There will be blood

Interview by Heather Scoffield in G&M with Harvard economic historian Niall Ferguson who predicts prolonged financial hardship, even civil war, before the ‘Great Recession' ends. There are some great quotes but I have summarized some of his comments by theme.

• Economic Recovery - Policy makers and forecasters who see a recovery next year are probably lying to boost public confidence, he said. And the crisis will eventually provoke political conflict, albeit not on the scale of a world war, but violent all the same.

• Canadian Economy - Canada is [considered] a winner because its banks are less leveraged, bank regulation here has been tighter, because its housing market hasn't been in a bubble quite the same way. Because this is a very unfair crisis.

• Globalization - [But as] The epicentre [of this crisis] is the United States, ... America's trading partners will get hit harder than the U.S. This is a crisis of globalization. Therefore, the more an economy depends on the global system, the harder it hurts. ... virtue is its own reward. You don't get any reward beyond the self-satisfaction of having been virtuous.

• US Currency - It's almost paradoxical that an American crisis ... reinforces the status of the United States as a safe haven. In a global crisis, investors want to increase their exposure to the U.S. Hence, the dollar rally. Hence 10-year Treasuries down below 3 per cent yields.

• China - Chimerica – the fusion of China and America – is one of my big ideas. Both sides stand to lose from a breakdown of Chimerica, which is why both sides are affirming a commitment to it. The Chinese believe in Chimerica maybe even more than Americans do. They have nowhere else to go. They want to keep, as far as possible, the U.S. importing Chinese goods. They want to keep currencies stable. Chimerica is intact. But I stress ‘officially' because there's considerable public disquiet. This [implosion of trade] poses the biggest challenge that the Chinese administration has faced since they embarked on reforms 30 years ago.

• Global Conflicts - A crisis of this magnitude is bound to increase political as well as economic [conflict]. It is bound to destabilize some countries. It will cause civil wars to break out, that have been dormant. It will topple governments that were moderate and bring in governments that are extreme.
  

• Russia - If Russia is looking for trouble the way Mr. Putin seems to be, I still have some doubt as to whether it can really make this trouble, because of the weakness of the Russian economy. It's hard to imagine Russia invading Ukraine without weakening its economic plight. They're desperately trying to prevent the ruble from falling off a cliff. They're spending all their reserves to prop it up. It's hardly going to help if they do another Georgia.”

• IMF - I think the IMF has been consistently wrong in its projections year after year. Most projections are wrong, because they're based on models that don't really correspond to the real world. If anything good comes of crisis, I hope it will be to discredit these ridiculous models that people rely on, and a return to something more like a historical understanding about the way the world works.”

• The Great Repression - [This crisis began in] August, 2007. when the various hedge funds started to hemorrhage. The stock markets carried on until October. consumer behaviour in the U.S. did not change until the third quarter of 2008. So there was a massive denial problem. [in October 2008] Bush calls for panic. I love it because it completely called the situation. There he was calling for panic ... to make people come out of denial. It took ages, ages, for people to realize this thing had fallen apart. Now, people have to try to unscare them before this thing becomes a self-perpetuating downward spiral. I think that's why you have to say ‘growth will return in 2010' with your fingers crossed behind your back.”
  

• Housing - Property ownership is something that our societies, particularly English-speaking societies, seem to be drawn towards. The notion that the majority of people should own their own homes dated from the 30s. It didn't really become a reality until the 50s. [The U.S] tax code privileges this asset class to take out mortgages and invest in property. I think that's a mistake. Canada doesn't have mortgage interest relief, and the home ownership rate is the same as the U.S. [So] we've sort of pushed the home ownership rate up to what seems to be its maximum, and beyond. It will clearly come down. The lesson of the subprime crisis is that you shouldn't give mortgages to people who can't afford them. Duh …

• Markets - There are some fantastic investment opportunities that pretty soon are going to start attracting buyers. The returns on the super-safe, highly-liquid U.S. Treasury portfolios are next to nothing. The potential returns from buying distressed assets or from buying companies that can't roll over their debt, are double digit. And it doesn't take a lot of imagination to see that the buyers will be sovereign wealth funds or other entities in surplus countries. The world divides in two, the debtors and the creditors. The debtors … (U.S., Europe) ... are going to have to sell of their assets. Call it the global foreclosure. They're going to be selling their assets cheaply to those who have the surpluses. “It's revenge of the sovereign wealth funds. They got burned. And this time, no more Mr. Nice Guy.”

• Bonds - $2-trillion worth of debt is going to hit the market this year, maybe more. Supply is exploding just when demand is contracting. You don't need to be a Nobel laureate to see that that has to impact on the price. The difference is there is this thing called the Fed that can step in and start buying the stuff if the foreign demand fades.

• Bubbles - In the Ascent of Money, I argue that you can't really have a bubble if you don't have a monetary authority that has been excessively generous. From John Law in 1719 to Alan Greenspan in the late 90s, there's always a banker, there's always a central banker making credit too readily available.

• Inflation - When the central bankers got together at Jackson Hole [in the 1990's], the view that emerged ... was, we shouldn't really pay attention to asset prices in the setting of monetary policy. I thought it was a mistake at the time because it seemed to me crazy to ignore asset prices. Why differentiate? What's the difference between pricing a loaf and pricing a house? Why do we care about one and not the other? [So] I think there was a flaw in the theory there, that essentially you could call the Jackson Hole consensus.
  

• Europe - European banks are far more leveraged than American banks. I don't see Europe as offering up any particularly good model in any respect. In fact, Europe's prospects could get a whole lot worse this year, [as] it could be very, very hard indeed to keep the Euro zone together. There will be howling anguish, all kinds of pain, conflict between Germans and the others. It's going to get very uncomfortable indeed. Spain [may be an exception]

• U.S Protectionism - No administration with Larry Summers in the White House is going to be a protectionist administration. Here's a man whose commitment to free trade and free capital movements nobody doubts.

• Positives? - Yes 1) Chimerica is holding up. The Chinese don't seem to want to get divorced from their American spouse and 2) this isn't leading to World War Three or Four, depending on how many world wars you think there have been [but] there will be instability. But it's hard to see a simple and quick macroeconomic happy ending.

• Canada is not going to suffer as badly as many other economies around the world. The biggest fault lines in the global system are in Asia ... and maybe in Eastern Europe. That's where things are going to be really unpredictable.

• There was a time when if you said the United States was going to suffer a lost decade like Japan did in the 1990s, everybody would have said you were a mad pessimist. That begins to look like quite a good scenario. And I think it's a realistic scenario.

• One of the facts is if you subtract mortgage equity withdrawal from the Bush years, the real underlying rate of growth of the U.S. economy was 1 per cent. So much of the consumption has been fuelled by mortgage equity withdrawal. So that seems like a reasonable growth rate for 10 years. … We just don't have an improvement of standard of living of the sort we're grown used to. And indeed if you have a more equitable redistribution through the tax system. If we simply go back to where we were, in 2005, that's surely not the worst thing that could happen to us.