Ferguson explains financial trust at Open VISIONS
Published 1:03 am, Wednesday, November 25, 2009
Financial guru Niall Ferguson spoke before the Open VISIONS Forum, Monday, Nov. 9 at Fairfield University's Quick Center. He gave the audience a crash course in the financial crisis we all are experiencing.
Once upon a time, Ferguson said, "someone could borrow money from you and you could rely on the fact that it would be paid back at some future date." He noted that the Latin root of the word credit is "credo" which means, he said, "I believe." He explained that we enter a relationship of trust any time anyone, whether it be a person or bank, borrows money.
He reminded the audience that it doesn't matter whether money is silver coins, clay tablets, seeds or paper, because when we deal with money we set up a relationship with the other. As far back as 4000 years ago in Mesopotamia, small clay tablets were used. In an introductory film, Ferguson showed a small clay tablet upon which was written that the debtor will repay a lender 330 measures of grain on the harvest date. On another tablet it read, "the debt of 4 measures of barley should be repaid to the bearer of the clay tablet." That familiar phrase, "repaid to the bearer," was the one that interested Ferguson the most, showing then a 20-pound note, saying although it itself has no intrinsic value, it is a promise to pay the "bearer." And that he said, is the same as it has been done for thousands of years.
Next, he showed the back of a ten dollar bill where it states, "In God We Trust."
"No, that is not true," he said, grinning from ear to ear. "By trading your goods and labor for a fist full of bills you are not trusting in God, you are trusting the U.S. Treasure Secretary will not produce so many of the damn things that by the time you come to spend them they are worth even less than the paper they are printed on."
He said we forget that as long as there have been banks, bond markets and stock markets, the world has faced economic crises. One need only look back to the Medici's or, "to the world's first stock market crash of the Mississippi Company. It was, he said, "the Enron of 1720."
John Law had established the Mississippi Company to develop the then-French colony of Louisiana in North America.
(Law's note-issuing bank was a spectacular success -- until it collapsed after a bank run in 1720, plunging France and Europe into a severe economic crisis. France was so traumatized that, until recently, "banque" was not used. Hence, terms like "Credit Lyonnais," "Credit Agricole," "Credit Foncier" etc. are used.)
Using a screen to help clarify his comments, he first showed a map of the world that showed countries not outlining their shapes, but rather "scaled to their economic importance." The U.S. appeared as a large rectangle approximately equal to the size of China. Countries were also shaded darker or lighter, which showed the individual wealth of various countries. The U.S. was darker depicting that as people we are rich, whereas China is as almost as large economically, but shaded lighter because the individual wealth is much less.
To illustrate that idea more specifically, he showed that in 2006 the measured economic output of the entire world was worth around $48.6 trillion. The total market capitalization of the world's stock markets was $50.6 trillion, 4 percent larger. The total value of domestic and international bonds was $67.9 trillion, 40 percent larger. What that meant, was that what he called Planet Finance was beginning to dwarf Planet Earth.
Standing in front of a poster of Julie Andrews as Mary Poppins, he said he told a group of investors who had invited him to the Bahamas to speak about the fast approaching crisis. After hearing him, one of the bankers said they shouldn't invite him again, but should show the film Mary Poppins the following year instead.
Ferguson reminded the audience what an ironic statement that was because if they remembered, "Mary Poppins is about a bank." Poppins, he reminded the audience, takes the children to the bank to visit their father, and young Michael is advised to put his tuppense ha'penny in the bank. He doesn't want to and demands his money back. Clients in the bank overhear him and soon they all want their money back, causing a bank run that forced the bank to close.
Then he went on to explain the six causes of the crisis.
"¢ Excessive bank debt
"¢ Contamination of the bond market
"¢ Federal reserves neglects asset price inflation
"¢ The extension of insurance into the realm of financial risk.
"¢ The encouragement of wider homeownership.
He went through each one, but focused on the first, saying with 17th century's introduction of "fractional reserve banking," money became largely invisible. Banks immediately lend out your money. This is where trust enters. "We trust," he said, "that when we go to get our money it will be there. Without trust, the whole system breaks down."
In other words if banks borrow more and more money and have bigger and bigger loan books, the banks become highly vulnerable. According to Ferguson that is what happened. The banks lost trust in one another.
He compared the U.S. to early 1900 Britain, which was the empire that underestimated Germany. China and the U.S. used to have a symbiotic relationship that he dubbed, "Chimerica." But the U.S. wasn't paying attention. China saved and the U.S. spent. As a result, Ferguson said that U.S. savings went from about 5 percent to zero and Chinese savings went from 30 percent to nearly 45 percent.
"Today," he said, "America underestimates China, a country that could become the size in every way of America by 2027." And when that happens, Ferguson says, "China will not only be an economic competitor which it is now, but a diplomatic and military competitor."
He doesn't think we are a dying nation, but another nation is building faster than we are able to keep up. We have to recognize that China will become more of a rival than a partner and if that happens, he says, "Chimerica could turn into chimera."
Professor Valeria Martinez, assistant professor of finance, opened the question and answer session with a question about the high percentage of Americans who are financially illiterate and was that a consideration when he wrote his book in the style that he did.
Ferguson was glad she asked the question because he agreed that finance is not a mainstream subject, and one that never has been even though he feels it needs to be. Ferguson feels that if 69% of Americans have mortgages, then 69% of Americans should be financially literate. By not teaching Americans, we will continue to set them up as "suckers."
Kelsey Biggers, managing director of K2 Advisors, asked Ferguson if he thinks we are wired as humans to repeat these mistakes. According to Biggers, when we face these crises, we learn a lot, then by midterm, we learn less and in the long-run, we ultimately learn nothing and repeat the same mistakes.
Our reaction to this crisis, Ferguson said, was much like the primitive people on the Serengeti Plain. When they see a four legged creature approach, they either run for a tree or kill it. When agriculture began some 4000 years ago, the planting and waiting for the seeds to grow was very simple but as time passed, trade, banks, stock markets, etc became the norm which made dealing with money more and more complex. So, when crises arise people revert back to the primitive behavior of fear and panic and they run. He thinks this will not change.