False Economy: A Surprising Economic History of the World by Alan Beattie

Misadventures of the Most Favoured Nations: Clashing Egos, Inflated Ambitions, and the Great Shambles of the World Trade System by Paul Blustein

Adam Smith observed that man has an intrinsic “propensity to truck, barter, and exchange one thing for another.” False Economy and Most Favoured Nations provide different and interesting perspectives on economic growth and trade.

Alan Beattie, the world-trade editor for the Financial Times, explores the basis for economic success and failure.

The central simple conceit (every non-fiction book now requires one!) is the contrasting fortunes of Argentina and America. Mr. Beattie shows that in the nineteenth century, the two nations exhibited similar potential and enjoyed not dissimilar natural endowments. The thought leaders of the time favoured Argentina to succeed relative to America. History records that the result, like most predictions beyond the next ten minutes, were different. America, despite its current problems, is the world’s largest and most successful economy and Argentina remains a basket case and serial defaulter on its debt.

Mr.Beattie’s analysis highlights that the choices of rulers and the sequences of decisions may influence success powerfully. Perhaps disappointingly for nationalists and conspiracy theorists, he finds little evidence that natural resources, religion or the interference of colonial masters affect economic success.

For example, natural resources are considered especially troublesome – the “Dutch” disease. Richness in natural resources can create few local jobs and profits for locals. Profits accrue frequently to foreign multinationals and corrupt politicians’ Swiss bank accounts. But sensible management of these resources can assist development. Mr Beattie uses the contrast between Botswana’s successful management of its resource wealth and other African countries to illustrate this.

Well written, False Economy does not purport to be comprehensive. The breadth of geography and topics covered at time make the book feel slight and superficial. Flights from topic to topic and the author’s desire to be clever sometimes jar. These minor criticisms aside, False Economy is both an interesting and at times insightful read.

In Most Favoured Nations, Paul Blustein, former Washington Post reporter, critically analyses the World Trade Organisation (“WTO”) and the reality of free trade. The author is singularly unimpressed, like many others, with both the WTO and the successive futile trade negotiations. We are currently in the Doha round soon to be followed by the Homer Simpson “Doh” Round.

Mr. Blustein’s thesis is that the benefits of global trade have been overstated, probably egregiously so. He argues for the simpler framework of the Global Agreement on Trade and Tariffs which made progress in reducing and eliminating barriers to trade in preference to the utopian and ultimately unrealisable objectives of the WTO which would ultimately benefit mainly the wealthier nations.

Short on historical and economic analysis, Mr. Blustein’s book is at its most compelling in its portraits of individuals, both ordinary and the great, in the world of trade. His portrait of Mike Moore - a former New Zealand politician who became a WTO director, after a massive campaign to obtain the position expending a part of his personal fortune on the effort – is a good example.

The coverage of negotiations within the WTO itself is especially acute. Mr. Blustein describes Kamal Nath, the Indian commerce minister, pressing Peter Mandelson, the European trade commissioner, to specify the year by which Europe would phase out its export subsidies: “I want a date! I want a date! I want a date! But not with you!” Kamal Nath features again in another session, questioning the U.S. position: “Next time you can bring a picture of an American farmer? Because I have never actually seen one. I have only seen US conglomerates masquerading as farmers.”

Most Favoured Nation shows that the machinations of the WTO and world trade are always lively if ultimately unproductive.

Interestingly, the third law of publishing says that the relative importance of the topic declines at a speed that is directly proportional to the number of books written on the subject. False Economy and Most Favoured Nations appear at a time when models of economic growth are changing and growth in global trade is reversing for the first time in years in the wake of the global financial crisis.

© 2010 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives- Revised Edition (2010, FT-Prentice Hall).

John Cassidy (2009) How Markets Fail: The Logic of Economic Calamities

Like Mark Anthony with Julius Caesar, many have now come to bury the Efficient Market Hypothesis (“EMH”) rather than praise it. Amusingly, some of the critics who have recently found their voice are those who for years made their living from financial markets that were predicated in no small measure from the intellectual dogmas that EMH was central to.

In his previous book Dot.Con, John Cassidy, a writer for the New Yorker, provided a penetrating history of the Internet bubble and its bust. In How Markets Fail, Mr. Cassidy attempts a critique of modern economics. In this regard, he covers similar ground to Justin Fox’s The Myth of the Rational Market and Pablo Triana’s Lecturing Birds on Flying.

At its best, How Markets Fail provides a vivid history of recent economic thought and its influence on events that laid the foundations of the global financial crisis. Drawing on anecdotes and interviews, Mr. Cassidy provides an accurate outline of the developmental trajectory of modern economies.

His description of a noted confrontation between Raghuram G. Rajan and orthodox economists led by Larry Summers and members of the Fed, at a Jackson Hole meeting is revealing. Rajan, then the chief economist of the International Monetary Fund, warned about the risks embedded in the financial system. His detractors blithely denigrated the concerns on ideological grounds.

