The Keynes Society Presents...

How to

The Keynes Society welcomes a large number of school...
A word from the organiser
Welcome everyone to Eton College and to the Keynes Society. Thank you all for
attending this eve...
[Ha-Joon Chang ]

Thing 22:
Financial Markets need to
become less, not more efficient.

What they tell you
The rapid devel...
[Paul Ormerod]
Extracts from
Positive Linking:
global rationality of economic man with a
kind of rational behaviour which ...
[Ann Pettifor]

How did we get
here when we
have been here

The Global Financial Crises is the result of ignoring,...
[Andrew Hayley]
The 2008
Financial Crash:

A Wider

It is difficult to read any newspaper without stumbling upon s...
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Eton College Forum on the Global Financial Crisis


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The title of this event is ‘No More Business As Usual: How to Avoid Another Financial Crash.’ The 2008 crisis marked a sea-change point.It was a fa ilure on three counts: 1. A failure of oversight from Governments and Central Banks alike, 2. A failure of modeling in not being able to predict the crash and 3. A failure of ideology. Underpinning the crisis was the fundamentally flawed neo-liberal ideologue which has dominated main-stream economic thinking.

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Eton College Forum on the Global Financial Crisis

  1. 1. The Keynes Society Presents... How to Avoid Another Financial Crash The Keynes Society welcomes a large number of schools and colleges to tonight’s event. Among our guests are students and teachers from: Lord Wandsworth College Magdalen College School Mary Hare School for the Deaf Merchant Taylors’ School Royal Grammar School Guildford Sacred Heart RC School Sir William Perkins Surbiton High School Swanlea School The John Warner School The Marist School Tonbridge School Watford Girls’ Grammar School Woodbridge School Biddenham International Schools Bishop Ramsey CE School Burgress Hill School Charters School Dean Close School Downe House School Downside School Dr Challoner’s Grammar School Guildford High School Heathfield School Holt School Holy Family Catholic School King’s School Worcester Longdean School At tutor2u, we love education. Our aim is to support learning wherever it takes place - online, in person at our student and teacher CPD courses and via mobile devices. The tutor2u website ( is one of the world’s most popular e-learning destinations and receives over 30 million visitors each year. Through a series of subject blogs and other e-learning resources, the website provides teaching ideas and resources and student support materials, including revision notes, quizzes and guidance on exam technique. Become a fan of tutor2u on Facebook: Follow tutor2u on @tutor2u Join the Economics & Business Teacher Group on Linkedin Official Sponsor
  2. 2. A word from the organiser Welcome everyone to Eton College and to the Keynes Society. Thank you all for attending this evening, we have a spectacular discussion in store! When I first started organising this event way back in May, little did I know the grand scale it would reach. We are very fortunate to have four panel members of the highest quality tonight, all of whom are prepared to challenge the prevailing consensus. The venue, School Hall, is Eton’s largest lecture hall and will provide a fitting backdrop to tonight’s proceedings. The title of this event is of course, ‘No More Business As Usual: How to Avoid Another Financial Crash.’ The 2008 crisis marked a sea-change point. In my eyes, it was a failure on three counts: 1. A failure of oversight from Governments and Central Banks alike, 2. A failure of modeling in not being able to predict the crash and 3. A failure of ideology. Underpinning the crisis was the fundamentally flawed neoliberal ideologue which has dominated main-stream economic thinking. The event will, on one level, analyse the causes of the 2008 crash, the worldwide response, what lessons have been learnt and how future crashes can be avoided. Yet on a deeper level, the aim of this evening is to challenge existing world views and discuss the exciting new developments in economic theory. Foremost amongst these is a redefinition of human ‘rationality’ in a way that takes into account advances in behavioural economics, particularly advances in network theory. We hope to shake off the shackles of the textbooks and syllabi in order to encourage innovative and bold new economic thought. When planning this event, I wanted it to being as interactive as possible, engaging as many knowledge-thirsty students from a wide range of schools. I am delighted that 27 schools (bringing 375 students) will be attending this evening, a staggering number and far exceeding any Society meeting Eton has ever had. Furthermore, half of the evening will be devoted to questions from the floor. My hope is that the evening will be one of collaboration, thought-provocation and engagement. It has been an honour and a joy to organise this event; I hope that everyone has a fantastic time! Speaker profiles Ha-Joon Chang International Bestselling