Sunday, May 2, 2010

The Love Of Money -- Thoughts On Finance and Financial Reform

For the love of money is a root of all kinds of evil: which some reaching after have been led astray from the faith, and have pierced themselves through with many sorrows. -- 1 Timothy 6:10

Greece is being pierced with many sorrows at the moment, facing the prospect of years of deflation induced by drastic cuts in government spending, imposed as a condition of the $146 Billion the EU and the IMF have jointly agreed to lend Greece.

What sort of sorrows?  Essentially, Greeks will be working more for less--and will do so for the foreseeable future.  Among the new government spending cuts imposed by the bailout package:
  • Scrapping bonus 13th and 14th month wages for public sector workers as well as for retired people from both the public and private sectors.
  • Raising the retirement age for women from 60 to 65, bringing it in line with that for men;
  • Raising the sales tax from 21pc to 23pc this year.
Politically, the sorrows include a passing of a measure of sovereignty from Athens to Berlin, as Germany's pivotal role in assembling the bailout package empowers them to dictate many of the conditions:
Berlin was Europe's capital last week, basking in summer heat of 26 degrees. The heads of the European Central Bank and the International Monetary Fund (IMF) – both French, oddly – arrived as supplicants, pleading with Chancellor Angela Merkel and a stern finance committee of the Bundestag to save monetary union. Nowhere else mattered. The markets have stopped listening to Paris or Brussels.
On the other side of the globe, China is struggling to avert the sorrows of a bubble economy,  raising bank reserve ratios and employing other mechanisms to stave off inflation but with no immediate impact:
China’s third increase of bank reserve ratios this year left benchmark interest rates and the yuan’s peg to the dollar unchanged, risking the need for more concerted effort to contain property prices and inflation in coming months.
The common thread in both financial events is a subordination of policy and basic economic activity to a quest for currency.  Greece's bailout is driven by their accumulation of so much sovereign debt that they are effectively excluded from capital markets, while China's manipulations are calculated to curtail a growth of the money supply without curtailing the economic expansion behind the money supply:
The latest move adds to a government crackdown on property speculation after record price increases in March and came on a holiday weekend, with Chinese markets shut today. Within an hour of the central bank announcement, Finance Minister Xie Xuren said that officials remained committed to expansionary policies to cement the nation’s recovery. 
These events make it worth reminding oneself of the fundamental nature of money, and its relevance to economics at any level.  As Steve Forbes notes:
It's time to get back to basic economics. Money--both the paper and electronic varieties--is, in and of itself, worth nothing; it has no intrinsic value. It is a means--and a profoundly important one--of enabling people to more easily conduct transactions without having to go through the clumsy and utterly inefficient barter process.
Money is important only in that it makes transactions by which we convert other resources into the things and services we desire for whatever reason--and utterly irrelevant in all other aspects.  Money is a measure of value only.

As the above quotation from Timothy points out, a focus on money invariably leads to trouble.  Artificial manipulations of various money metrics, such as interest rates, serves mainly to distort the value statements implicit in the prices of goods and services.  Artificially pushing prices down (as China seeks to do) implicitly declares things to be somehow less valuable, even as the desire and demand for those things is otherwise unchanged. Constant borrowing, the particular fiscal sin of Greece (and, indeed, of a great many nations including the United States), explicitly involves paying for those things without surrendering other resources--in essence curtailing one-half of every transaction.

Perhaps nowhere is the irrationality of a focus on money itself more apparent than in the contradictory efforts in Washington to "reform" America's finance industry.  While on the one hand the SEC is pursuing a fraud case against one of the largest of the Wall Street banks, Goldman Sachs, Congress is pursuing "reform" legislation that would encourage Goldman to engage in still more of the behavior for which the SEC is seeking redress:
Recall that during the financial implosion of late 2008, Goldman was not bailed out directly by taxpayers, but instead received tax dollars as a creditor of AIG. Goldman received $12.9 billion in the “backdoor bailout” of AIG because of the credit default swaps it owned that AIG had insured. Goldman and other of AIG’s counterparties were paid by the government 100 cents on the dollar in this bailout, whereas creditors in bankruptcy court often get less than 50 cents on the dollar.
Bear in mind that Goldman Sachs was, ostensibly, an "investment bank" until 21 September 2008, when Goldman and Morgan Stanley, the other major investment bank in the United States at that time, opted to become "bank holding companies" and submit themselves to regulation via the Federal Reserve. Bear in mind also the presumed purpose of an "investment bank" is to assist "...corporations and governments in raising capital by underwriting and acting as the agent in the issuance of securities."

There is no denying the value to business of intermediaries such as a Goldman Sachs in gathering together the necessary funds to build a new factory or bring a new product to market. There is also no denying that the buying and selling of derivatives that has fascinated Wall Street in recent years has little to do with the actual raising of capital. Indeed, the financial crisis of 2008 did much to prove Warren Buffet's prescient 2003 description of derivatives as "financial weapons of mass destruction"; indeed, much of Greece's present financial dilemma appears to stem from their use--and apparent mis-use--of derivatives to sustain years of deficit spending.

A love of money, it seems, has the capacity to wipe out the economies of entire nations.

Perhaps, then, the Biblical caution offers some guidance for how to reform both financial markets and public finances.  If we are to focus less on money itself, one way to do that is to focus more on the actual value of things.  If we can remember that, in the act of purchase, we are merely converting one resource into another--e.g., turning a day's labor into food for the table--and that money is never a resource but merely the medium, perhaps we can see how to order our affairs--both public and private--so as to avoid the sorrows an inordinate focus upon money brings.  If governments can absorb the grim reminder of Greece that even sovereign debts must in time be repaid, they can muster the institutional will and discipline to not borrow beyond their capacity to repay.  If banks can acknowledge their contribution to value lies solely in their capacity to facilitate non-financial business activity, perhaps they can be dissuaded from the reckless and risky gambles that derivatives transactions have proven themselves to be.

From a practical policy perspective, the Biblical caution invites governments to restrain their spending to such revenues as may reasonably be raised--that while there can and should be debates over how much government should tax, and what government should tax, there should be little debate that government should not borrow except in extraordinary circumstance.  Similarly, the Biblical caution suggests that investment banking should return to its original focus--helping businesses raise capital--and should not "invest" in synthetic means with derivative pseudo-securities whose connection to tangible assets is increasingly nebulous, and that proper government regulation of financial markets would be to maintain clear relationships between investment securities and underlying tangible assets, and that money supplies be allowed to grow--or shrink--as a rational response to the expansion or contraction of an economy's asset base--not manipulated to gain transitory advantage over other currencies in other markets.

So long as governments and financial markets focus inordinately on money, and not at all on the actual values of things, the sovereign debt crisis of Greece and the private debt crises of Wall Street are dramas that will be replayed again and again.  Any effort to "reform" financial markets should begin with moving market focus away from money itself.