Where is the Global Financial System (GFS) headed? Why it needs to be changed? Do legislative reforms such as Dodd-Frank really work? How recent events such as the 2 billion loss of JP Morgan Chase still happen? Is the Euro going to survive the crisis? We asked these and other questions to Robert Pringle, author of “The Money Trap” and you will be surprised by his answers.
“In my book I argue for fundamental reform both of banking and of money – to link finance for ever to the real economy, and to stop bankers and other financial intermediaries gambling with our money”, said Pringle in this exclusive interview.
“The Money Trap” explains the causes of the financial crisis and outlined new ideas to reform the international monetary and financial system.
“We have to search for the key needed to unlock the door marked “exit”. Where will we find the way out of the money trap? To find it, we must imagine and then realise a new economic and financial order”, he said in these Q&A.
As the first executive director of the Group of 30, an influential think tank based in New York (now in Washington, DC) he worked with financial authorities and executives throughout the years. The experience gave him the knowledge to examine these complex issues inside out. Pringle is also the founder and chairman of Central Banking Publications, a financial publisher specializing in public policy and financial markets, where he edited for 20 years the Central Banking journal. The publication has subscribers in 120 countries including the great majority of the world’s central banks.
Robert Pringle is the former Editor of The Banker, has monitored and commented on changes in markets and official policies for more than 40 years and worked for the Financial Times and The Economist.
LFDB: You mention in your book that the structure of incentives by the GFS to agents is one of the issues that we have to deal with. Can you explain further and give some examples?
Robert Pringle: The GFS provides the wrong incentives for two main reasons. First, it is weak, and, secondly, it is still based mainly on national policies and regulations.
Thus instead of focussing on customer services, clever bankers spend time finding ways round the regulations, for example by moving operations to places with less stringent rules, or to jurisdictions that apply them less strictly. Often, regulation has encouraged harmful swings in economic activity and credit.
Because the system is seen to be weak, banks have also invested much time and money in lobbying regulators. They can influence new rules before they come into effect – as we have seen with the lobbying over Dodd-Frank – and in the process of implementing rules.
Also, despite the efforts of the G20 group of leading economies and the Financial Stability Board (the international regulatory body), financial regulation remains essentially national.
Indeed, the entire monetary system – with its characteristic model of independent central banks following forms of inflation targeting with flexible exchange rates – is inward looking. It forces policy makers to focus on what is good for their country alone rather than the international community more widely. This is incompatible with the proper working of a globalized world economy. It encourages nationalist measures such as protectionism.
LFDB: Also you state that the crisis was a symptom of a dysfunctional monetary and banking system, can you try to explain when did this started and how?
RP: We have been through a number of credit and financial cycles in the past 40 years. Each time, the response of the central banks and governments has been similar – tighten up regulation, put a floor under the banks, and try to prevent recessions by expansionary monetary and fiscal policies. Each time, they claimed that these measures would fix the problem; in fact they merely made the next crisis worse. As the managers of private sector financial institutions learnt to anticipate such responses, they did not take enough care about their business decisions. Together with a bonus-based compensation culture, this encouraged excessive risk-taking.
LFDB: Many people ask why none of the bankers, executives, sophisticated investment vehicles creators; broker or traders that became part of the chain that provoked the financial housing bubble are not in jail. What do you think?
Anger is fully justified and an important pressure for real change. In my book I argue for fundamental reform both of banking and of money – to link finance for ever to the real economy, and to stop bankers and other financial intermediaries gambling with our money.
Pending such fundamental reforms, we should return to an ethic of personal responsibility.
Top executives should come under stronger pressure to resign as soon as something shameful happens in their organisation even if they were not personally responsible for it. In this way they will make sure they know as much as possible about what is going on. At present, they have incentive to know as little as possible – so that they can deny any connection with the scandal.
Regulation cannot fix this problem, which is in the last resort an ethical one.
RP: The euro area is confronting problems that all countries living in a global world economy and financial system have to face. Having your own currency, like the US dollar or pound sterling, does not protect you from these dilemmas and problems. Having your own currency enables your local politicians to promise to spend money – the people’s money – and enables governments more easily to postpone taking the hard decisions needed to live with a global world economy.
I expect the euro to survive but it may not have all of its present members in 12 months’ time. Those countries that have the political will to implement needed reforms – and most of the current members have such political determination – will be able to stay in the euro. Indeed, if current reform plans are fully implemented, the euro area will emerge stronger in the long run from this crisis.
LFDB: With all the regulations and risk controls, events such as the 2 billion loss of JPMorgan still happen, what do you think about it?
RP: It shows that the culture of aggressive, risk-taking investment banking is still prevalent in the leading institutions. Again, the top people could say they were not aware of such risk-taking. But it is their responsibility to set the tone and monitor risk-taking.
This underlines the need to split up the big banking groups, and such incidents increase the pressure for such break-ups.
Governments should stop pretending that “more regulation” or “better regulation” can make the banking and financial system stable and safe. This is false and dangerous, as it takes responsibility further away from the management of individual firms to keep their capital and liquidity string enough to withstand shocks and to make their own assessment of risks.
LFDB: Was Dodd-Frank really needed? And can you highlight overall the good and flaws of that legislation?
RP: I welcomed Dodd-Frank when it was passed a step in the right direction, but banks’ lobbying power is watering it down and will water it down further when it comes to implementation.
My view now is that this monstrously complex piece of legislation proves that the current banking and finance system should be abolished. It has reached the end of the road. Either we go for a fully nationalized finance system, with extensive state direction – and we are moving in that direction – or we need to construct a reformed system where individuals choose what level of risk they are willing to accept for the money they place with financial intermediaries and take the consequences.
In The Money Trap I argue that we need to move to a new model of finance and banking.
LFDB: Do you think that the dollar will continue to be the international currency for business?
RP: The dollar should take its place in a global network of currencies linked to a common benchmark or standard. We need a reference point, or platform, against which currencies including the dollar, euro and pound, can measure themselves. I suggest one way of defining such an international currency, which I call the Ikon, in my book.
LFDB: In an economic crisis scenario where two philosophies rule: some think that there is no need to rescue financial institutions and pour more money into economic systems and others that this need to be done (at taxpayers expenses) What do you think is the answer?
RP: In a system with strong rules, the authorities would have the confidence to let weak banks fail, however big they may be – banks that cannot provide collateral to secure assistance, and banks that may have been rescued in the heat of the moment, to prevent the panic spreading, but which on close inspection are not viable in the longer run.
In the present crisis, banks are being kept afloat that need to fail or be merged with others. It will be years, possibly decades, before the long-term lessons of this unique crisis are fully learnt.
LFDB: Finally, can you layout in bullet points what needs to be done to reform the GFS?
RP: Here are a few:
*We have to search for the key needed to unlock the door marked “exit”. Where will we find the way out of the money trap? To find it, we must imagine and then realise a new economic and financial order.
This requires an international agreement to build strong international standards for money and banking.
*A world currency unit would be defined in such a way as to represent a share in the world’s total economy – its total productive capacity.
*Existing national currencies would link to this new standard. Governments would discipline their spending so as to maintain convertibility of their currencies at a fixed rate into this new currency.
*This new monetary system would be voluntary; it would not be a ‘big euro’ – a compulsory single currency for the world – but a standard to which individual nations would wish to link to.
*Adherence to such a standard would have many benefits.
*These standards should re-connect finance with the real world of jobs and work. They should re-connect the past, present and future generations. They should connect people of the world across time and space.
*We need to have faith that these goals can be reached.
NE: For more information on the book or the author, go to www.themoneytrap.com