author Ha Joon Chang is a specialist in development economics and Reader in Political Economy of Development at the University of Cambridge. In 2005, Chang was awarded the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought. He is author of Kicking Away the Ladder: Development Strategy in Historical Perspective (2002), which won the 2003 Gunnar Myrdal Prize and Bad Samaritans: Rich Nations, Poor Policies and the Threat to the Developing World (2007). Since the beginning of the 2008 economic crisis, he has been a regular contributor to the Guardian, and a vocal critic of the failures of our economic system. In 2010, Chang released his bestselling book: 23 Things They Don't Tell You About Capitalism. Ann Pettifor Ann Pettifor is a widely published author and analyst of the global financial system. She co-authored the Green New Deal, which was published by the New Economics Foundation in July 2008. She predicted an Anglo-American debt-deflationary crisis back in 2003, and is known for her work on the sovereign debts of low income countries and for leading Jubilee 2000. She is currently a fellow of the New Economics Foundation, Director of Advocacy International Ltd and PRIME (Policy Research in Macroeconomics). Paul Ormerod Paul Ormerod is the author of The Death of Economics, Butterfly Economics and Why Most Things Fail. He studied Economics at Cambridge and his career has spanned the academic and practical business worlds, including working at the Economist newspaper group and as a director of the Henley Centre for Forecasting. He is the founder of Volterra Partners. He is a fellow of the British Academy for the Social Sciences and in the 2007/ 2008 academic year was a Distinguished Fellow at the Institute of Advanced Study at the University of Durham. In July 2009 he was awarded an honourary Doctor of Science degree by the University of Durham for the ‘distinction of his contributions to the discipline of economics’. He presents regularly at a wide range of business and academic events. Crispin Odey Yours Sincerely, Anthony Beaumont, Event Organiser and Chair Crispin Odey is a London-based hedge fund manager and the founding partner of Odey Asset Management. He founded Odey Asset Management in 1991, George Soros being one of the original investors, seeding Odey $150 million. Odey came to wide attention in 2008 when he successfully anticipated the credit crunch. Odey Asset Management's Odey European Inc. fund was ranked No. 5 on Bloomberg's 2012 list of the 100 TopPerforming Large Hedge Funds.
  3. 3. [Ha-Joon Chang ] Thing 22: Financial Markets need to become less, not more efficient. What they tell you The rapid development of the financial markets has enabled us to allocate and reallocate resources swiftly. This is why the US, the UK, Ireland and some other capitalist economies that have liberalized and opened up their financial markets have done so well in the last three decades. Liberal financial markets give an economy the ability to respond quickly to changing opportunities, thereby allowing it to grow faster. True, some of the excesses of the recent period have given finance a bad name, not least in the above-mentioned countries. However, we should not rush into restraining financial markets simply because of this once-in-a-century financial crisis that no one could have predicted, however big it may be, as the efficiency of its financial market is the key to a nation’s prosperity. What they don’t tell you The problem with financial markets is that they are too efficient. With recent financial ‘innovations’ that have produced so many new financial instruments, the financial sector has become more efficient in generating profits for itself in the short run. However, as seen in the 2008 global crisis, these new financial assets have made the overall economy as well as the financial system itself, much more unstable. Moreover, given the liquidity of their assets, the holders of financial assets are too quick to respond to change, which makes it difficult for real sector companies to secure the ‘patient capital’ that they need for long term development. The speed gap between the financial sector and the real sector needs to be reduced, which means that the financial market needs to be deliberately made less efficient. ...Now, the real trouble is that what countries like Iceland and Ireland were implementing were only more extreme forms of the economic strategy being pursued by many countries- a growth strategy based on financial deregulation, first adopted by the US and the UK in the early 1980s. The UK put its financial deregulation programme into a higher gear in the late 1980s, with the so-called ‘Big Bang’ deregulation and since then has prided itself on ‘light-touch’ regulation. The US matched it by abolishing the 1933 Glass Steagal Act in 1999, thereby tearing down the wall between investment banking and commercial banking which had defined the US financial industry since the Great Depression. Many other countries followed suit... Weapons of financial mass destruction? The result of all this was an extraordinary growth in the financial sector across the world, especially in the