests from Iceland to Greece and Spain suggest that creditors are shifting their support away from democracies. They are demanding fiscal austerity and even privatization sell-offs.

This is turning international finance into a new mode of warfare. Its objective is the same as military conquest in times past: to appropriate land and mineral resources, communal infrastructure and extract tribute. In response, democracies are demanding referendums over whether to pay creditors by selling off the public domain and raising taxes to impose unemployment, falling wages and economic depression. The alternative is to write down debts or even annul them, and to re-assert regulatory control over the financial sector.

Near Eastern rulers proclaimed Clean Slates to preserve economic balance

Charging interest on advances of goods or money was not originally intended to polarize economies. First administered early in the third millennium BC as a contractual arrangement by Sumer’s temples and palaces with merchants and entrepreneurs who typically worked in the royal bureaucracy, interest at 20% (doubling the principal in five years) was supposed to approximate a fair share of the returns from long-distance trade or leasing land and other public assets such as workshops, boats and ale houses.

As the practice was privatized by royal collectors of user fees and rents, “divine kingship” protected agrarian debtors. Hammurabi’s laws (c. 1750 BC) cancelled their debts in times of flood or drought. All the rulers of his Babylonian dynasty began their first full year on the throne by cancelling agrarian debts so as to clear out payment arrears by proclaiming a clean slate. Bondservants, land or crop rights and other pledges were returned to the debtors to “restore order” in an idealized “original” condition of balance. This practice survived in the Jubilee Year of Mosaic Law in Leviticus 25.

The logic was clear enough. Ancient societies needed to field armies to defend their land, and this required liberating indebted citizens from bondage. Hammurabi’s laws protected charioteers and other fighters from being reduced to debt bondage, and blocked creditors from taking the crops of tenants on royal and other public lands and on communal land that owed manpower and military service to the palace.

In Egypt, the pharaoh Bakenranef (c. 720-715 BC, “Bocchoris” in Greek) proclaimed a debt amnesty and abolished debt-servitude when faced with a military threat from Ethiopia. According to Diodorus of Sicily (I, 79, writing in 40-30 BC), he ruled that if a debtor contested the claim, the debt was nullified if the creditor could not back up his claim by producing a written contract. (It seems that creditors always have been prone to exaggerate the balances due.) The pharaoh reasoned:

the bodies of citizens should belong to the state, to the end that it might avail itself of the services which its citizens owed it, in times of both war and peace. For he felt that it would be absurd for a soldier … to be haled to prison by his creditor for an unpaid loan, and that the greed of private citizens should in this way endanger the safety of all.

The fact that the main Near Eastern creditors were the palace, temples and their collectors made it politically easy to cancel the debts. It always is easy to annul debts owed to oneself. Even Roman emperors burned the tax records to prevent a crisis. But it was much harder to cancel debts owed to private creditors as the practice of charging interest spread westward to Mediterranean chiefdoms after about 750 BC. Instead of enabling families to bridge gaps between income and outgo, debt became the major lever of land expropriation, polarizing communities between creditor oligarchies and indebted clients. In Judah, the prophet Isaiah (5:8-9) decried foreclosing creditors who “add house to house and join field to field till no space is left and you live alone in the land.”

Creditor power and stable growth rarely have gone together. Most personal debts in this classical period were the product of small amounts of money lent to individuals living on the edge of subsistence and who could not make ends meet. Forfeiture of land and assets – and personal liberty – forced debtors into bondage that became irreversible. By the 7th century BC, “tyrants” (popular leaders) emerged to overthrow the aristocracies in Corinth and other wealthy Greek cities, gaining support by canceling the debts. In a less tyrannical manner, Solon founded the Athenian democracy in 594 BC by banning debt bondage.

But oligarchies re-emerged and called in Rome when Sparta’s kings Agis, Cleomenes and their successor Nabis sought to cancel debts late in the third century BC. They were killed and their supporters driven out. It has been a political constant of history since antiquity that creditor interests opposed both popular democracy and royal power able to limit the financial conquest of society – a conquest aimed at attaching interest-bearing debt claims for payment on as much of the economic surplus as possible.

When the Gracchi brothers and their followers tried to reform the credit laws in 133 BC, the dominant Senatorial class acted with violence, killing them and inaugurating a century of Social War, resolved by the ascension of Augustus as emperor in 29 BC.

Rome’s creditor oligarchy wins the Social War, enserfs the population and brings on a Dark Age

Matters were more bloody abroad. Aristotle did not mention empire building as part of his political schema, but foreign conquest always has been a major factor in imposing debts, and war debts have been the major cause of public debt in modern times. Antiquity’s harshest debt levy was by Rome, whose creditors spread out to plague Asia Minor, its most prosperous province. The rule of law all but disappeared when the publican creditor “knights” arrived. Mithridates of Pontus led three popular revolts, and local populations in Ephesus and other cities rose up and killed a reported 80,000 Romans in 88 BC. The Roman army retaliated, and Sulla imposed war tribute of 20,000 talents in 84 BC. Charges for back interest multiplied this sum six-fold by 70 BC.

