Traders on the floor of the New York Stock Exchange. It's easier to gamble spare capital in the financial markets than it is to use it for new machinery
The assumption of George Bush's administration was that there would be only minor knock-on effects from the bankruptcy. It was profoundly wrong, as events rapidly proved. On Monday, 15 September there was chaos on the world's financial markets. Fear that other banks were vulnerable meant that no institution was too big to fail. In the UK, pressure was particularly intense on Halifax Bank of Scotland and Royal Bank of Scotland. In the US, even Goldman Sachs was felt to be at risk. A month of mayhem ensued, only brought to an end by governments everywhere agreeing to stand behind their banks with almost incomprehensible amounts of taxpayers' money.
Never again
The crisis exposed the structural weaknesses of the bubble years and policymakers said what they always say at this point in the economic cycle: never again. Faced with evidence of the fragility of globalisation, they announced that the system required fundamental reform. At this juncture, it is appropriate to assess how they have been getting on.
There were four big economic shifts that helped cause the credit crunch and the recession that followed; from regulated to de-regulated markets; from manufacturing to finance; from west to east, and from labour to capital. There was also a deep cultural change, affecting Britain and the US in particular, which we will return to at the end.
Attempts at re-regulation have, predictably, centred on the financial sector. They have involved pressure to break up the banks so that they are no longer "too big to fail"; calls for the banks to be taxed more heavily; and work on new capital arrangements that would ensure institutions are better buttressed in difficult times.
The global banks have immense lobbying power and the power of inertia on their side. Nothing stifles change so much as the passing of time. It is tempting – particularly in the light of Bob Diamond's appointment as the boss of Barclays – to believe that the moment for reform has passed. That may well prove to be the case, but for now it is a premature conclusion. New rules for capital adequacy are being drawn up and they will be phased in over the coming years. In the UK, the coalition government has announced a £2bn levy on bank profits and would support a broader financial activities tax if other leading financial centres do likewise. A commission has been set up by George Osborne and Vince Cable to look at whether the banks should be split up into retail and "casino" branches. The assumption is that the government will "bottle it", but Osborne and Cable deserve credit for ensuring that the members of the commission are no patsies. Reforms of the structure of UK regulation, with a bigger role for the Bank of England, are also meaningful and welcome. Conclusion: progress but too early to say whether it will be deep and meaningful enough.
There is less cause for optimism when it comes to shifting the economy away from its reliance of consumption and public spending towards export-led growth. It is not just that Britain notched up a record visible trade deficit during the coalition's first three months in office; it is also that the measures it has taken, in the name of fiscal rectitude, have been so damagingly short-termist. Cancelling the loan to Sheffield Foregemasters, cutting the science budget and infrastructure spending all speak of the depressingly familiar Treasury cheese-paring rather than any attempt to rebalance the economy. Despite the 20% cut in the exchange rate, the UK lacks the capacity to make a cheaper pound work in its favour. Since Tony Blair came to power in 1997 manufacturing's share of the economy fell by two-fifths to just 12% of national output. Government policy threatens to make matters worse. Manufacturing output is still 10% down on its pre-recession peak even after growth of about 5% in the past 12 months.
The same applies to the US, where the improvement in last week's trade figures masked a significant deterioration over the past year, during which time the deficit has doubled. China's trade surplus, meanwhile, continues to hit new records, while Germany's sparkling growth in the second quarter was heavily dependent on exports.
As a result, rebalancing the global economy also seems far off. Beijing, at least, seems aware of the need to boost domestic demand and its stimulus has had positive effects on investment and consumption but as the Organisation for Economic and Co-operation and Development noted last week, global imbalances are widening after narrowing during the recession.
Manipulation
The Centre for Economic and Business research estimates today that the share of global output from the rich countries of the OECD will drop from just over 77% in 2004 to a little under 66% by 2015. In the US, there is a growing sense that China's increasing economic prominence is due to currency manipulation so that its exports enjoy an unfair advantage on world markets. Expect growing tension between the world's two biggest economies.
The unemployment legacy of the crisis was discussed in this column last week. It is encouraging that the International Monetary Fund and the International Labour Organisation are united in recognition of the need to create jobs and make them pay decent wages, but the current policy is to keep interest rates low and hope for the best. Corporate profitability is high after the cost-cutting of the past three years, encouraging optimists to argue that there will shortly be a surge in investment that will create new jobs.
But this may not happen. Firstly, potential investors are being deterred by fears about weak demand. Secondly, it is much easier to gamble spare capital in the world's financial markets than it is to use it for new plant and machinery. This brings us to the deep cultural change mentioned above: the demand for immediate gratification.
Andrew Haldane, Bank of England executive director for financial stability, said recently in Beijing that rapid gains in economic growth in the modern age were accounted for by patience: investing for tomorrow meant sacrifice today. "Studies have shown that happy people save more and spend less," he argued. "Happy people also take longer to make decisions and expect a longer life. In short, they are patient. These patterns are connected and reinforcing."
But patience does not always triumph. When impatience takes control, we save less and borrow more. We take snap decisions, thinking little about long-term consequences. This sort of behaviour, as Haldane noted, reaches its apotheosis in the financial markets. "Most traders' brains harbour the impatience gene. Often they harbour little else."
So, it would be a real sign of progress if there was evidence that the gods of the financial markets were re-learning the virtue of patience, thus setting an example to mortals. The sad fact is nothing has changed. The business-as-usual mindset makes the case for reform even more compelling.
