Deutsche Bank wasn’t the only global institution under the gun of the US Justice Department. While the German bank settled for a record fine earlier this year, RBS was also hit. Theirs was an eye popping $4.9 billion settlement. The ostensibly British bank had already set aside $3.4 billion for the anticipated civil penalty, meaning that only $1.4 billion (and change) would hit Q2 2018 earnings.
Shares in the bank rose sharply on the news.
It’s hard to generate the same level of outrage as ten years ago. Maybe that’s the point. In the smoldering aftermath of global dollar panic, it was easy to cast villains. Everyone wanted one and Wall Street provided plenty.
Not so much anymore. Stocks are at record highs, so fewer people seem to care about the excesses of such a long-ago age. As part of the DOJ investigation, thousands of RBS emails of housing bubble vintage were subpoenaed, and are now a matter for public record in the wake of the settlement.
They are every bit as salacious as you might expect. The BSD’s from the eighties may have been long gone, the mystique remained behind anyway. The big stuff isn’t stocks, it’s always FICC. The head trader at RBS received a call from a friend just after things got serious:
[I’m] sure your parents never imagine[d] they’d raise a son who [would] destroy the housing market in the richest nation on the planet.
Egos run big in FICC, as big as their portfolios. The unidentified RBS scoundrel modestly replied, “I take exception to the word ‘destroy.’ I am more comfortable with ‘severely damage.’”
And so it has been written. It was “toxic waste” and a culture out of control that nearly killed the system. That’s wrong on both counts; it was never really about subprime nor those who took advantage of it, but how things got that way in the first place. And the massive expansion that brought all this upon us didn’t nearly kill the system, as this last decade has proven.
The eurodollar era was one of riskless return. There wasn’t anything anyone could dream up that wouldn’t make someone money. There wasn’t any bank, no matter how previously stodgy, that wouldn’t bend every standard to do it. Expansion was the name of the game, no matter how you built the bottom line.
These are not new problems. They are, in fact, the same kinds of questions that informally humans have been asking themselves about since before written history. So long as there has been money there has been the temptation to conjure it on demand. What’s unusual about the last half century is who was doing the conjuring.
It wasn’t central bankers and governments, for once, though the latter appreciated the monetary and financial space to have become overtly reckless (along with housing market participants), while the former were very eager to take credit for all the economic “moderation” it seemed to generate.
In June 1990, Milton Friedman wrote for National Review Magazine:
From time immemorial, money has existed, and, from time immemorial, it has been connected with a commodity, though the specific commodity has varied widely. From time to time, individual countries have cut the link and adopted fiat currencies, but almost always as a temporary response to a crisis, such as war, never as a permanent system. Of such episodes, Irving Fisher wrote in 1911, “irredeemable paper money has almost invariably proved a curse to the country employing it.”
While Fisher was dead wrong about 1929, he was certainly right about this as we can attest. Friedman, too, in what he foresaw as how things perhaps should work. Monetary systems need safety valves. These are different depending upon the type of system under which they might be employed.
Under a true gold standard, financial recklessness could be corrected by the (public) hoarding of gold. It was a very messy and often destructive process, but effective nonetheless. Excesses were expunged but via depression. Blunt instruments, but maybe that’s all that is available.
After the Great Depression, however, you can understand why officials and even regular folks anywhere in the world might wish to try another method. Perhaps something wielded with a bit more precision and far less prone to severe breaks. In many ways, we can relate given how far in the other extreme everything went afterward.
The world of floating currencies was proposed in quasi-official capacity by Friedman in 1950. As an advisor to the US Treasury Department overseeing the Marshall Plan being carried out in Europe, Friedman argued that floating currencies could help restore Europe’s shattered economy and financial infrastructure.
The idea was not to have everything float, though. You had to pick one; if the currency was free to float then domestic monetary policy had to be carried out predictably and mechanically, taking away any possibility for an activist central bank (or whomever else might be the source of money supply). If you wanted instead the ability to carry out a discretionary monetary policy, then the currency had to be fixed (which is distinct from a currency peg, which Friedman regarded as the worst form).
In some way, there had to be the means for self-correction. Friedman’s main argument was that under his floating arrangements they would be more orderly and therefore less likely to result in the devastation of lost decades (or partial decades, like the 1890’s).
The rise of the eurodollar in the 1960’s under the cover of the primitive shadows (“missing money”) meant that neither method was realistic. Everything floated everywhere and in every possible way – before Nixon acted in 1971. It was, in my view, anyway, more stunning qualitative expansion than quantitative. The asset bubbles didn’t arrive via the quantity of offshore shadow money alone, more so the explosion in various types of it.
