Hard Times – from 1854 to 1504 (Dodd-Frank)

Masters and “Quiet Servants”

Charles Dickens wrote “Hard Times – For These Times” (usually known as “Hard Times”) in 1854. This was a bleak analysis of mid-19th Century factories and the mechanistic drive for material reward.

The world of the Industrial Revolution saw immense material improvement within a 19th Century mindset that saw business develop on the back of “resources” – whether they were natural resources (like coal) or human resources – Dickens’s “quiet servants”. Resources were resources and how they were discovered, whose they were, the conditions under which they were mined, how they were shipped or the conditions under which they were placed into the manufacturing process were not much of a consideration.

Britain and other developing nations of the time grew wealthy on their own drive, ingenuities, financing and trading and manufacturing instincts but the whole process would have collapsed if access was not obtained to raw materials from the rest of the world and the use of “human materials” from all over (including their own countries). The terms “human resources” is still with us along with natural resources – but the “quiet servants” grew louder.

Gradually, from 1833 when Britain enacted laws that children under nine should not work in factories, throughout the second half of the 19th Century and into the 20th, our human resources (people working in factories and mining, for example, in the industrializing nations) campaigned and secured rights over income, health and safety, length of the working day and age restrictions.

Developed countries worked out that, to work well and succeed, we had to develop ways that we all could share to some extent in the benefits that material gain provided. This is the basis of free and fair societies based on successful economies.

From nation to global

The last thirty years has seen a vast shift from developed nations using the rest of the world merely to buy from and sell to, to a shift to manufacturing and now development and R&D throughout the world. Trade has grown internationally and the so-called integrated “global economy” is in place. We are no longer merely the industrialised west and the under-developed rest, but an inter-connected web of nations within one, world economy.

Yet, the strains are clearly showing. Allied to the vast changes in internet communications (similar to the vast increase of communications that shaped 18th Century politics and the 19th Century – the telegraph and the phone), all peoples of the world now see themselves as part of this world (or global) economy in the same way that 19th and early 20th Century factory workers saw themselves vis a vis factory owners. They then, understandably, demand rights and safeguards.

This is now happening on a world scale as we develop our global nation (economically).  The changes are profound and, if done properly, will be of enormous benefit.

21st Century Responses

This week saw the approval after two years of the US SEC (Security and Exchange Commission) of articles 1502 and 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The two measures could have major implications for all of us in that (properly implemented) they set a real standard for the globalized economy in two, crucial areas:

  1. the willingness of all of us to buy items cheaply no matter how the raw materials were obtained
  2. the willingness of all of us to buy items from wherever in the world, no matter what corruption was employed in their provision.

Article 1502 refers to the mining of key raw materials in Africa such as tantalum, tungsten, gold and tin. It will (after an implementation period) require all suppliers and manufacturers to state that their products do not contain raw materials that financed war or bloody conflict. So many years after blood diamonds were headlined, there is now a statute that demands that companies step back and consider what they are buying. Manufacturers that buy such raw materials have had to count the cost of reputational disaster if they continue to sidestep basic human responsibilities in this global market. Now, there will be a legal imperative in the USA.

Article 1504 is the Cardin-Lugar rule which sets rules for country-by-country reporting of companies in the extractive industries concerning the revenues and profits they make in all countries where they do business (on a project by project basis).

Both articles require all companies that are listed in the USA to comply (although not immediately), wherever those countries are based. The European Union is expected to pass similar laws.

The implementation of the two articles will help to drive change on a global scale, where individual nations (e.g. where the resources are extracted) are unable to do so. Why? For several reasons:

  1. Developing nations (especially resource-rich and economically poor) are prone to corruption and often unable or unwilling to enact these laws themselves;
  2. Developing nations (especially in parts of Africa) use resource revenues to fund conflicts and wars;
  3. Corporations operating in those areas need to show global sensibilities – where treatment in their overseas subsidiaries and employees is brought up to levels that we believe are credible and reasonable. It is hard to do that without legal change as competition is too high to expect corporate ethics (whatever that means) to work on its own.