Mr.Cassidy also attempts to extend the text to encompass a critical review of what he calls “Utopian Economics”. The central focus of the criticism is that society is best served by individual self-interest and free markets. Mr. Cassidy’s argument is that individual self interest does not work, markets frequently fail, price mechanisms are flawed and markets are plagued by problems of information asymmetry – different levels of knowledge between participants.

In his criticisms, How Markets Fail is perhaps a little too eager to embrace behavioural economics and the work of Hyman Minsky. Useful as both alternatives are, they are also incomplete explanations of the complex economic and financial relationships.

In the final section of the book argues that it was these failures that led to the disastrous sequence of events that caused the global financial crisis.

Well written and researched, How Markets Fail is superior to the growing list of titles that cover similar ground. Mr. Cassidy largely succeeds in his objectives although the book does not extend the debate. The book undoubtedly will introduce a new generation of readers to the debate and encourage further debate.

There are some contentious and erroneous pieces of analysis of individual technical elements of the theory. In this regard, Donald Mackenzie’s brilliant An Engine Not A Camera provides a more technical and deeper analysis of aspects of the theory.

Recent criticism of the EMH, Chicago economics and “free market idolatry” tends to gloss over some interesting anomalies. Markets are rarely entirely free and regulatory failures were a contributing factor to many of the problems that have emerged. That is not to make the case for unfettered ‘red tooth and claw’ capitalism but to point out that many proposed regulatory interventions will not necessarily have the intended effects.

All economics is deeply embedded in a political, cultural and sociological framework. In many ways, it is symptomatic of these underlying issues.

For example, the analysis of sub-prime mortgages misses several factors. Firstly, a lack of growth in real income, especially for middle and lower paid employees, made it difficult for them to achieve the material success that was daily sold to them by the media and advertising. Secondly, the rise of stated income and low or no documentation mortgage reflected the change in work practice where large parts of the work force were no longer employed full-time. Casual or part-time employment and contracting arrangements made the required proof of income difficult.

Interestingly, many problems arise from the lack of humility about the theories. They are, at best, incomplete and highly conditional models that compare unfavourably to middle-age medical and religious superstitions.

Robert Merton articulated this concept precisely. “At times we can lose sight of the ultimate purpose of the models when their mathematics become too interesting. The mathematics of models can be applied precisely, but the models are not at all precise in their application to the complex real world. Their accuracy as useful approximations to that world varies significantly across time and place. The models should be applied in practice only tentatively, with careful assessment of their limitations in each approximation.” Ironically, the speech was less than a year before the collapse of LTCM. Writing in 1995, Merton foreshadowed the events that were to unfold 3 years later at LTCM: “any virtue can become a vice if taken to extreme”.

As recent events in Copenhagen suggest, the only thing that history tells us is that mankind generally are poor learners. Mr. Cassidy quotes a recent column by Harvard’s Greg Mankiw: “despite the enormity of recent events, the principles of economics are largely unchanged.” Professor Mankiw suggested that student still needed to learn about “the efficiency properties of market outcomes.”

How Markets Fail is perhaps merely a sub-set of a wider phenomenon – How Mankind Fails.

© 2010 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

David Roche and Bob McKee (2008) New Monetarism – New Edition

David Roche and Bob McKee are President and Chief Economist of Independent Strategy, a global investment consultancy. Both experienced market economists with a wealth of practical investment and financial market knowledge, they self published New Monetarism in 2007 and issued a new edition in 2008.

The book is the most succinct and penetrating analysis of the changes in financial order that took place in the last 10-15 years that is available. Pithy (the text runs to around 100 pages), untrammelled by jargon and extraneous garbage (generally deployed by authors to obscure or rescue a failing argument) and mercifully free of interviews and anecdotes, New Monetarism sets out the key drivers of the build up of liquidity and its effect on the global economy.

Messrs Roche and McKee present a convincing argument of how much of global “growth” over the past 20 years was, in reality, driven disproportionately by borrowing that fuelled asset price bubbles that in turn have allowed further borrowing. The authors show how the growth in liquidity was driven by macro-economic factors (the decline of inflation and low oil prices) and changes in financial markets (the growth of derivatives, changes in intermediaries such as banks, investors, hedge funds and “innovative” new financial products).

The book covers the rise of emerging markets and the massive liquidity vortex created by the large foreign exchange reserves and its affect on capital flows, cost of capital and ultimately growth.

Importantly, New Monetarism succeeds in tying the disparate elements together in a coherent narrative.

Presciently, the first edition of New Monetarism appeared in September 2007 just prior to the calamitous collapse of financial markets. The new edition is updated and also includes a new chapter Parched World that looks at a post-GFC world. It provides a useful guide to possible developments in financial markets.

Paul Krugman, writing in the New York Times, called the U.S. economy the “Madoff Economy”. Messrs Roche and McKee show that the world for the last decade or two has been a gigantic Ponzi game.

The only lesson that central bankers and politicians have learned is that there is nothing wrong with a Ponzi scheme. It is just that you can’t allow the game to end. Present initiatives to arrest the problems are merely designed to prolong the game without addressing the root cause and imbalances.

