How the Crisis Catapulted Us Into the Future

“How the Crisis Catapulted Us Into the Future,” is the title of Martin Wolf’s opinion piece in the Financial Times this morning. Wolf, in the article, ruminates on what he experienced last week at the World Economic Forum held at Davos and how this all fits into the world we are now living in.

Wolf concludes: “The crisis has not proved a great turning point, so far. But we cannot conclude that it is of small significance. It has brought some transformation, much acceleration of previous trends and, above all, great uncertainty. That uncertainty was present all along. But now we know.” (http://www.ft.com/cms/s/0/5fc7e840-2e45-11e0-8733-00144feabdc0.html#axzz1Chh2pOYC)

The usual items are mentioned. First, the “turnarounds” such as the tightening of financial regulation, the de-leveraging that still continues, the lessening of “global’ imbalances”, and the vulnerability of the Eurozone’s “excessive accumulations of private and public sector leverage.” Then there are the “accelerations” such as the new focus on sovereign fiscal affairs, the “accelerated shift in the global balance of economic power,” the changes in relative attitudes in the west and in the east, and the uncertainties related to how the future is going to work out.

There is another change that has taken place over the past three and one-half years that Wolf doesn’t allude to but is one that has also accelerated during the crisis and will play an even more important role in the future. A consequence of the financial crisis has been the rapid advancement in the use of information technology in the world and the effect this advancement has had in changing the way we all do business and how we govern and how we all live.

First, the headlines in newspapers all over the world tell us of the events taking place in Tunisia and Egypt, and in Jordan and Syria, and elsewhere. Could these events, would these events have taken place if information had not spread about conditions in different parts of the world and if communications had not been as complete as they are. In Egypt the Internet was closed down, but that didn’t stop information from traveling.

Analysts have argued that two factors seemed to be catalysts for the uprisings that have taken place: food prices and unemployment. In terms of the former, information spread that food prices were an international concern and impacting countries with autocratic governments the worst. Unrest was experienced in other countries as more and more people reacted to governments that were a part of the problem and not a part of the solution.

In addition, people had more and more information that countries other than the developed countries were experiencing economic expansion. China and India and Brazil, among others were creating a future and putting people, educated people, to work. This was not happening in Tunisia or Egypt, Jordan or Syria or in some of the other countries experiencing unrest.

Information and the spread of information is something governments are going to have to take more and more into consideration in the future. But, this does not just extend to social issues.

Governments are finding it harder and harder to hide things. One of the fallouts of the crisis in the Eurozone is that governments like Greece were hiding things so that its financial condition was not really apparent to its people and to people in the investment community. Spain is now experiencing some of this within its regional governments. This is causing Spain real headaches in attempting to stem the impending financial crisis it faces.

But, people in the United States cannot be too smug in this area. More and more we are finding out how state and local governments “hide things” in managing their finances especially in the accounting for pension fund liabilities.

On top of these revelations, there was the release of large amounts of inside information connected with the organization called WikiLeaks. This, apparently, has had some impact on middle eastern events as well as disclosures relating to military and diplomatic relationships. We were reminded once again of this release of this “secret” information in the article in the New York Times Magazine, “The Boy Who Kicked The Hornet’s Nest” which appeared over the weekend. (http://www.nytimes.com/2011/01/30/magazine/30Wikileaks-t.html?adxnnl=1&ref=magazine&adxnnlx=1296651604-/6As33QJtY/sr5n+tM0J5w)

Information spreads and, although it may be contained in the short run, over the longer run its spread cannot be stopped. This is a major problem for governments.

The WikiLeaks adventure also spilled over into the business sector as several firms or banks were threatened with disclosures. But, the information “leakage” problem extends far beyond just WikiLeaks. Today, in Mr. Wolf’s paper, the Financial Times, there was a detailed piece on “industrial espionage” titled “Data Out of the Door.”( http://www.ft.com/cms/s/0/ba6c82c0-2e44-11e0-8733-00144feabdc0.html#axzz1Chh2pOYC)

“Cyber-spying has fast become a specific threat for many companies. ‘Industrial cyber-espionage is one of the biggest problems that all nations are facing,’ says Melissa Hathaway, a former US intelligence official and the leader of a digital security review set up by President Barack Obama.