Among Rome’s leading historians, Livy, Plutarch and Diodorus blamed the fall of the Republic on creditor intransigence in waging the century-long Social War marked by political murder from 133 to 29 BC. Populist leaders sought to gain a following by advocating debt cancellations (e.g., the Catiline conspiracy in 63-62 BC). They were killed. By the second century AD about a quarter of the population was reduced to bondage. By the fifth century Rome’s economy collapsed, stripped of money. Subsistence life reverted to the countryside as a Dark Age descended.

Creditors find a legalistic reason to support parliamentary democracy

When banking recovered after the Crusades looted Byzantium and infused silver and gold to review Western European commerce, Christian opposition to charging interest was overcome by the combination of prestigious lenders (the Knights Templars and Hospitallers providing credit during the Crusades) and their major clients – kings, at first to pay the Church and increasingly to wage war. But royal debts went bad when kings died. The Bardi and Peruzzi went bankrupt in 1345 when Edward III repudiated his war debts. Banking families lost more on loans to the Habsburg and Bourbon despots on the thrones of Spain, Austria and France.

Matters changed with the Dutch democracy, seeking to win and secure its liberty from Habsburg Spain. The fact that their parliament was to contract permanent public debts on behalf of the state enabled the Low Countries to raise loans to employ mercenaries in an epoch when money and credit were the sinews of war. Access to credit “was accordingly their most powerful weapon in the struggle for their freedom,” notes Ehrenberg: “Anyone who gave credit to a prince knew that the repayment of the debt depended only on his debtor’s capacity and will to pay. The case was very different for the cities, which had power as overlords, but were also corporations, associations of individuals held in common bond. According to the generally accepted law each individual burgher was liable for the debts of the city both with his person and his property.”[2]

The financial achievement of parliamentary government was thus to establish debts that were not merely the personal obligations of princes, but were truly public and binding regardless of who occupied the throne. This is why the first two democratic nations, the Netherlands and Britain after its 1688 revolution, developed the most active capital markets and proceeded to become leading military powers. What is ironic is that it was the need for war financing that promoted democracy, forming a symbiotic trinity between war making, credit and parliamentary democracy in an epoch when money was still the sinews of war.

At this time “the legal position of the King qua borrower was obscure, and it was still doubtful whether his creditors had any remedy against him in case of default.”[3] The more despotic Spain, Austria and France became, the greater the difficulty they found in financing their military adventures. By the end of the eighteenth century Austria was left “without credit, and consequently without much debt” the least credit-worthy and worst armed country in Europe (as Steuart 1767:373 noted), fully dependent on British subsidies and loan guarantees by the time of the Napoleonic Wars.

Finance accommodates itself to democracy, but then pushes for oligarchy

While the nineteenth century’s democratic reforms reduced the power of landed aristocracies to control parliaments, bankers moved flexibly to achieve a symbiotic relationship with nearly every form of government. In France, followers of Saint-Simon promoted the idea of banks acting like mutual funds, extending credit against equity shares in profit. The German state made an alliance with large banking and heavy industry. Marx wrote optimistically about how socialism would make finance productive rather than parasitic. In the United States, regulation of public utilities went hand in hand with guaranteed returns. In China, Sun-Yat-Sen wrote in 1922: “I intend to make all the national industries of China into a Great Trust owned by the Chinese people, and financed with international capital for mutual benefit.”[4]

World War I saw the United States replace Britain as the major creditor nation, and by the end of World War II it had cornered some 80 percent of the world’s monetary gold. Its diplomats shaped the IMF and World Bank along creditor-oriented lines that financed trade dependency, mainly on the United States. Loans to finance trade and payments deficits were subject to “conditionalities” that shifted economic planning to client oligarchies and military dictatorships. The democratic response to resulting austerity plans squeezing out debt service was unable to go much beyond “IMF riots,” until Argentina rejected its foreign debt.

A similar creditor-oriented austerity is now being imposed on Europe by the European Central Bank (ECB) and EU bureaucracy. Ostensibly social democratic governments have been directed to save the banks rather than reviving economic growth and employment. Losses on bad bank loans and speculations are taken onto the public balance sheet while scaling back public spending and even selling off infrastructure. The response of taxpayers stuck with the resulting debt has been to mount popular protests starting in Iceland and Latvia in January 2009, and more widespread demonstrations in Greece and Spain this autumn to protest their governments’ refusal to hold referendums on these fateful bailouts of foreign bondholders.

Shifting planning away from elected public representatives to bankers

Every economy is planned. This traditionally has been the function of government. Relinquishing this role under the slogan of “free markets” leaves it in the hands of banks. Yet the planning privilege of credit creation and allocation turns out to be even more centralized than that of elected public officials. And to make matters worse, the financial time frame is short-term hit-and-run, ending up as asset stripping. By seeking their own gains, the banks tend to destroy the economy. The surplus ends up being consumed by interest and other financial charges, leaving no revenue for new capital investment or basic social spending.

