I had some expectations before going to this lecture after reading Niall Ferguson's several books on Empire and watching him several times chit-chat with Fareed Zakria on CNN.
(Telegraph Review of the Book for further background)
Nicely puts the current crises in perspective: "Money doesn't make the world go round, but "it does make staggering quantities of people, goods and services go around the world,"" according to Niall Ferguson.
along with this lecture I attended, makes it a convenient way of not reading the book, but coming to grips with its main points.
Ferguson starts the lecture by going over how debt securities, stock market capitalization and exchange traded derivatives (each more than 50 trillion) has over-taken World GDP (48 trillion). This relative growth of finance has "outgrown our planet earth" believes Ferguson. Mocking the uber-quoted Goldman Sachs report over 2 years ago on the BRIC - Brazil, Russia, India, China - economies, he amuses the the lecture crowd with dramatizing the current the global liquidity crises where the "BRICs are dropping like BRICKS".
Going back in history (aside from being irritated by the Lecture Theatre's dysfunctional PowerPoint remote), he takes the current crises vis-a-vis the 1914 economic crises. In fact, Ferguson believes the 1914 crises (different to the extent it was caused due to a geopolitical shock) was much bigger than the Great Depression, but was suppressed by Governments all over the worlds through various instruments.
Recalling an invitation to the Bahamas to lecture some Hedge Fund whiz-kids almost 2 years to the day of this lecture, he recounted how the Hedge Fund Scrooges failed to heed his warnings on the forthcoming crises and instead told him that they should rather watch Marry Poppins next time. Considering there was a "run on the Banks" in Marry Poppins, this stirred a few laughs in the crowd and Ferguson happily agreed with the short-sighted hedge fund magnets on their movie choice.
Going back to why this lecture is important, Ferguson reminds everyone that Northern Rock was the first British bank to fail since 1866; this lack of appreciation of financial history is the main problem right now.
Swinging from Ancient Mesopotamia where clay tablets were used as money (these tablets can be found in the British Museum even today - quite robust) to Potosi in Bolivia - main source of silver for the Spanish Empire in the 16th Century - Ferguson cites that the failure of the Spanish Empire to understand to the true meaning of money led to the first European-wide inflation. Disregarding the loss of life that resulted in mining silver, the Spanish Empire kept wanting more to finance wars; however inflation was only natural since they could not understand what money meant. Here Ferguson drives his main point: Money is not metal, but based on relationship and trusts. (UBS ADVERT maybe?)
Then Ferguson handsomely dips into the Renaissance where the Medici family made MONEY respectable by utilizing economies of scale. How a breakdown in trust had led us from Medicis to Lehman Brothers has led us to some sort of blame game. Hailing Fractional Banking at par with Newton's discoveries, Ferguson believes that Fractional Banking has been crucial in our growth as it has led to the creation of credit like never before seen in our history.
Not only have Bankers abused trust, Ferguson gave a cold caveat: European Banks are even more leveraged than US Banks. What does this mean? Well, simply that the crises will become was worse in the European Theatre than we imagine right now.
Charting out to the next part of the lecture, Ferguson tries to explain the rise of the Bond Market as an integral part of finance. Bonds were initially instruments for financing Government debt, but now the Bond Market encompasses mortgages in the form of Collateral Debt Obligations (CDOs), and no wonder we have no idea what is going on in this world. Such archaic instruments make it hard for anyone to understand all the risks involved. He praises Nathan Rothschild (maybe because he has written a book about him) for single-handily internationalizing the Bond Market by getting Prussia, Russia, Brazil, Spain to the London Bond Market. (Sell bonds to wage wars - a good idea.)
The third part of the lecture is on the Stock Markets. Invented in Amsterdam to finance the Dutch East Asia Company, they have grown beyond imagination. They essentially price future relative price earnings into present price - clearly this is what makes them volatile. Ferguson gives the example of John Law (1720) just after the Napoleonic Wars and how the Mississippi Cornucopia led to the first bubble in France.
What causes financial bubbles?
1 - great expectations
2 - Lack of monetary authority
He criticizes Ben Bernanke's infamous speech in 2005, "The Great Moderation", where Bernanke wrongly prophesies that bubbles were over. Ferguson further believes the US Feds' focus on inflation, and lack of focus on asset-price inflation thereof, is a large reason why we are in such a mess right now. Interesting......
Fourth part is the insurance industry. First invented in Edinburgh, the industry made a lot of money by calculating risks that follow a normal-bell curve with incidents around the mean. Ferguson compares financial risks to earthquakes that are a lot bigger and harder to calculate. An example from history was the Tokyo-Yokohama earthquake that destroyed the Japanese insurance industry. He feels this is precisely why we need Welfare states to insure against big incalculable risks like earthquakes and financially busts.
Fifth part of the lecture focused on Real Estate. Ferguson looks to the Great Depression where a great leap led to greater ownership of land. According to him, Property Ownership Democracy championed by Regan and Thatcher makes a lot of political sense, but has financial limits. This obsession with property ownership as a the sole form of wealth generation for most of us is a bad idea, since property prices can swing both ways.
He blasts NINJA - No Income, No Job, (and) no Assets - loans
Finally, he talks about the financial crises as a global crises. CHIMERA, a portmanteau of China-US relations holds the key for our future declares Ferguson. On a funnier note, he explains CHIMERA is like marriage: "One does all the saving, while the other does all the spending." This analogy probably brought out the most applause during the lecture.
Ferguson ends by reiterating that the Western Financial System much like Democracy is bad, but it's the best system we have been able to develop so far, so we have no choice but to accept bubbles and busts. Three reasons contribute to such a cyclical roller coaster: 1) our own psychology; 2) future uncertainly; 3)evolutionary character of the financial system.
Date: Thursday 6 November 2008
LSE