By Anthony de Jasay
Part I
George Stigler, the 1982 Nobel laureate, was almost as great a humorist
as he was an economist. His deadpan irony was devastating. In his The Economist
as Preacher and Other Essays he speaks of "that most irresistible of all
the weapons of scholarship, infinite repetition."(1)
I call "parrot talk" the loud and relentless repetition of
some plausible fallacy that is first launched as an original and debatable
notion by some minor authority or small group, often with an axe to grind, and
then, by a mysterious process of perverse selection, is taken up and hammered
home by public intellectuals and the media, triumphantly becoming a firmly
established truth. When used as prophecy or forecast it is liable to be
self-fulfilling. When used as explanation and diagnosis, it dictates the remedy.
In either case, it is capable of causing deep and lasting damage in political
thought and the public policy the thought tends to shape.
In the present column I will be dealing with a
few particularly insidious and dangerous subjects of parrot talk. I will first
recall a few that I had identified in earlier writings. Then I will present
some more recent untruths, such as the idea of "financial
capitalism", the supposedly vital need, to stock up the banks with extra capital,
monetisation of the debt, and the alleged vices of modern capitalism, such as
speculations and short-termism.
Fundamental Fallacies(2)
Among my Collected Papers there is an essay entitled "Parrot
Talk."(3) It treats a number of fallacies in political philosophy that,
looking plausible and pleasing to most people's ears are being repeated on
every possible occasion with an air of assured conviction. Each time they are
declared, more academic parrots take them up and relay them in ever wider
circles until they become ineradicable common knowledge that feeds prevailing
political thought.
One of these fallacies, pilloried in "Parrot Talk," is the
separateness of production and distribution. The gross national cake is first
baked according to the laws of economics, and then sliced and distributed
according to the collective decisions of society. It remains unsaid that the
very reason why a cake of a certain size is baked at all (rather than a
sweeter, bigger or smaller one or indeed none) is that its distribution will be
of a certain kind and not a different one. Income is not a grabbed and
redistributed with impunity without reacting back on production.
Another fallacy, often repeated to reassure the voter called
"liberal" in English English that he has little to fear from the
candidate called "liberal" in American English, is that it is
possible to bring about equality of opportunity without enforcing equality of
outcomes. It takes a minute of extra thought to realise that once preceding
outcomes are allowed to be unequal, current opportunities cannot possible
remain equal.4 But this extra minute of thought is suppressed by the rising
noise of parrot talk. Finally, the essay notes that the most widely accepted
modern theory of justice lays down, as its first principle, that everybody must
have a right to the greatest possible liberty compatible with the same liberty
for everybody else. One may ask why having a right to liberty is better, or
different, than having liberty itself. Adding the "right to" should raise
suspicious second thoughts, or perhaps it is just empty verbiage—but having a
right always sounds nice, and passes well in parrot talk.
Must Safety-First Economics Prevail?
What the earlier "Parrot Talk" essay sought to do in political
thought, the present one aims to do in the current language parrots use about
finance. It is written by taking as read certain well-established theses of
neo-classical economics that are basic to what in English English is called
"liberalism".
Thanks to incessant repetition in the last few years, public opinion is
now convinced that risk is a bad thing and ought to be purged from the economy
as far as possible. Economics, on the contrary, teaches that some risk is
inevitable because the future is not predictable, and necessary for efficiency.
The size and severity of risk and its price should and under a regime of free
contract would adjust to each other. The wish to avoid risk by paying the
market to bear it (e.g. by hedging, forward dealing or insurance) would, in
equilibrium, be equal to the willingness of the market to assume that risk.
This situation is an optimum, because neither the marginal risk-avoider nor the
marginal risk-bearer can expect to do better by moving away from it. The
spectacular stock and bond market losses of 2008-2009 showed that the
expectations of large operators, such as the insurer as AIG, may occasionally
be spectacularly wrong (especially if biased by existing regulations and Fannie
Mae activities, as was the case in the U.S. residential mortgage market), but
they did not invalidate the theorem. The losses were the outcomes of zero-sum
games and as far as one can tell, they involved no destruction of tangible
value. As Milton Friedman would say, for every loser, there was a gainer.
