Paper Promises: Money, Debt and the New World Order
by Philip Coggan
(Allen Lane, 2011)
The banking industry "divides the nations into two groups, creditors and debtors, and fills each with malignity towards the other". So wrote John Taylor in An Inquiry into the Principles and Policy of the Government of the United States, published in 1814. This struggle between lenders (creditors) and borrowers (debtors) is Philip Coggan's central theme and he views the current financial crisis as merely the latest battle in a long running war between those who own wealth and those who seek access to it.
Coggan draws attention to two important features of this war, namely the dual function of money and the control of money supply. First, he argues that creditors are primarily concerned with money as a store of value, since they want to protect and preserve the wealth they have already accrued; whereas borrowers are more concerned with money as a means of exchange, since they hope that an increase in economic activity will allow them to accrue wealth in the future. As the amount of money in circulation increases, so does the risk that money will fail to provide a secure storage function: claims on established wealth are debased by the pursuit of claims on future wealth.
Second, Coggan describes the process by which we have moved away from coinage with intrinsic value, to mass produced money (coins and paper) backed by gold, then to the Bretton Woods system of money backed by dollars (which in turn were backed by gold), and finally to the modern system in which money is backed solely by the promise of governments to honour its value. Contemporary governments, tempted to make promises that they will not be able to keep, have created the illusion of wealth by printing more money: the cost has been domestic inflation, the diversion of wealth into non-productive investment leading to asset price-bubbles and, finally, the current crisis of confidence in the sovereign debt markets.
The prognosis, Coggan suggests, is not good. Growing loss of confidence among creditors in the ability of governments to pay back the money they have borrowed will be matched by growing dissatisfaction among debtors that governments can no longer provide the services and benefits they have promised. The battle between creditors and debtors will become politicised in the West and will lead to some combination of inflation (bad for creditors), stagnation (bad for debtors) and default (bad for everyone). Added to this, there is an international dimension to the problem, since the West (and in particular the US) has borrowed heavily from Asia (and in particular the Chinese). The next battle between creditors and debtors will take the form of a struggle for control of international economic policy-making. The outcome that Coggan predicts involves the heavily indebted Western nations ceding power and influence to China.
When prices in the asset markets were rising rapidly in the 1990s and early 2000s it was commonplace for "boosters" to predict a glorious future of continuous year-on-year increases in real wealth for all; now that the bubble has burst and economic growth has stagnated, so "gloomsters" are in the ascendancy, forecasting a miserable future of default, stagflation and the decline of the West. Pessimism is back in fashion and Coggan's book offers us a grand historical narrative with which to anchor the current penchant for negativity. Nevertheless I find his arguments unconvincing: first, the financial system is more complex and, second, economic activity is more co-operative in nature than Coggan's account suggests.
One of the main short-comings of contemporary financial commentary is the tendency to conflate a highly diverse range of financial activities under the name "banking" and then to assume that all banks are similar in structure and ambition. The term "The City" (or "Wall Street" for that matter) is then used to describe a corporate person rather than a place of corporate activity. Within the financial sector banks play an important role, but there are many different sorts of banks doing different sorts of things, sometimes in competition with each and at other times operating in wholly separate spheres of activity. Further, much of what happens in the financial sector happens outside of banks, properly defined.
From which it follows that statements that take the form "all bankers thought x" or "all bankers wanted y" or "all bankers must be forced to do z" are mostly vacuous. They might describe accurately what some bankers thought or wanted or should be required to do; but they almost certainly do not capture the wide range of thoughts, desires and obligations that exist within the financial sector as a whole. For all the praise that has been heaped upon Nassim Nicholas Taleb (and Coggan adds to the pile) for drawing our attention to the relevance for financial markets of David Hume's scepticism about inductive arguments, many leading financial commentators continue to make the very error that Hume exposed. Just as not all swans are white, so not all bankers are x or y or z, whatever x or y or z might be: assuming that a number of particulars stand for the universal is an error of logic, and thus to be avoided not embraced.
Those employed within the financial sector are a heterogeneous bunch, who resist simple generalisations about their intentions and actions. Likewise Coggan's division of the world into creditors and debtors, engaged in repeated struggles to control the nature and quantity of money, presents us with a black and white picture which would be better painted using a large palette of greys. Much of the irresponsible borrowing that took place in the two decades prior to the onset of the financial crisis was undertaken by those who were already wealthy. Leverage, much beloved by the hedge fund industry, allows the rich to borrow more aggressively. The biggest debtors are generally those with the most assets, while those with the least collateral to pledge find it hardest to access debt finance.
The relationship between creditors and debtors is an example of symbiosis and not an example of the life and death struggle for survival. Creditors have more wealth than they require for their immediate needs, hence their willingness to lend; but they want their money back to fund future consumption and therefore have a strong interest in the ability and willingness of borrowers to repay. Debtors have insufficient wealth for their immediate needs, hence their willingness to borrow; but they have a strong interest in maintaining a stable financial system both because they might need to borrow again in the future, and because they hope to become wealthier over time, in which case they will want to lend their own surpluses.
Modern finance, including the dematerialisation of money, has made possible a huge expansion in the scale of economic activity. From time to time this activity runs out of control and, temporarily, wealth is destroyed rather than created. But, we tend learn from our mistakes and are not condemned to repeat them endlessly. The story of money is a story of mutual advantage not a story of inevitable conflict, it is a story of progress not a tale of decline, and paper promises turn out to be as good as any other sort, most of the time.