It's Time to End Global Boom and Bust

Jeremy Warner Daily Telegraph January 23, 2010

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Published: 8:15PM GMT 22 Jan 2010

Comments 13 | Comment on this article

Properly reforming the banking sector's finances will be tricky Photo: Getty Images

"In Italy, for 30 years under the Borgias, they had warfare, terror, murder and bloodshed, but they produced Michelangelo, Leonardo da Vinci and the Renaissance. In Switzerland, they had brotherly love, they had 500 years of democracy and peace – and what did that produce? The cuckoo clock."

So says Harry Lime, the villain in the classic Carol Reed movie The Third Man. Of course, his facts are famously flawed, but the remark might equally well apply to economics. An economic bust is a savage affair, but it is only the natural reaction to a sustained boom. It is also a necessary corrective, driving out the old and ushering in the new. The one follows the other as surely as night follows day. Busts are punishment, if you like, for the excesses of the boom.

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The holy grail of economic policy has always been to abolish this cycle, and by implication the excesses of the booms. But is that actually possible without destroying innovation and growth? More to the point, is it what we really want? The cuckoo clock looks a poor trade for Michelangelo.

Published: 8:15PM GMT 22 Jan 2010

Comments 13 | Comment on this article

In our newly reduced circumstances, we look back in disapproval at the excesses of the past 10 years and rail against the bankers for trying to recreate them. But booms are liberating, exhilarating experiences which produce extraordinary economic advancement. The "Roaring Twenties" are now widely portrayed as a portentous decade that sowed the seeds for the Great Depression and renewed world war. Yet they also produced transformational technologies and industries, as well as some truly stunning breakthroughs in healthcare – and the finance for these developments came from a credit bubble.

Not everything to have emerged from the more recent boom can be characterised as an unalloyed good – far from it. Yet the Nineties and Noughties also gave us the communications revolution, the impact of which is only just beginning to become apparent. Look through the smoke of the present bust, and there is a whole world out there brimming with opportunity and growth. And it was not the foresight of regulators and governments that created this infrastructure, but the excesses of financiers and consumers.

This is one of the critical points that should be kept in mind when approaching the issue of banking reform. I'm not about to argue that bankers should be allowed to do what they like. They abused their freedoms and they deserve to lose them. Personally, I've long been a supporter of the sort of radical reform that the Obama administration now proposes, separating high-risk activities from basic banking. Its previous, compromised agenda fell hopelessly short.

Yet we may now face the opposite problem, which is a politically inspired over-reaction. The purpose of reform should not be to punish the bankers, satisfying though that may be, still less to impose big-government rules on the free market. Rather, the aim should be to make banking more accountable, more transparent, and – by forcing a more appropriate pricing of risk – inherently safer.

Over the past decade, banks have lost sight of their core function, which is putting other people's money to good and safe purpose. The interests of highly paid employees have taken priority over those of clients and the wider economy. To keep bonuses up, balance sheets have been recklessly expanded to sizes that eclipse the capacity of individual nations to underwrite them.

This unprecedented growth in leverage has focused primarily on traded assets, or securities. Initially, it delivered big gains and bumper earnings for these self-styled masters of the universe, but it also pumped up a bubble which was bound eventually to burst.

The direct costs to the taxpayer of having to refinance these obese monsters of the financial scene are one thing, but they are dwarfed by the wider economic and fiscal consequences. By the time this is over, national debt across the developed world will have doubled.

Something certainly has to be done to stop this happening again. But it would be naive to think that structural reform will entirely rid us of the ebb and flow of the credit cycle, which is as much a part of the free market as the tides are of the oceans. The alternating switchback of euphoria and despair which defines the movement of markets is deeply rooted in human nature. Most attempts to play god and impose a different way of doing things have ended disastrously.

Reform must therefore proceed in a measured and internationally co-ordinated fashion. And I worry about the motivation behind Obama's Damascene conversion to the cause of unilateral reform. There is nothing quite so dangerous as on-the-hoof policy, concocted for reasons of political expediency. These are complex and treacherous waters, and if we disrupt the process of credit creation in a heavy-handed fashion, we will damn ourselves to a future of stagnation.

After the last bust, and the collapse of firms such as Enron, America over-reacted by bringing in the overly restrictive Sarbanes-Oxley laws. In the process, it put itself at a severe international disadvantage. Separating the banks from the casinos is the right approach – but we have to do it right.

Comments: 13

Jeremy says: "and there is a whole world out there brimming with opportunity and growth." Yes, Jeremy, so there is. And we are keen to use the new technology & inventions which will be available. As we have done in the past. But in the past it has all been funded on debt & house price growth, which is debt also. That has come to an end. An even bigger end when public spending is cut, as it will be. So. No cash, or less of it to buy the new goodies. We can't have growth without buying the goods. Opportunity will be stifled if it is taken & there is no benefit. The World is going to have to "brim" very slowly while we work off the waste. Is this bust then? For how long? I for one am spending only the bare minimum until my savings earn again & my finances improve. And if taxes go up I will make more cuts. Because I have to. And everyone else will have to. Because we are bust. Sparky. 23.1. 13.00.

we need to central bank created boom and bust because, the boom sucks people into debt and restricts their freedoms, while the bust takes their assets, all happening while the system masquerades as progression and freedom.. i dont need to be forced to work to produce a fancy iphone during a tech boom when i have my house and security taken in a bust!!.. central banks and boom and bust are fundamentally anti freedom

Banks can go bust and we're forced to guarantee the deposits, that's the problem. It doesn't matter what the cause of the crisis was since it is no longer the problem. Tails we lose. We need to protect deposits from future crises rather than try and prevent future crises. It's great when people risk their own money on speculative investments.