Damage did occur due to massive mismanagement of the shock waves, but not
because risk was allocated by price in the first place. After all the ensuing
parrot talk, the received truth now is that risk is bad and almost
reprehensible and should be purged from the system. Poor system! Risklessly, it
would be heading for an unpromising future.
"Finanzkapitalismus"
German parrot talk has achieved the feat of uniting in a single word two
of the most hated ideas that in other current languages would take two or more
to express.
There must be some people, though not very many, who would be happier as
cavemen or nomadic herdsmen battling periodic famine and the cruelty of
elements than denizens of our urban civilisation. For the rest of us, however,
the populist dreams of abolishing the "dominance of money and the
dictatorship of the market", as well as seeking "production for real
needs, not for profit" should and can be dismissed as irrational ranting.
It would be rational if we harboured a strong streak of masochism that could
best be satisfied by self-inflicted economic and social pain.
At a more sophisticated level than masochistic oratory, a few standard
accusations are obstinately levelled against finance, capitalism or both. Often
no distinction is drawn between the two, which can be excused on the ground
that finance and capitalism have flourished together and though each can be
imagined without the other, the result looks painfully contrived. Quantitative
economic planning by input-output matrices, on the one hand, and market
socialism on the other, are examples of such contrived monstrosities. You can
perhaps run an economy without prices set in a single money of account, but it
looks hardly promising. You can perhaps run a money economy while suppressing
the profit motive, but it looks unpromising, too.
The steady stream of parrot-talk charges come under two headings. One is
morality. Capitalism is immoral because it promotes immoral or at best amoral
conduct in pursuit of a morally worthless objective, profit. It also generates
inequality of material conditions among men, and relations of subordination. It
is not realised that all economic systems, except perhaps subsistence farming,
do these things and have done so through history. Where capitalism is superior
to its real or putative alternatives is in its relation to morality. It is the
only system where the optimal rule to follow in order to achieve success is
"honesty is the best policy", ( though following a rule is not the
only or necessarily a better road to success than not following one).
Capitalism, as has been recognised by the more intelligent among its defenders,
systematically economises morality: it needs less of it than other systems in
order to function properly. It achieves more with morally fallible human agents
than in other systems could hope to do by relying on the scarce supply of
clean-handed, selfless, public-spirited people they could find. Capitalism
shrinks the opportunities for corruption, pre-capitalist and socialist systems
open them widely.
Under the less high-minded heading of stability and efficiency, parrot
wisdom, particularly since the mayhem of 2008, has it that an excessive
financial superstructure renders the economy top-heavy, crisis-prone and badly
in need of re-regulation after the decades of doctrinaire free-marketism of the
latter part of the 20th century. This charge, for all its plausibility with
bank rescues and stubborn unemployment weighing on our minds, is nevertheless
an arbitrary one. The capitalist economies and in particular their financial
service sectors prior to 2008 were too lightly regulated in the view of some,
too heavily in that of others. They were in either view hybrids. There is no
earthly way of telling, from the performance of a hybrid system, what the
performance of a pure system would have been. Maybe putting the banks in
straitjackets would have averted 2008, maybe setting them really free to swim
or sink would have done it. Maybe neither would have made much difference. But
pretending to know that more regulation was needed, as Mr. Volcker, Mr. Mervyn
King, Dodd-Frank legislators and the Basel committee do and as incessant parrot
talk to the same effect raises to the rank of a self-evident truth, should not
be allowed to serve as an argument-stopper.
Probably the best French current affairs commentator exclaimed the other
day that every day hundreds of billions of money transactions flow through the
exchanges without the least attempt by governments at regulating them, and this
was truly terrifying and inadmissible. She might as well have added that every
day hundreds of billions of hectolitres5 of water slosh about in the oceans
without the least attempts by governments to regulate them, and this was truly
inadmissible and terrifying.
PART II
Strengthening the Banking System?
