A decade after it hit, what was learnt from the Great Recession?
Governments skilfully tackled the symptoms, not the underlying disease
Dec 16th 2017
TEN years ago this month, America entered the “Great Recession”. A decade on, the recession occupies a strange space in public memory. Its toll was clearly large. America suffered a cumulative loss of output estimated at nearly $4trn, and its labour markets have yet to recover fully. But the recession was far less bad than it might have been, thanks to the successful application of lessons from the Depression. Paradoxically, that success spared governments from enacting bolder reforms of the sort that might make the Great Recession the once-a-century event economists thought such calamities should be.
Good crisis response treats its symptoms; the symptoms of a disease, after all, can kill you. On that score today’s policymakers did far better than those of the 1930s. Government budgets have become a much larger share of the economy, thanks partly to the rise of the modern social safety net. Consequently, public borrowing and spending on benefits did far more to stabilise the economy than they did during the Depression. Policymakers stepped in to prevent the extraordinary collapse in prices and incomes experienced in the 1930s. They also kept banking panics from spreading, which would have amplified the pain of the downturn. Though unpopular, the decision to bail out the financial system prevented the implosion of the global economy.
But the success of those policies, and the relatively bearable recession that resulted, allowed governments to avoid more dramatic interventions of the sort which, after the 1930s, gave the world half a century of (relative) economic calm. By reducing the need for radical innovation, the speed and efficacy of the response left the world economy less reformed and so vulnerable to the same forces that made the crisis possible in the first place.
Several shortcomings stand out. In dealing with the Depression, governments ultimately discarded the gold standard, the global currency regime that helped propagate the disaster. Countries on gold sacrificed monetary-policy independence, and had to respond to a loss of market confidence with an economy-bashing increase in interest rates, for instance. The system transmitted distress around the world. When one country acted to build up its gold reserves, others saw a sudden drain on theirs. The sooner a country left gold in the 1930s, the sooner its recovery began.
But the international system that facilitated the more recent financial crisis has been neither abandoned nor reformed. Open capital flows can put countries at the mercy of sudden swings in market sentiment. To manage this, many emerging markets accumulate foreign-exchange reserves, which can be drawn on in crisis. But these reserves add to a global glut of capital which depresses interest rates and encourages borrowing. Because reserves are so often held in the form of dollar-denominated bonds, they can destabilise the American economy. They also heighten the world’s exposure to American financial stumbles. This regime helped turn an American housing bust into a global crisis, and remains in place now. Although dangerous financial vulnerabilities in America will take time to build up again, the present financial peace is likely to be far shorter than the 75 years that separated the Depression and the Great Recession.
Big short memories
That would be less troubling had the world made itself more robust to future crises after the last one. In the years after the Depression, sweeping banking and financial reforms created new regulatory institutions and placed tight constraints on financial behaviour, which made finance a very boring industry for most of the next half-century. From the 1980s to the 2000s, those restrictions were largely undone: banks were given freer rein over the activities they could engage in and products they could create. The financial crisis could not have occurred without this liberalisation. Yet in its wake, the financial sector has been treated relatively gently. Oversight and disclosure have been improved and capital-adequacy rules toughened (see previous story). But some of these rules are now being relaxed, at least in America, and the financial industry’s weight in the world economy has scarcely changed. As a share of American GDP it has actually increased somewhat since 2007.
The stabilisation policies used in the Great Recession were vastly superior to those of the Depression. But today’s governments have done a worse job of learning from experience than did their forebears. Franklin Roosevelt did not simply seek to restore growth. Rather he promised reflation in order to make up the ground lost during the downturn. After the Great Recession, in contrast, most central banks (the Bank of Japan being a notable exception) were content to prevent prices falling, and have not actively worked to make up lost output. As a result, the recovery has been much weaker than in previous cycles, including the Depression (see chart), and monetary policy has taken longer to return to normal, leaving economies poorly prepared for the next recession. Similarly, the Great Recession demonstrated the value of automatic fiscal stabilisers, but governments failed to seize the opportunity to link tax and benefits more closely to the business cycle. Indeed, rules that have recently been adopted, such as Europe’s fiscal compact, constrain rather than harness fiscal policy.
The Depression enabled radical change by discrediting untrammelled capitalism and the elites who supported it. That had dangerous side-effects: it also empowered fanatical and dangerous political outsiders. Though financial and political elites were not spared a populist backlash after the Great Recession, they have largely kept their seat at the table, blocking the enactment of bolder reforms. The success of the response to the downturn helped avoid some of the disasters of the 1930s. But it also left the fundamentals of the system that produced the crisis unchanged. Ten years on, the hopes of radical reform are all but dashed. The sad upshot is that the global economy may have the opportunity to relearn the lessons of the past rather sooner than hoped.
Bitcoin-futures contracts create as many risks as they mitigate
And don’t mention tulip-bulb futures!
Dec 14th 2017
OFTEN promoted as a way of mitigating risk, futures contracts are frequently more like new ways of gambling. That was true of a close precursor to the instrument, introduced in the Netherlands in 1636, linked to the hot investment of the day—tulip bulbs. Likewise the world’s first two futures contracts linked to bitcoin. One launched on the Chicago Board Options Exchange (CBOE) on December 10th; the other was due to follow a week later on the Chicago Mercantile Exchange (CME).
