26 February 2009

Economist Niall Ferguson on the Financial Crisis: "There Will Be Blood"


"The way to make money is to buy when blood is running in the streets."
John D. Rockefeller

Here are excerpts of a lengthy interview with the noted economist Niall Ferguson. The entire interview can be read at the link provided to The Globe and Mail where it appeared.
Niall Ferguson, MA, D.Phil., is Laurence A. Tisch Professor of History at Harvard University and William Ziegler Professor of Business Administration at Harvard Business School. He is also a Senior Research Fellow at Jesus College, Oxford University, and a Senior Fellow at the Hoover Institution, Stanford University.
Who can truly say what will happen? After all, life is a school of probability. But if the trends of hubris and reckless disregard for justice continue we may very well have an opportunity to test John D. Rockefeller's investment advice.

The Globe and Mail
'There will be blood'

By Heather Scoffield
February 23, 2009 at 6:45 PM EST

...Policy makers and forecasters who see a recovery next year are probably lying to boost public confidence, he said. And the crisis will eventually provoke political conflict, albeit not on the scale of a world war, but violent all the same.

"There will be blood."

...And much of today's mess is the fault of central bankers who targeted consumer-price inflation but purposefully turned a blind eye to asset inflation. (The emphasis is not only purposely, but willfully so - Jesse)

....Partly because they can throw so much at it, and they can do it at a lower cost than anybody else, because the U.S. retains the safe-haven status, which makes the world so unfair. Here is the world's biggest economy, which gave us subprime mortgages, rampant securitization, the collateralized debt obligation, Lehmann Brothers, Merrill Lynch. It is, in a sense, the fons et origo of this crisis. And yet, because it retains safe-haven status, in a global crisis, investors want to increase their exposure to the U.S. Hence, the dollar rally. Hence 10-year Treasuries down below 3 per cent yields. It's almost paradoxical that an American crisis ... reinforces the status of the United States as a safe haven.

...As you know, Chimerica – the fusion of China and America – is one of my big ideas. It's really the key to how the global financial system works, and has been now for about a decade. At the end of The Ascent of Money, I speculate about whether or not that relationship will survive. If it breaks down, then all bets are off, for the U.S. and indeed for Asia. I think that's really the key point. Both sides stand to lose from a breakdown of Chimerica, which is why both sides are affirming a commitment to it.”

... “There will be blood, in the sense that a crisis of this magnitude is bound to increase political as well as economic [conflict]. It is bound to destabilize some countries. It will cause civil wars to break out, that have been dormant. It will topple governments that were moderate and bring in governments that are extreme. These things are pretty predictable.

The question is whether the general destabilization, the return of, if you like, political risk, ultimately leads to something really big in the realm of geopolitics. That seems a less certain outcome....

...It's just that I don't see it producing anything comparable with 1914 or 1939. It's kind of hard to envisage a world war. Even when most pessimistic, I struggle to see how that would work, because the U.S., for all its difficulties in the financial world, is so overwhelmingly dominant in the military world.”

....“It's obvious, surely we know by now, that this is something quite different. It's a crisis of excessive debt, the deleveraging process has barely begun, the U.S. consumers are not going to suddenly bounce back and hit the shopping malls just because they get a tax cut. The savings rate is going to continue to rise. These processes have tremendous momentum that quite clearly differentiates them from anything that we've seen, including the early 80s, including 73, 74, 75. Those big crises, the ones that we have lived through, were bad. But seems certain to be deeper, and more protracted.”

...“One possibility is that policy makers are lying in order to encourage people and prevent depression from become a self-fulfilling psychological conditions. That's why it's called a depression … Maybe they don't really believe this, but they're saying it in order to cheer people up, and if they're sufficiently consistent, perhaps people will start to believe it, and then it will magically happen.”

...“August, 2007, was when this crisis began. And if you were really watching the markets carefully, April is when it began, when the various hedge funds started to hemorrhage. The stock markets carried on until October of that year. And in many ways, consumer behaviour in the U.S. did not change until the third quarter of 2008. So there was a massive denial problem. It was like Wile E. Coyote running off a cliff, and they'd run off a cliff and they didn't look down so they didn't start falling. As soon as people realized it was bad, the behaviour switched. Now, people have to try to unscare them before this thing becomes a self-perpetuating downward spiral. I think that's why you have to say ‘growth will return in 2010' with your fingers crossed behind your back.”

...“We kind of have had a bubble in the sense that we've seen such a rally in U.S. government bonds. It's tempting to say that will burst and we'll see yields go back up. Because, you know, $2-trillion worth of debt is going to hit the market this year, maybe more. Supply is exploding just when demand is contracting. You don't need to be a Nobel laureate to see that that has to impact on the price. The difference is there is this thing called the Fed that can step in and start buying the stuff if the foreign demand fades. So it's not completely guaranteed that we'll see bonds sell off in price. (Yes but if the Fed starts overtly monetizing Treasury Debt the limiting factor will be the value of the dollar. It is a 'hinged' constraint, Bonds and Dollar - Jesse)

“There is still this inertia that prevents the dollar from falling off a cliff, that keeps the Treasury market from falling off a cliff. That's really important to bear in mind. I don't think we'll see a bubble distressed assets, because I think the price of these assets has started to fall. Anybody who comes into the market now is essentially paying a premium. There will be better bargains in the middle of this year, and maybe even better bargains later on. If I were in the market to buy distressed assets, I would wait, I would wait a bit longer until they're really desperate. And it might even be better to wait until they're bankrupt.”

...“In the Ascent of Money, I argue that you can't really have a bubble if you don't have a monetary authority that has been excessively generous. From John Law in 1719 to Alan Greenspan in the late 90s, there's always a banker, there's always a central banker making credit too readily available. The second thing is, though, that regulation may not prevent that.”

..."The two great zones of conflict in the 20th century were central and eastern Europe, and a critical part of northeast Asia – Manchuria, Korea. It makes me a little nervous that those are also places that are going to take a very heavy share of the pain. But we're looking at a Great Recession, not a Great Depression. We may be looking at a Lost Decade.

There was a time when if you said the United States was going to suffer a lost decade like Japan did in the 1990s, everybody would have said you were a mad pessimist. That begins to look like quite a good scenario. And I think it's a realistic scenario.

One of the facts is if you subtract mortgage equity withdrawal from the Bush years, the real underlying rate of growth of the U.S. economy was 1 per cent. So much of the consumption has been fuelled by mortgage equity withdrawal. So that seems like a reasonable growth rate for 10 years.

We just don't have an improvement of standard of living of the sort we're grown used to. And indeed if you have a more equitable redistribution through the tax system, which Obama is committed to, it might actually be no discernible downside for middle America and lower-class Americans. So many of the benefits of the boom went to the elites. If you have a lost decade plus redistribution, it may not be that dramatic a change for many, many people. People just have to get over the fact that their wealth wasn't worth what they thought it was in 2006. Whether it's their stock market portfolio or their housing. If we simply go back to where we were, in 2005, that's surely not the worst thing that could happen to us.”