Geopolitics

[acharya]

The gods of greed

They promised economic stability, order and prosperity. But instead the world's bankers have delivered chaos, debt and uncertainty - and then blamed the feeble governments that surrendered control of the global economy to them. In the first of three extracts from their new book, Larry Elliott and Dan Atkinson explain how the reckless speculation of a super-rich elite has left us all the poorer

Illustration: David Parkins

March 2008 was no time to be a welfare scrounger in Gordon Brown's Britain. That month saw a much-trumpeted move, the latest of many since Labour came to power in 1997, to end the so-called "sick-note culture".

On March 17, Dame Carol Black, the government's national director for health and work, declared that absence and worklessness related to sickness were costing the country £100bn a year, and it was announced that ministers were to look at replacing the doctor's sick note with a "fit note", detailing what people can do rather than what they cannot when they are on leave for health reasons. This was of a piece with the "tough love" approach of Brown and his predecessor to those on welfare benefits. It was all about reminding those who wanted to get their hands on public money that rights came with responsibilities.

Four days later, the chief executives of Britain's five largest banking institutions - Barclays, HBOS, HSBC, Lloyds TSB and Royal Bank of Scotland - met the Bank of England. In the jargon of the City, they wanted governor Mervyn King to widen the types of collateral against which the Bank would lend to the clearing banks. In plain English, they wanted him to lend taxpayers' money against much flakier assets than would normally be considered acceptable.

Why did they need this handout? Because banks themselves had stopped lending each other money. The collapse of the US housing market, and the complex financial instruments that had been spun off from it, had caused chaos in the money markets. The victims of last year's "subprime crisis" included two of the world's most respected banks, America's Bear Sterns and France's BNP, while the "credit crunch" that followed claimed Britain's Northern Rock. Those banks that escaped unharmed were sure of only one thing: with so many of their peers exposed to incalculable risks, there was more bad news to come.

That fear seems amply justified. Speculation has left the global economy more vulnerable to a financial collapse than at any time since 1929. According to the supposedly sophisticated models used by market practitioners, a stock-market crash such as the one in 1929 was likely once in 10,000 years. They said the same, however, about the stock market crash of 1987, the collapse of the hedge fund Long Term Capital Management in 1998 and the subprime crisis. The obvious conclusion is that these models are flawed. The International Monetary Fund (IMF) recently described the crisis that erupted last August as "the largest financial shock since the Great Depression". George Soros, the billionaire speculator who knows a thing or two about financial upsets, says the world is facing the "most serious crisis of our lifetime".

Fortunately for the banks, in Brown's Britain they are seen as a cut above the average benefits scrounger. A month after they visited King, the governor announced a £50bn "special liquidity scheme" to provide emergency loans to struggling institutions. It was a similar story across the Atlantic. Over the weekend of March 15 and 16, America's central bank, the Federal Reserve Board, launched a rescue for Bear Stearns, the country's fifth-largest investment bank. To smooth a takeover by JP Morgan Chase, the Fed assumed up to $30bn (£15bn) of Bear's more doubtful assets. Were this act of corporate welfare not sufficient, the Fed also announced that it was to provide emergency liquidity to the market. For good measure, it cut interest rates.

What was most extraordinary about all of this was not the bailing-out of City and Wall Street types who had spent decades, like surly teenagers, insisting that they wanted only to be free from the stuffy, paternal state institutions to which they now turned for help. Rather it was the failure of those same institutions to insist on any quid pro quo. In the real world, when a wild-child son or daughter comes home, tail between their legs, their "boring" parents usually require them to clean up their act in return for financial support and use of their old bedroom. Not so in the world of banking and finance. In remarks to the press in March, the British treasury actually ruled out tougher controls.

But then there is plenty of evidence that, in Britain as elsewhere, those in government could see little wrong with the system as it is. Democratically elected governments have, over the past three decades, willingly ceded control of the world economy to a new elite of freebooting super-rich free-market operatives and their colleagues in national and international institutions like the IMF, the World Bank and the World Trade Organisation. These New Olympians, who earn that title by their remoteness from everyday life and their lack of accountability, have gained this control on a prospectus every bit as false as much of the promotional material for the "exotic securities" of which they are so fond. The charge sheet is as follows:

· They promised economic stability - and have delivered chaos and volatility.

· They promised an economic order based on enterprise, thrift and personal effort - and have delivered one based on chronic indebtedness and wild speculation.

