Rhineland Capitalism 1, Liberal Market Capitalism 0

by Henry on March 25, 2008

Two quotes; one from Wolfgang Munchau, the other from Steve Clemons, seem to me to resonate in interesting ways. First, Munchau:

Another factor that pushes in the same direction is the weakening of the US financial sector. This has been a crisis of Anglo-Saxon transaction-based capitalism. Not too long ago, it was considered to be vastly superior to the eurozone’s old-fashioned relationship finance. I doubt that in a few years’ time people will continue to assess the relative strengths of the Anglo-Saxon and continental European financial systems in quite the same way. I would also expect the eurozone economy to withstand the economic shocks of the credit crisis in relatively better shape.

Then Clemons:

As TWN readers know, I have been on a lot of international travel lately—to Beijing, Mumbain, Tokyo, Berlin, London, Brussels, and Tel Aviv. In all of these places, I met angry and frustrated finance ministry bureaucrats, central bankers, retail bankers, investment bankers, and other fund managers. All of them had a single message that rang a bit like the US accusing China of shipping out poisoned pet food and lead-paint covered toys. They said American regulators failed. “You exported poisoned financial products.” Most Americans have no idea how low American prestige had fallen in the world before the financial crisis—but for the mother ship of modern day capitalism to fail so badly in managing the social contract between economic stakeholders and the finance industry is yet another enormous blow to America’s ability to compel other nations to do as we do, or as we want.

The Munchau piece is an interesting straw in the wind; it would be fair to say that Munchau has been, until quite recently, one of the more prominent cheerleaders for the ‘reform’ of European economic institutions. That he is changing his tune suggests to me that he’s hearing much of the same sort of talk that Clemons is reporting, and that he now believes, quite possibly correctly, that the kinds of informal information sharing and relationship building that, say, the German system of capitalism has allowed, provide a better way of understanding and dealing with economic risk than the forms of risk assessment and management that appear to be breaking down in the US and elsewhere. Which is not to say that the continental system as it used to be1 is perfect either – it has its own pathologies (most obviously, its tendencies to cronyism). But it is to say the assertions which you read regularly in the business press about the inevitable decline and collapse of this model are, as I’ve suggested before, the product of a boom-bust cycle in media hype over the virtues of untrammeled free market capitalism.

The Clemons piece too has interesting things to say about what this means for US economic power. The US has benefited in all sorts of ways from what might be described as a kind of regulatory seignorage. Because the US model is perceived as associated with economic success, other countries have flocked to emulate its approach to financial regulation (warning – link goes to academic article in PDF) in particular. This has meant that these other countries have had to pay the adjustment costs of adapting to US style market regulation rather than vice versa. Now, as Steve says, this reputation has at the least been substantially dented; depending on how things go over the next year or two it may be completely sunk. At the least, the US is going to have a much harder time convincing countries in the developing world and elsewhere that they should adopt the kinds of market regulation (or, more precisely, deregulation) that the US has preferred. Quite possibly, the US is going to have to wake up to the fact that it is going to have to do some adjusting too, rather than imposing its will on others as it has been wont to do.

1 Many of its major institutions have broken down over the last several years so that banks have gotten partially detached from the networks that they used to be embedded in. Indeed Landesbanks such as, most notoriously, Sachsen LB, have dipped their toes in the international financial system and gotten badly scalded. It will be interesting to see how or whether pressures on these banks (Deutsche Bank is perhaps the most important bellwether) result in a return to previous practice, or whether the new equilibrium is sticky.

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Boîte noire » Archive du blog » Les petites choses utiles du mardi, vol. 77
04.01.08 at 9:03 am

{ 21 comments }

1

HH 03.25.08 at 4:02 pm

Bernanke can print money, but he can’t print trust. It is the bleeding out of trust from our financial system, accelerated by the thugonomics of rascals from Reagan to Bush, that is alarming business leaders abroad.

America is desperately in need of measures that can restore trust to society in general and financial institutions in particular. The strange blindness of American academia to the need for Trust Studies is part of the systematic avoidance of an issue that is increasingly central to America’s economic and political health.