© 2009 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

Keynes: The Return of the Master By Robert Skidelsky (2009)

John Maynard Keynes is having an excellent crisis. Dead for over a half a century, the British economist is enjoying a comeback as desperate governments and even more desperate economists adopt massive and dramatic fiscal stimulus to prevent the current crisis developing into a depression.

Renewed interest in Keynes is evident in the rash of new books re-examining his work and legacy. There can be, of course, no suggestion that authors and publishers are merely cashing in on the opportunity.

Mr. Robert Skidelsky is recognised as an authority on Keynes, based on his peerless three-volume biography of the man. The Return of the Master tries to reposition the economist’s work and insights in the light of recent events. It is an interesting and eminently readable overview of some themes that can be found in Keynes’ work.

Drawing, at times heavily, on the biography (authors must be allowed the license to ‘self refer’), Mr. Skidelsky’s central theme appears to be that most post Keynesian economics is problematic and the great man’s insights are ‘misunderstood’. Specifically, Keynes’ thought on "radical" or "irreducible uncertainty" as a primary cause of economic instability is not given enough recognition or prominence. Mr Skidelsky argues that in ignoring uncertainty, modern economics makes a serious intellectual error. Some of the criticisms are entertaining and also valid.

The book probably overstates its case. It is a bit like Nostradamus’ prophecies – followers see in the elliptical words what they wish to see.

The modern world is fundamentally different to that which Keynes inhabited and analysed. The insights gleaned from Keynes are ambiguous when viewed from the viewpoint of the economies and markets of 2009. There is selective resort to specific dictum to justify any specific course of desired action. There is sometimes insufficient acknowledgement of the complexity and ambiguity of Keynes’s own views on economic theory and its practice.

In the run-up to the 1929 election, Keynes discovered a seminal political truth about deficit spending. Lloyd George, an economically challenged politician, was delighted when Keynes provided the rationale for spending taxpayers’ money on social programs to bribe voters. Keynes absorbed this lesson well and maintained a constructive ambiguity throughout his life allowing him to appeal to politicians who favoured government spending and those who favoured middle-class tax cuts.

Economics is, at best, an inexact, inadequate and evolving set of theories seeking to explain complex relationships in a constantly changing world. The major insight that Keynes offered was regarding the inability of theories to explain actual events and how any attempt to apply the theory had unintended consequences. In an essay titled "The Great Slump of 1930," published in December of that year, Keynes acknowledged: "We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand."

Writing in the Financial Times (5 February 2009) Benn Steil, Director of International Economics at the Council on Foreign Relations, succinctly set out the background to the return of Keynes: "when the facts are on our side, we pound the facts; when theory is on our side, we pound theory; and when neither the facts nor theory are on our side, we pound Keynes." The Return of the Master and the many other titles appearing about Keynes are testament to this tendency rather than the validity or otherwise of his nostrums.

When an author or thinker’s own published total output is exceeded in a single year by that of writers writing about his ideas, it is a fair assumption that there is a ‘bubble’ in his or her stock.

© 2010 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

In Fed We Trust: Ben Bernanke’s War on the Great Panic by David Wessel

Too Big To Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System—and Themselves. By Andrew Ross Sorkin

The Sellout: How Three Decades of Wall Street Greed and Government Mismanagement Destroyed The Global Financial System by Charles Gasparino

The economists have had their say. The financiers have had theirs. Prominent Cassandra’s have been caught in print ‘predicting’ various past crises. Even traders have written extensively about lap dancing and excessive drinking that, apparently, lay at the heart of the global financial crisis. It is now the turn of the hacks – journalists!

In these books, three well connected and savvy journalists – David Wessel (Wall Street Journal), Andrew Ross Sorkin (New York Times) and Charles Gasparino (CNBC) – set out a ‘blow-by-blow’, ‘wasp-on-the-wall’ accounts of the crisis.

In Fed We Trust and Too Big to Fail are heavily focused on the period around the collapse of Lehman Brothers and the subsequent financial market meltdown. In Fed We Trust emphasizes the role of the Fed and Bernanke in the narrative, trying to explain how the authorities tried to cope with the developing problems. In contrast (though the difference is slight as both books cover similar territory), Too Big to Fail has at its center the figure of Henry “Hank” Paulson. The Sellout is somewhat differentiated by its more expansive view of the history of the events leading up to the crisis seen through the lens of people and personalities involved in the business.

In Fed We Trust and Too Big to Fail are largely faithful chronological accounts of events. The differences lie in some of the anecdotes and the depth of the historical background that is portrayed. If you were Rip van Winkle and missed the last 18 months, the books would be invaluable in avoiding the need to watch reruns of CNBC or Bloomberg TV to catch up on the sequence of events. The Sellout is more nuanced and floats (sometimes barges) back and forth across time.

Eminently readable and entertaining, the books are long on anecdote and light on analysis. This perhaps reflects the mass audience targeted.

