For Global Investor/isf ‘s 25th anniversary, senior figures who have worked in the financial sector for at least a quarter of century are giving their views on key developments over this period. First up is State Street Global Advisors, John Nugee. Now a managing director at the firm, and head of its official institutions group, his career has included high-level positions at the Bank of England and The Hong Kong Monetary Authority, giving him a unique perspective on the global economy’s last 25 years.
Global Investor/isf: What has been the most significant market crash of the last 25 years?
John Nugee: It’s not the most obvious answer but I think the Asian financial crisis of 1997/98 is the most important market fall in that time, due to the impact the IMF’s harsh bailout terms had on subsequent economic policy in the region. When the Asian countries faced challenges they turned to the IMF for help on the basis that it’s the common insurers of countries and central banks. The IMF responded with terms which were harsh to the extent of being unpalatable, causing those Asian states to say, ‘if that’s the price of common insurance, we’ll self-insure’.
They did this by building up levels of foreign reserves beyond a level the world has ever seen before. It’s worth remembering in 1998 total central bank reserves were about $1.3tn - today, China’s alone are greater than that, with Asian total reserves about $7tn dollars, and a global figure closer to $10trn.
This has been achieved by managing their currencies, and implementing a strong, export-driven, mercantilist, national economic policy, leading to ongoing surpluses, global imbalances, and the great consumer explosion of debt which we now dealing with.
So Bernanke was right that the recent crisis was a result of some countries saving too much?
I don’t agree 100% with Bernanke that it is the savings glut which has led to the consumer crisis in the indebted West, but the 1997/98 financial crisis was a seminal moment for Asian states, leading them down a path which created the current global trade imbalance. This asymmetry can’t be cannot be brought under control when the surplus countries don’t appear to be interested in reducing their surpluses.
The problem is debtor currencies have natural constraints, both moral and from the market, against borrowing too much – but there are no constraints against saving too much.
You would assume as these surplus countries get richer it will create a more consumerist society but this is very long-term process. There is no short-term lever that either world opinion, or markets, can use to dissuade a country from ramping its surplus any higher.
Would the London market have turned into a financial backwater if it hadn’t been for the Big Bang in 1986?
London’s success as an international financial centre is not solely due to the Big Bang and it wouldn’t necessarily have became a complete backwater had we not done something. But it would certainly be less vibrant and smaller.
There are three things that can kill a financial centre’s ambitions to become international: if it’s too bureaucratic, if it’s very idiosyncratic, and if it’s too domestically focussed. London is none of those things – but contrast it with Tokyo. It’s a huge financial centre, the Japanese economy is bigger than the UK’s, it stands alone as the leading economy of Asia and yet it is clearly not an international financial centre. It’s too bureaucratic and with such immense domestic potential it doesn’t need to look outside.
Shanghai may well find unless it address these three things its ambitions will take longer to be fulfilled they it might hope.
Was Paul Volcker right when he said the ATM was the banking sector’s only contribution to society in the past 25 years because, “at least it was useful”?
Clearly he said that for effect – but I think he is right in the sense that the banking sector needs to remember it’s a service industry, and one of the things to emerge out of the crisis is that it had lost sight of this. Things were done in financial engineering on the basis of, ‘if it can be done, it should be done’. But sometimes it's important to ask, ‘does anyone actually benefit from this?’
And in this context, if you look around at what the banking industry has done in recent years the ATM is something that has really revolutionised the man in the street’s life from his perspective.
That doesn’t mean, however, it is the only useful innovation from the banking sector.
The man in the street doesn’t understand that mortgages are easier to obtain - or at least were easier to obtain in the early 2000s, than previously. One remembers mortgage rationing, one remembers the mortgage queue. Even though the banking system isn’t still working properly mortgages are more available than they were 25 years ago because of the greater innovation in the financial sector.
So to say nothing else has been of any use is clearly an exaggeration, however, the statement hones in on the idea that the banking sector is a service sector, and it must benefit customers.
Has the recent crisis ended the discussion over whether there should be a separation of monetary and supervisory powers?
It looks as though the experiment of separating the FSA didn’t work. But you have to be careful when you say the FSA didn’t work, because what you are actually saying is, ‘had the Bank of England been in charge throughout then the UK system would not have got into this crisis’.
I think that is a strong statement that's not possible to make. You can have good regulation done in separate bodies and bad regulation done in combined bodies.
Is the growth of leverage the most important financial development of the last 25 years?
It’s an answer that will be easier to give in five years time because leverage throughout the industry is being rapidly reduced. Recapitalising the banking sector is simply another way of saying it’s reducing its leverage. But it’s clear that leverage in all forms - by banks, by investors, and financial instruments - certainly enabled the financial sector to grow more rapidly than the economy that it served.
Should the regulators have intervened earlier?
I don’t think you want the regulator to say, ‘you are growing too fast, don’t’. I think it is entitled to ask, ‘is there an end user demand for what you're doing, is it well funded?’
I do wonder if historians in 50 or 100 years time will look back on the period form 1998 to 2008 and ask, ‘did nobody notice the real economy was growing at 5% nominal, and the financial sector which supported it was growing at 15% nominal?' It’s as if restaurants were growing at three times the rate of people eating at them.