23. Unusually Uncertain

In Carl Sagan’s novel Contact, an unknown alien, encountered by Dr. Ellie Arroway, talks of Earth’s “astonishingly backward economic systems.” Abandoning the Great Moderation and Goldilocks economy, the world embraced Botox economics. Botox is a toxin, commonly used to improve a person’s appearance by removing signs of ageing. However, the effect is only temporary, with significant side effects.

As the global financial crisis rolled on, Financial Botox, a flood of money from central banks and governments, covered up unresolved and deep-seated problems. The prevailing thinking was from Will Rogers: “If stupidity got us into this mess, then why can’t it get us out?”

Botox Economics

Government spending, industry support schemes such as “cash for clunkers,” tax cuts, investment incentives, and subsidies all boosted activity. Low or zero interest rate policies (ZIRP) engineered a recovery in stocks and financial markets. Historically low interest rates, especially in dollars, made anything offering reasonable income look attractive. One analyst told investors: “We like the junkiest of the junk.”¹

Capital injections into banks, central bank purchases of toxic assets and explicit government support for bank borrowings helped stabilize the financial system. Changes in accounting rules deferred write-downs of potentially bad loans and suspect securities, allowing banks to create their own reality. For investors “a bubble is a rising market that one is not invested in; if one is invested, then it is a bull market.” Naysayers were dismissed.

Coordinated government action across the globe on an unprecedented scale stopped the crisis turning into depression. Policy makers everywhere gambled on growth and inflation, as a painless means to adjust the deeply indebted global economy. In the words of François Duc de La Rochefoucauld in the seventeenth century: “Hope, deceitful as it is, serves at least to lead us to the end of our lives by an agreeable route.”

Behind the glossy and smooth surface, the interior remained decayed and rotten. In the U.S. mortgage market one in ten householders was at least one payment behind. If foreclosures were included, then one in seven mortgagors was in distress. Commercial real estate, office, and retail properties experienced high vacancy rates, falling rentals and declining values. In 2009 Japanese investment bank Nomura secured a 20-year lease of the 12-story Watermark Place on London’s River Thames for £40 per square foot, 40 percent lower than the rents of nearly £70 per square foot prior to the global financial crisis. Nomura did not have to pay any rent until 2015.

Unemployment remained high, even though enforced reduction in working hours, and taking paid or unpaid leave reduced the rise in unemployment levels significantly. Working hours and personal income fell.

Global trade stabilized after precipitous earlier falls. By late 2009, world trade was 8 percent above the low of May 2009 but 14 percent below the peak of April 2008. Trade protectionism threatened recovery in global trade as countries followed beggar-thy-neighbor policies. While paying lip service to free trade, governments encouraged the purchase of locally produced goods, happily subsidizing local industries. Each country sought to lower the value of its currency to gain a vital edge over competitors to capture a larger share of the market in an effort to maintain growth. It had all been seen before, especially during the 1930s.

Société Générale bank analyst Dylan Grice wrote: “Apparently heroin addicts can become so drug dependent that their bodies cannot withstand the shock of withdrawal, and failure to continue taking the drug triggers multiple organ failures. I just wonder how apt that analogy is to our government debt dependency today.”² The global economy had exchanged a heroin addiction (debt) for a methadone addiction (government support).

Joseph Tainter in The Collapse of Complex Societies identified the approach:

Where under the [Roman] Principate the strategy had been to tax the future to pay for the present, the Dominate paid for the present by undermining the future’s ability to pay taxes. The Empire emerged from the third century crisis, but at a cost that weakened its ability to meet future crises.³

No one knew how long governments could keep the economic life support system switched on.

China Syndrome

First suggested in 2007, the decoupling hypothesis argued that emerging markets would be immune to the problems of developed countries, with China driving the global economy, fueling the next global investment boom. Instead, recession in the United States and Europe triggered a collapse in exports and a slowdown in China’s economic activity.

Facing the specter of unemployed workers plotting revolution, comrade leaders directed massive spending and bank lending, embracing Botox economics. Ghost cities, unoccupied and empty, rose in China, driven by cheap money. No one knew who would buy the new condominiums that sprang up everywhere or travel on the new super highways and super fast trains. The revival drove decoupling hypothesis 2.0, a theory in which a billion Chinese would overnight urbanize and consumerize, driving 10 percent growth forever. China would replace America as global consumers of last resort, rescuing the world.

Analysts relied on Chinese statistics, which were unreliable and frequently manipulated by officials to meet political and personal objectives. Commenting on the time taken to compile growth data, Derek Scissors, from the Washington-based Heritage Foundation, wryly observed: “Despite starkly limited resources and a dynamic, complex economy, the state statistical bureau again needed only 15 days to survey the economic progress of 1.3 billion people.”⁴ Another commentator expressed surprise that revenue and cost gymnastics were not an official event at the 2008 Beijing Olympics. Investors just took playwright Lillian Hellman’s advice: “It is best to act with confidence, no matter how little right you have to it.”

Within China, a new class of wealthy individuals, usually affiliated with the Chinese Communist Party, aped their overseas peers—at least in their consumption of luxury goods.