A bank is solvent if it can pay off its liabilities to third parties,
some on demand, others on their due dates, by liquidating its assets. As long
as the bank is believed to be solvent, the necessity to liquidate all its
assets to pay off all its liabilities does not arise. In the perhaps laudable
attempt to provide a tangible foundation for the belief in solvency, an
all-European panel of central bankers and officials sitting in Basel is
empowered to require banks to maintain certain fixed proportions between
various classes of their assets and their liabilities. These requirements have
been progressively tightened from the initial set known as Basel 1 to the
present Basel 3. Greatly simplified, the requirements amount to a solvency
ratio by which, under Basel 3, a bank is allowed to have 93 of third-party
liabilities for every 100 worth of assets. This means that its own equity
capital must be no less than 7 for every 100 worth of assets. Since the starting
figure for the system as a whole was only 5, the average bank had to increase
its solvency ratio by 2 to reach 7 before the deadline in 2017. Most banks were
expected comfortably to surpass this level out of a few years' retained
earnings. So far, so good.
However, behind this safe looking outcome there lurks a fundamental
doubt. External liabilities are fixed in nominal value; 93 is unambiguously 93
in the currency, e.g. euros, in which it was denominated. However, whether an
asset is valued at 100 in the balance sheet to match the 93 on the liability
side and leave an equity of 7 is a matter full of ambiguity. An immensely
complicated set of guidelines laid down by the International Accounting
Standards Board (IASB) tells the auditors what method of valuation by the bank
of its assets they may accept, but there is room for different interpretations
of the guidelines. By and large, an asset must be "marked to market";
if it was bought for 100 and its market price declines to 80, it must be
inscribed at 80 on the balance sheet. It may then serve to support only 74.4 of
liabilities. Since the latter still figure at 93, something has to give.
Not all marketable bank assets must be "marked to market", and
not all bank assets are marketable. Most, in fact, are not quoted and are
exchanged only sporadically or not at all. Mortgages may not have been packaged
into tradeable mortgage-backed securities, and industrial and commercial loans
may be valued by the lending bank at par as long as they are "performing",
i.e. as long as current interest due is being paid. However, while these asset
classes may escape the letter of the "marked to market" rule, should
they escape its spirit? When recession threatens, is it not reasonable to say
that if these asset types were traded on a market, their price would decline by
10 per cent or more in a matter of months? Should the bank's balance sheet not
reflect this? If half of the bank's assets are written down by 10 per cent, the
bank's own equity capital shrinks from 7 to 2 per cent. Since Basel 3 says that
for safety it should be 7 per cent, should depositors, especially the big
wholesale ones, panic and start a run? Worse still, if the spirit of the
"mark down to market" is not respected and assets are not written
down but the large depositors, indoctrinated by parrot talk, think that they
ought to have been, the balance sheet will no longer be trusted and the
eventual panic could be much worse.
The irony of it all is that if it had not been hammered home to the
public that a solvency ratio of 7 per cent is needed for safety, even the harsh
"mark to market" rule could be endured without much damage—for the
bank is solvent as long as it can pay off its liabilities, and technically it
can do this with a solvency ratio of 0.
If the bank's solvency ratio were 7 but must not be breached, the effect
is the same as having a 0 ratio.
Clumsy interference in misguided attempts to improve on matters knows no
bounds, for even improvements can be further improved. No sooner did European
banks get used to the idea that they must have at least 7 per cent equity that
Mme. Lagarde, the new Director General of the IMF, in apparent haste declared
that it was "urgent" to recapitalise them by raising their solvency
ratio to 9 and the biggest banks to 10 per cent by July 2012, a mere 9 months.
This was the classic case of bellowing "Fire!" in a crowded cinema.
Some banks rushed to the stock market, raiding it for extra capital, leaving
that much less for industry and commerce. All others began aggressively to
reduce their assets, partly by dumping large chunks of their holdings of
Italian, Spanish and other sovereign debt, and partly by denying credit to
their less important small and medium business customers. Absurd situations
arose. Airbus, up to its neck in aircraft orders, cannot step up production
because its subcontractors cannot get the credit they need to raise more
working capital.