· They promised a "transparent" future in which all costs and prices would be clearly laid out - and have delivered a world of bizarre, occult financial knowledge.

· They promised a greatly expanded middle class of property- and share-owning individuals - and have unleashed havoc on professional and white-collar career structures.

But then none of this ought to be surprising. The New Olympians are unconcerned with - in fact, hostile to - job security (other than their own), social tranquillity and the traditional aspiration for both the good life and the quiet life. They roll their eyes when they hear that the Detroit car worker, the Argentinian shopkeeper or the Cornish fisherman is complaining that their way of life is under threat. Like it or lump it, the New Olympians say. That's just the way it has to be. Meanwhile, elected politicians bend over backwards to make life as pleasant as possible for them.

That was vividly illustrated in February when the British government backtracked on its extremely modest proposals to increase taxes on some of the heroes of business and finance. These were the wealthy "non-domiciled residents" who, while living in the UK, claimed their residence to be elsewhere and paid tax only on income shown to have been earned in Britain. In his pre-Budget report in October 2007, the chancellor, Alistair Darling, had proposed a tougher regime for those 20,000-odd non-doms who had been in Britain for seven years or more, a regime that included the payment of an annual £30,000 flat tax to the exchequer. The backlash from the assembled bankers, ship-owners and other tycoons was predictable, as their political and media apologists lauded their contribution to economic growth and employment and warned of disaster should these philanthropists take themselves elsewhere.

Vince Cable, the Liberal Democrats' treasury spokesman, noted the bizarre nature of the campaign being waged: "We hear stories that a high proportion of non-doms will flee ... It is also claimed that public discussion of non-dom taxation is dangerous because it might frighten these fragile creatures away. This is effective propaganda. We are in the absurd position that some taxpayers on modest incomes have started to feel sorry for the wealthy tax-avoiders."

To be fair, at least 100 Labour MPs failed to accept that global competition means that all workers except CEOs and top directors must accept lower real wages and pensions and poorer working conditions. Nor did they find it convincing that globalisation makes all types of labour more abundant, except chief executives. Brown and Darling, however, seemed to have swallowed the argument. The charge would stay, it was announced, but into the waste-bin went earlier, hated suggestions of making non-doms report on the source of their earnings abroad. Furthermore, there was a categorical statement that the tax changes would not be retrospective.

Growth under the Blair and Brown governments has relied excessively on speculation in two forms: that in the City and that by home-owners. Economically, the legacy is a debt-sodden, lopsided and unequal country in which the pay of those at the top rises at 10 times the rate of those at the bottom. Instead of taking on the City, however, the government has turned its attentions to the workforce - both blue-collar and white-collar - which has to be made ready for the global challenge from China and India by being re-skilled and re-educated and by learning how to be "entrepreneurial". Furthermore, the majority is routinely subjected to ever more illiberal, intrusive and obnoxious interference from state agencies, whether in terms of visual surveillance and the proposed identity card scheme, or in terms of being instructed to change their "attitudes" on a range of subjects.

In the period before the New Olympian takeover, market capitalism proved remarkably good at providing both peace of mind and material advancement. Living standards rose rapidly, financial crises were rare, banking crises rarer still. The New Olympian regime, by contrast, has offered neither faster growth in living standards (for at least 99% of the population) nor peace of mind. The modern era has been characterised by slower growth in average real incomes, higher levels of debt to maintain living standards, greater job insecurity and financial crises that have become more frequent and more far-reaching. The only class that has benefited unambiguously from the new world order has been that of the New Olympians, just as the only creed that has been accepted has been their creed.

The ancient Greeks believed their 12 most important gods and goddesses lived on Mount Olympus. They all had a special significance. Zeus, the lord of the gods, ruled the sky; he was responsible for thunder and lightning. Poseidon, his brother, was the king of the sea; he could ensure that a traveller returned safely home to port. Aphrodite was the goddess of love, Ares the god of war, Apollo the god of the sun and music. Today, there are another dozen governing spirits that hover above and direct our daily lives.

