The consensus that there will be or already is a downturn going on in the US and other major economies is near universal, and the overall make-up of this 'recession' is being explained in traditional terms of negative growth for two quarters. But this recession is not of a kind that has been witnessed before.
This is not a typical inflation recession of the kind we saw in the 1960's through the 1980's, where governments brought in higher interest rates to cap price rises, slamming the brakes on investment and consumption. Nor is this a sudden jolt recession as in 1973 when oil prices quadrupled overnight, shocking the world into a rapid slowdown. It is not even a growth surge recession where critical resources or people are in short supply, causing a fallback in activity.
This recession will no doubt take a while to explain itself, and become labelled for its chief characteristics. Already it seems to be a recession caused in a new way to any others which have gone before it. In this post, I will try to give my interpretation as to why the world, in the middle of a period of the fastest growth ever known throughout history, seems to be slipping backwards into one almighty mess.
As I write the two biggest bond insurers in the world have just lost their Moody's Triple A status, and are losing market value fast. They cover exposure on $2,400 billion of bonds. If they go into liquidation, the effects on the world's banks will be terrible. In the words of Jamie Dimon, chief executive of JPMorgan, said this week when asked about bond insurers: “What [worries me] is if one of these entities doesn’t make it . . . the secondary effect . . . I think could be pretty terrible.”
Where did it all go so wrong?
Computers and IT are so much a part of our world now that it is easy to forget how recently these came into existence as everyday items in our lives, and assumed a pivotal role. I am 54 now, but I had not even seen a computer until I was 30. It was a privilege to see how tasks which before had been so time consuming as to be almost impossible, became easily achievable. For example doing the month end processing of accounts in my business used to take a whole month manually. With my first computer the whole thing was finished in less than one day. It was absolutely staggering to experience the change, and have so much time given back. Computers ended drudgery for millions.
Then came the arrival of information. On the back of all the data that began to be stored in PCs and mainframes, gradually the light of detailed information could be shone on business decision taking. When making a business decision prior to say 1984, you were mostly in the dark. It was hard to find out, for example who was a good risk and who was bad risk. You had to practically start your own detective agency, and build contacts to get good information about people in your industry.
Then one day, suddenly, and especially with the arrival of the internet, you could start paying at a reasonable price to find out in seconds if you wished to take a risk on a business proposal or not. What had once been a risk, requiring instinctive judgement, where an error would cause painful loss, could be tackled with a ready supply of online information at reasonable cost. Yet more pain was eliminated.
Businesses benefiting from these changes all over the world were able to grow much faster than before.
And then economic information about other countries began to improve so that people planning international investments could feel safe about exchange rate and other commercial risks, while at the same time being able to use email and internet telephony and other technologies to be 'with' people around the globe, all connected into a neat network that worked as a cohesive unit. None of this was possible prior to the 1990's.
Business and investment simply spread all over the globe, sending the world on a growth path of unprecedented proportions pulling hundreds of millions of people previously beyond the reach of the international economy, and joining them into the game. International finance in particular was revolutionised and empowered by technology to move money from where it was cheap to where it was expensive, and make enormous profits.
People borrowed money in Tokyo at 2%, converted currency and lent it in Britain in Sterling at 5%, or in New Zealand in local dollars at 6%, making gains on these currencies that swung up as their assets rose in price before a wall of money, and as their interest rates rose. This became known as 'The Carry Trade'.
Sovereign Funds such as China's trillions of dollars became available to swing around the globe riding short-term trends, or being used to shore up the dollar ensuring the USA provided a healthy market for Chinese manufactured goods. Hedge Funds found they could drive share prices down or up by concentrating their enormous financial resources, increasing investment returns as they went. Private Equity investors found that they could make money faster by buying businesses and selling them again, after a quick burst of energy to boost their earnings then by building them, or growing them long term. They could browse their targets online, and move in from a distance.
And yet while people were turning on their screens and looking at apparently rock-solid information, and feel sure that that they were buying a sure bet, and committing their organisations to placing billions into new and different risks, an air of unreality had somewhere crept in. In the beginning computers were speeding up tasks that had previously taken too long to be practicable. Then they provided information so quickly and efficiently, that what had previously been highly risky decisions, became well-informed low risk decisions. But then people decided to keep the party going, and use computer technology to repackage risks, and create new kinds of risk never before tradeable, buyable or sellable.
To do this, they had to make assumptions about the risks they were undertaking. But as they had all become used to the computers efficiently organising the complex details of their businesses, and calculating complex risks, many people had lost the risk-negotiating skills that were second nature to anyone in business pre-computers, to use their own minds to provide simple straight-forward notions, to refer to common sense. Lost in the machines and the complex systems they had created, people have forgotten how to be responsible for, or even to see the overall picture.
With the sub-prime securitisation, for example, buyers assumed that only a certain proportion of the debts they were buying would be problematic. They never imagined that nearly all of them would turn bad, although maybe even just one day spent checking around would have told any sensible person not to get involved.
In the Norther Rock Building Society in the UK, the Directors never imagined a situation would occur where other banks would not be willing to lend to them at all, and yet banking crises have happened every so often throughout history. The Directors there too had abandoned a sense of ordinary responsibility about the risks they were incurring.