This is why relinquishing policy control to a creditor class rarely has gone together with economic growth and rising living standards. The tendency for debts to grow faster than the population’s ability to pay has been a basic constant throughout all recorded history. Debts mount up exponentially, absorbing the surplus and reducing much of the population to the equivalent of debt peonage. To restore economic balance, antiquity’s cry for debt cancellation sought what the Bronze Age Near East achieved by royal fiat: to cancel the overgrowth of debts.

In more modern times, democracies have urged a strong state to tax rentier income and wealth, and when called for, to write down debts. This is done most readily when the state itself creates money and credit. It is done least easily when banks translate their gains into political power. When banks are permitted to be self-regulating and given veto power over government regulators, the economy is distorted to permit creditors to indulge in the speculative gambles and outright fraud that have marked the past decade. The fall of the Roman Empire demonstrates what happens when creditor demands are unchecked. Under these conditions the alternative to government planning and regulation of the financial sector becomes a road to debt peonage.

Finance vs. government; oligarchy vs. democracy

Democracy involves subordinating financial dynamics to serve economic balance and growth – and taxing rentier income or keeping basic monopolies in the public domain. Untaxing or privatizing property income “frees” it to be pledged to the banks, to be capitalized into larger loans. Financed by debt leveraging, asset-price inflation increases rentier wealth while indebting the economy at large. The economy shrinks, falling into negative equity.

The financial sector has gained sufficient influence to use such emergencies as an opportunity to convince governments that that the economy will collapse they it do not “save the banks.” In practice this means consolidating their control over policy, which they use in ways that further polarize economies. The basic model is what occurred in ancient Rome, moving from democracy to oligarchy. In fact, giving priority to bankers and leaving economic planning to be dictated by the EU, ECB and IMF threatens to strip the nation-state of the power to coin or print money and levy taxes.

The resulting conflict is pitting financial interests against national self-determination. The idea of an independent central bank being “the hallmark of democracy” is a euphemism for relinquishing the most important policy decision – the ability to create money and credit – to the financial sector. Rather than leaving the policy choice to popular referendums, the rescue of banks organized by the EU and ECB now represents the largest category of rising national debt. The private bank debts taken onto government balance sheets in Ireland and Greece have been turned into taxpayer obligations. The same is true for America’s $13 trillion added since September 2008 (including $5.3 trillion in Fannie Mae and Freddie Mac bad mortgages taken onto the government’s balance sheet, and $2 trillion of Federal Reserve “cash-for-trash” swaps).

This is being dictated by financial proxies euphemized as technocrats. Designated by creditor lobbyists, their role is to calculate just how much unemployment and depression is needed to squeeze out a surplus to pay creditors for debts now on the books. What makes this calculation self-defeating is the fact that economic shrinkage – debt deflation – makes the debt burden even more unpayable.

Neither banks nor public authorities (or mainstream academics, for that matter) calculated the economy’s realistic ability to pay – that is, to pay without shrinking the economy. Through their media and think tanks, they have convinced populations that the way to get rich most rapidly is to borrow money to buy real estate, stocks and bonds rising in price – being inflated by bank credit – and to reverse the past century’s progressive taxation of wealth.

To put matters bluntly, the result has been junk economics. Its aim is to disable public checks and balances, shifting planning power into the hands of high finance on the claim that this is more efficient than public regulation. Government planning and taxation is accused of being “the road to serfdom,” as if “free markets” controlled by bankers given leeway to act recklessly is not planned by special interests in ways that are oligarchic, not democratic. Governments are told to pay bailout debts taken on not to defend countries in military warfare as in times past, but to benefit the wealthiest layer of the population by shifting its losses onto taxpayers.

The failure to take the wishes of voters into consideration leaves the resulting national debts on shaky ground politically and even legally. Debts imposed by fiat, by governments or foreign financial agencies in the face of strong popular opposition may be as tenuous as those of the Habsburgs and other despots in past epochs. Lacking popular validation, they may die with the regime that contracted them. New governments may act democratically to subordinate the banking and financial sector to serve the economy, not the other way around.

At the very least, they may seek to pay by re-introducing progressive taxation of wealth and income, shifting the fiscal burden onto rentier wealth and property. Re-regulation of banking and providing a public option for credit and banking services would renew the social democratic program that seemed well underway a century ago.

Iceland and Argentina are most recent examples, but one may look back to the moratorium on Inter-Ally arms debts and German reparations in 1931.A basic mathematical as well as political principle is at work: Debts that can’t be paid, won’t be.

Footnotes:

[1] James Steuart, Principles of Political Economy (1767), p. 353.

[2] Richard Ehrenberg, Capital and Finance in the Age of the Renaissance (1928):44f., 33.

[3] Charles Wilson, England’s Apprenticeship: 1603-1763 (London: 1965):89.

[4] Sun Yat-Sen, The International Development of China (1922):231ff.