First among these modern gods is globalisation. The ancient Greeks worshipped Zeus; today's cosmopolitan elite pays homage to a world without borders. From the acceptance that economic power had shifted from the nation state to the global market, everything else stems. Governments that seek to meddle with the global market do so at their peril. Rather than tame globalisation, they are supposed to ready their citizens to compete in a world of cut-throat competition. Rather than putting tariffs on foreign steel or banning a foreign company from buying their ports (as the US has done) or seeking to prevent cheap food from undercutting their farmers (as the French have done), they should invest in education, skills and science in the belief that this will "brain-up" their population and create a knowledge economy that will find an upmarket niche in a world awash with cut-price goods. This, of course, is Brown's approach. Whether or not it works is another matter. As the twin engines of the economy struggle, there is little evidence of the knowledge economy riding to the rescue. Indeed, the managerial incompetence that marked the opening of Heathrow Terminal 5 suggests a national shortage of grey matter.

The twin brother of globalisation is communication. The development of powerful digital technology has transformed the way the world works. Had a French bank run into difficulties as a result of financing Napoleon's wars in 1807, for example, it would have taken days for the news to arrive in London, and weeks for it to get to New York. Yet when BNP announced that it was having problems, every dealer in Wall Street and Canary Wharf knew within seconds.

Nation states, despite the impact of globalisation and communication, retain considerable power. They control the flow of imports into their markets; they have controls on the movement of capital; they run industries that are considered to be strategic; they believe that some sectors of the economy - health and education - should be shielded from the full blast of competition. These are, however, impediments to the smoother running of the global market and thus need to be removed. The World Trade Organisation - a supranational body with punitive powers for governments that transgress its rules - started a new round of talks in November 2001 designed to open up markets in agriculture, manufacturing and services. The IMF and the World Bank insist that poor countries receiving financial assistance should abandon state control of their mines, banks and energy companies. In Brussels, the European Commission is dedicated to the removal of the restrictive practices and state subsidies that throw sand into the machinery of the single market. The next three gods are, therefore, liberalisation, privatisation and competition

The sector of the economy to benefit most from these developments was finance. International banks had always tended to have global reach, they could benefit more than any other sector from more rapid communication, it was in their interests to have barriers on capital removed, they picked up hefty fees for organising privatisations, and competition allowed them to wipe out weaker competition. What was not really apparent until last year was how powerful this sixth god - financialisation - had become. In countries like Britain, the expansion of the City of London had been the engine of the economy's growth - the fastest-growing parts of the finance sector expanded at around 7% a year between 1996 and 2006. Meanwhile, manufacturing output stagnated. Financialisation, it was argued by its proponents, was good for a country like Britain. It allowed the country to specialise in what it was good at, made London the hub of global finance, encouraged innovation and - by allowing the market to decide where capital should go - made the economy more stable. Whether this proves to be true in the long term remains to be seen. In the short term, economic growth did not accelerate, productivity did not surge, there was no miracle cure to the balance of payments and only rare glimpses of trickle-down.

Until last year, it was easy to argue that these first six gods were beneficial to the global economy, and at worst, neutral. Privatisation in developing countries, for example, was heralded as a way of preventing corrupt ruling cliques from siphoning off profits into Swiss bank accounts. Globalisation was specialisation on a grand scale: the logical conclusion to the sort of division of labour that Adam Smith and David Ricardo had envisaged 200 years ago. The modern world not only means that we can keep in touch by email with our cousins in Cape Town and buy an agreeable Malbec from an Argentinian vineyard in the foothills of the Andes, but also allows our pension fund to buy shares in an Indian software company. On paper, this life of greater choice, freedom and opportunity sounds splendid. It is certainly preferable that modern communication technology allows Mozart's clarinet concerto to be heard on a CD player in any living room rather than being the exclusive preserve of the court of the Austro-Hungarian emperor in Vienna. In reality, however, the world doesn't work this way - and that's because the remaining six gods have such potentially dangerous properties. These are speculation, recklessness, greed, arrogance, oligarchy and excess

Speculation is not always harmful. Britain's 15 years of uninterrupted economic growth from 1992 onwards was the direct consequence of sterling being forced to leave the European exchange rate mechanism following an attack on the pound orchestrated by Soros. Freed from the need to use excessively high interest rates to defend sterling, growth picked up and unemployment came down. Yet the activities of the big banks and the hedge funds in the first half of 2007 had no noble purpose: far from rectifying a glaring public policy error, they exploited a problem in the private sector - the granting of mortgages in the US to those who couldn't really pay them. Financialisation had created an inverted pyramid. Instead of having a broadly based productive economy supporting a financial sector that had speculation as one of its lucrative but less important activities, a diminished productive sector supported an ever-bigger financial sector that saw speculation as the very reason for its existence.