Despite taxes on imported goods, sales of luxury goods grew at 25 percent annually in 2010, more than twice the rate of increase of overall consumption. For handbag maker Louis Vuitton, the “Middle Blingdom” was its largest single market, accounting for 15 percent of its global sales. China’s share of the global luxury market was forecast to rise to 44 percent by 2020, despite average wages of about 25 percent of that in developed countries. Wealthy Chinese, analysts noted, now had everything they needed and were progressing to buy a whole lot of things they didn’t need as well.⁵

With rising inflation eating away savings earning low interest rates in banks, the Chinese who could afford to bought up property, betting that the government would ensure that real estate prices would keep rising. This was the Wen Jiabao put, named after the Chinese premier, consciously referring to the famed Greenspan put. The assumption was that the Chinese government would ensure high growth. In many cases, the properties stood empty, awaiting future sale at a large profit.

A viral 2010 email captured the anger about China’s growing differences in living standards. To purchase a 1,076-square-foot (100-square-meter) apartment in central Beijing costing 3 million renminbi ($450,000), a peasant farmer would have had to work since the Tang dynasty that ended in A.D. 907. A Chinese blue-collar worker on the average monthly salary of 1,500 renminbi ($225) would have had to work since the opium wars of the mid-nineteenth century. Prostitutes would have to entertain 10,000 customers; a thief would need 2,500 robberies. Snail House, a popular Chinese TV soap opera, combined house prices, sex, corruption, and political intrigue. A woman becomes the mistress of a party official to obtain his help to buy a flat, while a young couple struggles unsuccessfully to raise the deposit for an apartment.

Another email described the fate of ordinary Chinese with sardonic humor:

Can’t afford to be born because a Caesarean costs 50,000 renminbi [$7,500]; can’t afford to study because schools cost at least 30,000 renminbi [$4,500]; can’t afford to live anywhere because each square meter is at least 20,000 renminbi [$3,000]; can’t afford to get sick because pharmaceutical profits are at least 10-fold; can’t afford to die because cremation costs at least 30,000 renminbi [$4,500].⁶

These were the consumers whom Western economists had tasked with driving global growth.

In China, ordinary people felt increasingly abandoned by the state, which now favored the wealthy and well-connected. Economic growth of 10 percent each year papered over a lot of sins—over-investment in ambitious infrastructure projects, frequently with poor economic rationale, environmental degradation, confiscation of land, growing social inequality, and institutionalized corruption. Insiders worried that China’s economic success was unsustainable. They feared that a slowdown in growth would expose the problems.

Wolfgang Münchau, columnist for the Financial Times, observed:

Instead of solving the problems to generate a recovery, the political strategies have consisted of waiting for a recovery to solve the problem. The Europeans are relying on the Americans to generate growth. The Americans are relying on the Chinese, who in turn are waiting for the rest of the world.⁷

In London’s Science Museum, there is a contraption consisting of yellow tubes connecting a number of tanks and cisterns where colored water is pumped through sluices and valves governing its flow. Built in 1949 by William Phillips, an engineer who converted to economics, the model demonstrates the flow of money within an economy. By pouring a lot of water into a bucket with a large hole, the world now sustained the impression that the receptacle was almost full.

Regulatory Dialectic

Regulators and economists, who contributed to the crisis, offered solutions, confirming Goethe’s observation: “There is nothing more frightening than ignorance in action.” Regulatory initiatives relied on self-confidence, which Samuel Johnson observed is “the first requisite to great undertakings.”

Former Fed Chairman Paul Volcker put his name to restrictions on banks trading on their own account or investing in hedge or private equity funds. Proprietary trading is hard to define. Testifying to Congress, Volcker indicated elliptically that bankers knew whether they were trading on proprietary account, recalling U.S. Supreme Court Justice Potter Stewart’s statement that while it was hard to define, he knew pornography when he saw it.

Hitherto little-known Arkansas Democratic Senator Blanche Lincoln and her Committee on Agriculture, Nutrition, and Forestry controversially proposed that banks spin off their derivative activities and be prevented from hedging their own genuine risks. Faced with a close re-election race, Senator Lincoln only wanted to be identified in voters’ minds for her anti-Wall Street stance: “My legislation brings a $600 trillion market into the light of day and ends the days of Wall Street’s backroom deals...that nearly destroyed our economy, hurting Arkansas small businesses and costing millions of Americans their jobs.”⁸

Regulators and legislators held educational sessions with banks and economists, ignoring author Thomas Pynchon’s warning: “If they can get you to ask the wrong questions then the answers don’t matter.”⁹

In January 2011, a new business-friendly study opposed steps to bring transparency to derivative markets, claiming that proposed regulations would result in 130,000 lost jobs and a $6.7 billion reduction in corporate spending. The study’s release was timed for maximum impact, coinciding with regulatory debate about proposed derivatives rules.

The study was undertaken by an “independent” economics and public policy consulting firm and included contributions by all-star academics. Except many of the firm’s advisers, including Nobel-prize-winner Joseph Stiglitz, were not advisers at all. When confronted, the consulting firm confirmed that Stiglitz had not contributed to the report, but had worked on other reports.

