Posts tagged Recession

As you may know from reading my previous articles, I am interested in how the financial system is regulated. Not necessarily from a compliance perspective but more through an interest of how regulation can drive the financial markets. So the recent talk at LSE on ‘What should economists and policymakers learn from the financial crisis?’ was an event I had been looking forward to for some time. It quickly became apparent though, that due to the “economic rock star” line-up, I wasn’t the only one waiting with bated breath (yes, at one point they were referred to as economic rock stars). Despite confidently applying for tickets under four different alias’s, I was rather put out not to have received one. I found solace, however, and attend the video link on campus.

A LSE professor opened with quite a good quote from Peter Diamond, an American economist. He said “When analysing a topic, only three papers normally have a real contribution. The trick is to know which three”.

The talk consisted a short speech from each of the delegates, Mervyn King, Ben Bernanke, Olivier Blanchard, Lawrence Summers and Axel Weber. Below are my highlights.

Ben Bernanke said that our recent crisis was akin to many other financial crises with the “classic prescriptions of liquidity provision, liability guarantees, asset evaluation and disposition, and recapitalization where necessary.” The difference to previous financial crises was that down to the global nature of the financial system, and the scale and complexity of the global financial institutions.

Bernanke went into detail about the uncoordinated abandonment of the gold standard in the 1930s and the ensuing competitive depreciation of rates. Countries used what he called ‘beggar thy neighbour’ policies, which intended to boost domestic economies through stronger exports achieved by the depreciation of exchange rates. The problem with this type of response was that the gains that this country felt were offset by the losses their trading partners felt. This then depreciated the currencies of their trading partners and due to the relative nature of currencies, removed any gain felt by country who had depreciated first. Everyone was worse off. Currency depreciation has been in the news a lot this year and was a major worry until the G20 nations agreed to not target exchange rates competitively. Bernanke continued his talk along the same vein, making note of the collaboration between central banks across the world and celebrating this coordination as the reason the global economy is showing signs of recovery. The financial industry is riddled with global complexity and the coordination of regulators and central banks will be integral to its future. Later in the talk Axel Weber argued the need for a global regulator, referencing the trouble he has as Chairman of UBS to coordinate operating globally but adhering to differing national laws. He emphasised that, when the Basel III initiative was formulated, harmonised implementation was key. This has not been seen and the focus on national implementation hurts large multinationals.

A particularly enjoyable element to the talk was reflecting on the recent crisis without politics being involved. A point that was reinforced by almost every speaker was that the independence of central banks is important. The pioneering move by Mervyn King to make the Bank of England responsible for setting interest rates was lauded and it was implied that economics works better without politics.

The ‘rockstars’ in concert (by videolink)

The talk gave me a fresh look at economic figures. The speakers had all devoted their lives to understanding the economic history from the past so they could better control our economic futures. It felt very much as though I was in front of a group people who has pressed the buttons and pulled the levers to guide us through such a drastic economic depression in the best possible way. 

The talk was not without warning though. Axel Weber said that we need to be mindful of implementing regulation during a period of recovery. The quick speed of implementing regulation can hurt growth at a particularly sensitive time. Axel also took the opportunity to have a dig at the press, stating that when regulators change the time frames it should not be construed as a result of bank lobbying – the banks were asked for their opinions.

The current situation in Cyprus was flagged as a stark reminder of the risks still out there. Whilst indicators are positive, the recent rally could be a misleading signal and the underlying progress of the economy still lacks a necessary forward leap. A fundamental rebound is not yet clearly in sight and when is does occur it will be against a debt ridden backdrop.

A video podcast of the talk can be found here

Since the hype of American elections is likely to soon subside, I thought it may be a good time to take a look at the general outlook for the economy. Every day I seem to read articles that are either vehemently bearish or vehemently bullish and it is hard to find clarity amongst the chaos. As with all problems, it can be beneficial to strip away the noise and look at the fundamentals. In the case of the economy this means going right back and looking at the factors within an economy that are needed to promote economic growth.

Economic growth isn’t something that just occurs. It is a bi-product of a number of factors such as the consumer’s propensity to spend, employment levels, a strong infrastructure, technological advance, demographics, investment and various other elements. When you look over that list it becomes apparent that many of our 2012 economies are lacking, particularly in the Western world. Birth-rates are slowing on a global scale. Infrastructure is becoming dated and new investment is lacking (although intitiatives are being put in place to address this). High unemployment, low consumer sentiment and general uncertainty have served to decrease the consumer’s propensity to spend. Combine these factors with huge government deficits and a lack of available credit and it becomes clear that expecting economic growth may be somewhat naive.

This leads me to consider that maybe we are wrong to expect growth. The past 20, 30 or even 50 years have seen what you might consider abnormal conditions. The baby boomer period made huge population gains; stock markets saw some of the biggest bubbles on record, as well as some of the biggest busts. Rapid recoveries and the availability of credit have made us all live lives that we perhaps couldn’t afford. With reserves spent, resources reaped and prudence an old lesson that we are being forced to remember: maybe we are wrong to hope to return to pre-crisis levels.

In the FT yesterday, a representative from a London based property company said that he believed the housing market would not return to pre-2008 levels until 2015. This seemed a little off key to me as pre-2008 was a much swelled bubble and I don’t see returning there as a desirable outcome for anyone. This highlights a psychological problem which may affect the way we look at the economy. Humans tend to revert back to what is normal; but when normal is wrong (in the case of the economy, the last 20 years may have been an anomaly) reverting back can have disastrous consequences. The returns that have been experienced over the past 20 years are going to be hard to come by and to search for them will be risky.  As investors make this search, proper risk management will be become more important than ever.

Here is an assignment I did for the Contemporary Issues in Finance module whilst at university. The assignment was to write an Economist article that investigated whether the regulatory proposals being made during the crisis were indicative of a convergence of international financial systems. 

Mid-Crisis Regulation

For the UK, GDP figures have confirmed that the UK is in a double-dip recession (link). This news may have had more of an affect on the markets if everyone wasn’t so excited by the Euro news which raises the question, ‘is this a fickle rally?’. If the UK is still in recession then surely when this good news wears off nothing will have changed?

Well, the answer depends on your point of view. Fundamentalists might say that until the underlying issues with the UK economy are fixed, any market rallies will be short-lived. Another way of looking at it requires a pinch more optimism and a belief in positive feedback loops. If I look at my portfolio before leaving work on Friday and it is up 1.44% (like the FTSE 100 at the time of writing - FTSE100 quote) I might be a bit happier this weekend. That might mean that I decide I will eat out tonight, book that holiday or buy that television, which, in turn, might mean that businesses make more money this weekend, which in turn will create growth.

Who knows what people will decide to do this weekend and who knows whether the Fundamentalist or the Optimist will prevail, one can only hope.