Draw right lessons from global crisis
The whole question about privatisation of profit and socialisation of cost: It’s a very loose term. People often throw out these terms—like, the taxpayers have picked up the bill. When the whole thing unfolds, you often find that more often then not, the taxpayers have actually made a profit. Also sometimes providing liquidity does not involve a fiscal cost. There is a confusion that because the authorities are involved somewhere the taxpayers are therefore paying the bill. It is a fundamentally misleading argument. Quite honestly, when I look at the aftermath of the two crisis I was very familiar with—the aftermath of the third world debt crisis in the nineteen eighties and the 1997 Asian crisis—if you did a proper cost-benefit analysis of which taxpayer where picked up the bill this argument does not hold. If you look at the costs of that clean up afterwards, I mean the one figure that sticks in my mind, (if you remember there was a huge argument about the Hong Kong monetary authority intervening in the stock market). But as a result of the intervention, which theoretically put the taxpayer at risk, they are sitting on a profit of $10.5 billion.
In people’s minds if you have more than a million you are in a funny money territory. But if you look at most of these institutions, shareholders have lost billions. The share price of Citigroup, which is one of the most widely held stocks in the world, dropped from a high of 53 to a low of 14 in the span of one year. It has now recovered to around 19-20 where it is fluctuating. But the fact remains that the shareholders have taken a hair cut. Many of those shareholders happen to be pension funds which means you and me. So there is no question that private sector shareholders have not taken a hit. They have taken a huge hit, some people argue it’s a disproportionate hit given the fact that the problem had actually originated with the regulator.
Where did the problem arise: There was a moral hazard of regulation. The (US) Federal Reserve obviously in retrospect printed far too much money while the regulators at the same time did not regulate the US mortgage market. So regulation is as responsible for financial failure as private sector behaviour. The two go hand in hand. I mean one can ask with all the sophistication of Basel-II how did this happen. People like me were saying with Basel II watch out. But how many editorials did you see that said did we get Basel II right. Frankly, I don’t think we did. We got carried away with sophistication. Just as in this particular case we got carried away with sophistication of extraordinarily abstruse quantification for risk modelling. What the sophisticated risk modelling does at a time when central banks print so much money and therefore pushes far too much liquidity in the system, is that it encourages asset price appreciation. And actually over the last five years we saw the cyclicality of this. First it went into stocks and then the bubble burst. Then it went into commodities first and backed off a little bit, then it went into real estate then that bubble burst, then into commodities and that bubble is just about to burst. The fact is that excess liquidity like excess water in a reservoir will find its way somewhere. The issue becomes when one talks about the moral hazard, before one asks the question of the private sector defaults, what were the signals being sent by the regulators. They were all wrong signals in the first place.
Now the fact is how do you know whether you have printed too much money or not. To me there is only one simple answer— you look at the movement of the world economy and compare that with the actual increase in liquidity. The net production of dollars in terms of credit flows outstanding relative to world growth shows a disparity of 17-18% of US GDP year-on-year for nearly 8 years, even after accounting for the act the US dollar is the global reserve currency.
What happens under such circumstances given the fact that people don’t hide money under mattresses? It has to show up somewhere. And if its not going to show up in the stream in the production of goods and services, its going to show up in the asset prices.
On Greenspan: I think he was absolutely wrong that central bankers should not interfere with asset bubbles, they should instead deal with the consequences of asset bubbles bursting. Frankly, I think we have been through three cycles of that and we should by now say that the cost is too high. We have to take asset price inflation into account when you are printing money. One of the great dangers of monetary policy today for instance is that there is no coordinated handling of global liquidity. You have got three global reserve currencies—the yen, euro and the dollar. I think in 10-15 years time we also have to prepare for the fact that the Indian rupee and the Chinese yuan will be two more global reserve currencies. Given the way the world is structured today, unless the big central banks coordinate the transmission of global liquidity, we are going to have problems in the system somewhere. And the one thing that has not occurred post-Bretton Woods is any coordination among central bankers in the total amount of aggregate liquidity they are pumping into the global system.
Has India and China done better by keeping up capital controls: I would say that India and China have grown and they have capital controls. There are no further correlations. China has reserves of over $1.5 trillion, India has reserves of $300 billion though its going down. But these reserves are signs of weakness. To me they are not signs of strength. You can understand reserves building up on the part of Singapore or Saudi Arabia. The latter makes a billion dollars a day from selling oil. But look at continental economies like India and China. The growth of reserves of this type essentially indicate two fundamental problems—one is their financial systems are primitive relative to the needs of the real economy and two the financial flows which should be managed through a market system, does not operate. In Singapore the financial markets are largely owned by the government but they still behave as per market principles. That is not true of the public financial system either here or in China. These are quasi-political public financial systems. They do not act as market agents, instead they act on directions (from the government). What has happened is that because of the primitive nature of our financial system, the kind of surpluses that we are earning through our invisibles, which would normally have been invested by the private sector if we had an open capital account are instead being invested by a single agency on behalf of the government. That too probably at a spread loss. It’s a concentration of risk, a mismanagement of currency risk because those $300 billion should be managed by the private sector. That would have been appropriate with millions of different decision agents making up an efficient market at work.
To me it is the first and most glaring and obvious sign that the financial system is totally out of sync with what the needs of the real economy are. In my view if you know that 10 years from now you are going to be one of the four largest economic blocks of the world it makes absolutely no sense in logic or morality to carry on the way we are doing today. We have to liberalise our financial system, we have to employ global standards, we have to create global institutional players and we have to integrate with that system. You cannot do it in a step function sort of way. Because in that case, the dislocations are far too large. It is better that we make a relatively seamless series of transition then one massive dislocation when we become on major $5 trillion economy which is in sight in a decade or two decades. We should be at $3 trillion by 2015 and possibly over $5 trillion by 2020. We are talking about 11 years from now.
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