G20’s Fiscal Illusion – Refunding the Louisiana Purchase

Thursday, April 02, 2009 | Posted by: Brian Maguire
Categories: Business | Tags: innovation, regulation, financial innovation, the ascent of money, niall ferguson, turner review, derivatives, alastair darling, louisiana purchase

Niall Ferguson, Scotland’s finest export since steel, recently wrote that the development of credit and debt is: “as important as any technological innovation in the rise of civilization, from ancient Babylon to present-day Hong Kong.” Glasgow born Ferguson, a financial historian and Harvard professor, has delighted television audiences with his pithy presentation of The Ascent of Money. Despite all the monumental fiscal calamities he details, a recurring message is “We never really learn”.

Prudent thinkers will caution that if we don’t learn from our banking mistakes this time, we’re just storing up more chaos for the future. Most of us, however, really don’t care what we’re storing up, so long as our house prices rise with the tide, and at great speed. We can’t argue with fiscal prudence, but consumer demand is for more cash in our pockets – and where there’s demand, there’s a way.

Financial innovation has had a bad press recently. Those bad bankers took big risks and crashed the markets. CEOs of banks didn’t really understand the complex derivatives which added billions in balance sheet profits. It was an illusion, of sorts.

Regulation is something of an illusion too, simply because regulators are always one step behind the innovators. Take the coding of genomes and data privacy for instance. The US Houses of Congress took ten years to enact a bill protecting data gleaned from DNA profiles; by the time the bill passed it was out of date. In the intervening years, the core of the bill remained the same, but the capacity to read, analyse and secretly distribute DNA information had quantum leaped, primarily through advances in online technology.

That the regulator is always behind the curve is not necessarily a bad thing. Fiscal innovators need to climb over the next peak if they are to sustain a competitive business, the regulator is the useful passenger who can observe the driver and ask: “Aren’t you going to fast; did you put your seatbelt on; do you have a licence?” We have to drive from A to B, but we are learning as we go.

Barack Obama promised to listen, learn and lead, as he commenced his visit to the G20 Summit. One might call this Obama’s approach to financial ‘L’. As President Obama listens, he will surely learn that the world isn’t going to change all that much. Sure, we’re going to get new global oversight, and some new stringent compliance requirements, but look at the detail of what has already been published, and you will see a regulatory light touch, and few barriers to innovation. If there is a global consensus at this point, it is that financial innovation must not be impeded by regulation.

In his short Turner Review speech, Chancellor Alastair Darling mentioned innovation six times, his thoughts echoed by the Governor of the Bank of Canada on day one of the G20. Niall Ferguson explains how a great financial bubble, very similar in cause and effect to events today, was nurtured in France by a convicted Scottish murderer. It brought the French state to its knees and reshaped the world order. We knew President Sarkozy was upset about something, but is he really getting his own back on the Scots by threatening to wreck the G20? Much like high-value divorce settlements now being recalculated, perhaps Sarkozy would like a rethink on Napoleon’s Louisiana Purchase – not the first property auction in history, but one of the least profitable.

Sarkozy is the arch-pragmatist and the Sarkozy-Merkel, Franco-German bluster has been carefully choreographed. Of course they will see their demands for stronger regulation agreed to, but so what? Every economy needs fiscal illusion to survive, and while regulation is designed to manage the fear of the unknown, bull markets will thrive on the thrill of the new. The new illusion will be fiscal transparency – now, that’s innovative!