The firm stated that it had undertaken the report at a client’s request: “It was a hypothetical study.” The firm suggested that the reason a number of academics advisers wanted to distance themselves from the report had nothing to do with the report’s conclusions. It was because of the movie Inside Job, which raised questions about economists and their consulting arrangements with big business.¹⁰

Banks and their lobbyists believed, like English poet William Davenant: “Had laws not been, we never had been blam’d; / For not to know we sinn’d is innocence.” Wolfgang Schäuble, the German finance minister, had the right idea: “If you want to drain a swamp, you don’t ask the frogs for an objective assessment of the situation.”¹¹

Familiar arguments were trotted out—loss of competitive advantage, diminished financial innovation, slower capital formation, and higher cost of capital. If arguments for self-regulation failed, then banks tried to minimize scrutiny, masterfully narrowing proposed rules limiting impediments to profitable activities via exclusions and exemptions. As American radio and television commentator Charles Osgood observed: “There are no exceptions to the rule that everybody likes to be an exception to the rule.”

Bankers threatened relocation to friendly locales, with the loss of jobs and taxes. When London introduced higher taxes and intrusive regulations, banks considered moving to Geneva, Monaco, Bulgaria, or Macedonia—any place with lower taxes, the required infrastructure, minimal regulations, good-looking women or men, recreational facilities, and favorable divorce laws.

The U.S. Financial Reform Act that emerged was 2,300 pages long. The Congress website warned: “This bill is very large, and loading it may cause your web browser to perform sluggishly, or even freeze.” As one commentator put it: “it’s no longer an act, it’s word processors gone mad.”¹² In 2010, 500 central bankers and regulators from 27 nations produced Basel III, 440 pages of new rules. The frenetic activity recalled Italian author Giuseppe di Lampedusa: “everything must change so that everything can stay the same.”

As before, the revised rules were susceptible to being manipulated, through regulatory arbitrage. Many of the rules had little to do with improving regulation, instead focusing on familiar regulatory turf wars or battles for power, staff and budgets, as well as settling of old scores. Regulatory initiatives did little to address the quality of regulators and the acuity of oversight or enforcement of breaches of the law.

The case for greater oversight of the financial system was not helped by the fact that the U.S. Government Accountability Office (GAO) had found faults with the SEC’s financial statements, since it began producing audited statements in 2004. In November 2010, the GAO found that the SEC’s books were in disarray, failing in fundamental tasks such as accurately accounting for income from fines, filing fees and the return of illegal profits. Ironically, if any company’s auditor had identified similar long-standing weaknesses in its accounting, the SEC would have investigated it immediately.

The much-touted Volcker rule, limiting the ability of banks to trade with client money, emerged riddled with loopholes, most notably allowing banks to take positions where they are trading securities and instruments with or for clients. Reviewing the legislation, a leading derivative lawyer told banks: “Given so much of proprietary trading has a client nexus to it, I’ll be embarrassed if I don’t manage to exempt all your activities from the rule.” Large banks promptly shut down their proprietary trading desks, transferring traders to client-focused market-making operations where they continue to trade as before.

Legislators and regulators discovered that Groucho Marx was right: “[government] is the art of looking for trouble, finding it, misdiagnosing it and then misapplying the wrong remedies.” The complexity of the issues means that ultimately no laws may be effective. As one famous law maker, Adlai Stevenson, observed “Laws are never as effective as habits.”

Recurrent financial crises may not be preventable, being embedded in the DNA of markets. As John Kenneth Galbraith warned: “Euphoria leading on to extreme mental aberration is a recurring phenomenon...there are no very obvious regulations that act as a safeguard and preventive; only acute personal and public awareness can do so.”¹³

Patient Zero

Greece, the cradle of Western civilization, was Patient Zero of the next phase of the crisis. As historian Arnold Toynbee observed: “An autopsy of history would show that all great nations commit suicide.”

Greece’s significance was not size (0.5 percent of global GDP) but its sizeable debts—€270 billion (113 percent of GDP) projected to rise by 2014 to around €340 billion (150 percent of GDP). Greece’s budget deficit was around 12 percent. Profligate public spending, generous welfare systems, low productivity, an inadequate tax base, rampant corruption and poor government were responsible for the parlous state of public finances.

In 2010, Greece found itself unable to borrow around €50 billion to pay back maturing debt and fund its budget deficit.

Greece was the canary in the coalmine, highlighting similar problems in the PIGS (Portugal, Ireland, Greece, and Spain), countries, which had €2 trillion of debt. Larger countries, the FIBS (France, Italy, Britain, and the States), had similar problems—high public debt, unsustainable budget deficits, and (in most cases) unfavorable trade deficits. There were long-term problems of ageing populations and unfunded social welfare schemes (pensions and health systems). Greece highlighted that government debt levels may be unsustainable and investors may not continue to finance them.

After prevaricating, the EU proposed a highly conditional €110-billion rescue package for Greece, including a contribution from the IMF, which would supervise implementation of the economic cure. Continued market skepticism forced the EU to go nuclear—a €750-billion stabilization fund to support eurozone countries.

Journalists spoke of financial ‘shock and awe’. ‘Panic’ better summed up the actions. Initially, stock markets rose sharply, especially shares of banks exposed to Greece who would benefit from the rescue. The interest rates on Greek, Irish, Italian, Portuguese, and Spanish bonds fell sharply. President Nicolas Sarkozy turned the eurozone’s sovereign-debt crisis into a personal triumph, letting it be known that the rescue was 95 percent French. Le Figaro reported Sarkozy’s comment that ‘in Greece they call me ‘the savior’.”

