Our investigation into how the redistribution of wealth from wages to profits has seen the concentration of huge stockpiles of wealth in institutional cash pools led last week to the discovery of 5 imbalances in the global economy:
- Ever greater wealth being concentrated in a tiny number of hands (the 1% and 0.1%);
- Such vast wealth being managed by a small number of asset managers;
- The concentrations – the institutional cash pools – looking for safe, liquid investments (e.g. government bonds), rather than investments in private sector productivity that carry more risk but help grow the economy;
- Meanwhile there is an imbalance between the performance of ICPF portfolios and the promises they have made to their clients, making them willing to take on leverage to achieve their targets;
- And finally there is the imbalance in trade, with some countries producing the goods (particularly South East Asia) and others consuming them (particularly the US and UK) – the US funding this through sale of dollar denominated assets, for which an almost insatiable demand exists only because the dollar is the currency of global trade, and the UK being the centre of this international trade in dollars.
Pozsar’s own comments on this are striking. He summarises these imbalances in his 2014 paper for the US Department of the Treasury, and then states (page 64):
“If neither shrinking imbalances or broadening the official safety net is palatable, partial solutions would recognize that the ecosystem’s existing needs will be met by new structures that need to be understood and monitored to avoid new systemic excesses.”
The conclusions of this paper mainly concern the need to start collecting data that will give a clearer picture of this set of financial relationships – the “understood and monitored” part in the above sentence. He also touches on the implications for regulation, which he discusses in more detail in other papers.
But notice how he dismisses the idea of shrinking these imbalances as not being “palatable”. The US Department of the Treasury is not about to start tackling wealth inequality, so it was not worth Pozsar giving it any more than this passing mention.
But what did he really think about this? Well after leaving this job he published another paper (early 2015), and his conclusions merit quoting at length.
Having outlined two regulatory reforms that are needed, he then states (page 24):
“We would only be shifting the problems of leverage and private money around, not solving them. This leads to the third entry point: reforming the ecosystem that banks and asset managers inhabit.”
He is pointing to the need for a much more fundamental reform of our financial system. He continues (page 25):
“Just imagine a world where exchange rates would be freely floating and the stock of reserves would revert back to past benchmarks of levels sufficient to cover short-term foreign trade and debt bills. Reserves over and above this amount would be distributed among households equally. Furthermore, imagine a world where idle corporate cash pools would be taxed and distributed among households.”
This is what Pozsar really thinks. If we could only ignore the politics and focus on what empirical analysis tells us about how the economy works, there is a need to address wealth inequality and trade imbalances, through taxation. He goes on to outline how such reforms would lead to a more stable financial economy.
By implication, he is saying that you cannot just leave this to the free market, it takes government intervention, which is unpalatable enough. But even worse, these proposals would require global cooperation, particularly when addressing trade imbalances. No wonder he subsequently acknowledges (page 26):
“Of course, these thought experiments would be tough to implement politically both at the local and at the G20 level. But they are worth pondering about to appreciate the broader context in which the debate about managing the risks of shadow banking and financial stability should take place.”
His recent 2017 paper, with di Iasio, really hammers this point home (page 31):
“In light of the above, financial and banking regulations seem to be second best policies when systemic risk is fuelled by transformations of the financial ecosystem which closely mirror developments taking place in the real economy. A more comprehensive approach to financial stability and balanced growth may require policymakers to tackle the very structural and fundamental macro developments to which financial intermediaries provide private-sector – sometimes grossly inefficient – responses. This paper argues that financial stability risks can be inherent in income/wealth inequality, global imbalances and other macro factors that create demands and need financial intermediaries accommodate. In this respect, the benefits of redistributive policies – including global currency and corporate tax reforms –usually examined from a demand management perspective, may also have relevant financial stability benefits, through their impact on the size of wholesale funding markets. Similarly, promises made in the past – like those of defined benefit pension plans – should be renegotiated whenever real returns fall short of expected returns in a structural way.”
Here we see it – the private sector (read “free market”) can be grossly inefficient, and we need policies that redistribute wealth.
But note that the whole focus of this is financial stability. The paper was written for the European Systemic Risk Board, established by the EU in the wake of the financial crisis. The arguments are entirely based on empirical analysis of what is needed to have a stable economy.
There are many who argue for a reduction in wealth inequality on the basis that it is unjust. And there are those who argue vociferously that it is government intervention to reduce inequality that would itself be unjust – that natural justice is achieved by allowing free markets to distribute wealth in response to the freely expressed desires of the consumers (expressed through their consumption choices). This latter political theory has become wedded to mainstream economics, which provides a pseudo-scientific argument for unfettered free markets with minimal taxation and state intervention, whether in the form of regulation or public sector expenditure on services. (I say “pseudo-scientific” because this theory is not based on empirical research, but rather on deductive reasoning, sometimes logically flawed reasoning, starting from a set of assumptions about the real world that are in fact the exact opposite of real-world conditions – but that’s a whole different subject.) But what I want to draw your attention to is that arguments for or against addressing wealth inequality are usually based on political beliefs about what constitutes justice.
Pozsar’s work, and the arguments in this blog, are entirely divorced from politics. The focus is purely on scientific analysis of how the economy actually works in practice. And Pozsar’s brilliant empirical work leads to the conclusion that, to create a stable economy, we need to address wealth inequality and trade imbalances.
Such proposals will normally result in shock and horror from many quarters, including much of the economic mainstream. But these responses are generally political, not scientific. Pozsar is not some loony left-wing radical – he is an analyst of the US economy for Credit Suisse Investment Bank, working for Global Economics and Strategy in its Fixed Income and Economic Research Division! He just wants to know how the system works so that he can make money out of it. He’s previously worked for the New York Federal Reserve, the IMF and the Department of the Treasury. You could not get a more mainstream CV. (Similarly, di Iasio works for the Bank of Italy.)
But his analysis shows clearly that the current set of imbalances destabilises our economy. If we want a stable economy that is not misallocating capital resources and thereby leading to bubbles and crashes, we need to address these imbalances. And next week I will extend this analysis from financial stability to the question of how we create an economy that provides enough for everyone.