As bitcoin’s price has soared to new highs (see chart), holders may be happy to have a way to hedge their exposure at last. But for many, the contracts are just another way in. Both contracts settle in cash (ie, for the difference between the agreed price and the actual spot price). No exchange of bitcoin is needed; similarly, in the Dutch precedent, no bulbs were involved.
Early trading on the CBOE certainly suggests a speculative market. In the first few hours, prices rose so quickly that trading twice had to be suspended. The contract has so far traded at a significant premium, of up to $2,000, to the spot price. This suggests there are more buyers than sellers—even though selling in the futures market offers a way to bet against bitcoin.
It may be that investors are willing to pay some premium to evade the mounting hassle entailed in buying bitcoin. In recent days, many bitcoin exchanges have seen systems failures. Also, prices have differed between exchanges by as much as 25%. And hackers stole bitcoin worth $64m (at the time) from a Slovenian exchange.
But the futures contracts have problems of their own. The CBOE’s price is set by an auction on just one modestly sized bitcoin exchange, Gemini. The CME’s price, in contrast, will be based on an index compiled from data from four exchanges. The collateral, or “margin”, required for clearing the contracts highlights their riskiness. The CBOE contract requires 44%; the CME first announced it would charge 35%, but then revised the figure to 47%. On most futures, margins are around 5-15%.
Thomas Peterffy, the head of Interactive Brokers, a large brokerage, warns that there could be a risk to clearing-houses themselves. Bitcoin, he points out, “can reach any price”. If bitcoin futures are taken up in large numbers, bitcoin prices rise far enough and end-clients are not able to put up more margin, brokers will be on the hook; a big enough rally could mean small brokers run out of money. This would leave the clearing-house responsible for unwinding the contracts, a difficult task if the margin for bitcoin contracts is mixed with that from other contracts, as now. Mr Peterffy thinks exchanges need to clear bitcoin futures in a separate legal entity.
Others share his concerns. In a rare open letter to the Commodity Futures Trading Commission (CFTC), America’s futures regulator, the Futures Industry Association (FIA), a global trade body, criticised the exchanges’ use of a self-certification process for the new contracts. It argued that this did not leave room for a debate about appropriate safeguards and whether separate clearing was needed. Ed Tilly, boss of the CBOE, says accusing his firm of sneaking in the new contract unnoticed is unfair. It has been discussing bitcoin with the CFTC for months (as has the CME).
Despite the unease, many brokers are helping clients use the new contracts. Optimists hope that bitcoin futures will become well-established and even make underlying markets more robust by dampening volatility. Pessimists recall that the tulip-futures innovation of 1636 did not stop the tulip-bulb crash of 1637.
The WTO remains stuck in its rut
Its ministerial meeting in Buenos Aires finishes with virtually no noticeable progress
Dec 14th 2017| BUENOS AIRES
“THERE is life after Buenos Aires,” soothed Susana Malcorra, chair of the 11th ministerial meeting of the World Trade Organisation (WTO). Multilateralism may not be dead, but it has taken a kicking. Expectations were low as the meeting began in the Argentine capital. They sank even lower as it progressed. Delegates failed to agree on a joint statement, let alone on any new trade deals.
Many arrived with a culprit already in mind. Robert Lighthizer, the United States Trade Representative, was the face of an administration that is both questioning the benefits of multilateralism and jamming the WTO’s process of settling disputes. As negotiations progressed, some delegates groused that American leadership was lacking. Some even speculated that the Americans might be happy if multilateral talks foundered. What better proof, after all, that the system is broken?
Ms Malcorra, without mentioning the Americans by name, warned against creating scapegoats out of those who might recently have “shifted gear”. The WTO, after all, had problems before Mr Lighthizer took up his job. Decisions are made by consensus, which leaves deals vulnerable to hostage-takers. In some cases, the victim is the negotiating agenda. Still hanging over the WTO is a 16-year-old negotiating round, in theory meant to further global development. Until that round is concluded, members such as South Africa are reluctant to negotiate on any new issues, like rules on e-commerce or investment facilitation.
Members arrived in Buenos Aires in disagreement, and refused to budge. The Indian delegation wanted to lift restrictions on its government’s ability to distribute stockpiles of food. When the Americans refused, the Indians looked for a way to retaliate. They ended up killing an agreement to ban subsidies for illegal, unreported and unregulated fishing—as national leaders had agreed to do by 2020 as part of the United Nations’ Sustainable Development Goals. Cecilia Malmstrom, the European trade commissioner, called this failure “horrendous”.
Amid the triumph of self-interest over the greater good, there were some grounds for cheer. For now, it seems Mr Lighthizer is planning to influence the multilateral system from within. A joint statement released by America, Japan and the European Union pledged “to enhance trilateral co-operation in the WTO” when dealing with excess capacity, forced technology transfer and local-content requirements.
Perhaps more importantly, members are actually moving ahead on some issues. A coalition of countries ranging from America and the EU to Cambodia has signed up to negotiate new rules on e-commerce on a plurilateral, rather than a multilateral, basis. As long as enough members agree among themselves for the deal to be worthwhile, and do not discriminate against other members of the WTO, a deal is possible. The message was clear: if some members want to block discussion, then they will be left behind.
It seems unlikely that a surge of plurilateral agreements will be enough to jolt the WTO into life. For that, the organisation’s members will need to show more commitment to it—and to learn the art of compromise. Roberto Azevêdo, the WTO’s director-general, wrapped up the conference by reminding members that “multilateralism doesn’t mean that we get what we want. It means we get what is possible.”
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