It would be naive to believe that greed could ever be expunged from financial markets: the pursuit of riches is, and always has been, a factor motivating those who buy and sell shares, bonds, currencies and commodities. Nor is it uncommon to find that the brokers and dealers do rather better out of asset-price bubbles than their customers; as long ago as 1940 the Wall Street veteran Fred Schwed wrote a book called Where Are the Customers' Yachts? Every so often, however, the money lust becomes so pronounced that it crosses the dividing line between cupidity and criminality. Since 2002, a wave of mis-selling has been evident in the US real estate market, with tales of pensioners with only a tiny amount outstanding on their loans tricked into remortgaging their homes at ruinous rates of interest by unscrupulous mortgage brokers.

In January, panellists at the World Economic Forum in Davos were asked how the big banks of North America and Europe had failed to spot the potential losses from subprime lending. The one-word answer from a group that included the chairman of Lloyd's of London and the chief risk officer of the insurance company Swiss Re was "greed". As one participant put it: "Those running the big banks didn't have the first idea what their dealers were up to, but didn't care because the profits were so high."

It goes without saying that those responsible for the speculative bubble of early 2007 could not conceive that one day it would burst. That was where the arrogance kicked in. The super-heroes of the New Olympian order were the brightest and the best of their generation. Their activities were making massive profits, a good chunk of which were being paid out in seven-figure bonuses that kept property markets humming in the Cotswolds and the Hamptons. Could they really be guilty of crass stupidity? Even when cracks did start to appear, the New Olympian class managed to blame everyone but themselves.

Bob Diamond, the American chief executive of Barclays Capital in London, earned £22m in 2006 and was the sort of person who saw no reason why his money-making activities should be curtailed by red tape. But in August and September 2007, once the going had got tough, Diamond conducted a vigorous campaign against the Bank of England's Mervyn King for failing to provide the same sort of help to banks in the UK as was being provided by the Fed or the European Central Bank, which had stepped in after BNP's problems. As one commentator noted, this state of affairs was tantamount to the police being forced to provide a getaway car to bank robbers for fear that even greater damage would be caused by not doing so.

The response to the market meltdown helps illustrate the final two principles that govern the modern world. One is that, despite the lip-service paid to democracy, western societies are in effect run by moneyed oligarchies, who have as little time for their wage slaves as did the ruling elite of ancient Athens. In February 2008, two weeks after Darling's U-turn on the taxation of non-doms, Brown and his ministers opposed a private member's bill designed to give greater rights in the workplace to agency workers - part-timers who face some of the lowest wages and toughest working conditions of any group.

It is tempting to say that the final god of modern finance is weakness, because it was certainly apparent in late 2007 and early 2008 that the apparent strength of the financial markets was illusory. The happy-go-lucky mood evaporated instantly, with the write-down of losses accompanied by some token sackings of executives and followed by more stringent lending for the real victims of the credit crunch - individuals and businesses forced to pay more when they borrowed. Weakness, though, cannot really be included as a principle of the New Olympians, since nobody willingly seeks to be weak. Rather, our 12th and last principle is excess. It is an axiom of the global order that there is never too much of anything: never too much growth, never too much speculation, never too high a salary, never too many flights, never too many cars, never too much trade. It was for that reason, perhaps, that the financial crisis was accompanied by rising inflation - as demand for oil and food pushed up prices globally - and by almost daily evidence of the impact of global warming. Losses in the financial markets; hardship for pensioners facing dearer heating and food; climate change. There were no prizes for guessing which the New Olympians considered the most pressing issue for policy makers.

The gods promised us paradise if only we would obey and pamper their hero-servants and allow their strange titans and monsters to flourish. We did as they asked, and have placidly swallowed the prescriptions of the lavishly rewarded bankers, central bankers, hedge fund managers and private equity tycoons, while turning a blind eye to the rampaging of the exotic derivatives, the offshore trusts and the toxic financial instruments. Had they delivered, there would, at least, be a debate to be held as to whether the price was too high, in terms of the loss of democratic control and widening social inequality. But they have not. Chronic financial instability and the prospect of, at best, years of sluggish economic activity are the fruits of their guidance.

These gods have failed. It is time to live without them.

© Larry Elliot and Dan Atkinson 2008