rich countries. The growth was not simply in absolute terms. The more significant point is that the financial sector has grown much faster - no much, much faster - than the underlying economy. According to a calculation based on IMF data by Gabriel Palma, my colleague at Cambridge and a leading authority on financial crises, the ratio of the stock of financial assets to world output rose from 1.2 to 4.4 between 1980 and 2007. The relative size of the financial sector was even greater in many rich countries. According to his calculation, the ratio of financial assets to GDP in the UK reached 700 per cent in 2007. ...In the old days, when someone borrowed money from a bank and bought a house, the lending bank used to own the resulting financial product (mortgage) and that was that. However financial innovations created mortgage-backed securities (MBSs), which bundle together up to several thousand mortgages. In turn, these MBSs, sometimes as many as 150 of them, were packed into a collateralized debt obligation (CDO). Then CDOs-squared were created by using other CDOs as collateral. And then CDOs-cubed were created by combining CDOs and CDOs-squared. Even higher-powered CDOs were created. Credit default swaps (CDSs) were created to protect you from the default on the CDOs. And there were many more financial derivatives that make up the alphabet soup that is modern finance. The result was an increasingly tall structure of financial assets teetering on the same foundation of real assets (of course, the base itself was growing, in part fueled by this activity, but let us abstract from that for the moment, since what matters here is that the size of the superstructure relative to the base was growing). If you make an existing building taller, without widening the base, you increase the chance of it toppling over. It is actually a lot worse than that. As the degree of ‘derivation’ - or the distance from the underlying assets- increases, it becomes harder and harder to price the asset accurately. So, you are not only adding floors to an existing building without broadening its base, but you are using materials of increasingly uncertain quality for the higher floors. No wonder Warren Buffet, the American financier known for his down-to-earth approach to investment, called financial derivatives ‘weapons of ‘financial mass destruction’ - well before the 2008 crisis proved their destructiveness. ...Thus, exactly because finance is efficient at responding to changing profit opportunities, it can become harmful for the rest of the economy. And this is why James Tobin, the 1981 Nobel laureate in economics, talked of the need to ‘throw some sand in the wheels of our excessively efficient international monetary markets.’ For this purpose, Tobin proposed a financial transaction tax, deliberately intended to slow down financial flows...Other means include making hostile takeovers difficult (thereby reducing the gains from speculative investment in stocks), banning short-selling (the practice of selling shares that you do not own today), increasing margin requirements (that is the proportion of the money that has to be paid upfront when buying shares) or putting restrictions on cross-border capital movements, especially for developing countries. All this is not to say that the speed gap between finance and the real economy should be reduced to zero. A financial system perfectly synchronized with the real economy would be useless. The whole point of finance is that it can move faster than the real economy. However, if the financial sector moves too fast, it can derail the real economy. In the present circumstances, we need to rewire our financial system so that it allows firms to make those long-term investments in physical capital, human skills and organisations that are ultimately the source of economic development, while supplying them with the necessary liquidity. We ap on of fin an cia lm as sd es tr uc tio n Selected extracts from 23 Things They Don’t Tell You About Capitalism
  4. 4. [Paul Ormerod] Extracts from Positive Linking: global rationality of economic man with a kind of rational behaviour which is compatible with the access to information and computational capacities that are actually possessed by organisms, including man, in the kinds of environments in which such organisms exist.’ In the complex situations which characterise much of our lives, copying is a powerful way of solving this problem, of scaling down the vast dimension of choice and its subsequent consequences into a manageable rule of behaviour. We might copy different agents for different reasons, but we copy nonetheless. Are we in fact rational? The conduct of business and policy decisions of all kinds must take account of the fact that the fundamental features of our social and economic worlds have been qualitatively transformed over the course of the past century. The word ‘must’ is used here with its full imperative force. Network effects are the driving force of behaviour. The description of the world of the 21st century is the background against which we have assessed the validity of the model of how a ‘rational’ agent behaves. According