Una contribución al debate de las ideas

Epílogo libro M. King, ‘El fin de la Alquimia’ (Deusto, 2016)

La gran virtud del libro del que tengo el honor de escribir unas breves líneas a modo de epílogo, es que se trata de un libro sobre ideas. El texto no es una crónica de como el autor contribuyó a salvar el mundo –como suele suceder en las obras de este perfil–, sino que es una reflexión profunda, enriquecida con la dilatada y rica experiencia de quién escribe, sobre las causas últimas de la grave crisis financiera que tan importantes cambios y consecuencias han supuesto en el escenario económico global. De hecho, no se trata de un libro sobre la crisis propiamente dicha, sino de una obra sobre la banca y el dinero que se sirve de la crisis como hilo conductor. A diferencia de otras obras del mismo género, Mervyn King realiza un esfuerzo por profundizar en las causas últimas de la patología bancaria superado la tentación de meramente realizar un análisis epidérmico de los síntomas, como ha sido la tónica en otros libros (con las excepciones de rigor que se quieran poner). En este sentido, el autor no rehúye el planteamiento de ninguna de las cuestiones que resultan clave para dar con los porqués del comportamiento disfuncional generalizado por parte del sistema financiero que desembocó en la grave crisis de 2008.

El tono ligeramente disonante del que fuese antiguo gobernador del Banco de Inglaterra sirve para evidenciar algunas de las diferencias con respecto al diagnóstico que ha dominado la corriente mayoritaria, siendo este más completo y amplio a la hora de abordar las diferentes cuestiones. Seguimos a día de hoy sin contar con un consenso claro y mayoritario sobre cuáles fueron las causas de la última crisis. King se desmarca de las tesis defendidas por otros protagonistas preeminentes de la crisis que se han lanzado a escribir su visión con respecto a la crisis como Ben Bernanke, también Hank Paulson o Tim Gaithner, al remarcar en su análisis la importancia de los propios bancos centrales, y demás elementos de la arquitectura del sistema financiero, como causas fundamentales de la crisis al alimentar la “búsqueda desaforada de retorno” a toda costa por parte de las entidades financieras para compensar así las caídas en la rentabilidad derivadas de las políticas de crédito artificialmente barato por parte de los propios Bancos Centrales. Fueron estas políticas de dinero barato, señala el autor, las que en última instancia favorecieron un escenario de sobre confianza generalizada en los mercados y dieron lugar, entre otras cosas, a un crecimiento desaforado de los balances y una acumulación excesiva de riesgos en el sistema. El autor de El fin de la Alquimia señala acertadamente como este comportamiento hunde sus raíces en la asimetría entre ganancias y pérdidas con la que operan los bancos en donde con respecto a estas últimas, en última instancia, están cubiertas de forma tácita por el contribuyente. Todo esto deriva en un perverso sistema de incentivos que favorece un comportamiento disfuncional en las entidades. Incentivos y asimetrías, advierte el autor, que no han sido corregidas y que no hacen descartable que el conjunto del sistema financiero no vuelva a ser foco de problemas e inestabilidad en un futuro.

La gran conclusión del libro, que quién les escribe comparte plenamente, es que en última instancia la crisis económica ha sido consecuencia de una falla de ideas, de una equivocada comprensión de cómo funciona la economía realmente. Por eso no es de extrañar que la crisis financiera haya reavivado, más que menos, el debate intelectual con respecto a la propia ciencia económica. Se trata de un debate demasiadas veces encorsetado al terreno de juego que establece el Sanedrín académico neoclásico, sobre todo por lo que respecta a las grandes tribunas de pensamiento y grueso de responsables políticos. Suelen ser únicamente unas pocas voces sueltas, ajenas a las círculos de poder académico y a los altos cargos, versos sueltos, las que cuestionan los dogmas siendo categorizadas como heterodoxas de inmediato. Es bueno entender esto para poner el valor este tono disonante de King, un peso pesado dentro del establisment financiero y académico mundial, que pone una interesante nota de color, al demasiadas veces monocroma debate académico mainstream donde las diferencias son siempre de matiz, nunca de grado. Resulta meritorio, por ejemplo, que King aborde con claridad el tema, por otro lado crítico y fundamental, de la protección de los depósitos o el mismo sistema de reserva fraccionada, elementos ausentes en la ecuación de análisis del grueso de economistas y que, sin embargo, resultan piezas imprescindibles si queremos realmente alumbrar un sistema bancario y monetario que favorezca un comportamiento racional por parte de los bancos y permita a las economías crecer de forma sostenible y no de forma burbujeante como hasta ahora.