The books are all unashamedly America centric – the rest of the world does not exist other than as backdrop to the narration. Perhaps that reflects events and a certain world view. When U.K. based Barclays Bank, backed by their government, wisely backed out of a last minute bid for Lehmans, Hank Paulson, the Treasury Secretary, muttered that the British had “grin-fucked us.”

The emphasis is on a “rippin’ yarn”. Banks failing, people lying, cheating and desperate to survive, large sums at stake, leaders faced with major decisions – the stuff of tall tales. The events are extraordinary enough to provide the drama.

The level of detail provided is sometimes puzzling. The attempt to provide “colour” is sometimes unproductive and often obscure.We learn that Bernanke played a prank on President Bush one day by coordinating the whole economic staff, along with even Dick Cheney to wear tan socks (clearly an inside if unfunny joke). Donald Kohn, Fed Vice-Chairman, lived in his son's basement, rode his bike to work parking it in the Fed garage reserved for its governors’ cars and likes to run up and down the stairs of the Fed building.

The books deal in a simplistic manichean financial world. The “evil” is the avarice, arrogance, and sheer stupidity that created a dominant set of financial institutions that ultimately profoundly weakened the economy and financial security of millions of middle-class Americans. The “good” is the saviors - Paulson, Bernanke and the core cast of “Musketeers” (Don Kohn, Tim Geithner and Kevin Warsh) –who conceive and implement the “whatever it takes” strategy to prevent looming calamity.

The simplistic divide is hard to sustain as the authors have mixed views on all the participants the drama. A fact frequently glossed over is the saviors seem to have been able to locate the buried bodies because they had some part in putting them there in the first place. Nobody really emerges with his or her reputation quite intact.

A more problematic aspect of the works is the method used. As journalists with extensive contacts among the key players, the books rely on interviews and hearsay. While this gives authenticity to the story, at times, it is apparent that the sources have cleverly manipulated the authors to gain a particular view of events. To an extent, the need to maintain access to these contacts means that it would be inhumanly difficult to be totally honest in any assessment. This means that certain characters are treated kindly and others are not.

Paulson, Bernanke and Geithner are painted favorably and treated with a little too much care and courtesy. The issue of the bailout of AIG that benefited a number of banks, including Goldman Sachs, is not explored as incisively as it might have been. Perhaps, predictably, Richard Fuld (Lehman Brothers) and Jimmy Cayne (Bear Stearns) come off badly. Stan O’Neal and John Thain (Merrill Lynch) are painted as villains. The SEC’s Christopher Cox is not portrayed favorably. The most telling portrait is from Mr. Gasparino - Tommy Maheras, CitiGroup’s head of fixed income, is “a riverboat gambler” recklessly betting the bank’s balance sheet.

All three authors are also self-consciously embedded within the narrative showcasing sometimes self-serving recollections. The desire to reconstruct scenes from sources as the authors were not attendees pays homage to a Victorian melodramatic tradition.

In Fed We Trust, Too Big to Fail and The Sellout feel rushed, a concession to publishing pressures and deadlines and could have done with tighter editing. For the most part, the books provide an interesting overview of the events of 2008. They are not exhaustive nor are they deeply insightful. In fairness, they don’t purport to be. Each book, in their different ways, provides useful histories of the events that will ultimately allow economic historians to probe the issues better.

Other hack’s tales are sure to follow - after all many ambitious journalists followed and recorded the drama. They are soon to be joined by memoirs of the principal players. Hank Paulson’s sizable volume of recollections and undoubtedly self-justification is due for publications shortly. One suspects that the janitor’s and pizza delivery boy’s tale of the crisis are not that far away.

© 2009 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

The 86 Biggest Lies on Wall Street by John R. Talbott (2009)

First published in 1977, The Book of Lists, compiled by David Wallechinsky, (his father) Irving Wallace and (his sister) Amy Wallace, contained hundreds of lists including: famous people who died during sex, people suspected of being the real Jack the Ripper and people misquoted by Ronald Reagan. It was wonderful idea and a delightful occasional diversion.

In 86 Biggest Lies Mr. Talbott, a former investment banker, borrows the basic idea though the list is less unusual, less salacious and less esoteric than its eclectic antecedent. Mr. Talbott focuses on the problems of the global financial crisis and reduces it to a list focused on causes, faux solutions, investment ‘truths’, economics, finance, derivatives, hedge funds, government and regulation. The author’s track record in warning of the current crisis and banking crisis in 2003 and 2006 provides credibility.

The format is simple - Lie #, a typical formulation held as self evident truth followed by Mr. Talbott’s critique. The central thesis is that if you know the lies then you are better placed to understand and solve the problems that exist.

Mr. Talbott, who is nothing if not prolific (he has turned out almost a book a year since 2003), is probably correct in many of his targets. Attacks on everything and everybody leaves little standing and grate after a while. Pronouncements like the “entire global banking system is insolvent” without any facts or analysis do not forward the argument. The banking system does have problems but not every bank in the world in bankrupt, I think!

As required by publishing convention, Mr. Talbott offers answers, though unpopular ones – lower growth, shrinking size of the economy, inflating away the debt etc. The suggestions are genuine, honest and not without merit but they are neither startling nor new.