to this theory, agents gather available information about an issue, process it to arrive at the best possible decision given their fixed tastes and preferences, and do so in isolation from other agents. In other words, their preferences are not affected in any way by what other agents do. Neither do they change in any way over time. Clearly this is not the world works. To be fair, the theory may have been a reasonable approximation to reality in the late nineteenth century, when it was first being formalised. But in general it does not fit with the world in which we live now. There are many reasons for this, but the principal one is the fact that our individual tastes and preferences are not at all fixed and independent of the preferences of others. They evolve over time. And a key factor in their evolution is that we often copy the opinions, actions and choices of others. The word ‘copy,’ is a shorthand way of describing a range of motivations for an agent changing behaviour as a direct result of the influence of other agents. The fashion motive is one. Peer pressure is another, as is the related but subtly different concept of peer acceptance. For example, the more people who are obese in your social circles, your networks, the more acceptable it is for you to be obese also. People do not decide to copy others deliberately and become obese themselves, but the social pressures and influences on them not to become obese are relaxed when other people in their networks are already obese. Even in the 1930s, as we have seen, Keynes believed that the world was sufficiently complex, sufficiently difficult to interpret, that ‘we have as a rule, only the vaguest idea of any but the most direct consequences of our acts.’ Keynes argued that the very concept of rationality needed to be redefined in such a world. Copying other agents often makes sense because they might be- it does not mean that they necessarily are- better informed than we are as individuals. In the 1950s, (Herbert) Simon again raised the need to reassess the definition of what constitutes rationality of economy man: ‘The task is to replace the The rational paradigm has spectacularly failed to explain and predict not just how the present crisis emerged, but how it spread and burgeoned, initially starting with a relatively small US mortgage crisis, quickly developing into a credit and banking crisis, leading to a world-wide financial crisis, a global debt crisis for small and then big countries such as Italy, and finally, at the time of writing, into a general political crisis threatening the economic stability of the entire planet and the welfare of everyone on it.” Three Key Ideas: Networks: How people, firms, things are connected to each other, and how different ways in which they are connected have different implications. Complex Systems: How the properties of systems as a whole emerge from the interactions of their component parts. These are systems in which the whole is more than the sum of the parts. ‘Rule of thumb’: Decision makers in economics. How we can understand many social and economic questions better if we relax the traditional assumption that decision makers attempt to find the ‘best’ decision. Instead, they appear to use simple rules of thumb to arrive at ‘fairly good’ decisions.”
  5. 5. [Ann Pettifor] How did we get here when we have been here before? The Global Financial Crises is the result of ignoring, denying and even concealing lessons known to our predecessors. The most important lesson is that the interests of the private financial sector are ultimately opposed to the interests of entrepreneurs, innovators, creatives and society. In the 1930s our predecessors insisted that democracy be placed in a position superior to the power of money, that finance should be servant and not master to the economy and society. In between 1931 and 1970 finance was wrested from the private sector and placed in the hands of the transparent and accountable state, under a mandate (the 1944 Bretton Woods Agreement) to maintain stability and balance in trade and finance. The instigator behind this radical re-ordering of society was John Maynard Keynes. Keynes is often derided as a 'tax and spender' or as an 'inflationist'. He is most often defined by the fiscal policies he put in place to help economies recover from the crisis of 1920s financial liberalism. Yet Keynes was primarily a Monetary Reformer. He rejected the liberal financial order of the pre-Depression years and sought to provide the world with a soundly managed monetary system. Keynes argued that that the level of employment and activity in an economy depended critically on the rate of interest. Pre-requisite to a prosperous and just society was a low rate of interest. A low rate of interest permits private industry to thrive. For capital investment projects to expand, activity depends on affordable and cheap finance. Ecologically sustainable finance must also be cheap finance. Because, if the cost of finance is halved then a great deal more investment projects become viable, including renewable energy projects, public transport, sustainable construction and the