Going Soft on Power

We are all looking back on 2012 as the year when the UK has been said to lead the way in a number of areas – the Olympics, Sir Bradley Wiggins and the Tour de France, Murray and the US Open, James Bond and the Queen, with Danny Boyle wrapping it all up to show the UK on the side of good.

But, like every nation, we are not just the nice guys. The UK has also become better known internationally for bribery and bank irregularities (LIBOR fixing, money laundering for terrorists), the Leveson inquiry into the press and phone hacking, the indictment of our police over Hillsborough, alleged police wrongdoing that led to a cabinet minister resigning (Andrew Mitchell) and Jimmy Savile reminding us all of what this country was like just recently.

So, 2012 has been a very strange year for the UK – a “curate’s egg” of a year. Monocle Magazine (itself named after an eyepiece that was popular in the 19th Century) rated the UK the world’s top “Soft Power” in 2012 as a result of the Olympics, Murray’s tennis feats and James Bond (among other things). Yet, at the same time, our banks are being shown up for massive failures on LIBOR, HSBC’s lack of control and willingness to allow money laundering on an exceptional scale and the recent Rolls Royce bribery allegations.

The UK is home to amazing ideals and potential: from sports stars and a tremendous passion for sport, home of democratic freedoms, a country based on welcoming the world to its shores and an internationalism based on a long-lost Empire and a need to be important but be seen to be doing the right thing; an independent spirit that makes us not want to be subsumed in Europe or the USA but to straddle the middle and be all things to all.

The UK is also home to the World Wildlife Fund and to a host of NGO’s and charities that see the UK as the centre of the struggle for the world to be a better place. Our aid programme (directed by DfID) is well-meaning even if sometimes misguided (recent nonsense in Rwanda being a good example).

Yet, business and financial irregularity brings our self-righteousness back to earth with a bump.  While we may be able to export a high degree of soft power through our great sporting and artistic talents, a nation like the UK has to be wary that its reputation is not completely destroyed by letting our ancient mercantile and trading instincts come first. Sometimes we don’t know if we are on the side of James Bond or SMERSH.

Britain’s “export” trade

The UK was a mercantile nation well before becoming the first into the Industrial Age and its Empire was established on the back of pioneering instincts and a trading mentality – heavily mixed with politics and ownership. Our wealth was built on the back of exploration and an eye for what sold well – whether it was gold or slaves.

Whereas the Chinese and its tributary system did not seek to rule the countries with which it traded, the UK sought vertical integration through Empire. It exported its laws, its systems, its language and its instincts throughout the world – the good and the bad. Writers like Niall Ferguson have debated whether, on balance, the British Empire has done good or bad overall, but, like the apology being demanded currently for Turing, this is history. As AN Wilson so majestically says in “The Elizabethans”, it is hard for us to look back on that age with the eyes and experience of the 21st Century.

What matters today are the after-effects of the actions taken and also in the actions being taken today along with the belief systems that are current. While Monocle may be right that we export some good and reap some soft power, the UK also exports some bad that may well negate the soft power that we so want to aspire to at a time when the West’s economic power is diminishing fast. Joseph Nye calls the mix of soft and hard powers,  our overall “smart power” and we are in danger of losing the “smarts”

When Transparency International – UK was setting up its “Defence against Corruption” project and I was an adviser to them, a great deal of discussion took place about how corruption has three legs  –  the corrupted (the government and individuals who were bribed), the corruptor (usually a company that did the corrupting) and the nation where the corruptor was based.

Much of the discussion around TI’s Corruption Perception Index is about the first, but the latter two are as much party to the corruption as the corrupted.

When Jack Straw originally produced his white paper which ended with the introduction of the Bribery Act (a very late addition to the codifying of our laws and the subject of many years fighting between NGO’s and companies as well as between the UK government and OECD – where we had signed up to the OECD Anti-Bribery Convention many years before), he pointed out that the UK was a relatively bribery-free nation.

It is true that since the times of Samuel Pepys (when anything could be bought through bribery) the UK has cleaned up its act at home. As we became wealthier, we became less corrupt (although there remain many instances of bribery and corruption still).