To Ayn Rand libertarians Dodd-Frank is an economic travesty and many in the US are waiting for Romney and Ryan to get elected and reverse these laws. That would be the travesty. It is enough that in developing nations, the gaps between the rich and the rest are widening; it is enough that nations like Greece are now collapsing economically. There is potential for real strife in nations where inequality is too widespread.

But, we now live in a global economy where we are all dependent on each other. That means simply that best practice (that works on a national scale) has to be introduced globally wherever feasible. The intricate balance of trade, manufacturing, design and the need for natural resources (as well as the need to work together on climate change issues or disease control, for example) dramatically increase the need to treat the global economy as one economy – which it is. This means that national rights have to be respected but that is not enough.

Article 1504, for example, takes the trust element away from many nations like Equatorial Guinea, where the leadership is a kleptocracy and where riches from oil revenues do not go to the people in any meaningful form. Country by country reporting will, eventually, put an end to opaque deals between companies and those who have taken over the ownership of natural resources in those countries by showing transparently what profits are made and revenues generated on a project by project basis. Citizens in those countries will begin to be able to see how those revenues are used or not. Information is valuable and a first step to more equitable conditions.

21st Century Ethics

As we enter the fifth year of the post-sub prime recession (with economic collapse in Greece and high youth unemployment in Spain), we remain much more concerned with ourselves than with people and nations thousands of miles away. The change that global economics has wrought, however, is that we can no longer ignore the plight of those so far away even if we (wrongly) wish to do so. Their plight is ours just as the impoverishment (economically and educationally) of our inner cities is a blight and our plight.

The Chinese view things differently, of course. A thousand years of relative impoverishment has left it hungry for economic growth and its hunger leads it to plunder the natural resources of Africa. China’s legalist centre, its Confucian heart and its loathing of western imperialism means that it is content to leave governance issues aside. Its own internal corruption (the corruption of a centrist and legalist government, where bribes are the common currency of the status quo) means that it is unlikely to require good governance in return for its acquisition of raw materials. In fact, its non-linkage of governance requirements gives China a distinct trading advantage in Africa.

It is to be hoped that this is a short-term business expedient and a long-term mistake for the Chinese. Just as the best manufacturers in the 19th and early 20th Century were leaders in improving conditions for their employees (notably, Henry Ford who wanted his own staff to be able to afford to buy his cars) and just as the US spearheaded safety rules in the 20th Century, it is likely that the best companies will understand that improving the safeguards overseas (whether in their own companies or those of suppliers) will be important, medium-term investments.

Reputational loss is now potentially huge (as Apple realized when suicides at one of its biggest suppliers in China, Foxconn, began to rise and changes in working practices were required by Apple). The raw materials that we require for so many of the goods that we buy are obtained under horrendous conditions in Africa. It is not just blood diamonds but all those naturally occurring elements that the SEC has just regulated into law.

In addition, the country-by-country reporting will shine a light on the regimes that take in billions of dollars of income and disburse so little to their people. Pressure will mount from outside and inside.

Organisations like One, Transparency International, Global Witness and Enough and the Publish What You Pay coalition deserve huge credit for a relentless drive over many years to enact such positive changes. The US Congress deserves huge credit for bringing it into law in the powerhouse of the US economy. The EU should follow and they should all work within the OECD and elsewhere to ensure that these measures, providing an ethical underpinning to the global economy, are made global.

We live in a globalized economy and comparative advantages should be developed through intelligence, hard work and ingenuity – not via the impoverishment or hardship of our global neighbours.  The bringing into implementation of Dodd-Frank’s articles 1502 and 1504 suggests that the global economy is waking up to the fact that our “quiet servants” deserve respect wherever they are – close to home or further away. The global economy (and climate change and air travel and the internet….) means we are all neighbours now.