86 Biggest Lies comes over as a little simplistic. Finance and financiers have a lot to answer for but they are not the sole problem at the heart of the financial crisis. It comes over as a rant delivered with considerable bravado but little detailed support to some of his assertions. Perhaps that is the nature of lists, light on detail with a lot of things ‘to do’.

There is subtle danger in this populist approach. Thomas Pynchon observed: “If they can get you to ask the wrong questions then the answers don’t matter.” Simplistic causes and solutions may prevent real issues from being debated and dealt with.

© 2009 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

Wall Street Revalued: Imperfect Markets and Inept Central Bankers by Andrew Smithers (2009)

The Road to Financial Reformation: Warnings, Consequences, Reforms by Henry Kaufman (2009)

In a sense, this crisis is about values (the prices paid for many assets) and the rules (regulations governing financial markets). It is also about rules (rigid model based formulations of price) and values (ethics or the lack thereof). These two books provide different perspectives on the issues.

In Wall Street Revalued, Andrew Smithers, an experienced practitioner (in fund management and now as a consultant), explores the value of stocks. This is a theme that Mr.Smithers has written about before, most notably in his 2000 book Valuing Wall Street which together with the Robert Shiller’s better known Irrational Exuberance presciently highlighted the overvaluation of new economy Internet stocks.

Wall Street Revalued argues that assets can be objectively valued and managing asset prices should be one of the central functions of central bankers. Mr. Smithers’ asserts that denial of these fundamental principles lay at the heart of the global financial crisis. On valuation, Wall Street Revalued favours the “q” ratio (the replacement cost of a company’s assets) and cyclically adjusted price-earnings ratio over the previous ten years (a measure also adopted by Professor Shiller).

Eloquent and persuasive, Mr. Smithers make his case well with the advantages of brevity and an abundance of charts and Tables. But some problems remain.

It is not clear how earnings or accurate replacement values can be forecast. This is particularly so at inflection points in economic history – I am sure horse and buggy makers were “cheap” on replacement cost and PE measures after the advent of non-equine modes of transportation. The ability of obscurantist accountants and derivative professionals to affect company earnings and cash flows has become increasingly important. The effect of leverage (both obvious and disguised) also affects these numbers perhaps more that Mr. Smithers acknowledges. How are these to be dealt with at an acceptable level of certainty?

If precise valuation were possible then surely the entire idea would have enabled computers loaded with Mr. Smithers’ data and insight to generate significant excess returns. Markets may deviate from fair value for varying, sometimes lengthy, periods. Echoing Minsky’s famous formulation – “conditionally coherent”, Mr. Smithers argues that markets are “imperfectly efficient”, fluctuating around their fair value.

The question then is over what time horizon will be the true value be achieved? As Keynes stated: “…this long run is a misleading guide to current affairs. In the long run we are all dead.”

As every sensible trader knows, the price you pay is always wrong. If you sell then by definition you are lowest price in the market. If you buy, then your bid is the highest. They also know price is what you pay while value is what you hope and pray for. The mysteries of value remain.

Before Nouriel Roubini, Marc Faber and the others, there was Henry Kaufman – the original ‘Dr. Doom’. He too saw the crisis coming (this disease is clearly infectious!). The text contains an entire section on his prophetic and neglected early warnings.

Road to Financial Reformation provides a personal (at times) and insightful overview of the global financial crisis and brims with suggestions for reform to avoid a future recurrence. Intended for financiers and regulators involved in the industry, the book is a thoughtful analysis of the main issues.

Dr. Kaufman’s major concern is the blind faith in models and questionable innovations. He is critical of the rapid increase in size and concentration of financial institutions. He identifies how securitisation of bank loans “created the illusion that credit risk could be reduced if the instruments became marketable” and led to a decline in the credit quality of debt. He also shrewdly identifies how the idea of liquidity altered from assets (what you could sell) to one centered on liabilities (what you could borrow).

His solutions are unsurprising. He advocates a single regulator and increased regulation. Amusingly, he urges that “amid the blizzard of quantitative, technical offerings…courses in economic and financial history should be required for all business degrees.” As Marx warned history has a tendency to repeat first as tragedy and then as farce. It is not entirely clear why the simple study of it would prevent this.

The reliance on central bankers, on the part of both Mr. Smithers and Dr. Kaufman, to prick asset bubbles and take responsibility for regulating the financial system is brave.

Recently, Ben Bernanke, President of the Federal Reserve, confessed: “I did not anticipate a crisis of this magnitude.” Mr. Bernanke further acknowledged shortcomings in a more traditional area of central bank expertise – ensuring the adequate capitalisation of banks. It is far from clear that central bankers would be capable of identifying mis-valuation and acting on it. Most tellingly, traders and investors did not prove particularly able at this task. And they were better paid than central bankers.

Regulation and governance generally rely on enforcement and strict compliance. Dr. Kaufman conveniently neglects mention of the fact that he had a seat on Lehman Brothers’ board and a member of its finance and risk committee.