Se trata de un mensaje con toques contrarian del cual tuvimos algunas muestras en los compases iniciales de la crisis pero que, poco a poco, estas voces fueron quedando ahogadas por lo que fue configurando la sabiduría convencional con respecto a la crisis económica. Ahí esta la hemeroteca para quién la quiera consultar de voces que alertaron de algunos elementos equivocados en el diagnóstico que hizo Washington en los inicios de la crisis como Jean-Claude Tritchet, muy escéptico con respecto al diagnóstico de la situación de 2009 elaborado por la Reserva Federal y que dio pie a los programas de compra de bonos y que ahora tantas dudas despiertan entre amplias capas de analistas e inversores, Wolfang Schäuble, el actual ministro de finanzas alemán, o Axel Webber, antiguo gobernador del Bundesbank. Pese a todo, las tesis de Bernanke y compañía, que podemos resumir como: crisis de liquidez, cíclica debido a fallos de mercado por falta de regulación; se acabaron imponiendo a la visión más Europea de la misma: crisis de solvencia, estructural, cuyo origen se sitúa en las políticas de dinero fácil por parte de los bancos centrales que alimentaron la burbuja especulativa y el crecimiento de la deuda. Al final, con matices, Europa ha ido siguiendo el plan anti-crisis diseñado por Washington. El libro de King, aunque por momentos ecléctico y en donde el autor navega con mucha habilidad por ambas orillas, pone en valor muchos de los aspectos que configuraron en un inicio el grueso del diagnóstico europeo cuando realiza una visión crítica de la salida en falso que ha supuesto, en muchos aspectos, el grueso de medidas monetarias ultra expansivas adoptadas hasta ahora.

En la base de esta divergencia de visiones subyacen distintas maneras de entender como funciona la economía: una más matemática, optimizadora y equilibrista; la otra más humanista, dinámica y articulada alrededor de la acción humana. Ideas falsas, dan lugar a diagnósticos equivocados, y estos a políticas económicas que lejos de arreglar los problemas de raíz meramente alivian síntomas generando nuevas distorsiones, nuevos problemas sin solucionar los viejos, y que, en el mejor de los casos, únicamente generan una prosperidad ilusoria consolidando este escenario de economía burbujeante y de expectativas limitadas al que parece que poco a poco nos hemos ido resignando. El debate sobre el método, es decir de que manera verificamos teorías y extraemos conclusiones, no es nuevo: David Hume ya planteo de forma célebre el problema de inducción a mediados del siglo XVIII, que luego fue reformulado por Popper en el XX, y sofisticado de nuevo por Nassim Taleb en el XXI. La crisis ha subrayado la importancia del mismo ya que, en buena medida, de ello depende que sepamos dar con un diagnóstico acertado y remedios acorde a los males que lastran la confianza y limitan el crecimiento.

Con independencia de las discrepancias que inevitablemente suscitarán al lector muchos de los postulados de King, como le ha sucedido al lector que ahora les escribe –bienvenidos sean los discrepantes si vienen con argumentos–, el libro constituye una contribución de primer orden y de gran valor a la espinosa y difícil cuestión de cómo ordenar la banca y el sistema monetario en el siglo XXI.

Luis Torras

Barcelona, 10 de mayo de 2016

Mervyn King y el futuro del capitalismo“, La Razón, 19 de septiembre de 2016.

Weimar revisited by Edward Chancellor

The spectre of Weimar Republic-like inflation has haunted some fevered minds since central banks revved up their printing presses after the Lehman Brothers bust. No hyperinflation has yet emerged. Still, a milder manifestation of the social malaise which gripped Germany in the early 1920s is becoming evident in the West. Monetary policymakers are urging more extreme actions in their frantic pursuit of higher inflation. They should be careful what they wish for.

Historians agree that the origins of Germany’s post-war inflation lay in the failure of the country’s political classes to make hard choices. The Germans had funded their war effort largely with debt, accompanied by the printing of central-bank money. After the Weimar Republic was established in 1918, inflationary finance continued. Government deficits funded with newly printed marks had the advantage of maintaining employment at high levels and keeping the economy buzzing. As inflation soared, enterprises were able to borrow from the Reichsbank at rates so low that capital was, in effect, free.

This policy had the support of many seemingly reasonable people. Walther Rathenau, the cultured head of the electronics firm AEG and a future foreign minister, suggested in January 1921 that should the economy turn down “we ought to print money a bit faster and start construction works, using the employment these create as a dam against the depression. It is incorrect when people said that printing money was bringing us ruin.”

Rathenau, who was assassinated some 18 months later, lived long enough to change his mind. He later complained of the “delirium of milliards” (a thousand million) after the mark collapsed on the foreign exchanges and prices began escalating out of control. “We are living in a bubble,” observed the chastened politician. “Our companies pay dividends – but in fairy gold. We are eating our own accumulated resources, the result of generations of work of our ancestors.”

John Maynard Keynes agreed with these sentiments. “In the modern world,” wrote Keynes in the Manchester Guardian in the autumn of 1922, “organization is worth more in the long run than material resources.” The printing of paper marks, he continued, had brought temporary economic benefits “at the cost of a ruinous disorganization, both present and future and still to come. (Germany) has confiscated most of the means of livelihood of her educated middle class, the source of her intellectual strength; and the industrial chaos and unemployment, which the end of the inflationary boom seems likely to bring, may disorder the minds of her working class, the source of her political stability.”

The celebrated economist, whose later work gleefully extolled the “euthanasia of the rentier”, turned out to be correct on all points.

One of the curious features of the Weimar inflation was the refusal of the Reichsbank to accept that rising prices resulted from its own money-printing. Rather its president, Rudolf Havenstein, maintained resolutely that the decline of the currency was responsible. Inflation, he claimed, produced a shortage of currency which it was the Reichsbank’s duty to rectify. When it was suggested that the central bank set interest rates too low, Havenstein replied that it wasn’t his duty to make market rates but to follow them. In response to calls that Havenstein change course, he insisted on the central bank’s constitutional independence.