However, in some ways we became more Confucian – we were most obsessed with doing right at home and exported our worst sins overseas. Companies from the UK in many industries such as energy, construction and aerospace and defence bribed for business. As the recent ITV programme “Exposure” aired on 10th October, 2012 showed, bribery by British firms overseas remains too common despite the Bribery Act. Rolls Royce is accused of two major acts of corruption in Indonesia and China dating back several years. It will have to show that its systems and policies are now consistent with the Bribery Act requirements or staff could be held culpable.

National reputation – national character

In the defence industry, the cry was always “If we don’t bribe, the French will”. The Chinese and Russians may be the chief bribing competitors these days but we have now enacted the Bribery Act – so, by law the exporting of bribery by companies from the UK should be at an end – including any company that does any business in the UK.

Maybe the issues that have been uncovered at Rolls Royce are old news but many concerns persist and suggest that the short-term gain mentality remains. In a posting from October I reported on a Financial Times article (from a survey by FTI Consulting) that showed a third of board members in the UK would bribe if they felt it was needed to win business. This worrying statistic shows clearly that the UK’s soft power base is in danger.

Our 2012 national reputation was portrayed in Danny Boyle’s Olympics opening ceremony as quirky but unselfconscious; a nation of tremendous artistic, scientific, engineering and business success, caring and cultured. Ai Weiwei summed it up well in an article in the Guardian (it is well worth reading the whole article:

“Brilliant. It was very, very well done. This was about Great Britain; it didn’t pretend it was trying to have global appeal. Because Great Britain has self-confidence, it doesn’t need a monumental Olympics.”

This was a characteristic portrayed throughout 2012 – a year when our sporting achievements have been at their highest in athletics, in golf (along with the rest of Europe), in tennis, in cycling and in cricket (we even beat New Zealand at rugby). Only in football (our national sport) has a less than successful and a less than wholesome image been portrayed.

But, maybe this is where the link may be. Football has become a huge business and business has no ethics of its own – we are continuously told that companies have no souls (as tax avoiders such as Google, Starbucks, Amazon and the rest show clearly). Football was a working class sport but is now a multi-billion pound successful business. Its sporting soul has disappeared as our exports grow – its “self-confidence” becoming mere hubris.

Soft power and hard exports

It could be said that football has not suffered yet along with its financial success (it still has its fan base). It took someone like Lord Coe to defeat the doomsayers that forecast the Olympics in London, with its huge corporate branding, would go the same way but it was a success with real people. Football remains hugely popular but the corruption in FIFA allied to racism at football grounds in Eastern Europe and the huge pay gap between the performers (being paid £20,000 and upward per week) and the fans means that its brand is continuously being corrupted.

If, in the age of smart power, if it is to be a continuing success, brand UK has to be clear and focused, not tainted by bad business ethics. It means not just abiding by the rules of international business but setting the standards – to take advantage of the good will that has been gained in 2012.

This means swapping the short-term (unreal) benefits of poor, 19th trading standards (where bribery and corruption was rife) to set real standards that are enshrined in the 2011 Bribery Act but where the UK has not put in the resources to implement the Act, where the US has shown a willingness to prosecute its own malfeasants in a way that shames successive UK governments.

Soft Power has to become (to use Nye’s term) smart power. Smart power is the ability to take advantage of the benefits that come from our leadership in key areas and to trade on them. Danny Boyle (through the Olympics opening ceremony and his refusal of a knighthood) shows the way away from the 19th Century mercantilistic British norms to a UK that has the ability to lead the world with its soft power allied to economic and political capabilities. This means waking up to what the 21st Century could mean – a global economy where improved communications can kill a business in progressively much shorter times as well as upsetting the benefits that the likes of Tolkein (The Hobbit is a classic British tale) and Fleming and the rest have provided to the country as a whole.

It means being self-confident enough to be seen to espouse good business not business at any price or any cost. There was no government reaction to the FT report cited above. There should have been. Doing good business is becoming the next stage of capitalism – we should be at its forefront as the challenge of the Chinese and others (who aspire less to this cause than the vocalized western consensus since WWII) grow: good business rather than bad business.