EZ money – you can Bank on it!

It is just like a circus act – spinning plates as the audience waits for one to fall. When one falls, the act is over and they all fall. The plates – the Eurozone and banks – are spinning still – just – but the spinner is tiring, there is less time to go and the plates are shaking wildly.

 

Both the European banking system and its impact on the Eurozone are in critical mode. The illnesses are not being treated – we are merely ameliorating the symptoms. The new package of measures announced on 29th June provide some breathing space but the banks are the same banks as they were before and the Eurozone has exactly the same problems as it did on the 28th June.

 

Twin Devils: EZ and Banking

 

Banking is a devilish concoction – see my earlier posting: https://jeffkaye.wordpress.com/2012/02/05/banks-and-time-travel/

which focuses on the Mephistophelean trade that banking makes with us – the bringing forward of tomorrow’s wealth into today (with our soul in return). No government since money was invented has properly understood banking or had the ability to control it and democracies are ill-suited to manage the banks, the bankers or their products (although that is not a case made for ending democracy!).

 

On the same day that the EZ nations announced their new answers to the EZ crisis, UK banks were being vilified for their LIBOR manipulations and for wrongly selling interest rate insurance to small businesses (many of which collapsed under the strain of the repayments when interest rates collapsed under the banking-induced downturn in 2008). It couldn’t be made up!

 

The EZ nations horse-trade over more loans to the banks which bypass the sovereign debt obligations of Italy and Spain, amongst others. Banks will get loans directly from the ECB (for example) – which means that Germany will guarantee 50% of the loans, but France, Italy and Spain will also carry a burden.

 

The twin devils are fighting for their existence and the markets applaud every move – but, the problems persist.

 

Twin headache

 

Banks have existed far longer than the EZ and will outlive it. The likelihood is that the EZ nations, fighting for the survival of the Euro, will continue to miss the point. Banks are not, in the main, national entities, they form part of a world-wide consortium. Banks are a supra-economy and their product – money – can be created easily and changes time – lending and borrowing transform today’s problems into tomorrow’s – in a way that nothing else in economics can do.

 

Banks’ ability to transform time (the magical transformation that lending and, to some extent, insurance provides) is exactly what has provided the EZ with its problems – and the issue that wrecked Lehmans and nearly wrecked the US banking system. The banks’ inability to control themselves within reasonable and rational limits of lending has now been transferred to the countries where they are based. Sovereign debt has been amassed to cover the time travelling antics of the banks. Twin problems.

 

Paying it Back

 

Most economists are unclear about the problems that banks provide when unregulated on a macro-economic scale – all governments suffer the same lack of understanding, Money is not just easily created and employed, it effects transfers between time that equilibrium-based traditional economics does not understand. A loan provided to a company at an interest rate with payments spread over many years represents the ability of that company to achieve something now rather than later. The debt is paid off through interest (the economist’s price of money) and over time. Discounted cash flow techniques (based on interest rates) debase the future – eventually, it completely discounts it as though it was worthless.

 

But, the price of money is not just the interest rate. Price is repaid from tomorrow’s debt mountain when the debts pile up beyond the ability of payers to pay. The devastation of the Greek economy and young people’s work prospects in Spain testify ingloriously to this. The price is a heavy burden when the macro-economic effects of out of control banks are misunderstood. Supply and demand curves for money are meaningless when money is more or less free and money becomes free very often in society – which assumes a zero risk. It happened in the 1990’s and it happened just prior to 2007/8 – money was free because it was being created from nothing – by new forms of leveraging in secondary and tertiary markets that no-one understood. Interest rates were of no use as bankers and financiers scoured the market for easy bets (for that is what they were).

 

Now, we face many years of deleveraging – where yesterday’s over-leveraging is paid back – where time travel gets reversed. It must be that the discounted cash flow calculations were wrong – the assumptions were riddled with errors.