The octogenarian Dr. Kaufman was joined on this committee by a Broadway producer, a former officer of US Navy, founder of Spanish-language TV station and a former chairman of IBM (from some 13 years ago). The 5 directors had been on Lehman's board for a collective 55 years. It appears that there were two meetings of finance and risk committee in 2006 and 2007. The composition of the committee is especially puzzling as there was no inkling that the investment bank was contemplating ownership of warships or producing musicals or programs for Spanish language TV.

Whatever the book’s other considerable insights, Road to Financial Reformation does not make the case for the capabilities of central bankers and other worthies oversighting either the markets or individual institutions. It may ultimately be a case of values rather than rules.

© 2009 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

We are now in the ‘debt war’. Having prevailed against the enemy in ‘the war against terror’, mobile phone usage in public places, road rage etc, the world is now engaged in a battle against debt. Like most modern wars, it is not clear who the enemy is, what our objectives are or what the strategy is but we do have a catchy marketing slogan courtesy of the ‘spin meisters’ – ‘the war against debt’.

In ‘Collateral Damaged: The Marketing of Consumer Debt to America’, Charles Geisst, a well known economic historian whose credits include the well regarded and best selling ‘Wall Street: A History’, documents the rise of debt in the U.S.

Starting in the 1920s, Geisst traces the increased use of borrowing and seeks to explain the ‘progress’, if that is appropriate phraseology, of America from a nation of savers into the world’s largest borrower. ‘Collateral Damaged’ is a well researched history of debt in America documenting the key steps in the build-up of borrowing that created the environment for the Global Financial Crisis (“GFC”).

Geisst’s analysis perhaps over emphasises the role of financial institutions as merchants of debt, selling loans to those who cannot afford it. He underestimates some the social factors that underlie the growth of debt including the effect of de-industrialisation of the 1980s and the lack of growth, after adjustment for inflation, of income for many sectors of the economy. It underestimates the effect of job insecurity and the social pressures in an increasingly consumerist society where what we own defines us in the growth of debt. To the extent that people borrowed to purchase real estate or stocks in the hope of gain, George Bernard Shaw’s connection between speculation and wealth, especially amongst those without money, remains relevant: “Gambling promises the poor what property performs for the rich, something for nothing.”

The impact of global capital flows on the creation of debt could have been covered more than it is. The demand for international investors for high quality dollar investments was also crucial in the entire securitisation process that underwrote some of the excessive growth in debt.

If Geisst’s ‘Collateral Damaged’ is a detached history of the conditions that created the debt war, then Ásgeir Jónsson’s ‘Why Iceland?’ is a bullet riddled missive from the frontlines.

Jónsson, the Chief Economist of Kaupthing Bank, the country’s largest bank before its collapse, provides a fascinating insight into how Iceland’s economy was transformed from its fishing and geothermal energy roots into a player in world finance. In the course of this evolution, a nation of 300,00 people created a banking system that had borrowed several times its GDP.

It is unsurprising that Iceland came to be regarded as the country that was actually a hedge fund. Ironically, the very factors which were to lead to its ignominious demise in late 2008 were the very same that made it, at least for a time, one of the global economy’s great success stories.

‘Why Iceland?’ documents Iceland’s collapse in considerable detail using the author’s close knowledge of behind-the-scenes events including the now under investigation meeting in January 2008 when a group of international hedge fund managers gathered in a bar in Reykjavik to discuss Iceland’s economy. The book is well balanced and but sometimes edges into easy answers such as gratuitous blaming foreign banks and hedge funds.

Despite the occasional lapse into economics-speak (apparently Icelandic economics was not different from that practised in the U.K. and the U.S.A.), the book provides an interesting history of the events that led to the collapse of the Icelandic economy. At a fundamental level it provides useful insights into how small open economics in the age of debt both prospered and became over-extended with apparent ease offering useful lessons for those few that are interested.

Iceland’s demise led to some of the worst jokes of the GFC. “Icelandic expertise in C-O-D fishing led to an ill-advised foray into C-D-O investments.” “The capital of Iceland? About Euro 20.” A tongue-in-cheek notice on eBay offered Iceland for sale: “Located in the mid-Atlantic ridge of the North Atlantic Ocean, Iceland will provide the winning bidder with a habitable environment, Icelandic horses and admittedly a somewhat sketchy financial situation.” It also spawned a board game – The Crisis Game.

Perhaps the most memorable thing to emerge from the Icelandic collapse is a term – ‘Kreppa’ economics, sometime shortened to Kreppanomics. ‘Kreppa’ in Icelandic, apparently, means “in a pinch” or “to get into a scrape”. It provided a graphic description of the disastrous meltdown of not only Iceland but also the global economy.

The reality is that the build up of debt at both an individual or country level beyond a certain point is simple Kreppanomics. Current belief in the recovery story and sharp financial market rallies fail to recognise that little has actually changed since the GFC began.

Fundamental failures have not been fully addressed. The required reduction in debt levels has not been completed. Increases in government debt have substantially offset reductions in private sector debt. Instead of dealing with the problem of leverage, the debt has also merely been rolled forward through a variety of clever warehousing structures and the manipulation of accounting rules.