The scale of hacking to gain corporate information has gone so far, she says, that the Securities and Exchange Commission…might soon need to require companies to assess routinely for the benefit of shareholders how well they are protecting themselves from electronic attacks.”

On the other side of the ledger, this fact also says a lot about what companies can and should
reveal to the investment community. People can get more and more company information these days and it is very important for a business to accept this fact and address the issue of how open and transparent it must be to earn the trust and confidence of the investing community.

Nothing can be worse for a company to be ‘”caught out” and have to admit it was hiding information from the public that should have been released.

Modern information technology is impacting business in another way raising all sorts of different questions. How closely can finance be regulated when finance, which is nothing more than information, can be transmitted around the world in seconds…or less? How can financial transactions be understood when financial information can be “sliced and diced” in any way it can conceivably be re-constructed? How fast can transactions take place? How fast should transactions be able to take place? How secure are all these transactions? How have “the Quants” changed their business practices since the melt down of August 2007? What other ways can the “physical” be transformed into just information?

Rahm Emanuel, formerly President Obama’s Chief of Staff, once stated that one should “never waste a crisis.” I believe that many people and organizations, especially people and organizations within the financial industry, acted this way during the crisis. As a consequence, the world is a very different place now than it was three and a half years ago.

The problem going forward is that many people and businesses are looking forward to what they can do in the future while many governments and other institutions, like religious groups, are only looking to regain the past. This divergence only adds to the uncertainty that Mr. Wolf observes in the world today.

Is QE2 a Bubble Machine?

One of the major contributors to world economic growth and development in the post-World War II years has been the ability of capital to flow relatively freely throughout most of the world. As capital began to flow more freely throughout the world in the late 1950s and 1960s, the rules of international monetary affairs changed. One of the most dramatic changes resulting from this freer movement of capital was the breaking down of the Bretton Woods system which finally breathed its last breath on August 15, 1971 as the United States removed itself from the gold system and began to float the dollar.

We are now experiencing some of the consequences of the free flow of capital throughout the world as the impact of the world’s central bank, the Federal Reserve System, is changing the behavior of nations.

One fear is that the changes are being made in the direction of imposing controls on the flow of
capital. As Nobel-prize winning economist Joseph Stiglitz has declared, the world seems to be evolving into fragments. Not exactly what the Federal Reserve had in mind.

This concern is captured by work being done within the International Monetary Fund that points to “the rising tensions as governments impose blocks on cross-border movements of speculative money.” (See “Surging Capital Flows Pull IMF into the Fray,” http://www.ft.com/cms/s/0/85907e38-1924-11e0-9311-00144feab49a.html#axzz1AGISipQS.)
“Emerging markets from Brazil to South Korea to Indonesia are complaining that a growing flood of money is boosting the value of their currencies and undermining their competitiveness. They have imposed different restrictions on investment to try to make sure those funds can’t leave the country suddenly.” (http://professional.wsj.com/article/SB10001424052748703675904576064233644690302.html?mod=ITP_moneyandinvesting_2&mg=reno-wsj)

“Fundamentally, the IMF wants to expand its oversight of capital flows and determine when restrictions make sense and when they are being misused.”

Up to now, the implied culprit causing this situation to occur has been the monetary policy of the United States, specifically the program of Quantitative Easing (QE2) initiated and executed by Chairman Ben Bernanke and the Federal Reserve System. The low interest rates created by the Fed, keeping its Federal Funds target in the 0.0 to 0.25 basis point range since December 2008 while flooding the financial markets with more than $1.0 trillion in liquidity, has provided the catalyst for the international flows of speculative money.