Karl Dunninger, a trader, captured the madness:

The most amusing part of this is that nations seriously in debt and without a pot to piss in will be ‘contributing’ some of the money to fund the debt. Spain, for instance, has pledged to do so. Where is Spain going to get the money from? Will they sell bonds at 8 percent to fund a loan at 5 percent? That’s a very nice idea...let’s see, we lose 3 percent on those deals. That ought to help Spain’s fiscal situation, don’t you think?¹⁴

It was reminiscent of the U.S. subprime debt crisis. Deeply troubled members of the eurozone could not bail out each other. On any reasonable analysis, the PIGS would still need to restructure debt—a polite term for default. Shock and awe quickly proved more shocking and less awe-inspiring than hoped. Only covering immediate financing needs, repaying maturing debt, and financing deficits, the plan did not address the problem of unsustainable levels of borrowing. The cost of borrowing for European countries rose to levels above those before the Greek bailout.

The IMF outlined the challenges facing the bankrupt countries: “a dysfunctional labor market, the deflating property bubble, a large fiscal deficit, heavy private sector, and external indebtedness, anemic productivity growth, weak competitiveness, and a banking sector with pockets of weakness.”¹⁵

Based on per capita income of $30,000 (roughly 75 percent of Germany), Greece gives the appearance of a developed economy. In fact, Greece’s economy and its institutional infrastructure are weak with low productivity, low quality, and endemic corruption. Around 30 percent of the Greek economy is unreported and informal, resulting in tax revenue losses of $30 billion per annum.

While entry into the euro assisted Greece’s ascension into major league status, it decreased competitiveness as the country priced itself out of many markets. The euro provided access to low-cost funds, financing a construction boom and generous social benefits. Greece’s borrowing fueled consumption or was channeled into unproductive uses. One commentator mused:

It’s a moot point whether Greece is a poor country masquerading as a wealthy country or vice versa.... If the old illusion was that Greece was a wealthy country, the new illusion is that Greece will, in short order, become wealthy enough to pay back ever-growing sums of debt.¹⁶

The same was true of many countries.

Russian writer Leo Tolstoy wrote that: “All happy families resemble one another, every unhappy family is unhappy in its own way.” The same could be said for the beleaguered European countries.

If Greece had a bloated public sector and an uncompetitive economy, then Ireland’s problems arose from exessive dependence on the financial sector, poor lending, and a property bubble. Portugal had slow growth, anemic productivity, large budget deficits, and poor domestic savings. Spain had low productivity, high unemployment, an inflexible labor market, and a banking system with large exposures to property and European sovereigns. Italy suffered from low growth, poor productivity, and a close association with the other peripheral European countries.

Ireland voluntarily implemented a draconian austerity program, trying to shrink its way to solvency. The Irish economy promptly fell into a deep recession. In late 2010 Ireland, too, needed an EU rescue package, prompting public anger at the humiliation. The Irish Times editorial referred to the Easter Rising against British rule, asking whether this: “was what the men of 1916 died for: a bail-out from the German chancellor with a few shillings of sympathy from the British chancellor on the side.”¹⁷ An Irish radio show played the new Irish national anthem to the tune of the German anthem. In Greece, the severe cutbacks in government spending saw strikes and violent protests on the streets of Athens.

Portugal, Spain, Italy, and Belgium now came under siege. In dealing with the threat, European politicians and central bankers preferred geography to economics. Prior to succumbing to the inevitable, Ireland told everyone that it was not Greece. Portugal now told everyone that it was not Greece or Ireland. Spain insisted that it was not Greece, Ireland, or Portugal. Italy said it was not in the PIGS in the first place. Belgium, a deeply divided country where the two main ethnic groups shared little more than a king and a large amount of public debt, insisted there was no “B” in PIGS or even PIIGS (if Italy was included with the other troubled economies).

Meetings of the EU in late 2010 and early 2011 broke up without clear agreement about how to deal with the European debt crisis. In April 2011, Portugal too sought a bailout. The predators of the financial markets now stalked the remaining over indebted countries, looking to pick them off one by one.

Amid talk of an even larger permanent safety net, Europe resembled a group of mountaineers roped together. As the members fell one by one, the survival of the stronger ones was increasingly threatened. With uncharacteristic common sense and clarity, Jyrki Katainen, the Finnish finance minister, identified the unpopular but obvious solution: “There’s no miracle which we should wait for. If you have more expenditures than income, then you have to adjust it.”¹⁸

Nowhere to Run, Nowhere to Hide

Policymakers had gambled that government support and public debt could keep the game going. David Bowers of Absolute Strategy Research set out the strategy: “It’s the last game of pass the parcel. When the tech bubble burst, balance sheet problems were passed to the household sector [through mortgages]. This time they are being passed to the public sector [through governments’ assumption of banks’ debts]. There’s nobody left to pass it to in the future.”¹⁹ It was the grifter’s long con, great if it works but difficult to pull off.

The European sovereign debt crisis showed that governments were now the problem, calling time on the wishful thinking of financial markets. Governments throughout the world were forced to embrace the new austerity to reverse the deterioration in public finances, with new taxes and cutting expenditures. In a CNBC interview in June 2010, New York Governor Patterson described it as “an unavailability of spending crisis.”

Withdrawal of government support would reduce global demand, threatening to create a prolonged period of stagnation, like Japan’s two lost decades. But the alternative—problems of public sector solvency and a clutch of sovereign debt rescheduling—risked a sharper deterioration in financial and economic conditions.