It seems that the world is still practising Kreppanomics and the debt wars are far from over.

© 2009 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

In the 1980s, the Japanese were taking over the world. In the 1990s, it was going to be an ‘Asian’ century. These days the pundits are betting on the ‘Chinese Age’. Like all such glib predictions, despite their superficial appeal, they mask complex undercurrents and issues that require careful study.

Michael Schuman, a business journalist, in ‘The Miracle: The Epic Story of Asia’s Quest for Wealth’ tries to describe the transformation that has taken place in Asia over the last 30 years. Schuman covers the post-war reconstruction built on electronics and heavy industry through to the age of outsourcing. The story is personalised and ‘The Miracle’ is at its best when recounting rich anecdotes about the politicians, such as Deng Xiaoping and Park Chung Hee, and business leaders, such as Sony’s Akio Morita and Wipro’ Azim Premji. Schuman’s snappy journalistic style adds colour and insight to the stories.

The Miracle traces the importance of globalisation of trade and capital flows as well as the role of America in the development of Asia. It perhaps understates the less than benign role played by the state in fostering economic development. The Book also is very forgiving of the political repression, social in-equalities and environmental degradation that underpin Asian development.

The defence would probably be that there are always costs to dragging millions out of poverty. In truth, the average business book reader would not be particularly concerned about those issues.

Paul Midler’s ‘Poorly Made in China’ offers a different perspective that is loquaciously captured in the lengthy sub-title ‘An Insider’s Account of the Tactics Behind China’s Production Game’ (obviously a Twitter marketing ploy!). A businessman who has worked in numerous factories in China, Midler provides interesting and, at times, scarily funny insights into a system that produces products that fail basic safety and manufacturing standards.

Midler identifies the process by which buyer demand for cheap products and the Chinese manufacturers willingness to meet the requirements lead to what he characterises in the chilling anodyne term – ‘quality fade’. This is the process by which manufacturers take increasing liberties with quality to eke out profits from unprofitable contracts. This entails cheaper components, altering chemicals, lower hygiene standards and, in general, lower everything.

Midler describes the process whereby manufacturers compete to gain unprofitable contracts to make sought after products. The sole reason is that access enables Chinese manufacturers to gain access to intellectual property allowing the manufacture of lucrative ‘knock-offs’ in places where patents and trademarks cannot be enforced.

Midler acutely records the tensions between buyer and manufacturers and the entire flawed system where ultimately the only true product control and testing is by the final consumer, sometimes, as in the case of the melamine contaminated milk, with tragic consequences

‘Poorly Made in China’ provides an interesting alternative to the hagiographic view of globalisation and trade much favoured by the Thomas Friedman’s of the world.

Underlying both ‘The Miracle’ and ‘Poorly Made in China’ is a view of the emerging world best captured by the term ‘Orientalism’, associated with Edward Said. A Palestinian academic, Said’s writings on colonialism explored the caricatures, cliches and pre-conceptions that shaped Western perception and therefore relationships with Eastern nations. Said’s argument was that the West’s view of the East was shaped by political power and unequal commercial exchange.

Said’s work built on George Orwell’s criticism of colonialism. Writing in 1939, Orwell provided a vivid and stark view of the developing world that has rarely been equalled: “When you walk through a town like this – two hundred thousand inhabitants, of whom at least twenty thousand own literally nothing except the rags they stand up in – when you see how the people live, and still more, how easily they die, it is always difficult to believe that you are walking among human beings. All colonial empires are in reality founded upon the fact. The people have brown faces – besides they have so many of them. Are they really the same flesh as yourself? Do they even have names? Or are they merely a kind of undifferentiated brown stuff, about as individual as bees as coral insects? They arise out of the earth, they sweat and starve for a few years, and then they sink back into the nameless mounds of the graveyard and nobody notices that they are gone. And the graves themselves soon fade back into the soil.”

The unwritten sub-text is that the East is there as a resource for the West. Developments are read and interpreted through the cultural lens of Western literary and economic tradition. ‘The Miracle’ and ‘Poorly Made in China’ are books in the ‘Orientalist’ tradition, which sees Asia as little more that a vast market, a cheap manufacturing base, (recently) a source of money and an opportunity for developed nations. The books never quite see the world from the point of view of the nations and people that they describe.

‘Prisoner of the State’, the secret journal of former Chinese Premier Zhao Ziyang, provides something of an antidote to a Western view of East Asia.

Remembered now mostly for his disastrous role in the Tiananmen Square student protests and subsequent massacre, Zhao Ziyang was Premier of the People's Republic of China from 1980-1987, and General Secretary of the Communist Party from 1987-1989. He was involved, with Deng Xiaopeng, in the economic reform of China. Produced from smuggled tapes during his house arrest after being removed from power as a result of his role and handling of the Tiananmen Square protests, Zhao produced a memoir covering details of the crackdown, the intricate manouverings of China's leadership, and the economic reform program.