Inflation was difficult to bring under control not merely because the central bank was obtuse and politicians feared the inevitable cost in terms of unemployment and bankruptcies. Rather, once under way, inflation develops its own lobby which is not responsive to reason. The industrialists, who benefited from inflation, only changed their position after the economy and society started falling to pieces during the course of 1923. Another group of beneficiaries, the over-worked printers at the Reichsbank’s presses, even went on strike when a currency stabilization plan was eventually announced.

By the time its currency was stabilized, the real value of Germany’s enormous post-war national debt had shrunk to a fraction of a 1913 gold mark – 35 pfennigs to be exact. According to economist Costantino Bresciani-Turroni, this amounted to the greatest peacetime expropriation in the history of the world. The country’s wealth, writes Frederick Taylor in his gripping account of the Weimar inflation, The Downfall of Money, was “no longer spread evenly among millions but largely coagulated in blobs among the new plutocracy”.

Capital had passed from the slow-witted to opportunists. Speculators, who spent their rapidly amassed fortunes with great ostentation, were bitterly resented. So were foreigners, who bought up properties and shares with hard currency. In January 1923, a government minister called for tighter immigration controls.

Germany’s inflation undermined morals and manners, and fostered corruption. Respect for government and the rule of law declined as prices escalated and social order broke down. Adolf Hitler eagerly exploited the growing rancor in society, inveighing against the money-printing which he claimed had crushed the “decent solid businessman who doesn’t speculate” and turned the country into a “robbers’ state”. The horrors of inflation fed the Germans’ desire for a political strong man.

Modern central bankers like to point out that despite the recent explosion of their balance sheets the much-feared inflation has yet to materialize. Nevertheless, the recent period of ultra-low interest rates has produced conditions which, though less extreme, are eerily reminiscent of the Weimar years.

Once again, an era of negative real interest rates has produced low unemployment and “bubble” prosperity. Powerful interests support the easy-money policy, while central bankers ignore the damage their policies produce. Wealth has been redistributed on a grand scale. The newly rich flaunt it, while those less well-positioned feel squeezed. Rancor runs high in society. Popular sentiment has turned against foreigners.

In several countries the political middle ground is giving way. Firebrand politicians like Donald Trump campaign on promises of national resurrection. Hard choices and substantive economic reforms are invariably avoided. And once again, monetary policymakers, unwittingly invoking the tragic Rathenau, intone that “it is incorrect when people said that printing money was bringing us ruin.”

The Nonexistent “Social Costs” of a Gold Standard System

Nathan Lewis via Forbes

One of the odd notions that has come down through the years is that a gold standard system has “social costs.” It does not. It creates a profit.

Of course, it does take effort to dig gold out of the ground. However, gold production never ceased after the end of the world gold standard in 1971. Roughly half of all the gold ever mined, in all of history, has been mined after 1971. Annual production today is the highest in history, and about double what it was in 1970. People seem happy to continue paying those “costs.”

If one is to use gold coins, then someone needs to pay for this gold. Who pays? Is it “everyone”? The government? Taxpayers? Who?

Let’s say an economy uses gold coins only. There is no paper money. (For simplicity, we will also assume no banks.) Someone works all week and gets a one-ounce gold coin in payment on Friday. The person has “paid” for this coin with a week’s worth of work.

Now, let’s have an economy with no gold coins, just paper banknotes linked to gold. Let’s say there’s a banknote worth one ounce of gold. (The U.S. $20 banknote, before 1933, was worth about 0.97 of an ounce of gold.) Someone works all week, and gets a banknote worth one ounce of gold in payment on Friday.

The “cost“ to the person of the gold coin and the banknote are the same. One week of work.

The government is in much the same situation. Whether its taxes are paid in coinage or in banknotes, the outcome is about the same.

The difference is at the currency issuer – the producer of the banknotes, which would be a central bank today. Let’s say that the currency issuer has a “100% reserve” system. For every banknote, there is an equivalent amount of gold in a vault.

This situation is not much different than where gold coinage was used exclusively. The amount of gold is the same.

Now, let’s say that the currency issuer has a 20% reserve, which was a typical level among private currency issuers in the U.S. during the 19th century. The other 80% of reserves consists of interest-bearing debt. Today, that would most likely be government bonds.

The amount of gold used by the monetary system has now fallen by 80%, replaced by interest-bearing bonds. The interest income from the bonds produces a profit for the currency issuer.

If you had a floating fiat paper currency, with no gold at all, the “cost” of the money would still be the same – a week’s worth of work. However, the assets of the currency issuer could be 100% interest-bearing debt.

Thus, we see that the “cost” of the money is the same in all cases – a week’s worth of work. The question is the “profit.” In a 100% bullion reserve system, there is no profit. However, with a 20% reserve system, there is quite a bit of profit. This profit accrues entirely to the currency issuer – today, a central bank.

