Going off the Rails: Global Capital and the Crisis of Legitimacy

This is an interesting take on the global financial system circa 2003, pre-Great Recession. You can see all the sources of the future problems under development, and it’s full of surprising things I didn’t know about how things differe internationally.

Here’s some choice bits I found reading. Note I have not actually looked up the data on all these, or checked on wild changes post-2003; caveat emptor.

Chapter 2
• Capital allocation dominated by equity markets is unique to the US and UK. Elsewhere it is done by banks.
• Hostile takeovers are unique to the US and UK.
• Boards composed of VCs and investment bankers are unique to the Us and UK.
• US and Europe have roughly similar labor productivity, but the US does this with less capital. European and Japanese capital performance is significantly worse.
• Outside the US and UK pensions are largely financed through state pensions, not equity investing.
• British productivity growth did not jump in the 1990s like in the US.
• Two-thirds of all venture capital funding between 1980 and 2000 was in 1999 and 2000.
• US productivity growth was dominated by incremental improvements in existing industries, not techology companies.

Chapter 3
• The third world is a capital ghetto. On paper, developed country investment should flow to developing for higher returns. In reality almost all of it is between developed countries and a few trendy developing ones multinationals pour cash into, such as Brazil. Emerging markets are 4% of global equity. African and Middle East investing returns around 20%, yet they get virtually 0 investment.
• Like the 19th century, capital flows have globalized to an amazing extent - but only in the developed world. Unlike the 19th century, labor flows have not. Unlike the 19th century, intranational capital flows are by huge funds, not individual investors.
• Hot money comes and goes with little rhyme or reasons. The asian financial crisis was completely unjustified. Between 1975 and 1997 there were 82 banking and 158 currency crises.
• Today’s financial system transmits shocks around the world just effectively as the gold standard did, but unlike the gold standard it doesn’t mitigate short-run movements in capital.
• Pension fund managers do not diversify to developing countries because the shock transmission destroys their gains and they’re so big they distort the markets by existing.
• Developing companies list their shares in London, because they can get access to pension fund dollars. This deprives home governments of tax revenue; South Africa is a good example, very developed markets but they can’t get the international investment at home.
• From 1982 to 2000 the ratio of US equities to GDP went from 33% to 181%. Tremendous amount of deregulation in capital allocation, virtually back to 19th century standards.
• Pension fund managers who don’t follow the market get fired. Since so much of the equity market is benchmarked against indexes, the indexes become self-fulfilling prophecy. July 2002 S&P removal of Nortel from S&P 500 dropped Nortel stock 14% in a day.
• Hedge funds are the only players left actually trying to allocate capital, somewhat in between all the momentum trading and speculating.
• LCTM shows what happens that if all players use the same risk models. This didn’t happen with Drexel Burnham.
• The 1980s and 1990s have seen ever-more market intervention by central banks. Just in the US 1987, 1991, 1996 LTCM, 2000, 2008. Greenspan policy of not popping bubbles but that propping up failures creates even more incentives for bubbles.
• The deflationary results when asset bubbles pop should be considered by central banks in planning, but they largely aren’t.
• Germany banks are 5x the size of equity, American banks are 1/3rd the size of equity.
• US central banker behavior shows what utter bullshit the rhetoric about hands-off, weak safety net capitalism is. We have a welfare system for rich people.

Chapter 8
• “On the face of it, the US had pulled off a remarkable trick. It appeared to have defied historical precedent by experiencing a bubble that was not followed by a devastating financial crisis. Yet any verdict on this huge experiment in economic management has to be provisional because little attempt had been made by mid-2002 to address the imbalances that accumulated in the economy over the 1990s. Companies and households remained over-borrowed, the government had moved from surplus to deficit and the current account of the balance of payments remained stubbornly vast.”

Chapter 11
• “The bizarre irony here is that the shareholder value movement has ended up replicating the errors of socialist planners in the old Soviet Union who imposed targets on industrial managers that were frequently met by fiddling the figures or doing damage to some other aspect of the business. By fixing on a single managerial incentive – the share price – the Anglo-American system has encouraged management to maximize short-term profits at the expense of longer term growth. When managers found that they could not generate enough short-term profit to satisfy investors and stock market analysts in the bubble period, they resorted to takeovers as a means of keeping one step ahead of the baying hounds of the financial community. And when takeovers became difficult to pull off in the depressed stock market conditions that followed the bubble, they took to window-dressing the figures either within the rules or fraudulently as at WorldCom.”

I’ve not read the full link yet Jason, but will quickly comment on a few things that jumped out at me in your bullet points:

Everyone in the uk has a state pension which is funded automatically all your working life through your National Insurance contributions (these get deducted automatically by your employer, so your pay arrives in your bank minus this). In more recent years private pensions have become more popular, but you will still pay those NI contributions as well, so in effect you end up with a state pension and a private one if you put money into one.

Since the option of Margret Thatcher in the 80’s to destroy our industrial base (rather than reform it) in favour of The City, britian has become a society financially dominated by the south east (the city of London) and a net consumer of goods. We only really ‘produce’ on the financial markets and in the education/brain sector. Productivity in the traditional sense has been on a downwards curve since the 80’s.

The third world is just the first worlds ultra cheap labour pool now, this last decade or two has seen an explosion of systems to allow us to exploit the third world, from slack business tax avoidence laws to dodgey deals under the table for our companies to set up shop in poor country x. In this system there is no incentive to actually develope these countries as that directly effects your ability to get that cheap as dirt labour.

Once i’ve read up on your link i’ll post anything else that comes up.

The state pension in the UK is very low compared to most other developed countries, though.

What happened was that Thatcher allowed companies to stop paying into the defined benefit pensions which had emerged from the UK system, killing them off over the next decade. Thus, most people are now dependent on stock-market linked pensions. (And the Government is working hard to make the remaining ones, such as in the public sector, prohibitively expensive for younger people)

I just picked up a book (haven’t read it yet) on a similar topic:

The Big Short:


Everything by by Michael Lewis is awesome. Collect them all!