While a recession of sorts is being artificially engineered, the public
is convinced that it must be a good and prudent thing to recapitalise the
banking system, for more financial strength is doubtless needed in this time of
"crisis". May we remark that if the authorities in their zeal to
manage the recession and parrot cries shriek "Crisis!", a 9 per cent
solvency ratio would not give better support to the banking system than 7 per
cent. What might help instead are fewer cries of "Fire!"
PART III
This is the third time in succession that this column
presents opinions concerning money and finance which appear superficially
plausible but only become firm truths when enough parrots repeat enough times
what their masters in Brussels, Paris or at the International Monetary Fund
(IMF) declare. The most recent occasion for the Parrot choir to hit fortissimo
was the October 8-9 "last-chance" Brussels summit to end all summits
and save the euro at least until the imperative need for another last-chance
summit emerges in a few months' time.
Safety First, Dearly
Britain went into this summit moderately concerned about the future of
the euro, the money of its largest trading partner, but also anxious about the
regulatory zeal of Monsieur Barnier, the Commissioner for the internal market,
and his distinctly non-liberal brains trust with its instinctive dislike of the
City of London. Confronted at dawn with a complicated and in part puzzling
draft agreement more or less accepted by 26 of the 27 drowsy government
delegations, the British asked for exemption from certain regulatory aspects, a
demand angrily refused by the French President. By the unanimity rule, the 26
willing governments are thus prevented from amending the Union's basic treaty
as desired by Germany (an amendment that may have taken several years to ratify
and survive referendums in several countries), and must be content with
intergovernmental agreements. The former would hardly be stronger than the
latter, but perfidious Albion is loudly blamed for vetoing it.
France is behaving like the jilted bride who becomes embittered, and
Britain like a clumsy lout. Each side blames the other and claims that the
other has dealt itself a losing hand. The bad blood may last a couple of years
but not more, for France needs British friendship to counteract the
overwhelming weight of Germany.
Meanwhile, the regulatory steamroller is advancing, flattening the
international financial landscape at a cost that lays between the stratospheric
and the astronomical. According to HSBC and Barclays, two of Europe's
half-dozen giga-banks, "ring-fencing" their retail operations to
insulate them from the hazards of the investment banking side, will cost them
up to 2 billion euros per bank in extra information systems and lost synergies.
The added safety is problematical. The Financial Times of December 9, 2011
reports that world-wide financial service companies are hit with an average of
60 regulatory changes every working day, a 16 per cent rise over last year and
no let-up in sight. Regulators announced 14,215 changes in the 12 months to
November 2011. Compliance departments have to cope with an annual increase of
up to 20 per cent p.a. until at least 2013. The Dodd-Frank bank reform act in
the United States and the Basel 3 rules in Europe are chiefly responsible. In
addition to burgeoning compliance costs Basel 3's jerking up the required
solvency ratio of the banks from 7 to 9 per cent in a matter of months is,
despite protestations to the contrary, putting on a "credit crunch"
in Europe that is turning the danger of a 2012 recession into a reality at a
cost in needlessly lost output of the order of 150-200 billion in one year.
It is fair to say that if and when 7 per cent of own capital turned out
to be insufficient for banking safety, 9 per cent would be no more sufficient.
Fractional reserve banking depends on confidence first and last. No realistic
solvency ratio can suffice if confidence is ceaselessly shaken by cries of
alarm by the powers-that-be who are competing for media attention, and by their
echo of shrill parrot talk. Regulatory houses of cards built by eager
busybodies cost dear and instead of restoring confidence, make for shyness.
"Naughty, Naughty
Child!"
The December 2011 agreement "to save the euro" is alleged to
provide for a voluntary limitation of structural budget deficits to 0.5 per
cent of GDP. This is to be the golden rule of every state. The key word of
course, is structural, meaning roughly taking the good years with the bad. If
the actual deficit is, say, 4 per cent, a state can always argue that it would
be 0.5 if this were not a bad year. In a good year, the same policies would
yield a surplus—and so on with jam, jam tomorrow, but never have a balanced
budget today.
