Creative destruction at risk

Niall Ferguson is a bestselling author, a professor of history at Harvard, a senior research fellow at Oxford, and a senior fellow at Stanford’s Hoover Institution. Ferguson is also as engaging a speaker as one could wish to hear.

Last night Ferguson spoke at a dinner in Washington D.C. hosted by Paul Stevens and The Investment Company Institute (ICI). Ferguson’s topics were his latest book, The Ascent of Money: An Economic History of the World, and of course the present economic difficulties.

As to those difficulties, Ferguson made a number of points. First, money is based on trust. These days, most money is in banks. Thus, the loss of trust in banks, due to the over-leveraging of bank assets, means a loss of trust in money. Ferguson notes that it was really the banks which lost trust in banks.

Second, you can insure against risk but you can’t successfully insure against uncertainty. There are reliable mortality tables, for example, but financial markets have too many outliers. Part of the current difficulties stem from the selling of insurance against uncertainty, e.g., through the credit default swap.

Third, it’s a terrible bet that property values will always go up. Yet we created incentives to borrow money to purchase homes as if this were a good bet. Ferguson views the subprime market as a social experiment, the idea of which was to change natural tenants into owners in the hope that they would improve their behavior.

Fourth, the central fact of the global economy today is the indebtedness of English speaking countries to Asian countries. This state of affairs is the reverse of that which obtained during the first wave of globalization.

Fifth, in light of this central fact, the G-20 is not terribly relevant. Ferguson believes it’s all about the U.S. and our Asian creditors; everyone else can leave the room.

Sixth, the Chinese stimulus plan looks like an ominous sign. It signals that China may turn inward and away from subisidizing our spending.

Seventh, the U.S. cannot afford to bail industries out when our savings rate is abysmal, nor are bailouts a good idea in any case. Banks are different though, since the economy grinds to a halt without credit.

Eighth, the near future will be characterized by great volatility in international markets, as nations adopt ad hoc (and probably ineffective) stimulus packages while central banks “race to zero” when it comes to interest rates.

Ninth, as a general matter, the rest of the world will be hit harder than the U.S. Indeed, the U.S. retains a great advantage over the rest of the world — its belief in “creative destruction.” As long as the U.S. retains this belief, it will be the leader in innovation, which Ferguson sees as the key to recovery and long term prosperity. However, the push towards regulation and bailouts suggests a loss of faith in “creative destructive.” In reality, though, it’s wrong in general to blame the current difficulties on lack of regulation. In the 1970s, the last period of serious economic distress, the U.S. economy was heavily regulated, and regulation contributed in some instances to the current situation.

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