like. Equally, government expenditure can be freely extended if the interest burden is low. During World War II when Britain borrowed more than it had ever done before, interest rates never rose above 3 per cent. Keynes's policies permitted recovery from the Great Depression, underpinned the allied war effort and fostered the golden age of economic activity that prevailed until the 1970s. It is a commonplace to regard the golden age as the result of state expenditure, but that is only one side of the story. The low unemployment, high activity and prosperity across the globe was also the result of private activity, when nations produced what they consumed, industry thrived and invested heartily. State budgets expanded, but were under control and rarely substantially in deficit. International trade, too, flourished, but was complementary, not pre-requisite to domestic achievement. There is often a tendency today - especially in Europe - to see trade as the only route to prosperity for weaker economies. But Keynes saw things differently. “If nations can learn to provide themselves with full employment by their domestic policy," he argued, "there need be no important economic forces calculated to set the interest of one country against that of its neighbours. International trade would cease to be what it is, namely, a desperate expedient to maintain employment at home by forcing sales on foreign markets and restricting purchases, which, if successful, will merely shift the problem of unemployment to the neighbour which is worsted in the struggle, but a willing and unimpeded exchange of goods and services in conditions of mutual advantage.” [Jae Hyung Kim] A New Economic Unit of Measurement: The Key to the Democratisation of Finance A buzz word for the solution to the Financial Crisis that occurred in 2007 seems to be the democratisation of finance - extending the sound financial principles to a bigger segment of our society. The main focus so far has been to utilise our information technology capabilities in order to better inform the public about the murky world of finance. However, I believe that the key to improving public awareness should be more simple, yet drastic. It is the adoption of an inflation-indexed unit of account. In 1967, the Chilean government introduced the ‘unidad de fomento’, which is the daily price of a basket of goods and services, just like an interpolated version of the consumer price index. It has been used extensively by the government, and increasingly so as a unit of account for commerce essentially, it is replacing money. People nowadays tend to quote prices in UFs, and use a UF-Peso exchange rate when paying with the local currency. This system clearly works: Chile is the most inflation-aware country in the world. The recent housing boom and the financial crisis that ensued could’ve been avoided if the governments had adopted this idea. One of the most significant errors that has infected the housing market is the poor understanding of inflation by the general public. In the early 1980s, rapid inflation in the United States meant that the stock market was very low in value. This reflected the very high nominal interest rates, even though real interest rates were not - an outcome called the ‘Modigliani-Cohn hypothesis’. Subsequent disinflation caused the stock market to go up, excessively. This socalled money illusion could have been avoided if the accounting had been done in this new unit of measurement. The housing bubble in the 2000s was, in part, caused by the public’s difficulty with understanding inflation. As the National Association of Realtors advertised, nominal house prices have, on average, doubled every decade. However, in real terms, prices haven’t budged for over a century (since the early 1890s). If we had measured home prices in these new proposed units, people would generally have known this fact, and would not have gotten the idea - as they did in the early 2000s - that home prices always went up. I have barely scratched the surface of the numerous benefits that this new economic unit of measurement for inflation can bring to our economy. Chile has already paved the road for reform, and we shouldn’t hesitate to apply it. The unfortunate lack of understanding that the public has for inflation is the achilles heel of our economy. After all, even the Great Depression could’ve been avoided had the workers understood that real prices were falling and thus allowed employers to cut nominal wages. The new economic unit is the way forward - it is a promising solution to the ignorant public and a shield to any future crises.
