Romesh Vaitilingam interviews Avinash Persaud for Vox

September 2009

Transcription of an VoxEU audio interview [http://www.voxeu.org/index.php?q=node/4146]

Romesh Vaitilingam: Welcome to Vox Talks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam, and today's interview is with Avinash Persaud, chairman of Intelligence Capital. Avinash and I met at the Global Economics Symposium in Germany in September 2009, where he was speaking at a session on the future of global financial governance. I began by asking for his perspective on global economical imbalances, which many people have seen as being the fundamental cause of the crisis.

Avinash Persaud: The very term "global imbalances" is an odd one, because what do we mean? That term suggests a bunch of countries with big deficits and a bunch of countries with big surpluses. That's not what's happening. There's one country with a massive deficit that is financed by about a hundred countries with surpluses. And these surpluses come from countries which are actually quite different. When you say surpluses today, people think you mean China, but actually it was Japan which was the first country who had a trillion dollars in reserves. The biggest change in reserves occurred in the commodity exporters, very different set of countries than China, which is a massive commodity importer.

So I think that really the problem with global imbalances is US deficits. And that is problem of all attempts of global economic coordination. It's the fundamental issue, which is how do you constrain the hegemon? How do you constrain the most powerful economy in the world?

Naturally, understandably, the leaders of that country are focused on what's good for their country, and the spillover effects - large and wide - are not really their concern, but it's the concern for the rest of us. And the whole point of global anything is about constraining the behavior, in this case, of US policymakers. Maybe in 25 years it will be Chinese policymakers.

And it's a challenge. The one fundamental policy that if it had changed would have made a difference, would have the US fiscal policy. If you had higher US taxes or less US spending, the exchange rate would have been weaker, the consumption would have been lower, and we would have not have had global imbalances. Fiddling around with China's exchange rate would have hardly made a dent on global imbalances.

Romesh: And one of the big changes since we last met here in Ploen was of course the fall of Lehman Brothers. The other was one was of course the change of administration in the United States in January of this year. Does that make a difference to efforts, as you say, to constrain the hegemon?

Avinash: Many of us had hopes that we could make choices, good choices in the crisis, between who we bailed out and who we didn't. I think that now this crisis is more mature, we have developed a more mature view, I think many of us at least, that actually it's impossible to do good in a crisis. Crisis management is very hard. I, like many people, thought that “we can let Lehman Brothers fail. We can send a signal to the marketplace”. Lehman Brothers was one of the smaller of the investment banks, and it wasn't known to be heavily involved in the housing market. That was the thinking that weekend when a buyer couldn't come forward, September 15th, 2008.

What we discovered one week later was that when Lehman Brothers failed, because it was a first time we let debt holders suffer, debt holders didn't want to provide debt to anybody else. And the cost of capital for banks rose so rapidly the day after Lehman Brothers failed, that not a signal financial institution in Britain, Europe and the US was solvent, not a single one.

So we learned that you can't really mess around trying to finesse what's right and wrong. In a crisis you've got to bail them out and then you’ve got to deal with picking up the pieces and the horrendous moral hazard you've spread afterwards.

Romesh: Is it fair to say that we're still in a crisis? Can we still talk about being in a crisis?

Avinash: I think the sense of panic has changed. We do seem to have gone from the first of half of this year, a vertical drop in the economies. In Germany's case, hardly touching the sides, GDP contracted by 6% on an annualized rate in the first quarter, that’s an amazing phenomenon. Global trade collapsed or leveled at a pace we haven't seen since the 1930s. And somehow it stopped. It's not really getting much better, but it does appear to have stopped falling. And so I think the whiff of panic is behind us, and I think people are beginning to focus more on solutions.

What's complicating the search for solutions is narrow political interest, which are part of the policy process, and they're really getting in the way. I would say last year, people were focused on what went wrong and how do we change it. This year, politicians are focused on what do the people, what do the public and voters think went wrong and how do we address that? And those are two very different things.

Romesh: Let's talk a little bit about financial regulation. I’d be interested in your view on where that debate has got to and where the policy has got to in terms of making changes that people have called for.

Avinash: There was a lovely mantra, that "banking is global, therefore regulation needs to be global." And I guess I used to subscribe to that view. I no longer do so, because if you think about the fundamental things that went wrong, they can really be addressed at the local level. Indeed, they can't really be addressed at the international level. The fundamental problem is that financial crashes follow financial booms. Any regulatory initiative that wants to stop crashes has to address the booms. But the booms aren't global. Sometimes they look global, but today, for example, we're in the mother of all recessions but every country is at a different point in that cycle.
So you if you're going to try to deal with the boom being counter cyclical, you're going to have to do that differently in every country. So you can't do that globally. The other problem is what I call the "Iceland problem," partly because I don't know many people from Iceland so it's easy to insult the country. I feel sorry for Iceland.

But in the United Kingdom, you had Icelandic branches. Iceland would have said to you that they were following global banking rules, but their enforcement of those rules, their interpretation of those rules, clearly could have been better. And they were in such a way as to promote international banking for Iceland, which became a big part of their GDP.

Indeed, that kind of replaced fishing, which had gone down significantly because of the over fishing in the North Sea.