As international tensions continue to grow, more and more explicit focus will be placed on the behavior of the Federal Reserve System. Experts are expecting that the whole issue of capital controls to become a “big part” of this year’s discussion of the G-20. French President Nicholas Sarkozy, chairman of the Group of 20 in 2011 is seen as a role-player in raising the international profile of the issue.

These international flows of speculative money are also being given credit for a good deal of the world-wide run-up in commodity prices. Speculative movements of funds have been given credit for increases in the prices of oil, gold, silver , and copper, among other non-food commodities.

Now, the rise in world food prices is gaining attention and concern. Today,the Financial Times leads with an article that includes the claim of “Food Price Shock” (http://www.ft.com/cms/s/0/524c0286-1906-11e0-9c12-00144feab49a.html#axzz1AGOW6ARZ). The Food and Agricultural Organization of the United Nations has warned that the world faces a “food price shock” as its benchmark index of farm commodities prices “shot up to a nominal record last month, surpassing the levels of the 2007-2008 food crisis.” This speculative crisis may be exacerbated if certain disturbing weather forecasts for 2011 are realized.

The concern is over the unrest that these higher food prices might have on potential unrest in many developing nations. There is even fear that this unrest could reach some developed countries including those in the Eurozone.

There has been growing discussion about the role that the Federal Reserve has played in the explosion of commodity prices throughout the world. Again, there are lots and lots of dollars “out there” and the cost of borrowing dollars is close to zero, especially in markets that are experiencing various degrees of inflation. Of course, this leads to the question of “bubbles”.

No one has really gotten a handle on the concept of credit bubbles and so there is a lot of discussion about what a credit bubble actually is, if credit bubbles even exist. Like pornography, credit bubbles seem to be whatever an observer wants to define them as.

Debate still exists about the “housing bubble” of the early 2000s. Again, the Federal Reserve kept its target interest rate extremely low for “an extended period of time” in order to insure that the economy did not collapse into a severe recession. Housing prices exploded in this period at double-digit rates of increase every year. The Fed Chairman at that time, Alan Greenspan, still refuses to acknowledge the existence of anything like a bubble in housing prices. Economist Ben Bernanke provided Greenspan with the justification for not acknowledging that a bubble took place.

So, a housing bubble took place in the early 2000s, unless it didn’t take place.

Is the flow of money into world commodity markets creating a credit bubble there? Is the flow of money into the currencies and stocks of developing countries creating a credit bubble there? Is QE2 the “bubble machine” of the world?

Something new has taken place in the world. The information Congress forced out of the Fed confirmed that the Federal Reserve System became the central banker of the world beginning in 2008. A consequence of this change in roles for the Federal Reserve is that, connected with the free flow of capital throughout the world, the Fed can become the “bubble maker” for the world. What the Fed does, does not stay at home!

I have frequently quoted the work of Raghuram Rajan, winner of the Financial Times/Goldman Sachs award for the best business book of 2010. (See a review of his award-winning book “Fault Lines,” http://seekingalpha.com/article/224630-book-review-fault-lines-how-hidden-fractures-still-threaten-the-world-economy-by-raghuram-g-rajan.) I now refer to a book written by Rajan fellow University of Chicago professor Luigi Zingales titled “Saving Capitalism from the Capitalists” (Princeton University Press). They write: “Bubbles are often pumped up by a whole new set of investors who do not have the experience or knowledge to invest carefully…There is no guarantee that even in a developed financial market the next new sector with limitless possibilities will not attract it own set of gullible investors.”

The international markets are attracting all sorts of money, a lot of it is money that is inexperienced in the investment in world commodities or the securities of emerging markets. These are the markets that have achieved a high profile in investment circles over the past twelve months or so.

QE2 seems to be working but maybe in ways that would not be recognized by Chairman Bernanke. But, he still denies that the early-2000s monetary policy of the Fed might have created a housing bubble.