This is a hard ask in the depths of recession – but, if the UK is to capitalize on its soft power base, then a UK for the 21st Century has to be built on a smart power base – rather than simply going soft.

Banks and Time Travel

So, Mr Stephen Hestor of Royal Bank of Scotland was pressured into giving up his bonus by a Parliament that threatened to vote against it.

So, Mr Fred Goodwin gets be-knighted by a committee advising the Queen.

Ancient institutions – the royal family and the House of Commons – are playing that old game (which the politicians invariably lose) about who is in charge – government (be they democratically elected or through birth) or the banks? Governments (at least the democratically elected bits) change with the whims of the electorate – banks and banking survive because money is the root of all our economic prosperity – banking is the provider of dreams.

It is a very old game. Since well before Nathan Rothschild strode above the travails of mid-19th Century politicians who were desperate for his bank’s money to fund their economies and wars, banks and bankers have formed their own super-economy – one that economists and politicians have progressively failed to explain or manage.

While the Royal Bank of Scotland saga focuses on bankers’ pay and the balance of reward between employees and shareholders (i.e. who should gain most from banks’ profitability), this misses the crucial issue completely.

What is it that makes banks and banking so critical to world economies in a way that no other industry is so that we are willing to allow them monopolistic rewards – the rewards akin to a totalitarian regime? More than this, how is the overall financial services industry – of which banks are just part – changing and how does it need to change to best serve people and real wealth producing companies, people and our governments in the 21st Century?

What are banks for?

At a simple level, banks are there to provide the alchemy to the economic system – they are asset transformers (David Llewellyn – the New Economics of Banking – 1999). Banks and financial institutions transform money received into money loaned. They transform short-term into long-term. They make tomorrow’s needs available today by making money work hard.

This transformation process (the essence of monetisation ever since the ending of barter economies) has been a crucial bedrock on which economic growth is based. The wealth effect of the asset transformers has been to bring forward tomorrow’s growth into today or next year’s into this or the next generations into this one. This time travel – the bringing forward of the future – is seen whether it is Governments spending trillions today to pay back in future generations, companies bringing forward projects on the basis of payback in three to five years all the way to purchases made on credit cards to pay back (or not) in a month or six. Banks and financial institutions have developed ever-more sophisticated ways to drive the transformation.

Sub-prime problems in 2008 showed, like most banking crises, the fault line in the world’s financial system – the cracks that often appear in that bedrock.

Pressure builds up just like the earth’s crust before an earthquake as financial institutions offer more and more high risk promises to transform the future to the present. In this case, promises to those who could never repay to buy properties they could never afford. It could have been corporate over-stretching. It could have been government over-spending – as it has now become: a massive sovereign debt crisis in the western economies.

The short-term bonus culture of the banks was and remains a symptom not the problem. The battle between senior bank employees and their shareholders is not the problem. The essential risk nature of banking (and there never has been a safe period when bankers were just bank managers who would not give loans – this is a myth circulated while banks were providing high risk loans throughout the corporate and national world) is that the asset transformation process (this time travelling capacity to bring forward tomorrow into today) is deemed to be so critical to the world’s economic system that banks (and many other financial institutions) are deemed to be vital and their survival guaranteed by governments. This has led inexorably to the current sovereign debt crisis in Europe and the ability of senior banking staff to act as monopolistic winners over both the banks’ shareholders and the rest of the economy. As David Kynaston wrote about the reasons for more recent banking excesses : “the most important is the arrival of the insidiously tempting one-way bet.”(David Kynaston – City of London – 2011)

So what (if anything) can be done to change this?

The Threat to the Time Travellers

As Llewellyn’s paper in 1999 suggested (and this was before the banking mayhem of 2008), banks are undergoing major changes that technology (for example) is forcing. Banking (for so long run by insider networks who knew each other and government ministers intimately, went to the same schools and spoke the same language) is now more open to other institutions (whether supermarkets or Virgin) and trading companies are better equipped to tackle the markets directly (corporate bond issues being the main way of doing this).

