Adair Turner, banks, bubble, Bunds, Challenger banks, China, debt, debt crisis, debt forgiveness, economics, European Central Bank, Eurostat, Federal Reserve, Japan, lending, risks, Society of Business Economists
He may have been the chief regulator in the United Kingdom, but Adair Turner chose a function in London hosted by the Society of Business Economists to tell a packed room of economists that more regulation is not the answer to averting another debt crisis.
Speaking about his new book “Between Debt and the Devil” Lord Turner, the former chairman of the Financial Services Authority, documented how no one saw the financial crisis (which later became the sovereign debt crisis) coming in 2007. But how we might have learned from the antics of Japanese credit lending as far back as 1990.
Turner also painted a less than savoury picture of what banks do rather than what GCE ‘A’ Level students are told they do in the standard practices of education. But he stopped short of following the example of some US economists in the 1930s who had proposed to President Franklin D. Roosevelt the abolition of banks.
He gave the example of India to illustrate that too much debt could be a bad thing. Sure, he said, if the subcontinent had more credit available in 1970 today its economic growth rate would have been higher too. But can you have too much credit? And if you do, what happens with it? Where does it go?
Turner’s central theme was one that has found a home on this blog in contributions three years ago, such as UK readies for new “first timers” property crash where I argued that debt is managed, not reduced, and where radical write-offs may be necessary. See also The merry-go-round of the world’s debt burden. It is passed around like a parcel between households, banks and governments, Turner said, as I hinted upon in Not even half way through the crisis – HSBC and other dispatches. Why was it ok that 60 years ago peripherals wrote off half Germany’s debt but it is not ok to consider such options now? See also Austerity makes debt bloat, but there is a better way.
Perhaps where I disagree with Turner’s view it is that Japan was not the first and only sign we knew things were going wrong. As a debt correspondent at Reuters, I had questioned before the financial crisis why it was that Bund futures volumes briefly rocketed from historical levels of 650,000 daily lots to 2.6m before coming back down to 650,000 lots. Surely a bubble? And why did the world’s money supply which took 300 years to reach USD35tn then double again in six years by 2006? So, along with Eurostat’s firebrand assessment soon after 2004 that Greece had “cooked the books” as one Reuters headline splashed, I would say that Japan’s 1990 crisis was an early warning signal but far from the last painful scream before we landed in a protracted crisis.
Certainly what was not in doubt was the wide scale complacency, even among debt strategists of how bad things were going to get. I remember once such poor soul receiving a phone call from me in late November or early December 2009 – after the newly-elected Pasok government had taken office in Athens and discovered a black hole in its finances – and offering up a prediction about Greek bond yields. At that point they were running at something like 50 bps over German Bunds. He said he would be “surprised” if they more than doubled by year-end before pulling back. Well then, he must have been blown away by May 2010 when Greece appealed for an international bailout and faced yields some 2,000 bps over Bunds.
But Turner and me are agreed that the recovery is far from here and the debt crisis is far from over – it has just become someone else’s problem.
Early in his presentation, Turner explained that classic textbooks would tell you that banks’ function is to lend cash in such a way as to allocate resources to capital investment. But in Anglo-Saxon economies and beyond, they have rather carried out two other activities: 1. propped up consumption and, as he called it, 2. encouraged competition between ourselves for assets which we already own, such as property.
Turner tried to slay two “fictions” as he called it. Firstly he said banks don’t use pre-existing savings to allocate to capital investments and secondly, banks don’t even fund more than 15 percent of the capital investment needs.
So rather than wealth generation, the banks have helped us find an outlet to spend and merely helped drive up asset values. He said that Japan’s stated goal was different. It had greater ideals such as encouraging lending to exporters and manufacturers – to wealth generators in other words. Japan, at least on paper, was keen to encourage capital investment.
But back to how things went wrong in Japan. Debt, Turner said, doesn’t just go away. It moves around. That is why it is not inflationary. “Our canary which we should have seen was Japan in the 1990s,” he said.
Interestingly, one of the questions I wanted Turner to expand on after his presentation was how did it go wrong for Japan when he had told us that capital investment lending had been encouraged? I didn’t have long to wait, someone at the front of the audience was in with the first question asking precisely that.
Turner’s response was that in reality Japan’s lenders broke “all the rules” of neo-classical economic thinking, and often backed croneys or white elephant projects. Hence why it only looked good on paper! Japan sank into the quagmire of high leverage that has dogged Anglo-Saxon economies too.
But if Japan’s prescriptive policy was wholesome yet not adhered to, he was scathing of China’s position in recent years. Fearing the fall-out from the financial crisis China embarked on a different policy push to Japan and rather than backing manufacturers it sank money into real estate and urban developments across its vast regions.
“In the four years since 2009 China poured more concrete than the United States did in the whole of the 20th century,” yet to make matters worse many of the constructions were poor and will never be occupied.
For someone appealing to us to think about fundamental reforms rather than blunt monetarist interest rate policies to counter the risks of future crises, Turner was remarkably unsympathetic to the idea of any alternative monetary armoury available. He asked how will yet more European Central Bank QE help German exporters when debt yields are already very low? He also doused excitement around the secondary effects this may have on the wealth effect, on the feel-good factor, and more consumption that might follow. He said that was all “questionable”. As for the benefits on forex of a weaker euro, he remarked you can boost EUR exports for Europe, but not when there is a global debt crisis.
He said of German policymakers “You were right, for the wrong reasons, and looking the wrong way.”
He also detailed that as income disparity in society grows it throws up new challenges. The wealthy tend to save a bonus. The banks will then transfer it to the impoverished who will spend it. But none of this spurs higher Gross Domestic Product, which would help all in society.
Turner encapsulated the fundamentals of the debt crisis that need to be challenged as: 1. An Inequality driver, 2. A Real Estate driver, and 3. a Global Imbalances driver.
“It is those fundamentals which must be challenged rather than just bank regulation,” he said.
Turner offered some forecasts too. Convinced that we are far from ending the current deflation era, he said he was sure the Federal Reserve would act to raise interest rates in December, but his 2018 forecast was that near-zero rates would be at 2 percent, UK rates at 1.5 percent, Japan’s still at zero or even back in negative territory, and China’s rates would fall to 2 percent. In other words, growth would not be strong enough to see sharp tightening, with the most aggressive of nearly 200 bps being the USA, the world’s biggest economy.
He went on to warn that all ways of stimulating demand are “inherently dangerous”. So we are back to supply-side reform involving the three drivers named above.
At the end of the presentation, I missed out on my question, but I was pleased to see a lady economist sitting nearby had a question pretty much the same as I wanted answered. It was about the emergence in the UK of alternative funding vehicles to the banks. These are so-called Challenger banks, crowd lenders and other initiatives which may not be as stringently-regulated as other lenders and would they present the next regulatory crisis?
Well, here Turner offered a few equations to warm up to an answer. His response was that “shadow banking” as he called it was present before the crisis and had actually significantly shrunken as a share since the crisis.
That may well be true, as dominant traditional banking comes back to the fore at least, but shadow banking is only a part of this since some institutions are not shadow but are not traditional banks. Did we expect someone who oversaw the creation of the regulation and approvals of some of the challenger banks et al really want to dishonour his past?