One of my favourite descriptions of globalization comes from JM Keynes, who at the end of the first wave of globalisation wrote (in Economic Consequences…)
‘The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and the new enterprises of any quarter of the world’
A modern day version might see Keynes driving a Tesla, speculating on Robinhood and paying for a new house with bitcoin, all whilst respecting confinement rules, obviously. It may not be as effortless as that, the Tesla might catch fire, the Robinhood account may crash or face a margin call and bitcoin may prove too volatile to do anything with.
The confluence of these finance centric eco-systems has led many people to hold that we are in an age of the democratization of finance – where platforms, tools and products are springing up that give the common man and woman access to the financial opportunities hitherto enjoyed by billionaire hedge fund managers.
This is not the case. Instead of the democratisation of finance, we are in an age of the democratisation of risk – where a range of risks, mostly arcane financial market ones, are increasingly distributed across retail investors. The issue is that the man or woman in the street, is unprepared for these risks. The other, finer point is that when many people across a population find they have the ‘same’ risk, and all react against it at the same time, dislocation occurs.
The news that Amsterdam has overtaken London as a financial trading hub reminds me that it in the 17th century it was a centre of financial innovation (William Goetzman’s book ‘Origins of Value’) and that innovations in finance follow a pattern where early investors and pioneers (especially those who own the infrastructure) do very well, asset prices rise in a parabolic way and this attracts the greater investing public (the democratisation phase), a crash or scandal ensues and regulators arrive late to the scene of the accident.
The derivatisation of the US housing market in the early 2000’s is a good example. Cheap financing meant people could afford more, and bigger houses, until the entire market collapsed.
The study of risk is now a large field. Bodies like the OECD produce a risk scorecard that countries can use in risk assessment, while a good number of institutional and hedge fund investors have become very good at risk management. The coronavirus crisis offers a particular lesson in risk assessment, crisis management and in risk absorption (through fiscal stimulus, the organisation of public services like healthcare and the provision of vaccines, not to mention human adaptability.
The tragic and dramatic experience the world has endured with the coronarvirus may – following on a chaotic Trump Presidency, Brexit and other catastrophes – convince many that the level of risk in the world has risen. I would say that it has not – though two risks loom very large – climate damage and indebtedness – and the factor that makes them distinct is that they are ‘democratisied’ or that they affect increasingly large numbers of people.
If there is a lesson here for politicians and policymakers it is not to permit the democratisation of the twin risks of indebtedness and climate damage (if you graph world average temperature relative to its long term average with world indebtedness relative to its average, the two lines fit nicely over each other).
The telling example was the response of euro-zone countries – notably Spain and Ireland – to their respective financial crises in 2011. In both cases bond market investors, and the eurozone itself, could have borne the risks associated with mounting indebtedness but, ultimately those risks were borne by government balance sheets, and by extension households.
Concretely, what I have in mind is perhaps two principles. That policy makers think not only in terms of the probability of specific risk event outcomes (i.e. from floods to wars) and their potential riskiness, but how those risk outcomes are distributed. Markets work like this – risks never go away, they are simply being continually redistributed across different investors and time frames.
The second element is that policy focuses more on realigning the risk of an event (e.g. polluters) with the fortunes of those who ‘produce’ that risk. In China, the former chairman of Huarong Asset Management was recently sentenced to death for gargantuan levels of corruption. This is accountability taken to extreme levels, but for the Biden administration and many governments in Europe, who foreswear a belief in ‘resets’, ‘stakeholder capitalism’ and ‘ESG’, the democratisation of risk is something they need to fight against.
Have a great week ahead
Mike
The Levelling 