The bust that follows boom is what is scaring folks. Not least because the boom was about house price inflation and the bust means a collapse as values come into line with realistic multipliers to incomes again. Interest rates will also have to adjust to attract savers - for retail deposits must back lending now wholesale funds are off the agenda. Any attempt to avoid this, smooth this, means massive state interference in free markets. Has this ever been successful?

The great conceit is the thing that has been haunting us for years - the idea that Governments can and should intervene to somehow "mitigate" (meaning avoid) a bust. The point that some people seem to miss is that Government should on the one hand be intervening as little as possible - its role should simply be to create the conditions for sustainable total wealth generation - whilst on the other providing the safety net for those who will inevitably fall out of the system. It should not centre its entire policy making on trying to fix the system to stop people dropping out as this inevitably leads to over regulation and less real wealth. Boom and bust is a critical part of the natural cycle, if anything the sooner bubbles burst the better as it tends to allow an ebb and flow of overall growth as opposed to the kind of loud bang and massive uncertainty that we are seeing today.

Innovation comes from competition. Competition comes from two or more companies trying to outperform each other for market share. THAT is fantastic innovation territory. THAT is where development thrives. Not robot trading platforms geared at 400:1. And not spending more money on housing rather than R&D. Innovation probably will come with bubbles as companies have to borrow. However, they've got to be the right type of bubbles. Next time, let's try and have an innovation bubble.

Gordon Brown's claim to have "ended boom & bust" (remember that one Gordon?) has not only been shown to be one born of massive hubris and conceit but was economically illiterate to boot. Remarkable really, for someone of his academic background. Recessions are not only unavoidable but may also be necessary to squeeze wasteful corporate and state expenditure and to improve productivity and business process innovation. All poicymakers can hope to do is to try to limit the extent of the recession when it comes and try to put policies in place that support the economy when it revives. Claims to be able to anything more are vanity at best and dishonest and cynical at worst.

jon livesey on January 22, 2010 at 08:59 PM "and in thirty years time we will be right back where we are today, in the next financial crisis, and the public will have learned absolutely nothing, as usual." Forget sex education! Teach kids how banks create money and how government funds itself via central banks. I doubt whether any politician will suscribe to that idea eh?

"Andew Marrs history of the Atlee catstrophe was Identical to those of Wilsons and Callaghans." That's a very good point, but I ask off and on why exactly we - meaning the voters - keep re-electing Labour. Every Labour administration ends in economic and fiscal disaster, and we don't re-elect them immediately, because we need the Tories in power for a couple of Parliaments just to repair the damage. But after a while, we seem to get tired of sobriety, and we decide that "just one drink" won't do that much harm, so we re-elect Labour, and to begin with we just get that mild, one dry sherry, buzz, but then ten years later the barbarians are at the gate and we're asking "Why did we do that?" But we keep doing it.

Boom & bust will never end as long as we live in a consumption based society. The desire for more will always prevail. Regulation can be deployed to curb some irresponsible greed, but will never catch up.

"Busts are punishment, if you like, for the excesses of the boom." The problem, Jeremy, is that (this time, at least) the punishment has been given mainly to those who did NOT commit the crimes. You're right, there's nothing all that terrible about overexuberance and its consequent hangovers, so long as the people who drank too much punch are by and large the ones with the hangovers. And too much deregulation has served to remove the link between partying and suffering, leaving a banking and speculating class who get all the spoils without being required to manage risk.

Thanks for this great article - well said ! just as diets are necessary after Christmas. When will governments ever get it ?

We dont need to abolish boom & bust but Labour Governments. Andew Marrs history of the Atlee catstrophe was Identical to those of Wilsons and Callaghans. As it was with Blair and Browns. The headlines were identical and the same old lies and same old tretchery. Destroying out traditions, eroding our freedoms, going to war, obeisance to the Kremlin and catasttrophic over spend on public services as productivity dives as their costs rocket.

"By the time this is over, national debt across the developed world will have doubled." That's true, but misleading, since *total* debt has certainly not doubled. It may have risen slightly, but the main effect of Bank recapitalisation was to replace private debt with public debt. If we want something to really worry about concerning debt, we should be worrying that in the West, total debt per dollar of GDP is creeping up again. In the US the ratio of total debt to GDP bottomed around 1980 at around 40% and has now climbed to over 70%. Also, since 1980, in the US private debt has actually climbed faster than public debt, even though most people only worry about public debt. Another way to put this is that it is taking increasing amounts of debt to create one Dollar extra GDP, and this has been going on for decades; it's not a feature of the current crisis. Incidentally, I am sceptical that you can really do anything to reform Banks. We may feel that we have them in our clutches right now, but that will pass as their need for public finance passes. What will happen now - unless we get a second crisis, which I think likely - is that we will forget this crisis as we recover, and in thirty years time we will be right back where we are today, in the next financial crisis, and the public will have learned absolutely nothing, as usual.