  6. 6. [Andrew Hayley] The 2008 Financial Crash: A Wider Context It is difficult to read any newspaper without stumbling upon some kind of journalism that commiserates the Financial Crash of 2008. This is rightly so, for we still live in a world afflicted by the consequences of the event. Unemployment still hangs at around 7%, whilst in the years before the crisis it averaged around 4.5%. Even today, this equates to around 4 million more people who are without jobs. I need not go into more detail. The 2008 crash, though, is arguably the tip of the iceberg (so to speak). It was the manifestation of a long period of ideological upheaval in capitalism and politics one that has proven harmful in a wider sphere of economic life. The original causes of the crash are well known. In 2005, house prices in major cities in California, Florida and Arizona (amongst others) were 150% greater than in 2000. The housing bubble began to deflate in 2006, though the construction slump was offset by strong export growth due to the weakness of the dollar. This became problematic, however, when lower home prices bore fruit in widespread mortgage defaults, bringing down with them an immensely complicated web of financial instruments. Collateralised debt obligations, along with various other heavily jargonised financial assets, rapidly unwound. For the highly leveraged banking system, insolvency became a major threat. With inter-bank lending now looking unpleasantly risky, the American financial system began to slide into a credit crunch. Any possibility of recovery was eliminated by the failure of Lehman Brothers, a mid-sized investment bank that collapsed in September 2008. Lending to the shadow banking system, comprised of many now infamous names such as Bear Stearns and Merrill Lynch, evaporated. The yield on junk bonds rose from 8% before Lehman’s fall to 23% in the aftermath. The maelstrom of the US banking system inevitably dragged down both the US and foreign economies, as consumption and investment collapsed in the face of financial turmoil. The wider causes of this can be traced back deeper into history. Indeed, it is important in studying both the crisis and its aftermath to consider the wider trends in economics in which it occurred. The 2008 crisis can be seen as the belated result of the proliferation of free market capitalism: the rejection of intervention in the belief that markets are best left alone. This is particularly attributable to Milton Friedman, whose liberalist approach was a profound influence upon contemporary policy makers such as Ronald Reagan or our own Thatcher. The effects of this ideological shift have been felt in the US economy since the Reagan and Carter eras, during which the elaborate regulatory system of the post-Depression years was systematically dismantled. Carter’s deregulation of the airline and natural gas industries (to name but a couple) was symbolic of a sea change in economic policy. Reagan continued of this reform in the financial sector, perhaps most notably in the 1982 Garn-St. Germain Act which relaxed loan type restrictions. The repeal of the de jure separation of commercial and investment activities as espoused in the Glass-Steagall Bill, which had also provided insurance for depositors, signalled the comprehensive demolition of the post-Depression regulatory system. The period following this was one of rising debt, inequality and instability. Between 1979 and 2007, the USA’s bottom 20% of households saw their incomes rise by 18%. For the top 1%, the increase was 277%. This elite band saw its after tax share of GDP rise from 7.7% to 17% over the same period. Paul Krugman in particular describes a process of ‘contagion’, as higher wages in the deregulated financial industry stimulate wider increases in executive pay. Reagan’s tax cuts also contributed to this worsening inequality. At the same time, the increase in consumption that had fuelled the liberal era’s growth was a result of huge credit expansion, with household debt rising from 47% of GDP in 1980 to 94% at its peak in 2009. Indeed, much of the prosperity of the period was a credit-driven illusion; wage rates have remained largely stagnant whilst average working hours have risen consistently. As the crash has proven, this is a thoroughly unhealthy condition for an economy. What was unhealthy in the economy as a whole proved wholly pathogenic in the financial sector. Free from the restrictions of post-Depression regulation and reassured by the safety net provided by Glass-Steagall’s deposit insurance, the banking system grew progressively more highly leveraged and began to dabble in increasingly risky areas (such as US sub-prime mortgages). The rise of a shadow-banking sector, free from the eyes of both the accountant and the law, was instrumental in the construction of a fundamentally unstable financial structure – so much so that it was felled by a relatively small number mortgage defaults. And this ideological shift was not just an American condition. One need look only to the behaviour of Iceland’s Landsbanki or Glitnir, and the subsequent financial cataclysm, or even the UK’s Northern Rock, to see evidence of a wider pattern of recklessness. The reckless tendency of the financial system was by no means the change that precipitated such chaos; it was the ideology-driven dismantling of the restraints on base human instinct. I think that in this sense the problem is a political one, in which government has failed to protect humanity from itself. The Dodd-Frank Act will go someway to re-regulating the American financial sector, but only time will tell if capitalism has learnt its lesson.
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