Treasury Secretary Hank Paulson has the toughest job in the world now. Taking over as the US dollar”s cheerleader proved problematic enough for much of this decade, but to do it in the last few months of an unpopular and lame duck Presidency was perhaps adding too many variables in itself. Billed as the China Expert who would get Beijing to float his currency, Paulson soon found himself less welcome in the Great Hall as Treasury Secretary than in his previous job as head of a Wall Street brokerage.
Then along came the financial market crisis, and with all his old friends from Wall Street hankering for bailouts, the poor chap must be getting very little sleep these days. The instinct to preserve people from one’s own past is almost impossible to avoid, seeing as the process only validates one’s own credentials. Thus, jobs for the boys have remained the hallowed tradition in both government and business for centuries.
The financial system meltdown of last year has been too dramatic to condense into one essay, and in any event I have written many articles on the subject previously, which are available in the online archives. The salient points to note are that bankers messed up by tying together the egregious greed of the common man to the grand design of Asian governments in running up large foreign exchange reserves. The results are now there for everyone to see.
The reaction from the favored few that stand atop the banking world’s pyramid has much in common with what you’d expect if you cut the lunch money of an obese kid. A lot of tantrums, followed by pleading are the order of the day now, but eventually everyone settles down to indignant sullenness. That at least is the theory – trouble is there is always the one authority figure that decides to be “compassionate” and in so doing creates a much larger monster than ever before.
Before he opens the sluice-gates of government largesse that could help his old Wall Street buddies to find the keys to their Ferraris and Porsches though, perhaps the Treasury Secretary should spend some time thinking about the Old Continent. Yes, that one.
Like father like son
France’s only claim to a last military victory involves the war it did not fight, namely the independence battle of America against the British. Inspired by French thinkers and receiving the Statue of Liberty in return, Americans had much cause to show gratitude to the French. Yet, the record of saving the French in World War II from a fate they had resigned themselves to changed much of the dynamic, while pushing America closer to its matriarchal tyrant, the British.
As the American economy started outstripping the war-ravaged European economies last century though, much of that admiration turned to crude humor, with particular emphasis on France’s lack of a military record and its supposedly effeminate culture. Meanwhile, the Anglo-Saxon model of capitalism produced substantial economic gains for the US and much of Western Europe, leading eventually to the implosion of a Soviet Union that simply couldn’t keep up with the Joneses.
At the same time, war-ravaged Europe followed a model of capitalism that involved significant levels of state intervention, much like Japan in the same period. In both groups, the process involved the grouping of companies into nuclear family pods, with each pod essentially competing against other pods while providing optimality in resources internally. This was, in other words socialism for the elite.
No group of people adapted to this system faster than the French, who eschewed the concept of family groups in favor of creating an elite group of insiders who ran the system. Knowing each other from their days in the various Grande Ecoles and other fine institutions, the French soon created a system of Mandarins that resemble Confucian China more than any other political system. Having control though isn’t the same as doing anything useful with it.
As the decline of Japan in the late ’80s showed, the family pods failed to adapt quickly enough to external environment changes and thus eventually failed. Their guiding hands in government, including the ridiculously powerful bureaucrats at Japan’s Ministry of International Trade and Industry failed to understand the workings of modern finance to the same degree of proficiency as they understood six-valve engines. Germany suffered a similar fate albeit a much slower and drawn out one, with its market capitalization changes rarely showing the kind of growth seen in American stock markets for the past few decades.
The relative under-performance of German companies to their American counterparts persists today, as any comparison of market capitalization against top-line revenues or total assets would show. Despite being much bigger in terms of assets and / or revenues, these companies have lagged their American counterparts in profits and hence, share price.
Interestingly, the question of whether oligarchies can perform better than modern capitalism was addressed over many decades with a resounding victory for the latter group. Indeed, an often-quoted statistic is often misinterpreted: when investors talk about the companies that have survived in the Dow Jones Index for the past hundred odd years, they inevitably conclude that frequent changes in the index represent the value destruction endemic in the Anglo-Saxon model.
In fact, it shows the exact opposite, namely the constant improvement of some business processes that in turn produce the great monopolies of each age, that are then discarded by the inexorable move of technology and innovation. Thus, the most valuable technology company of 10 years ago now struggles to remain relevant, while the giants of the American automotive industry are firmly nailed to their deathbeds.
This “creative destruction” owes much to a European thinker, namely Joseph Schumpeter, who argued that it was in getting rid of the old deadwood that new life could flow through the economy. After having followed him almost religiously for the past few decades, the US today stands ready to discard the lessons right at the point when they are needed most, ie the unraveling of today”s global financial system.
Let Wall Street bleed instead
Since we are discussing financial systems, perhaps its even more important for Hank’s team to examine how state intervention has failed to work in Japan, Germany, France or indeed any other country you can think of.
Just this week, Berlin has upped the bailout package for one of its moribund entities, IKB, while the financial regulator in Japan announced that Japanese banks had gorged themselves with over 1.5 trillion yen (US$14 billion) of collateralized debt obligation (CDO) structures which will probably cause losses of around 1 trillion yen eventually. Let that sink in for a moment – Japanese banks, after decades of state-guided control and serial rescues of the last decade, would likely manage to lose more than the top Wall Street firms combined.
Similarly, the big French banks that are products of serial shotgun mergers (even after the $7 billion trading debacle at Societe Generale debacle, see Rogue and the pogue, Asia Times Online, January 26, 2008, the first instinct of the French government was to find a suitable French buyer for the bank) have proved to be lousy at risk management. In large part, this is due to the overly complicated and horrendously difficult business models that come into being when organizations are merged; but the government doesn’t allow anyone to be fired nor any business to be discarded.
That kind of thing only happens because of the dead hand of the State that stifles innovation and perpetuates bad habits. It is understandable that Paulson and his partner in crime (Ben Bernanke, chairman of the Fed) would see the panic differently to armchair strategists such as myself. Yet, as I argued in the above article, the worst thing to do now is “something”. The better choice would be to let Wall Street drown in its own morass of mis-labeled deals and mismanaged risk. Let the ones who failed to follow the Anglo-Saxon model of capitalism perish, and let the winners pick up the pieces and move on.