We can also see that the profit enjoyed by the currency issuer doesn’t really change much, from a 20% bullion reserve/80% debt gold standard system and a 100%-debt system. The difference is only the 20% portion. The other 80% is identical. (In practice, today’s central banks still hold gold bullion reserves.) So, the gold standard system’s profitability is actually much the same as the floating fiat system’s profitability.

Some economists – including David Ricardo, in 1817 – have suggested ways of operating a gold standard system with no gold bullion reserves at all. The “gold exchange standards”, or currency-board systems, common in the 20th century, were one example of this. They are “100% debt” systems.

I suggest that you shouldn’t be too concerned about maximizing the profitability of central banks. They can look after it well enough themselves.

Concern yourself with the quality of the currency. For nearly two centuries, 1789 to 1971, the U.S. embraced the principle of gold-based money, and became the world’s economic superpower. Money was simple, stable, reliable and predictable. Despite short-term setbacks, the middle class grew steadily wealthier, generation after generation.

Today’s economists talk a big talk, but in the past forty-five years of floating currencies, have they ever been able to produce that kind of result? Mostly, they just bounce from one crisis to another, blowing bubbles along the way and leaving a train of wreckage in their wake. Have they learned anything? They seem to have gotten pretty good at “kicking the can”, avoiding a minor crisis with further distortions that lead to a bigger crisis later.

I think that there will eventually be a big enough crisis that people say: “Enough is enough. You’ve had your chance. Now it is time for you to go.” But before then, we will have to know what we will replace them with.

Interview with Russell Napier

LESLIE P. NORTON, Barron’s

Russell Napier, an independent strategist and market historian, likes to challenge investors’ comfortable assumptions. Based in Edinburgh, Scotland, he spent two decades as an equity-market and global-macro strategist at CLSA, the Asian brokerage, and now publishes a global macroeconomic and strategy report, “The Solid Ground,” on ERIC, an online platform he cofounded for investment research. He also created the Library of Mistakes, a financial-history library in Edinburgh, that he plans to replicate at universities around the world.

Napier has been bearish since 2011 on equities and commodities, and expects deflation to hit developed markets. He recently shared with Barron’s his views on the coming Brexit referendum, China’s currency, and today’s financial mistakes.

Barron’s: Britain will vote on June 23 on whether to leave the European Union. How do you expect the so-called Brexit vote to go?

Napier: It is too tight to call. The most important thing is that the move to a federal Europe is a massive constitutional change, which at some stage will need to be endorsed by the people of each sovereign state, usually by referendum. It is silly to believe this issue is just a United Kingdom thing. Look at polls all over Europe. People are voting for anybody who, whether on the extreme left or right, wants to maintain the sovereignty of that particular state within the European Union. That is completely contrary to the ability to have a functioning euro.

This is round one. The most important referendums will be those in the euro countries. I expect referendums in places like Finland, the Netherlands, and even Italy. European legislation is forcing Italy into a form of bank recapitalization, which won’t work and is bad for the Italian economy. Italy will move up the agenda quickly.

If the U.K. votes to leave, will Scotland push for independence again?

If Scotland votes to stay in and England votes to leave, there might be another referendum on Scottish independence. The problem would be that Scotland voted for something different previously, when it said it would continue to use sterling and wouldn’t have a border. If the rest of the U.K. is out of the EU, and Scotland wants to stay in, there would have to be a border. It would be difficult for Scotland to use sterling. If Scotland voted against independence last time, the Scots would really vote against it again. The shock and dislocation of having a border and passports, of not having sterling, are so big.

With several potential votes ahead, what is the outlook for markets?

The most important thing for investors would be exchange controls. If a member of the euro zone had a referendum on leaving the EU, temporary capital controls to protect financial stability would be politically justifiable. The dislocation associated with the speculation around the referendum would be huge. Provisions in the European treaties allow exchange controls under extreme circumstances.

The bigger picture is that open-end funds are facing greater illiquidity in their underlying instruments. There are $37 trillion of assets in open-end funds globally. Will politicians put up barriers to the free movement of capital, which would paralyze sections of the financial-services industry?

You recently wrote a report on policy singularity. What does that mean?

I invented the phrase to refer to the time when monetary and fiscal policy can no longer be distinguished. It is the final step in [former Federal Reserve Chairman Ben] Bernanke’s famous helicopter speech. Briefly, the steps [taken by the Fed] included quantitative easing; effectively pegging the yield curve; providing forward [rate-hike] guidance; putting up the inflation target; and foreign-exchange intervention. The Bank of Japan has run through the entire range of Bernanke’s recommendations apart from the last one, which he calls helicopter money. [In a 2002 speech referring to the possibility of monetary-financed tax cuts, Bernanke referenced the late economist Milton Friedman’s assertion that a central bank could create inflation and economic growth by dropping money from the sky.]

Once the central bank runs out of ammunition, it turns to the government. In Japan, there will be open ears. If we all woke up one morning and every major developed nation undertook policy singularity, you’d have to believe in growth, inflation, and reflation. But if one country does it unilaterally, like Japan, what you’d get is a precipitous decline in the yen. While the Fed is struggling to create money and the Europeans aren’t creating any, the Japanese central bank/government can create as much as it likes. That would imply dislocations for China, Germany, and other markets. It could put a lot of countries in trouble.

