Capitalism is safe and well (probably)

By William Rees-Mogg (THE TIMES, 30/07/07):

When presidents of the United States make reassuring statements about the stock market, investors with any historic memory prepare to run for the hills. The most famous example was Herbert Hoover after the 1929 crash: “The business of America is sound.”

Last week global stock markets fell heavily. On Friday President Bush commented that: “The world economy is strong.” Until that point, I felt fairly sure that what was happening in stock markets was a relatively minor correction, a response of the equity markets to the problems of the debt markets. Now I am not so sure. President Bush has shaken my confidence in the world economy.

Why should we worry about these reassurances from the White House? There is no one less suited to comment on markets than a president. The ideal commentator should have a lifetime experience of markets, but have no axe to grind. Of course, almost everyone has some interest in world financial markets, if only in terms of house prices, but a good commentator will have a detached point of view. No one in the world can be less detached about the world economy than a president, save possibly for a few rogue traders with overexposed positions.

Wise presidents leave it to other members of their Administrations to make any official comments that may be thought desirable. When the Treasury Secretary makes a comment, that is his proper business, though he will not be detached; in the market phrase, he will be “talking his book”.

When the President himself intervenes, that is a sign of higher than normal financial anxiety in the White House. Therefore, all presidential reassurances should be treated as alarm signals. What they tell one is not that “the world economy is strong”, but that the President is worried that the world economy is weaker than it looks.

Karl Marx thought that capitalism would eventually collapse because of its inherent contradictions. If one considers that capitalism was created by the Italian bankers of the Renaissance period, capitalism is now about 700 years old, and it has not collapsed yet. I would set aside any fear that capitalism is about to enter its own apocalypse, with the failure of the American sub-prime mortgage market as the fatal flaw.

However, Marx was probably right to think that the greatest strength of capitalism can also be its greatest weakness. Capitalism has survived because it has adjusted to its contradictions; that is what markets are for. Yet these reconciliations have to be constructed inside a narrow margin; in engineering terms, capitalism cannot afford to be over engineered, it cannot afford margins of safety that would represent an inefficient use of capital. Every battle in the capitalist system is therefore likely to be a near-run thing.

In yesterday’s Sunday Times, Irwin Stelzer wrote an interesting essay on the current contradictions. He listed four of them, the dollar, the sub-prime mortgage market, oil prices and the airline industry. I think he may have recently been through Heathrow, because he commented that: “This summer is a nightmare for travellers.” I would add a fifth, perhaps most important of all, which is the shift of the world economy from the North Atlantic axis of America and Europe, to the Asian superpowers of China, India and Japan. This is a change such as occurs only once or twice in a millennium.

Of these, the sub-prime mortgage market may seem the least significant, yet its significance has been in its weakness. Its borrowers are largely the black and Hispanic poor of the US. These loans are packaged and sold – no one takes full responsibility for them. They are the least desirable securities in the mortgage market. When sold in packages, they cannot be properly valued. Some of them have fallen to zero value because of rising levels of default.

Credit based partly on this flimsy foundation has been created on a huge scale and has fuelled a global inflation in asset values. The inflation has spread to every advanced country, affecting stock markets, house prices, particularly in Britain, and the art markets; it has produced an extraordinary speculative bubble in contemporary art of dubious long-term value.

The weight of money has financed private equity businesses as well as hedge funds. The secrecy, both of private equity and hedge fund finance, has meant that there is no public transparency to control the prudence of their operations. Both private equity and hedge funds have contributed to economic growth, but we do not really know where weaknesses may exist.

Irwin Stelzer put both sides of the case, as one should do when dealing with contradiction. There was a sentence of his which I’m sure will prove true: “We are coming to the end of an era of excess liquidity – so much money sloshing around the world that borrowers who couldn’t possibly repay were showered with loans, and companies were encouraged to borrow too much money.” The reaction against excess liquidity is the most important consequence of the defaults of the poorest customers of the sub-prime mortgage market. It is, as always, the weakest who go first to the wall, but reducing excess liquidity is uncomfortable for everyone.

If this is the “end of an era”, the other great issues will be affected. The dollar may be approaching the end of its period of decline; the pound is certainly miserable value if you have to pay $2 for it. Cheap mortgages may become a thing of the past, and so may double-digit rises in house prices. Oil prices will depend on the balance of supply and demand, not so much on the weakness of the dollar. Asia will continue to advance and Heathrow will continue to be a nightmare. The end of capitalism will be postponed for another century.