Tulips and art: beautiful but deadly
Many investment bubbles have burst in the past year—housing, credit commodities, oil and so on. But only now are we getting to the real froth.
The boom in contemporary art has been an incredible phenomenon: a true bubble of bubbles. It has exhibited all the classic features of the South Sea bubble of 1720 or the tulip madness of the 1630s. It inflated faster and more violently than other contemporary bubbles. While British house prices took six years to double, contemporary art managed it in just one, 2006-7. Insiders have long tried to justify the sense-defying tulip like increases in the value of some artists—the work of the Chinese painter Zhang Xiaougang, for instance, increased 6,000 times between 1999 and 2008—by claiming that we were living through some sort of golden age.
This, however, is pure poppycock, as Ben Lewis and I argue in our essay for the latest issue of Prospect. To understand why the work of artists such as Damien Hirst and Lucio Fontana have become so valuable, one must analyse it as a classic investment mania: from the point of “displacement,” when a new object of investment attracts speculative interest, to the point we are now at, where credit becomes overextended and the mania ends in panic. All that will ultimately remain is a stock of work that has been churned out by cookie-cutter artists without much regard to originality of aesthetic merit.
The acorn from which a mighty economics grew…
It is worth asking why central bankers so misread the credit boom. Unlike the bankers and the rating agencies, which stood to make millions from their error, the guardians of the credit system had no evident conflict of interest. And it simply isn’t good enough to suggest the bubble was hard to spot. Many more humble analysts and economists managed it.
No, argues Edward Chancellor in his essay for the latest issue of Prospect, the reason the central bankers failed was not that they were blind, conflicted or stupid. It was because they were, to quote John Maynard Keynes, the “slaves of some defunct economist”—in this case Milton Friedman. Our central bankers were drawn from a generation of economists who have been taught that financial markets tend towards equilibrium, that credit and asset price bubbles can be safely ignored, that international capital flows produce an optimal distribution of capital and that financial innovations are always to be welcomed. It is this intellectual enslavement that has taken us to the brink of the severest debt deflation since the 1930s.
Hedge funds say sorry. Sort of.
One of the most arduous tasks a hedge fund manager must perform in these troubled times is to write the periodic letter he sends to investors updating them on the performance of the fund. If things have gone awry, should he manfully take the rap - or should he (Russell Brand-like) evade the blame? Prospect has got hold of one such letter that gives an answer.
In the good times, of course, these documents were lengthy bragathons. In them, the manager usually sought to play down the impact of (generally favourable) market conditions and to play up his own unusual investment genius (known in the trade as his alpha). It was after all these market-beating skills that allowed him to draw substantial fees from the fund.
This style has mutated as the downturn has worsened. Now the market, rarely mentioned on the way up, has emerged as a significant influence on investment performance—as a recent gem of a letter from Toscafund shows. This is a London-based hedge fund, set up by a former banking analyst called Martin Hughes, which has been badly caught up in the downturn by its predilection for investing in banks, fund management companies and house builders, none of which have especially flourished in the recent environment. In the year to 30 September (the investment period covered in the letter) its fund was down 57 per cent.
Here, for the record, is that non-apology in part…
Continue reading ‘Hedge fund managers: a non-apology’
Winston Churchill once remarked, when he was chancellor of the exchequer, that he would rather have finance less proud and industry more content.
Were he still alive, Churchill would find the position little changed: industry remains frustrated by its low relative status in the British economy. But the issue with finance is now not so much its pride (although that remains considerable) as its size. Finance has grown way too big relative to the real economy. In this month’s cover story, I explore the reasons that made this—and the scale of the economic crisis it has precipitated—possible.
The statistics are certainly astonishing. In the 1960s, finance accounted for just 10 per cent of corporate profits in Britain and America. By 2006 this had risen to 35 per cent. Last year, a staggering one in five Britons earned their living in finance. As George Soros has remarked, it is manifestly an “overblown” sector, and needs to shrink. Yet this size is a puzzlement even to those who, like Soros, have done well out of it.
For a long time, academics clung to the notion that finance performed a useful role, shunting capital to its most profitable outlet. If you accepted that, more finance was inevitably a good thing, as it meant the economy was becoming more efficient. Thanks to increasing distortions in financial markets and greater frequency of crashes, this idea has come under increasing attack. Now, drawing on recent research done by Paul Woolley, I make the case that finance is not efficient but dysfunctional—and that accepting this is a vital first step if we are to recover from the current economic crisis.
John Gieve’s participation in our financial roundtable turned out to be virtually his last hurrah as deputy governor of the Bank of England in charge of financial stability. A couple of days after Prospect was published, news leaked out that he would be stepping down from the post next spring, two years early. What’s more, the news emerged in the most humiliating way possible for Gieve—on the eve of the annual Mansion House speech, when the Bank governor and the chancellor of the exchequer address the bigwigs of the City. It looked as if Gieve had been made the fall guy for the financial crisis.