The problems in Europe masked the bigger problem—US government debt, growing at $1 trillion a year. Commentator David Rosenberg observed in 2011:

In the past three years...the U.S. public debt [exploded] by $5 trillion—the country is 244 years old and over one-third of the national debt has been created in just the past three years.... The U.S. government now spends $1.60 in goods and services for every dollar it is taking in with respect to revenues which is unheard of—this ratio never got much above $1.20, not even during the previous severe economic setbacks in the early 1980s and early 1990s.²⁰

US national debt approached 100 percent of GDP. U.S. states and municipalities toiled under large debt burdens. In 2009, the U.S. Treasury received $3.1 million in gifts from citizens trying to pay down the country’s massive debt. Given that the United States owed its creditors $13.4 trillion, it would take 4,322,581 years of similar gifts to pay back the debt.

Government debt problems were almost universal. Japan’s public debt approached 200 percent of GDP, and the government each year borrowed more than it raised in taxes. The Ministry of Finance ran ads promoting ownership of government bonds: “Men who hold JGBs [Japanese Government Bonds] are popular with women!”

There was no shortage of ideas of trying to finance government debts. Bankers suggested the US issue perpetual debt, that is, the government would not be obligated to pay back the amount borrowed at all. Peter Orzag, former director of the U.S. Office of Management and Budget under President Obama and now a vice-chairman at Citigroup, suggested another creative way to correct the problem—lotteries. To encourage savings, banks should offer lottery-linked accounts offering a lower rate of interest, but also a one-in-a-million chance of winning $1million for each $100 deposited.²¹

As governments printed money to service their debts, the U.S. Postal Service issued 44-cent first class “forever stamps” that had no face value but were guaranteed to cover the cost of mailing a first class letter, regardless of how high that cost might be in the future. Between 2007 and 2010 the public bought 28 billion forever stamps. The scheme summed up government approaches to public finance—USPS was cleverly hiding its financial problems, receiving cash upfront against the uncertain promise to pay back the money somewhere in the never, never future.

Concerns about banks reemerged, as games of extend and pretend failed. Banks had lent over $2.2 trillion to the PIGS, with French and German banks alone lending over $1 trillion. In Spain the government was forced to rescue the regional savings banks, the cajas, who had made bad property loans. Once a pawn shop run by Christian charities, CajaSur opened board meetings with the blessing: “In the name of Jesus Christ, amen.” One incredulous European regulator asked: “How was a priest in Córdoba able to weaken the Euro? The world has gone mad.”²²

It was unclear how increasingly facile money games were going to fix the problems of excessive levels of debt. Like a man told that he is going to die in a particular place and who tries to avoid going there, governments refused to face the inevitability of reducing debt and with it economic growth.

Borrowing is repaid by selling assets or by redirecting income towards repayments. For private borrowers, the current value of their assets, such as their house, did not cover the outstanding debt. The income and cash flow generated was insufficient to cover interest costs or repay the borrowing. Governments had few assets to show for the money they spent. Unable to continue to borrow or raise sufficient taxes to pay down their borrowings, their only choice was to print money, destroying the value of the currency.

In Germany, the paymaster and strength behind the EU, ordinary citizens resented footing the bill for rescuing profligate European neighbors. Germany’s biggest tabloid Bild asked “First the Greeks, then the Irish, then...will we end up having to pay for everyone in Europe?”

Germans wanted the return of their Deutschemark, replaced by the euro, pining for a time when “Mark gleich Mark—paper or gold, a Mark is a Mark.”²³ The nightmare of Weimar, the erosion of the value of money, hovered in the background. As governments borrowed ever-larger sums, ordinary citizens feared that even gilt-edged government securities would become worthless. As a banker asks an old woman in 1918: “where is the State which guaranteed these securities to you? It is dead.”²⁴

In Germany, gold was available from vending machines in airports and railway stations—gold to go. Shoppers could buy a 1-gram wafer of gold for €30 or a larger 10-gram bar priced in early 2011 at €245. Refiners were unable to keep up with demand for gold bars and coins. As poet John Milton wrote: “Time will run back and fetch the age of gold.”

In the 1930s, Herbert Hoover prematurely predicted recovery: “Gentleman, you have come sixty days too late. The Depression is over.”²⁵ In early 2011, as policy makers announced “economic mission accomplished,” self-reinforcing events drove a pernicious reversal. The logo on a black T-shirt worn by Lisbeth Salander, the heroine of Stieg Larsson’s Girl with the Dragon Tattoo, represented the outlook: “Armageddon was yesterday—today we have a serious problem.”

Built to Fail

Paul Volcker identified the deeper problem:

We have another economic problem which is mixed up in this of too much consumption, too much spending relative to our capacity to invest and to export. It’s involved with the financial crisis but in a way it’s more difficult than the financial crisis because it reflects the basic structure of the economy.²⁶

Modern economies worshipped quantifiable economic growth following Lord Kelvin, the scientist: “When you cannot measure it, when you cannot express it in numbers, your knowledge is of a meager and unsatisfactory kind.” As Senator Robert Kennedy argued: “It measures everything, in short, except that which makes life worthwhile.”²⁷

Economic growth meant consumption, mostly optional. Philosopher Henry David Thoreau identified the tendency: “Most of the luxuries, and many of the so-called comforts of life, are not only not indispensable, but positive hindrances to the elevation of mankind.” Václav Havel, the Czech playwright, led the 1989 Velvet Revolution overthrowing communism. Twenty years on, he criticized the “palaces of consumerism” and an emerging society dominated by mobsters and bankers.²⁸ In Poland this new economy was known as the Glitzkrieg.