Economists knew these were big problems almost right away. Around the time the British pound blew up in 1992, Paul Krugman would write:
The instability of rates since 1973 has thus been a severe disappointment. Some of the changes in exchange rates can be attributed to differences in national inflation rates. But yearly changes in exchange rates have been much larger than can be explained by differences in inflation rates or in other variables such as different growth rates in various countries’ money supplies.
There was “something” else happening out there nobody (in official or mainstream Economic capacity) could put their finger on. Many blamed Friedman for getting it wrong about currencies, but what they all missed out on was another possible global arrangement far stranger. This was the one that in 2005 Ben Bernanke would mistake for a “global savings glut.” He got the location right, outside of the US, and then messed up the substance of it at the worst possible moment.
What if all currencies were allowed to float but that effective monetary policy in almost every major economy was conducted privately outside of those countries? Indeed, outside of every national boundary. They call it the dark web these seedy corners of the internet, and physicists have their dark matter, was the eurodollar dark money?
When sterling hit hard times in the early nineties, practically no one noticed what was different. Or, they like Krugman noticed but didn’t really and fully comprehend the ramifications. As one contemporary New York Times article put it:
The world’s currency markets, it seems, are no longer governed by central bankers in Washington and Bonn, but by traders and investors in Tokyo, London and New York, as the chaos in the currency markets this past week has shown.
The floatingest of floating currency systems. It would be a major violation of the corrective mechanisms that would be required under a more prudent global framework. Think about it; countries would gain unfettered (and hidden) monetary expansion at the same time their central banks would be freed from monetary criticism. In the US and Europe, they were even applauded their stewardship even though asset bubbles were rampant.
Since the source of all that monetary magic was the banking system itself, FICC (balance sheet capacity) reigned and whomever controlled FICC could write their own ticket. Even if that ticket might end in the end of the monetary system as a functional if flawed economic tool.
Going back to Friedman in 1990:
Now, for the first time, no major currency is linked to a commodity, however loosely; every major currency is a pure fiat currency. Moreover, this system is regarded not as temporary but as the normal state of affairs. The remaining gold holdings of central banks are simply the residual grin on a vanishing gold standard.
Fiat doesn’t begin to describe the eurodollar. It wasn’t printed at the behest of a troubled government fighting a war or against some other political emergency. Massive and sustained monetary growth, Bernanke’s global savings glut, was basically off the charts but more so off every map. Calling it the shadows doesn’t do it justice, either.
As I wrote earlier this week, the basic formula isn’t strictly money supply. It’s about matching supply with economic demand for money in the most efficient manner possible. Efficiency is a double-edged sword, though. It may mean at times corrective mechanisms that turn out messy and unclean.
This isn’t an argument for returning to gold, but to find the same beneficial properties that dominated under a gold standard and marrying them to the most modern operations. We don’t live in a static world; flexibility isn’t something that should be completely shunned. Too much unfettered flexibility, floating everything, that was the problem.
The eurodollar wasn’t really the inherent flaw, it was that it was dark money. Account for the missing stuff and then work backward through a determined effort to actually stay on top of things.
There aren’t any easy answers here, as Krugman wrote twenty-five years ago:
Laissez-faire economists are divided between those who, like Milton Friedman, want stable monetary growth and therefore want to leave the exchange rate alone, and those who, like Columbia University’s Robert Mundell, want the discipline of fixed exchange rates and even a return to the gold standard. Interventionists are divided between those who, like Yale’s James Tobin, regard exchange rate instability as a price worth paying for the freedom to pursue an activist monetary policy, and those who, like John Williamson of the Institute for International Economics, distrust financial markets too much to trust them with determining the exchange rate.
What ended up happening was none of those. The Great “Moderation” fooled everyone into thinking they all had it right and got what they wanted. It was a Rohschach Test of sorts. The only thing that was certain was that it was never moderate. They all just accepted the “global savings glut” and moved on to debating irrelevant stochastic minutiae.
We don’t have that luxury in 2018, though Jerome Powell sure thinks we do. He’ll get his wake up over the coming months, I expect, the same way Janet Yellen did in late 2014 and Ben Bernanke in 2007 and again in 2011 (an double global money clog). At some point we will eventually get back to discussing the global monetary framework again, and very likely on the basis of more widespread recognition of the follies of offshore dark money.
RBS didn’t actually destroy the housing market, though it doesn’t really let their employees off the hook. The process was begun a long, long time before the first subprime mortgage was ever packaged for its worst and most short-able qualities. The way in which that could have been possible was built first from dark money. The key for everyone else is not to have the most fun while it lasts, it is in designing a system that actually lasts. Even Bretton Woods didn’t make it that far (default in 1960; less than two decades), meaning a sustainable monetary system really and truly hasn’t been around since gold.
Maybe this is an argument for a gold standard after all! It truly is a difficult assignment, either way, but an increasingly necessary one. Not that anyone would know it in 2018.