So how do you deal with that? Can you come up with a single global rule that will be appropriate for every country, appropriate to Brazil, as in China, or India, or Russia? I don't think so. And even if you could, could you come up with a single measure of enforcement of those rules?

The best defense against the Iceland problem, is to require all banks operating in your jurisdiction to be national, to be subsidiaries of a local entity, to have local capital set aside to deal with the risks they have locally and be able to withstand the failure of an international parent. Again, the locus of that is domestic regulation, host country regulation.

Romesh: Lots of people have used this expression about there being opportunity in a crisis, opportunity to make changes. But I wonder if with the sort of return of confidence to some extent, certainly in the financial markets although not in terms of the real economy that that opportunity may have gone and actually we may have missed the chance to make changes in the intentional regulation either at the national or global level.

Avinash: I think there's a real danger that that is the case. I think that's a very important point you make. I have lived through seven international crises, none of them as big as this one. But in each of them, I was always surprised at how radical people got in the middle of the crisis. I remember Jaques de Larosiere saying, "Bring back capital controls,"" in December of 1992. I remember Bill Clinton after LTCM saying, "Let's refashion, reorder the global financial architecture." And then when the crisis is over, we always tidy away these bold, grand plans and we're are always left with the same three things, and it's always the same three things. It's more prudential controls, more transparency, more risk management.

And in my experience of the seven international crises in the past, those three things may be good, but they don't stop crises. And the real danger is, you can already hear it, people going back to these same three things, "We need more transparency, more prudential controls, more risk management."

Well, we tried to do that before. We invested heavily in those things and they didn't work. So I would have said doubling up on something that hasn't worked isn't the way forward, but that is what people may well be going back to.

Romesh: As you know, the focus of the GS that Dennis Snow and his colleagues tried to bring is to try to focus on real concrete implementable solutions. Perhaps, we could talk about one that you have discussed recently, which is the Tobin tax. Could you just give us an overview of what that would do and why you think it is workable?

Avinash: Well, bankers hate the Tobin tax. And if I want to make myself unpopular, I talk about the Tobin tax. I used to feel like most bankers, that a Tobin tax which is an idea that James Tobin came up with, the Nobel laureate, when the Bretton Woods system was being hammered by currency speculation in the early 1970s. That there would be a small tax on transactions. His idea wasn't really to raise revenues, it was to influence behavior, reduce the incentives for short term behavior. Bankers hate that idea; they argue that it's not feasible, the foreign exchange market is in cyberspace, it's not in the physical space. How could you do it? They argue it would destroy liquidity if you could do it. And I think both of those arguments are just false.

Today, there is increasing movement towards settling foreign exchange, or any over the counter market, in one place. They are huge benefits to settling in one place. You net out the risks, net out the exposures, you reduce operational risks, you reduce credit risks. Going away from the global settlement place would be a very risky and dangerous thing to do. And you could levy the tax in the global settlement center.

So I think you can levy the tax. You can levy the tax individually. The United States finances the US regulatory bodies by a tiny transactions tax on trading in US government bonds. It's a unilateral tax. Other countries don't levy it, the US levies it, and it works. Recently, they had to cut the tax, because it was raising too much money.

So I think this is quite feasible. The issue actually is, is it desirable? In terms of crushing global liquidity, I think the way we need to address that issue is that a tax is a little bit like the spread, the buyer's and seller's spread. And if you were to raise a tax, it's equivalent to raising the spread.

The spread today, the trade of spread between buying and selling rates, is much lower than it was 10, 15 years ago, much lower than it was even five or seven years ago. So if you were to effectively raise the spread back to where it was seven years ago, it's the same effect of the transaction tax. The market didn't collapse seven years ago, it was there, it was healthy. It was still the biggest market in the world, the foreign exchange market. So I think this is quite feasible.

Now my final point would be, should we do it? Just because we can do something doesn't mean we should do something. What I've observed is that the market does overproduce products that they make more money from, and they make more money from things that trade a lot.

So if you set up a buy-and-hold investment fund that buys assets and holds them for 20 years, you'll never ever see banker because they don't make much money from you. One trade and that's it.

If you then turn around and say you're going to set up a subsidiary, which is a hedge fund that's going to trade its entire portfolio every four days or so, you'll be seeing 50 bankers every day trying to get your business.

So we need to kind offset that socially not very useful bias, and the economist's classic response to a social externality is to raise a tax. So I think it actually makes sense. It's feasible. It's desirable. But it is guaranteed to make you the number one enemy of all bankers.

Romesh: Because in effect you seem to be saying the finance is too big, and what the Tobin tax has always been described as is throwing sand in the wheels of international finance and you're in some way shrinking the amount of activity and perhaps shrinking the sector.

Avinash: I think that my argument would not be anti finance, but it would saying there's some things we do in finance which are excessive. I think it's a tough argument to disagree with today, not the case two or three years ago. So, yes, if we can reduce of the short term activity…but I still believe a very unpopular thing, that finance can actually every now and then be useful. I noticed the Mexican government made $8 billion dollars from hedging against the oil price falling, and I thought that was a wonderful use of over the counter derivative.

Romesh: Avinash Persaud, thank you very much.