In the age of capital, financial assets and real wealth were confused. Money was a claim on real things, to be used or enjoyed. Increasing financial wealth, dividing real things into a larger number of pieces, did not create wealth. Trading things and boosting prices does not change a loaf of bread or its nourishment value. The world maximized something without understanding what it represented.

A strong stock market and high prices for houses and other financial investments were now barometers of growth, wealth and economic health. Investors in China used the Shanghai Stock Market to measure China’s economic progress. Unrepresentative of China’s economy, the stocks traded were characterized by inadequate information, poor economic data and questionable accounting disclosure. Regulation and corporate governance was poor, with frequent government intervention. Trading was speculative, anticipating investment fashions, changes in liquidity and government intervention.²⁹ Bill Miller, a famed fund manager, even saw the stock market as a substitute for the real economy: “Using the outlook for the economy to predict the direction of the stock market...is to look at things the wrong way round.”³⁰

Over 50 percent of stock trading was now between super-fast super computers using mathematical algorithms. The average holding period was a few seconds. In The Girl with the Dragon Tattoo, journalist Mikael Blomkvist sums up the stock market’s role:

You have to distinguish between two things—the...economy and the...stock market. The ...economy is the sum of all the goods and services that are produced every day.... The Stock Exchange is something very different. There is no economy and no production of goods and services. There are only fantasies in which people from one hour to the next decide that this or that company is worth so many billions more or less. It doesn’t have a thing to do with reality or with the...economy.³¹

Asked what the stock market would do, J.P. Morgan a century ago had given the correct response: “Fluctuate.”

By the late twentieth century, houses, providing shelter and refuge, were a financial investment, even though rising prices did not actually make anyone richer. Tapping into this seemingly increased wealth required borrowing money, which, as it had to be paid back together with interest, did not increase wealth.

Monetary values also shaped attitudes and behavior, at a deeper level. The anonymity of money and distance from the effects of their decisions allowed bankers to justify their decisions. Bankers structuring, selling or trading shares or bonds did not relate it to the factory or business that the instruments helped finance. Traders did not see that short selling shares or bankrupting a business resulted in workers losing their livelihoods and the hardship that families and communities suffered. As they did not make or create anything, the only measure was the money they made or lost.

In The Grapes of Wrath, John Steinbeck captured the confusion:

No man touched the seed, or lusted for the growth. Men ate what they had not raised, had no connection with the bread.... Owners no longer worked on the farms. They farmed on paper; and they forgot the land, the smell, the feel of it and remembered only that they owned it, remembered only what they gained and lost by it.³²

End of Ponzi Prosperity?

Economic growth and wealth was also based on borrowed money and speculation. It relied on allowing unsustainable degradation of the environment and the uneconomic, profligate use of non-renewable natural resources, like oil.

Aggressive increases in debt globally increased economic growth, allowing society to borrow from the future. It accelerated consumption, with spending that would have taken place normally over a period of many years squeezed into a short period because of the availability of cheap borrowings.

When few people were rich and most were poor, gambling was necessary to survive. Over time, society developed a risk-averse predictability, built around high levels of employment, job security, improving living standards, and welfare systems, including pensions and healthcare. As post-war certainties eroded, speculation, once associated with horse racing or glamorous casinos, became an essential means of assuring survival and financial security.

When the housing bubble collapsed, the American satirical magazine The Onion demanded that the American people be given another bubble to invest in. As Adam Smith recognized: “The chance of gain is by every man more or less overvalued, and the chance of loss is by most men undervalued.”³³

There are similarities between the financial system, irreversible climate change, and shortages of vital resources like oil, food, and water. In each case, society borrowed from the future, shifting problems to generations to come. In the end, you literally devour the future until eventually the future devours you.

Once, religious belief preached forgoing the pleasure of the present for the promise of reward in the afterlife. Now, society literally sacrificed the future for the ephemeral pleasures of the present. As Ireland’s boom collapsed, Abbot Mark Patrick Hederman encapsulated the triumph of material ambition over faith: “People lost interest in the other world while they were so successful in this one.”³⁴

Short-term profits were pursued at the expense of risks that were not evident and would only emerge later. Financiers entered into increasingly destructive transactions, extracting large fees and leaving taxpayers to cover the cost of economic damage. In a March 2010 paper, the Bank of England’s Andrew Haldane compared the banking industry to the auto industry. Both produced pollutants—for cars, exhaust fumes; for banks, systemic risk. Extreme money polluted the economy.

In 2010, the failure of a deep-water undersea oil well in the Gulf of Mexico caused an environmental disaster. BP believed any spill unlikely, not anticipating any risk to walruses, sea otters and sea lions. This was unsurprising as none of these species were found in the area. BP’s disaster-recovery plans for the Gulf of Mexico had been cut-and-pasted from a similar document for the Arctic.³⁵ Four days before the disaster, a BP employee defended a short cut: “Who cares, it’s done, end of story, will probably be fine.”³⁶ The failure cost 11 lives, and 4,900,000 barrels of oil leaking into the ocean. People of the Gulf Coast lost their livelihoods. Uncounted millions of animals, birds and other living organisms died.