How would helicopter money manifest in Japan?

It wouldn’t be about building more roads and bridges, but about [boosting] consumption. It would be along the lines of the government announcing that everyone in Japan with a child under 10 will live tax-free. The instant ramification would be much higher forecasts for the fiscal deficit, which would be funded by the central bank printing money. This puts money in the hands of people who might consume—people with children under age 10.

Did you know that Japan has a ministry for population growth, whose job is to drive the birth rate higher? Japan has tried everything else. If they have to go to the final step, they are prepared for it. I would be confident forecasting that the yen will be lower than 130 to the dollar within 12 months. [It was 105 last week.]

What other countries will adopt policy singularity?

Helicopter money is a long way off in the U.S. When it does come, it would be for building roads and bridges. In Europe, I can’t see how the banking system is robust enough to translate European Central Bank monetary policy into expanding balance sheets with more credit and more money. When the politicians are aligned with the central bankers, that is the end of independent central banking. It begins in Japan but it will spread.

You famously predicted the Chinese yuan will fall 20%. Lately it has held steady against the yen. What happens if the yen falls, as you expect?

The yuan’s price is the most political price in finance. China’s monetary response to economic slowing is constrained by its exchange-rate policy. If credit and monetary-policy growth rise to the levels required to sustain China’s debt-fueled growth, then the exchange-rate target can’t be sustained. If money growth rises to historical highs, it is reasonable to expect an exchange-rate adjustment of 20% or more. A fall in the yen is the perfect cover story. China could say, “Look, what do you expect us to do?” If the yen started falling, the yuan would follow, though not until after the U.S. presidential election. They would be too worried it would produce a Trump presidency.

What will the Fed do next?

The Fed’s hesitation to move interest rates higher reflects their understanding about the fragility of the global monetary system. On the national-income and product-account data, corporate profits are weak. Capex [capital spending] is beginning to slow, not that it was ever robust. Then you had that jobs number [the U.S. created just 38,000 jobs in May]. It is exceedingly worrying if you begin that slowdown process with interest rates close to zero.

I am not saying [Fed chief] Janet Yellen is completely out of bullets. She’s not in the same place as Japan or the ECB. But she has long conversations with [International Monetary Fund chief] Christine Lagarde, who has been warning everyone how fragile the global system is. She sees real distress in commodity producers. Yellen hasn’t been more aggressive in raising rates for reasons including China and Brexit. And [Japan’s Prime Minister Shinzo] Abe told the G7 that the world was on the verge of another Lehman Brothers crisis. Any interest-rate increase is more likely to be in 2018 than 2016. 

As the author of the book Anatomy of the Bear, you have some expertise in forecasting the stock market. What do you predict?

In a world where there is growth and inflation remains between zero and 4%, you get high valuations for equities. The current cyclically adjusted P/E ratio of 26 is high, but not exceedingly high. It could go even higher. The most damaging and dangerous thing for the equity market is deflation, because it means falling cash flows; if you have a lot of debt and can’t pay it, equity gets wiped out. Deflation often comes with credit distress. The market falls quickly, whether in 2007-2008, 1928-1929, or 1919-1921.

The market remains high today, but I see global growth falling and trade looking bad. We might slump to a recession with deflation. Markets move quickly when there is a credit distress because assets disappear. We saw that with Lehman. In the past two years, many borrowers have been in distress globally. I have long thought emerging-market debtors are the weak link, because they were borrowing in someone else’s currency. I still believe the stock market has to go below its March 2009 levels.

What do you make of the U.S. presidential election?

The presumptive Republican nominee, Donald Trump, is an arch-pragmatist, despite making ideological noises. If Hillary Clinton wins and the Democrats retake Congress, then the U.S. is much closer to helicopter money.

What asset classes do you like?

U.S. 30-year bonds; Singapore government debt, which yields slightly more than U.S. government debt; gold; and Japanese equities hedged into the U.S. dollar. When helicopter money happens, every investor in Japan will ask, “What the hell am I doing holding bonds?”

You founded the Library of Mistakes. What are some of the big ones being made in finance?

Many mistakes reflect overconfidence. The biggest financial mistakes are ones that bring down whole banking systems. We just had one built on the belief that U.S. residential property could never come down. The biggest mistake today is so-called macro-prudential regulation. For example, the U.K. just passed a law that will restrict a commercial bank’s ability to make mortgage loans based on the edict of the central bank. It is state intervention in the allocation of capital. It is capitalism with Chinese characteristics.

The job of a central banker is to set the price of money, and align the system to allocate credit and capital. Macro-prudential regulation is a return to the credit controls of Richard Nixon. Finally, in the U.S. today, there is the belief excessive leverage doesn’t matter because interest rates are so low. That isn’t true. The secret now is to degear, delever, and prepare for some bargains as things get cheaper. And if we get helicopter money, you have to reverse and regear.