His departure may gratify those who argue—like Mark Hannam, another roundtable participant—that regulators as well as bankers should face the chop when things go awry in financial markets. But there is a school of thought that Gieve did a more than reasonable job. Philip Stephens took up the cudgels on Gieve’s behalf in the FT on 1st July, pointing out that Gieve’s performance was perhaps more sure-footed than that of Mervyn King (who has recently been reappointed to his post as Bank governor). Gieve spotted much earlier than his boss that the severity of the crisis necessitated a major injection of liquidity into financial markets. King, Stephens points out, was at the time still hung up on the idea of not rewarding bankers who had taken foolish risks—even as a financial Chernobyl was unfolding around him.
That said, these differences don’t seem to have had much impact on the outcome. King got it in the end. Would things have been different had he taken Gieve’s advice sooner? In the roundtable, Gieve himself pretty much pooh-poohed the idea.
But if Gieve did a pretty good job in what were very difficult circumstances, it is also right that he should go early. The biggest lack in the crisis—from the perspective of the authorities—was early intelligence about stresses in the markets. The Bank now intends to correct that lack. Its expanded financial stability role will involve monitoring what banks are doing to gauge emerging risks. That requires someone with a deep knowledge of the markets, something that Gieve—a former civil servant—lacks.
King should now replace Gieve with Paul Tucker, a Bank insider with the necessary independence of mind and market expertise. This is clearly what he wants to do. But worryingly, the treasury may try to frustrate King. It seems to favour the alternative of appointing an old City hand—even though this would run the risk of the Bank being captured by the very people it is supposed to be regulating. Stephens’s article—which implied King may have been complicit in Gieve’s departure—may have unwittingly handed the mandarins some ammo in this fight.
The one thing surrounding Gieve’s departure which does deserve criticism is the way it was handled. Gieve was an able and loyal servant of the Bank and was entitled to leave with his dignity intact. Whoever leaked his departure in the way they did, and for whatever reason, paid him back in very poor coin.
There’s no end in sight, it seems, to the financial crisis that started last summer. But how bad is it and what can we do to prevent another one? Prospect assembled a panel of top financial experts, including renowned investor George Soros, economic pundits Anatole Kaletsky and Martin Wolf, and Bank of England deputy governor John Gieve to discuss these questions. It considered who was to blame for the crisis, how much worse it may get, and how we can avoid asset bubbles blowing up in future.
The shock phase of the crisis may now be past, but the panel were sceptical about an early recovery, fearing that the conjunction of a banking crisis and a commodity boom may lead to stagflation (where growth slows while inflation rises) and this could cause a serious shock in the real economy. The financial authorities came in for some stick about the way the crisis was handled, and for being too slow to spot the dangers. Gieve, who was in charge of financial stability at the Bank of England (he has since announced he’s going to leave the post early), admitted the authorities would in future have to be far more intrusive in the way they regulated the financial system. Even poking around in banker’s pay packets (how much, and are they being paid in the right way?) is now something the watchdogs are thinking about.
Other panel members suggested more severe penalties for bankers who cause big losses by taking reckless bets. Soros even suggested they should be shot. There was general agreement that banks should be made to pay—perhaps through higher taxes—for the implicit guarantees they receive through the financial system that the authorities will bail them out if things go wrong. And there was a general feeling that it would be a good thing if the financial system shrank, although most doubted that it would do so. Lastly, looking to the future, the panel expressed some foreboding that this shock may prove to be insufficient to change behaviour. If that’s true, we may be on course for a mega-bubble that will, in Kaletsky’s words, “totally blow up the financial system.”
The last nine months have seen an astonishing revival in the fortunes of the Conservative party. From a ten-point deficit in the polls last autumn, the Tories now enjoy a 20-point lead. And following a crushing by-election victory at Crewe and Nantwich last month, they are increasingly seen as the government-in-waiting. George Osborne, the shadow chancellor, is one of the key figures behind the revival. His speech at last year’s Conservative party conference—promising cuts in inheritance tax and stamp duty—is credited with rattling Gordon Brown sufficiently to make him bottle plans for a snap election he would probably have won.
Osborne is one of David Cameron’s key lieutenants in the mission to modernise the Tories and “decontaminate the brand.” At the astonishingly young age of 37, he has already become one of the most influential politicians in the country. Osborne emerges in my profile as a shrewd and disciplined tactician—sufficiently scarred by past failures in opposition to sacrifice ideology in pursuit of power. But in some areas it’s been easy for him to jettison some past Tory baggage: he’s a libertarian who has no problems with alternative lifestyles. He presents himself as someone who is genuinely comfortable with the modern world. His courage and tactical astuteness are not in doubt. But it remains unclear to what end will those talents be put if and when the Tories win power again. Please comment below.
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