The really interesting part of the golden rule, however, is that it is
supposed to incorporate automatic sanctions against the offender. Each state
will have the golden rule in its constitution. If it offends against the golden
rule, the European Court of Justice will nudge the country's constitutional
court to act. It, or the Court of Justice (it is unclear which), will
"sanction" the state. But what the sanction may be is a puzzle. The
constitutional court will not unseat the government, and its verdict may be
just shrugged off. The Court of Justice has no armoured column to send to
occupy the capital. A fine looks a more feasible punishment. But for the fine
to persuade a government to change its fiscal policy, its amount would have to
be huge, probably no less than 1 per cent of GDP. For a government desperate to
survive the next election, even that sum would not be a deterrent—the less so
as it may just drag its feet and not pay it, or be unable to pay it for the
very reason that forces it to run a budget deficit in the first place. In other
words, for all the talk about automatic sanctions, the new golden rule looks
just as unenforceable as the 1991 Maastricht treaty rule that both Germany and
France had simply shrugged off.
The sole realistic alternative is to punish the offending state by the
Court of Justice and the other European institutions shaking an index finger at
the offending state and saying "naughty, naughty child"! For the time
being, no parrot-master is admitting this and the parrots are happily repeating
that there will be no deficits because there will be "automatic
sanctions". The painful awakening could then serve as the subject of the
third or fourth-next "last-chance" summit meeting to save the euro.
Funny Bonds, Eurobonds
There is now a wide consensus that a major weakness of the eurozone is
to have 17 different states issuing 17 different sovereign bonds of different
creditworthiness. "Speculators" (the common European word denoting
financial institutions, pension funds and widows-and-orphans who try to put
their assets in instruments they expect to fall least, or rise most, in value
instead of passively awaiting whatever their destiny will bring them) then
"attack" (i.e. refrain from buying, or sell, or even short-sell) the
weakest-looking bonds; so that the weakest state will be unable to service its
debt and will have to be "saved" by stronger eurozone states, while
the "speculators" turn their attention to the next-weakest victim
that requires the next bail-out—and so on. The remedy, all agrees except the
German public, is to have euro-bonds not identified with any one state but
guaranteed jointly by all. Obviously, weak states are not very convincing
guarantors for other weak ones. The handful of strong ones, principally
Germany, are not sure that they wish to be the guarantors for all the rest of
the 17.
However, like funny money that has neither hard assets nor a
government's taxing power to back it, bonds are funny ones if issued by a body
that has no revenues with which to pay interest and to help refinance the
principal when it falls due. In order for eurobonds not to be funny, the body
that issues them would have to have the power to tax Europe's citizens in some
very substantial form—a power that no sovereign European state looks like being
ready to concede. In the last analysis, asking for eurobonds as the sole means
of keeping the eurozone in being, is to ask for a federal eurozone government
with monopoly power to tax but returning agreed parts of the revenue to member
states to let them have some degree of autonomy. At present, governments and
their electorates would angrily reject such a solution. It is more comfortable
to ask for eurobonds without thinking through the grim reality they would have to
bring with them. This, in any case, is the standard way in which European
public opinion likes to imagine the options it wants to believe in.
Footnotes
1. George J. Stigler, The
Economist as Preacher and Other Essays. (Chicago University Press, 1982), p.122.
2. [Editor: Anthony de Jasay
continues the great tradition in free market economics of exposing the commonly
held "fallacies" which prevent clear thinking on economic matters.
The 19th century French political economist Frédéric Bastiat was a master of
this form (see his Economic Sophisms (1848) available online at the Library of
Economics and Liberty and at the Online Library of Liberty). In our own century
there is Thomas Sowell, Economic Facts and Fallacies (New York: Basic Books,
2007, 2011) and the "letters to the editor" by Prof. Don Boudreaux at
Café Hayek.]
3. [Editor: To avoid confusion
one needs to distinguish between the general concept of "parrot talk"
which Jasay is exploring in this essay, and the essay in his Collected Papers
which has the title "Parrot Talk".]
4. This point was made by
Robert Nozick in his discussion of the earnings of Wilt Chamberlin in Anarchy,
State, and Utopia. (New York: Basic Books, 1974), "How Liberty upsets
Patterns," pp. 160 ff.
5. [Editor: A hectolitre is 100
litres, which is the equivalent of 26.4 U.S. gallons.]
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