The UK government and press defended BP, arguing that UK pensioners depended on its dividends. They pointed out that strictly speaking BP was not entirely a British company, as 30 percent of its shares were held by U.S. investors. When President Obama sought a temporary suspension of deep-water drilling in the Gulf of Mexico, oil companies argued the destruction of the eco-system of business. Financial considerations exculpated one of the biggest environmental disasters in history.

Bankers proposed creating tradable carbon credits to combat climate change. The credits would give businesses the right to pollute up to a specified level. The real driver was that banks could trade the credits, earning profits. John Maynard Keynes anticipated the environmental debate: “We are capable of shutting off the sun and the stars because they do not pay a dividend.” James Lovelock, who warned of climate change before it was fashionable, dismissed subsidised renewable energy and financial initiatives to control climate change as a money-making scam that “doesn’t do a damn thing as far as reducing climate change.”³⁷

The world tried, unsuccessfully, to defy financial gravity, with a variety of tricks. Their wealth and prospects greatly diminished, men and women everywhere found that, like Alexander Pope: “They have dreamed out their dream and awaking have found nothing in their hands.” As always, the reality was more complex. A few had gotten out before the problems started, through prescience or luck. Some lost the lot. Most people gave back the gains of the good years and more, finding themselves with a lot less than they thought. Their houses were worth less. The value of their savings and retirement funds had decreased substantially. But expectations had been built upon their recent “wealth” and belief in the inevitability of continued future gains from rising house and share prices. As writer Anne Enright reflected after the collapse of the Irish boom: “Ireland is a series of stories it tells itself. None of them are true.”³⁸ The same was true everywhere.

As Malthus and the Club of Rome warned, there are limits to growth. Computer engineer Jay Forrester observed:

Growth is a temporary process. Physical growth of a person ceases with maturity. Growth of an explosion ends with destruction. Past civilizations have grown into overshoot and decline. In every growth situation, growth runs its course, be it in seconds or centuries.³⁹

Environmental advocate Edward Abbey put it more bluntly: “growth for the sake of growth is the ideology of a cancer cell.”⁴⁰ At the launch of the “Redefining prosperity” project exploring limits on economic growth, Tony Jackson, professor of sustainable development at the University of Surrey, wrote in the New Scientist that a UK Treasury official accused the authors of wanting to “go back and live in caves.”

In Rabbit Is Rich, John Updike’s Harry Angstrom ruminates: “Seems funny to say it, but I’m glad I lived when I did. These kids coming up, they’ll be living on table scraps. We had the meal.”⁴¹

Losing the Commanding Heights

The crisis called into question the capability of government and policy makers to maintain control of the economy—Lenin’s “commanding heights.” All competing economic philosophies were underpinned by the same reliance on growth and built-to-fail economic models. An elite class of mandarins, economists, and bankers, uninterested in and unresponsive to the concerns of the wider public, believed that the economy could be managed by deliberate actions.

But governments and central banks may not be able to address deep-rooted problems in the current economic order. In 2008, Andrew Gelman, professor of statistics and political science at Columbia University, wrote:

The law of unintended consequences is what happens when a simple system tries to regulate a complex system. The political system is simple. It operates with limited information (rational ignorance), short time horizons, low feedback, and poor and misaligned incentives. Society in contrast is a complex, evolving, high-feedback, incentive-driven system. When a simple system tries to regulate a complex system you often get unintended consequences.⁴²

The economic model itself is the source of the problem. Zhou Xiaochuan, governor of the Chinese central bank, commented:

Over-consumption and a high reliance on credit is the cause of the U.S. financial crisis. As the largest and most important economy in the world, the U.S. should take the initiative to adjust its policies, raise its savings ratio appropriately, and reduce its trade and fiscal deficits.⁴³

More ominously Chinese President Hu Jintao noted: “From a long-term perspective, it is necessary to change those models of economic growth that are not sustainable and to address the underlying problems in member economies.”⁴⁴

Governments and central banks have intervened in the economy to protect and boost the prices of financial assets repeatedly over the last 30 years. The policies had little to do with real things—the goods and services that the economy produces in the long run. It is not clear how, if at all, printing money or other financial alchemy can really create wealth. In the financial crisis, their actions propped up prices at exaggerated levels, not reflecting their true value. In the eighteenth century John Law used similar strategies to prop up the price of shares in his Mississippi trading company until everybody realized that the delta was nothing more than a swamp.

Policy makers and bankers are united in denial. As John F. Kennedy knew: “The greatest enemy of the truth is very often not the lie—deliberate, contrived, and dishonest—but the myth, persistent, persuasive, and unrealistic. Belief in myth allows the comfort of opinion without the discomfort of thought.”⁴⁵

In 2009, Lloyd Blankfein, chairman of Goldman Sachs, described by Matt Taibbi of Rolling Stone as a “great vampire squid wrapped around the face of humanity,”⁴⁶ told the UK’s Sunday Times that he was “doing God’s work.” Facing public anger, Blankfein, who earned $54 million for a year’s work just before the crisis, remained unapologetic about the firm’s behavior. In a piece of historical revisionism that Joseph Stalin would have admired, Goldman Sachs claimed that it never needed government assistance and would have survived the crisis without it.⁴⁷ As old communists knew, it is difficult to know what will happen yesterday.