All of these actors probably believed or assumed in the back of their minds that as a whole industry was getting involved in taking on unacceptable risks in the same way that they were, either the risks were really quite minimal, or they all assumed that in fact the government or some higher agency was keeping a watch over them from on high.
George Soros expressed his view of how risks are being wrongly managed as follows - The super-boom got out of hand when the new products became so complicated that the authorities could no longer calculate the risks and started relying on the risk management methods of the banks themselves. Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility.
And yet governments too have become overwhelmed by another effect of technology - the immediacy of communications. This has stopped most governments from getting involved in any detailed risk management and planning, merely concentrating on the news battles of every day. If things looked good enough in the media, then that was a good day's work done. The reality of the risks being undertaken by bankers was not even on the radar.
In the UK, fr example Gordon Brown dismantled the control previously exercised by the Bank of England, splitting up its responsibilities between three separate agencies, leaving none of them able to do much to prevent a crisis like the Northern Rock from coming into existence. Why he did it, is not exactly known, but he had claimed for himself ten years of favourable media comment for having done so, before the pigeons have finally come home to roost. And now the mess is obvious, he is showing more concern with news managing the crisis than dealing effectively with its underlying cause, the mistakes he made by stripping away the controls.
News organisations might in earlier simpler times have started asking questions, for example if it was sensible for so much sub-prime securitisation to be going on, or for Building Societies in the UK to be financing themselves predominantly with 24 hour interbank money at variable rates, and lending it for years ahead at fixed rates. But the media has got itself involved in trading with governments for favors, typically offering favorable comment to government in exchange for the right to expand their businesses, or win advertising revenues etc.
In fact there has resulted from the detachment created by technology a total abandonment of anyone acting in the role of responsibility-taker. Governments are pinned down by the need for short term approval. Media will say or write whatever it takes to please the government or whoever they are canvassing for favours. The ordinary common sense input of everyday people has been overridden and lost completely.
In Britain you used to contact your MP if there was some problem and hazardous situation building up. He would write to the Minister concerned, and mistakes by government were often rectified before they became generally destructive. MPs have so little power now, with the power handed over to Brussels by Treaty, that most people don't bother trying to communicate back to government any more. They simply give up running their businesses, emigrate or find a way to get out of the way of the bureaucratic behemoth that government has become.
This is another critical change brought about by the same technology. In the hands of government, computer technology has enabled agencies to be created to manage industries such as farming or fishing, health, health & safety, families, money, education - in fact anything that moves, severely restricting the choices an individual person or company is permitted to take. In such an environment, most decide that it's not worth fighting the system to do any good, as they might have done in a past kinder slower pre-technology world. All people see left is the opportunity to look after themselves. Caring about others or consequences is nigh impossible anyway, and a totally frustrating pointless pastime, with government intruding into every aspect of life.
With regulation so powerful a force, and self-responsibility so heavily curtailed, people just concentrate on playing the system, and abandoning the natural tendency to seek a moral or right basis for doing things.
Technology has been allowed to dehumanise work, and hamper humanity until people no longer care. The economic advantages of technology are so great that this 'technology' recession need not even be happening. It is though because people have not learned how to limit the negative and destructive elements of technology's advance that the world is being cast into a period of extreme uncertainty.
There is a need for a totally new form of thinking, where it is remembered that technology is only a tool, and that humans are always at the centre of events. If those humans are made not to care, and only to seek easy pay-offs, then failure and catastrophy will be the result. It is time for the human side of life to become the focus, for common sense, simple truths to be rediscovered, for bureaucracy to be curtailed and for crazy irresponsible risk-taking to be ended.
Right now, we are being destroyed by the inability of people to find fulfilment and contentment, as bureaucracy and big business eats up their lives.
The solution is there, but it will take creativity and strength combined to ensure it is found in time. The power of technology must be harnessed, at the same time as the tendency for technology to detach people from reality, must be suppressed. It will be a moral crusade, a reconnection of people with themselves and each other, with the instinctive good sense that silently resides within a person, that needs no electronic data or support.
Sometimes in the words of Barack Obama or David Cameron, you can hear the beginnings of an understanding that the world is dangerously out of balance, and that they sense the need for an end to an emphasis on mechanistic process, on state bureaucracy and a refocus on people, their common sense and their well-being. This is the fight for the next generation, to put mankind ahead of, in control of and correctly served by technology. The technology recession is saying that the time for the rediscovery of old-fashioned human qualities has come. It will soon deliver the shocks that the world needs to end the universal arrogance that the computer age has created.
UPDATE 2010 January - how the 'quants' brought Wall Street to the brink
It describes a system a bit like I described, where technology took over from responsibility.
UPDATE - IHT report on how US Regulators are desperately trying to find where the risks are located and shore up the defences.
UPDATE - John Redwood writes that this is a crisis in the UK of messing with the regulatory system by Gordon Brown, and worldwide of bad management of banks.
FURTHER OPINIONS THAT MARKETS WERE WRONGLY REGULATED - HERE.