A book warning that future financial crack-ups lie ahead does not make for happy reading but contains some penetrating insights on how markets work.
I have read a number of James Rickards’ books, such as The New Case for Gold and Currency Wars, and while I have quibbles about some of his notions, I was looking forward to his latest offering, The Road To Ruin (his titles are not designed to cheer you up, although they do contain handy investment tips). This is, in my view, his most controversial book in what it proposes.
The 340-page book coincides with the election of Donald Trump to the US presidency and a win for the Leave campaign in Britain's June referendum on the European Union. We have had, meanwhile, nearly a decade of central bank experimentation: quantitative easing (aka printing money), negative real interest rates and the rest. Rickards' warnings are likely to find a welcome reception in some quarters, but not all.
At the start of the book we are introduced to the idea that policymakers might try to shut down financial transactions in the event of a market crack-up, including bans on asset managers' sales of assets. Such actions have been taken before. He likens this sweeping exercise of power to the “ice-nine” halt to activity portrayed in Kurt Vonnegut’s classic story, Cat’s Cradle. Such moves are already happening: India's central bank removed high-value bank notes, for example. There was the case of Cypriot government’s haircuts to bank depositors a few years ago, bans on hedge funds short-selling, and Greek restrictions on cash withdrawals. Governments have in the past seized private holdings of gold (Roosevelt in the 1930s); exchanges can be shuttered.
Rickards is at his best in my view in setting out his ideas around complexity theory and his argument that humans, particularly in crowds, are not as rational as other models of human activity say they are. (Humans are not moronic flesh robots, either, and that definitely includes politicians and regulators.) We have, for example, seen plenty of reasons for doubting the value-at-risk models used by banks and have had cause to be wary of derivatives, leverage and over-confidence in quantitative models. At a time when “robo-advisors” are all the rage, let us hope that none of the hubris embedded in some forms of financial thinking make their way into fintech.
The book, despite its scary-looking cover and title, is not about giving the reader the frights, but suggesting ways to limit, or at any rate understand, how financial complexity and policy hubris can lead to disaster. Rickards puts a lot of personal detail into this account - his description of his time at Long Term Capital Management and the saga of how that played out is gripping. He has seen some of the craziness of financial markets, and is not afraid to relate those experiences. I also liked his explanation of how even asset management houses, not normally considered systemically important, as is the case with banks, could be pressured by authorities to buy or not sell assets in the event of a market crack-up. These are risks wealth managers need to watch.
He enters more contentious ground in my view in his case for protectionism. Rickards starts by praising the insight of British political economist David Ricardo, who famously set out his idea of comparative advantage in explaining the case for free trade. However, such praise is quickly jettisoned as Rickards then proceeds to say that Ricardo’s idea only really applies when capital is immobile and says that in today’s very different world, with its free movement of capital and currency manipulations, Ricardo’s ideas do not apply so well or at all. And so he argues protection is not so reactionary or foolish after all.
This is controversial stuff, to put it mildly. If free movement of capital undermines the case for free trade, it might as well be argued that it also weakens the case for trade at any scale. Capital is mobile because it seeks the most return, and holders of pension plans and investment funds - tens of millions of ordinary citizens - will benefit from that, not just some narrow "1 per cent". Also, defenders of global free trade will surely point out that it has meant a vast extension of the division of labour and its associated benefits in terms of adding to the world’s economic pie (consider that China was a hell on earth as recently as the 1960s as Mao’s Cultural Revolution was in full, murderous swing). Protectionism is all too often a prelude to, or coincident with, rising nationalism and hostility to others. And a perusal of political history shows that tariffs are subject to special pleading by corporate interests at the expense of the consumer and less politically powerful producers. Not all protectionism involves tariffs, of course - supposedly well-meaning regulations of things such as labour conditions, environmental practices and the like can be a form of trade restriction. Protectionism can, in certain cases, breed complacency among home industries, although it can be useful in the very short run in helping to incubate nascent industries and create economic clusters, as arguably some of the "Asian tigers" did after World War Two.
Although he does not make this explicit in the book, when I spoke to Rickards in an interview, he agreed that I sensed that he might also hope to limit cross-border trade with tariffs not just to protect certain industries but also to limit what he sees as potentially unstable capital flows and curb cross-border financial contagion. He talks about how the financial system needs to have the equivalent of bulkheads in a ship so that, if the vessel is holed below the waterline, so to speak, damage is contained. It seems to me that his support for trade restrictions might be seen as part of that way of thinking. There is a trade-off: global trade can be enriching but carries more complexity and some people fare much better than others. Rust-belt towns - they are also now a feature of China, by the way - can be part of the downside of unrestricted free trade. Then again, tariff walls have their own costs, although not always ones that would elicit sympathetic news documentaries in the way that a closed factory in Detroit or Newcastle might do.
Even though I think Rickards is not right on the trade issue, I do think he is on the money when he sees how the current "Washington consensus" version of capitalism has many problems that require more than tinkering and hoping for the best. It is easier, certainly, to make the case for free trade when currencies are not being debased. Since the end of the dollar-gold window in 1971, we have had an unending period of monetary experimentation that has lasted to this day. Despite or because of post-2008 regulation, the Western banking system is more concentrated among fewer players than before. This is where, in this reviewer's opinion, the real problem lies.
The Road To Ruin is published by Portfolio Penguin.