I published this on the Huffington Post on 11th November, 2009.
In William Hogarth’s famous engraving of 1721, the world of finance, corrupted by the phantom of the South Sea Bubble, is cruelly satirised. To represent market cheerleaders, a goat sits astride a spinning carousel and asks: ‘who will ride?” Lured by this charlatan, investors crowd on to the shaky, but thrilling merry-go-round. In another corner a winged devil with a scythe throws chunks of Fortune’s body to a greedy crowd. And in the right hand corner – ‘trade lies dead’.
Today — as global trade lies dead, as unemployment rises, as wages and incomes plummet, as US consumption (70% of US GDP) and investment falls — share prices zoom upwards and commodity prices rock. According to Fortune magazine, the stock market climb of these last few months is the fastest on record. By November, the S&P 500 had surged by 62 percent to 1,093.08 after sinking to a 12-year low in March.
A trade that remains in the shadows — ‘the carry trade’ — roars ahead. (For the uninitiated: it’s just another version of ‘buying cheap and selling high’. Traders in money borrow e.g. dollars, at the Federal Funds rate of 0.25%- and then lend in countries (and currencies) where rates (or yields) are higher.
Nice work if you can get it — especially as a banker, with the competition wiped out, the Fed keeping interest rates low, and the risk of gambling with your own capital replaced by taxpayer-backed money.
It’s especially nice work if, while playing away, you can short the dollar and so ensure that on returning home to pay your dollar debts, the rate is lower. Fine and dandy of course, until either the dollar or the Fed rate rises. Then all hell will break loose, as traders scramble to repay debts at climbing rates. But until then, the unregulated ‘carry trade’ carousel will keep spinning round the globe.)
In another corner of the financial forest, and partly financed by the carry trade, the global bubble in equities, commodities and other risky assets is expanding into what Nouriel Roubini calls a ‘monster‘.
Many economists are helping to pump it up further. Some, like Abby Joseph Cohen at Goldman Sachs gave the bubble a puff by declaring the recession at an end in August. Jim O’Neill, chief economist at Goldman Sachs is a perma-optimist. He told me in an August 2008 BBC radio interview that this recession was ‘just another periodic crisis – I have already lived through five’, he remarked.
When a British economist Danny Gabay of Fathom Financial Consulting argued that poor GDP numbers could be explained by the fact that “the UK has some formidable headwinds, not least of which is the over-burdened consumer which is having to cope with a broken banking system, rising unemployment, and falling income growth,” his view was dismissed as “baloney” by Kevin Daly at Goldman Sachs, who, according to the FT, put greater weight on more optimistic recent surveys of companies.
These happy (and well-compensated) souls are joined by PhD-trained academic economists who cheered the recent 3.5% growth in US GDP, even though wiser heads declared this analysis a whitewash, and noted that ‘cash for clunkers accounted for 1.7%, i.e. half of the increase and the lower liquidation of goods in stock accounted for another 1%. In other words, 80% of this “growth” came from a temporary government boost that is already gone or was essentially technical in nature.’
But the cheerleader that investors should most beware of is one Prof. Frederick Mishkin.
In May, 2006, this American economist and one-time Federal Reserve governor, wrote a report called “Financial Stability in Iceland” commissioned by the Icelandic Chamber of Commerce. (See ‘Iceland as Icarus‘ by Prof. Robert Wade.) In this report he and his Icelandic partner opined thus: “Although Iceland’s economy does have imbalances that will eventually be reversed, financial fragility is not high and the likelihood of a financial meltdown is very low”. We know that Fred Mishkin (now of Columbia University) was not the only academic economist to act as cheerleader for Iceland’s reckless bankers. Prof. Richard Portes, President of Britain’s Royal Economic Society, played a similar role. (For more about Professor Portes’s role in the Icelandic saga, go here.)
Mishkin’s report was published in the same month that the IMF mission to Iceland came to very different conclusions. According to Prof. Wade, Mishkin “pocketed $135,000 for his contribution to the modest report.” A modest fee, we might add, for puffing up massive capital gains on behalf of reckless Icelandic bankers.
In the autumn of 2009 Iceland’s economy ‘debtonated’ and the country was quickly bankrupted. Bank failures, unemployment, political upheaval and massive destruction of value followed.
The disastrous bursting of the bubble created by Iceland’s bankers, has not punctured the Professor’s confidence, nor deterred his sponsors at the Financial Times or in the banking sector. On Tuesday, 10th November, 2009, Mishkin was given a column in the FT. The apparent purpose of the piece is to debate the risk of bubbles. Instead emphatically puffs up the ‘monster bubble’ in risky assets. He does so by posing a rhetorical question: “if bubbles are a possibility now, does it look like they are of the dangerous, credit boom variety?”
“The answer” writes this academic purveyor of advice and encouragement to the carousel set, “at least in the US and Europe, is clearly no.”
To paraphrase Wordsworth: William Hogarth, thou shouldst be living at this hour: Economics hath need of thee: she is a fen of stagnant waters.