How to cope with the next global financial crisis
Shann Turnbull
The foundations of an alternative finance system need to be established urgently to allow the real economy to survive the next global financial crisis.
The secretary-general of the Basel Committee that sets global standards for regulating banks has stated that another financial crisis “will be impossible to avoid”.
The governor of the Bank of England, Mervyn King, stated in October 2010, “Of all the many ways of organising banking, the worst is the one we have today”.
Earlier this year, his executive director for financial stability, Andrew Haldane described the “Doom Loop” created by banks being too big to fail with insufficient equity and liquidity.
Haldane also revealed how banks have created a credit bubble by making loans to each other that now equal the loans they make to the real economy. This process of balance sheet expansion also means that banks have become so interconnected that they have become interdependent. So if one big bank fails it will drag down others. This could include otherwise strong banks like those in Australia who are heavily depended on being funded from overseas.
Regulators around the world are now seeking to increase the equity and liquidity of banks to cope with the next crisis. However, The Financial Crisis Inquiry Commission Report of the US government this year did not identify either insufficient equity or liquidity as a cause of the crisis. Managing the risk of insolvency or lack of liquidity has always been a core function of banking. What has changed is the complexity of banking and its financial products.
As noted by the Australian Secretary to the Treasury, Ken Henry, in November 2008, “The array of financial instruments deployed within the global financial system has become so complex that it defies understanding. For decades to come, policy makers around the world are going to be asking why those with sufficient authority didn’t, at some point, stand above the buzz of the financial markets and declare, in simple language, that all of this simply doesn’t make sense.”
The inability of banks to understand and manage the complexity of their business was seen as the “key cause” of the crisis according to the US Financial Crisis Commission. They stated: “We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis.”
The inability of the current so-called “best practices” in corporate governance to deal with complexity is explained in the forthcoming article by Michael Pirson and myself in Corporate Governance: An International Review.
However, the reforms we described may take too long to introduce to prevent the next “inevitable” crisis. In any event why introduce reforms for a system that is “the worst”? Why not get it right and start building an alternative system that can supplement and augment the current fragile system to allow it be replaced in an orderly manner?
Establishing an alternative fallback, failsafe “lifeboat” financial system could be achieved in the next sitting of Parliament. Draft legislation is already available in the appendix of a handbook on introducing a supplementary currency of self-financing and self-liquidating money. The 1933 book on “Stamp Scrip” by Yale economist Irving Fisher can be downloaded from the web. As can the paper I presented to the July 2011 Australian Conference of Economists on the various “Options For Reforming The Financial System”.
Some of the options might well be introduced independently of any government initiative through the use of mobile phones to receive, store and pay out money. Over recent years this practice has become widely established in developing countries where there are few phone lines or banks. As local informal units of account are used, the banking system is completely bypassed. Central banks in some countries have allowed official money to be used by mobile phones and so also bypass the banking system, provided that the value of each transaction does not exceed $100. In this way mobile phones are introducing competition between currencies and denationalising money as advocated by Nobel Prize winning economist F. A. Hayek.
Market forces can be expected to make it inevitable that mobile phone money will spread to advanced economies. Why and how this could occur is set out in my article published in New York in 2010 on How Might Cell Phone Money Change The Financial System? The take-home message is that cell phone money represents a disruptive technology. It provides a way to create financial lifeboats to keep the economy afloat with the next crisis. It also provides a way to replace many banking functions.
References
- Drumond, M (2011) ‘Banks told to prepare for more shocks’, Aust Fin Rev, May 30.
- King, M (2010) ‘Banking: From Bagehot to Basel, and Back Again’, The Second Bagehot Lecture, Buttonwood Gathering, NY City, October 25.
- Haldane, A (2011), ‘Tackling the Credit Cycle and Too-Big-To-Fail’, presentation to the Inst of Intern and Europ Affairs, January 20, London.
- FCIC (2011), The Financial Crisis Inquiry Commission Report, USA, Washington DC: Govt Printing Office.
- Ken Henry quote from: Ramsey, A (2008), ‘It takes courage to say the f-word: failure’, Sydney Morning Herald, November 15th.
- Pirson, M & Turnbull, S (2011) ‘Corporate Governance, Risk Management, and the Financial Crisis-An Information Processing View’. In Corporate Governance: An International Review.
- Fisher, I (1933), Stamped Scrip, Adelphi & Co New York.
- Turnbull, S (2011), ‘Options for reforming the financial system’ presented to the 40th Austr Conf of Economists, ANU, Canberra, July 11-13.
- Hayek, F A (1976a), Choice in Currency: A Way to Stop Inflation, Occas Paper 48, The Inst of Econ Affairs, London.
- Hayek, F A (1976b), Denationalization of Money: An Analysis of the Theory and Practice of Concurrent Currencies, Hobart Paper Special 70, The Inst of Econ Affairs, London.
- Turnbull, S. 2010, ‘How might cell phone money change the financial system?’ The Capco Inst J of Fin Transf, 30:33-42, November.
Source: ABC posting on 11 Aug 2011, on “How to cope with the next global financial crisis” at http://www.abc.net.au/unleashed/2854160.html Web links to all of the above references will be found at the source URL.
Dr Shann Turnbull is co-founder of the UK based Sustainable Money Working Group (see: https://sites.google.com/site/smwgorg/), also Principal of the International Institute for Self-Governance, and is an ERA patron.