 

3D Chess played with blindfolds in different time zones

 

Economic management of banks and of sovereign debt makes assumptions based on projections that are misunderstood. Fund flows and interest rates that are meant to cover the supply and demand parameters miss the critical build-up of debts at a national level and at an international level. It is the mass of debt and the difficulty of managing that debt pile against a continuously changing assembly of poorer and poorer borrowers that constantly defeats bank management. The constant desire to bring forward projects from tomorrow into today – whether by an individual or a company or a government – feeds that process. It is the drive to consume now, the size, complexity and continuous shifts that make the problem so much greater than it was in the 19th Century.

 

3D Chess played with blindfolds and over different time zones looks easy in comparison and the answers are not easy to come by. The answers being implemented are micro-economic in the way that individual banks are required to increase capital ratios, for example.

 

The complexity in a period of deleveraging allied to a need for growth is enormous. Governments cannot (over time) have it both ways. Most developed nations are over-leveraged having borrowed far too much out of tomorrow’s wealth. At the same time, we are being told that we need more growth to help repay the debts. There is a limited intelligence involved here – or just maybe that the limited intelligence of politics is competing with economic reality. We should all be aware that for those countries in a downward spiral there are but three ways out of this: to deleverage (i.e. pay back debts); to reflate and debase a currency; to default – or a mix of the three. In the US and UK, reflation and currency debasement has been attempted; in Greece, there has been a default; elsewhere in Europe, the can keeps getting kicked but it looks more and more likely that German taxpayers will pay out for Italian and Spanish profligacy without the huge institutional and cultural changes that would make the investment worthwhile.

 

What’s the answer?

 

Governments have been trying to control banks for hundreds of years and failed. In the 21st Century, complexity has risen as has the ability of major banks and their staff to manipulate markets and manipulate customers.

 

This is not just a banking or EZ crisis – we have now to question our economic judgement and whether capitalism as we have practiced it for the last fifty years works. Just like corruption, banks and bankers will swarm into any gap that the market allows. It is not much use to anyone to swing the pendulum back and forth on regulation as economies grow or splutter.

 

After all, the problems in banking and in the EZ are problems of economies and problems that are due to a laissez faire relationship with growth as measured by….money (GDP). The only targets that we (not just the UK but world-wide) measure our success in is in money. The only targets are GDP targets – growth targets are GDP.

 

What is the answer? The answer lies in our ability to bring quality (and ethics) into our economic affairs.

 

Quality vs Quantity

 

As the Chinese and other developing nations rise up the GDP scale and as the world continues to use up its natural resources, we have not assessed why we continue to follow 19th Century economic principles that propose that we spend our way to happiness. GDP growth is important as societies develop – as hunger is eradicated, shelter is found, clothing is ensured and jobs provided. How important it is when we are “grown” is the debate that is now needed. Growth in what?

 

The rush for money (what seems to be the mainstay of society) is what has rushed the banks and EZ into the mire. We don’t understand the impact we are having on the next generation and beyond in terms of debts built-up and resources squandered.

 

We now have a quality vs quantity argument that underlies all the short-term “solutions” that we read about. The right answers require the right questions and the right questions may include something like: “do we need to use up tomorrow?” – that is what banking is, a discounted cash flow estimate of the future where everything is translated into numbers and where quality is completely overcome by the quantitative.

 

Numbers are in charge – and therefore banks (based solely on numbers) are at the forefront of such an economy. EZ crises are based on money and the addiction to numbers – GDP and growth. While this continues, so will our willingness to allow banks to seek out new methods of extracting tomorrow’s benefits to today.

 

To untangle societies from the rush for loans and products that banks supply (and EZ countries end up securing – and paying back through taxation) we should address the root cause – our predilection to the amassing of tomorrow’s money or its equivalent at the expense of tomorrow’s quality of life. Our kids and their kids deserve better – ask young Greeks or Spaniards.