As Keynes wrote in 1933:

We have reached a critical point. We can...see clearly the gulf to which our present path is leading.... [If governments did not take action] we must expect the progressive breakdown of the existing structure of contract and instruments of indebtedness, accompanied by the utter discredit of orthodox leadership in finance and government, with what ultimate outcome we cannot predict.⁴⁸

Zen Finance

Prospects of a less wealthy world with lower growth prompted erudite papers, books, and seminars, including The Future of Capitalism and The Economics of Happiness. There were downshifting and slowness movements, advocating a higher quality of life, and more leisure rather than material wealth. French President Nicolas Sarkozy commissioned a report by two Nobel prize-winning economists to develop a new measure—GNH or gross national happiness. One commentator termed it “gross domestic fudging if feminine attractiveness, length of vacations, and quantity of garlic in the food can be included, France will rank much higher than in more old-fashioned measures.”⁴⁹

An economic system built on a Zen Buddhist renunciation of wealth and materialism is unlikely. In 1979, U.S. President Jimmy Carter argued that consumption did not provide humans with meaning. He was defeated by Ronald Reagan, who asked voters if they felt better off after 4 years of Carter’s presidency, dogged by high unemployment, high inflation, high oil prices, and low growth. GNH acknowledged the end of high growth. The new measure allowed politicians to manipulate statistics, maintaining the fiction of improving living standards.

The global financial crisis prompted public demonstrations across the world, against bankers, finance, and government bailouts. In 2010, workers went out on strike, protesting against cuts in jobs, salaries, benefits, pensions, and working conditions as governments embraced austerity to restore public finances.

In the short run, ordinary people, paying for the costs of the crisis, were angry with financiers. During the 1789 French Revolution, financiers blamed for the social conditions were called the “rich egoists.” In the longer run, the effects of reductions in living standards, reduced wealth, and social hardship for the worst-affected members of society are unpredictable. In 1944, President Roosevelt called for a “second bill of rights” recognizing that “true individual freedom cannot exist without economic security and independence.” Roosevelt’s words resonate today: “People who are hungry and out of a job are the stuff of which dictatorships are made.”⁵⁰

But the complicity of ordinary people is difficult to ignore. Many were investors, directly or indirectly through retirement schemes, who turned a blind eye to excess. Investors ignored generous pay packets for bankers while the bankers made investors richer and facilitated economic growth. Home owners did not complain when their properties rose in value. Socially progressive people accepted the position of graffiti artist Banksy: “We can’t do anything in the world until capitalism crumbles. In the meantime we should all go shopping to console ourselves.”⁵¹

After the Bear Stearns hedge fund managers were found not guilty of all charges, a member of the jury said that not only was Ralph Cioffi innocent but that she would be happy to have him manage her money. 1980s’ New York Downtown performance artist Sue Anne Harkey captured this acquiescence: “It’s not about them, it’s about us. We are them and they are us. I have no pride, I have no shame. I have no guilt, hiding behind blame.”⁵²

Indian activist Arundhati Roy, who has waged countless battles against India’s drive for development while ignoring the human cost, wrote optimistically: “Another world is not only possible, she is on her way. On a quiet day I can hear her breathing.”⁵³ She echoed Pa in The Grapes of Wrath: “They’s a change a-comin’. I don’t know what. Maybe we won’t live to see her. But she’s a-comin’.”⁵⁴

But unable or unwilling to change, policy makers modeled themselves on the English ruling classes during the twilight of the British Empire as captured by George Orwell:

Clearly there was only one escape for them—into stupidity. They could keep society in its existing shape only by being unable to grasp that any improvement was possible. Difficult though this was, they achieved it, largely by fixing their eyes on the past and refusing to notice the changes that were going on round them.⁵⁵

Like F. Scott Fitzgerald’s tragic hero Gatsby, they looked back: “Can’t repeat the past? Why of course you can!”⁵⁶

Unknown Unknowns

Money was the mirror of the times. Extreme money was money made endless, capable of infinite multiplication, completely unreal. It changed everything—individual life, business, even countries. Voodoo banking made financiers the heart of the economy, increasing their profits. False gods and fake prophets, “los Cee-Ca-Go boys,” provided the text for debt and speculation. As Shakespeare wrote in The Merchant of Venice: “Even the devil can cite Scripture for his purpose.”

Everybody came to love leverage. To meet the need for debt, bankers built doomsday debt machines, slicing and dicing debt. Thinking risk had been tamed, traders engaged in financial arms races, stocking supermarkets with cocktails of risk for eager speculators. Hedge funds, the Minsky machines, emerged to play extreme money games.

The Masters of the Universe and their cult of risk had come to dominate economies and lives. Marshall McLuhan argued that “any technology gradually creates a totally new environment.” The human race created money and the finance economy. Somewhere thereafter, money and the finance economy recreated the human race, not always for the better.

Governments and policy makers now play financial games and pump money into the economy to try to restore growth and stability. There is increasing risk of a further more severe crisis, with a loss of confidence in government, risk-free sovereign debt and, of course, money itself. The risk of unavoidable financial, economic and social dislocation is ever present.

Ben Bernanke told the US Congress that the future now was “unusually uncertain.”⁵⁷ John Maynard Keynes understood “uncertainty”:

By “uncertain” knowledge...I do not mean merely to distinguish what is known for certain from what is only probable...the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence...about these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.⁵⁸

The future had always been uncertain. Human ability to predict and control the economic future had been an illusion. It was hubris—arrogant, excessive pride in achievements. In the end, Nemesis, the goddess of retribution and downfall, ends all dreams.