Yet, traditional banking methods and the banks’ place in the economy (especially in London) feels similar to what it has done for 200 years even if the competition is growing from other institutions and from overseas (Chinese banks – owned and dependent on the Chinese State – especially). Defence of our banks by our government against the newly developing nations financial institutions is one impediment to progress.

This could be a tipping point, though. Money and monetary systems will remain the kratogenic blocks on which economies slide and which cause massive earthquakes from time to time, but the banks’ position within these systems will change. Digitisation and the spread of wealth into the developing nations of China, Brazil and elsewhere will fracture the monopoly position of western banks and the West’s financial institutions. This may well be a good thing as monopolies are inherently massive impediments to improvement and sustainable growth.

A problem is that western economies that are dependent (or believe they are) on their banking system (London and New York especially but Paris and Frankfurt and elsewhere hate the prospect of losing their monopolies) will fight tooth and nail to prevent or at least slow the pace of change.

The other impediment to change is that those who are in charge of the change process – governments – don’t really understand the nature of banking. Tinkering at the edges (whether bonuses or knighthoods) is a waste of effort. Enlarging capital bases and splitting the casino elements of banking (which would be allowed to fail) from the more traditional lending elements of banks is moving to the right lines if (and this is the critical issue) there is an understanding of how this addresses the massive risks that banks are engaged in (and always have been). Many have argued that this splitting (providing only banks which are less susceptible to macroeconomic shocks should be given last resort assistance) is a cornerstone requirement.(Rochet, J-C Macroeconomic Shocks and Banking Supervision – 2008)

The enlarged capital bases and splitting of key activities into Chinese wall separated entities are hints of the crucial risk factors but not the answer in themselves. For risk and uncertainty are two entirely different features. Risk can be assessed, uncertainty cannot – a set of unknown unknowns. Individual bank risk at the micro-economic level may be manageable through higher capital ratios but take all the banks together and does an amalgam of micro-economic management techniques bulk up to a macro-economic solution?

As digitisation and competition (from other corporations and from newly developing countries) grow, it will lead to more opportunities to time travel. Yuan-based promises are no different from $ or € or £. The risks just get higher.

The critical issue is to manage the degree of tomorrow’s future wealth that we are willing to risk having now. Just like burning oil and gas today has a direct impact on our future generations, so monetary time travel can suck in tomorrow’s wealth. Just ask the Greeks (and Portuguese and the 50% of young Spanish without jobs) whether they agree with monetary time travelling – taking too much of the future for consumption now.

This is a hard call. Growth (at least that measured in the altogether faulty way that we measure GDP – quantity not quality) is at the core of our being. Banking has fuelled that core essence. Reducing the scope of banks and other financial institutions to bring tomorrow into today is a huge macro-economic decision that national banks (like the Bank of England) have to take on responsibility for.

National Banks – their role in macro-economic management of the Banking System

This is not just about bank regulation – it is about the how (at a macro-economic level) the risks and uncertainties are managed on a national and on a world-wide basis. Systemic and earth-shattering breaks in the system can only be better managed when international macro-economic indicators are understood and somehow controlled.

Transaction taxes, capital ratios, splitting bank operations are, I repeat, micro-economic devices. Macro-economic devices now need to be devised and international mechanisms established that regularly evaluate the banks’ individual exposure to macroeconomic factors. (Buch, Eickmeier, Prieto – Macroeconomic Factors and Micro-level Bank Risk – 2010). Building a model of this exposure using 21st Century macro-economic modeling techniques and used within an international banking framework, could be the starting point to better management of extreme banking risk.

But, it will take a transformation of international mindsets and international agreements to take 19th Century economic and political models into the 21st Century. Technology has moved on and presented individual banks and financial institutions with the ability to further manipulate economies and left governments in their wake. This needs some rebalancing and governmental management institutions need to be set up to oversee the critical part banks play in our world and to establish the macro-economic monitoring systems that are needed to avoid economic collapse.