While the focus around the book has been on the sensational events around the protests and subsequent crackdown, ‘Prisoner of the State’ provides interesting insights into the rationale behind China's economic reforms.

Anecdotes of Zhao’ overseas trips, where he begins to gain exposure to the glittering riches of overseas economies, provides a vivid backdrop to the changes in economic policy. The interest in reforms appears driven entirely by pragmatic rather than ideological concerns, such as declining living standards, concern about food security, observed inefficiencies in productivity and fear that economic failure would mean political ruination.

Zhao’s notes were clearly predicated on ‘his’ version of history. His commentary on leadership struggles and the complex interplay of different individuals and camps are difficult to verify to those without a deep understanding of the inner workings of China. His views on the weaknesses of the system, especially the issue of corruption and the sheer difficult of political and economic management of vast complex country, are extremely relevant. They show the difficulties of making simple predictions about the evolution of China.

The book is illuminated by the hidden tragic sub-text that this is ultimately the story of a man who finds himself a victim of a system that he entirely understands and helped create. In the end, Zhao does not quite understand this irony.

Unlike other books on Asia, ‘Prisoner of the State’, despite its flaws, provides insights not found in traditional perspectives on emerging nations grounded in the simplistic world of ‘El-dollardo Economics’.

© 2009 Satyajit Das All Rights reserved.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall).

Remakes are rarely as good as the original but can sometimes add something, if only a nostalgic and sentimental longing for the ‘real thing’. Justin Fox’s The Myth of the Rational Market (2009; Harper Business) and Pablo Triana’s Lecturing Birds on Flying (2009; John Wiley) are both remakes.

The Myth of the Rational Market is by the author’s own admission modelled on Peter Bernstein’s Capital Ideas: The Improbable Origins of Modern Wall Street. It is a history of a fundamental tenet of finance theory - the efficient market hypotheses (EMH) - which, its critic’s argue, has come up short in the GFC. More strident commentators even blame the EMH for the crisis.

Fox, a well credential-ed financial journalist, has written a clear and accessible history that successfully targets the non-financial reader. Its rendition of history, which owes much to Bernstein, is essentially correct and identifies the ill-fated tendency to elevate the EMH to a status that heavily distorted academic theory and policy approaches to markets.

The Myth of the Rational Market is at its best when telling the story and somewhat weaker in dealing with the nuances of the theory itself. Fox puts a lot of faith in the challenge of newer theories – behavioural finance and the adaptive markets hypotheses – and sees these as the way forward. Time will tell but these theories may be just as flawed. Ultimately, hypotheses are just that and market behaviours and the animal spirits may prove difficult to model.

A significant advantage of Fox’s book is that it brings the story up-to-date (Bernstein’s book was first published in 1992). Fox also is perhaps more sceptical of the theory than Bernstein, who knew and was close to many of the proponents and was much less critical.

The wonderful titled - Lecturing Birds on Flying – is a remake of and a paean to the Black Swan, also known as Nassim Nicholas Taleb. The book is a polemic against the Black-Scholes-Merton option pricing model. Other major themes are frenzied criticism of financial economics, economists, business schools, tenure, academics turned practitioners, etc in no particular order of importance.

Like the apostolic epistles, Lecturing Birds on Flying is an extension of the liturgy that Taleb set out in Fooled by Randomness and the Black Swan. The premise is similar if less successful. The book’s ambitious objective, as set out in Taleb’s foreword, to “make society a better, safer and more risk-conscious place” is unlikely to be achieved.

A puzzling aspect of the book is the writing style employed. The reviewer at the Economist was especially taken by the final sentence: “Deliciously paradoxically, the Nobel could end up diminishing, not fortifying, the qualifications-blindness and self-enslavement to equations-led dictums that, fifth-columnist style, pave the path for our sacrifice at the altar of misplaced concreteness.” One reviewer on www.amazon.co.uk commented on the terms “tumultuous tumultousness”, “unconventional conventionalism” and “dogmatic dogmatism”. The reviewer was concerned about persistent double negatives and sought to establish that a reference to an argument as “non-incoherent” means “coherent”?

As neither a linguist or a literary stylist, I can only assume that the author and editor felt the need to experiment with the extremities of the English language and expression to reinforce the message. In A Clockwork Orange, Anthony Burgess created a special teenage slang of the not-too-distant future called “Nadsat”. The effect here is not dissimilar.

In both books, there is an essential contradiction – the idea that models and theories cause market chaos is inconsistent with the fact that both authors says traders and practitioners often ignore models.

Both books miss an essential point about economists and theories. As John Kenneth Galbraith pointed out the only point of economics is to provide employment for economists. The irony is that it is also provides fruitful employment to authors in explaining the theories (in good times) and debunking them (in bad times).

Generally speaking, academic insights, even if correct, can rarely be applied directly to financial markets. Smart traders and investors have always known this and theory and practice are rarely bed-fellows on Wall Street or in the City. Economists and economic theory should not be taken too seriously. After all Keynes’ only regret in life was that he: “did not drink more Champagne”

© 2009 Satyajit Das