The contagion of cunningly engineered dishonesty is destroying America. How long before we seek a remedy?

2

mpowell 03.25.08 at 4:15 pm

My pessimistic prediction is that we won’t seek a remedy until it is far too late.

The collective ego that attaches to being the self-proclaimed greatest nation in the world is an insurmountable obstacle to political reform. It is a non-starter in the US to argue that we need to things differently to make other people happy with us. The political mass insists that regardless of what we do, nobody has any right to question our methods. I expect this sentiment to grow ever more shrill and demanding as our international reputation goes down the toilet. It will be generations before Americans come to grips with the new reality that we are creating.

On the other hand, there are pathways to remedies that do not require a renounciation of national greatness. But it’s harder to get to real solutions this way, so we’ll see.

3

lemuel pitkin 03.25.08 at 4:23 pm

The strange blindness of American academia to the need for Trust Studies is part of the systematic avoidance of an issue that is increasingly central to America’s economic and political health.

Sounds like somebody is working on his grant proposal!

4

Henry 03.25.08 at 4:28 pm

As an academic who studies trust, I haven’t seen any great blindness – indeed there has been an explosion in interest (and lots of good work funded by the Russell Sage foundation in particular, although they are now getting out of the business).

5

Geoff 03.25.08 at 4:40 pm

Once again, we need to save Wall Street from itself because it is too dumb and too greedy to get out of its own way. Ten years ago, in the aftermath of the East Asian financial crisis, mainstream American academic economists were hearalding the superiority of the American business model. Jeffrey Frankel, supposedly an expert on these kinds of things and editor of one of the NBER’s volumes on currency crisis, wrote that the East Asian financial crisis “displayed the superiority of the Anglo-American business model” over their Korean counterparts. Well, American finance is getting its share of well-deserved abuse. I genuinly hope this will allow some developing countries to at least partially close their capital accounts and to stop pretending that Western financial institutions can be exported to the Third World without any regard to the social context that market economies take place in…but I doubt it, because people at the IMF and World Bank still seem to think they have all the answers.

6

Steve Laniel 03.25.08 at 4:51 pm

At the least, the US is going to have a much harder time convincing countries in the developing world and elsewhere that they should adopt the kinds of market regulation (or, more precisely, deregulation) that the US has preferred.

As long as the U.S. controls development money, can’t it insist on the rules that the developing world has to play by? I.e., even if the deregulation it insists on doesn’t work, doesn’t its control of the purse give it enormous sway?

In order to believe that development money will be doled out more intelligently, I think we have to believe some things first — namely that the people in control of the World Bank et al. will respond rationally to the failure of U.S. deregulation, and will not insist on that style of deregulation for its client states. Is there any reason to believe that the World Bank would be rational in that way?

7

John Emerson 03.25.08 at 5:09 pm

You know, during the Plame incident I was being expected to help th nice CIA defend itself from the mean Republicans. Now Wall Street is coming around asking me to help them get past their little rough patch. Apparently they’re all willing to let bygones be bygones!

I feel so nice and warm. Apparently the cool kids like me now.

8

Mrs Tilton 03.25.08 at 5:15 pm

Landesbanks such as, most notoriously, Sachsen LB, have dipped their toes in the international financial system and gotten badly scalded. It will be interesting to see how or whether pressures on these banks (Deutsche Bank is perhaps the most important bellwether)

Not to quibble with your overall observation, but I’m not certain one can fairly lump Deutsche Bank in with the Landesbanken. (Viewed from one angle, Deutsche is a big London-based investment bank that happens for historical reasons to have a large retail network and a — currently empty — HQ building in another country.)

And as for the LBs, there are Lansdesbanken and then again there are Landesbanken. Not all are as badly run as SachsenLB or WestLB have been, and indeed some might even be termed sound. “Dipping their toes in the international financial system” is also a bit overbroad as a diagnosis of what hit SachsenLB, I think. The Int. Fin. Sys. offers plenty of boringly safe investment opportunities. SachsenLB’s problem was more, perhaps, one of “buying loads of toxic rubbish in a stupid attempt to recreate the yields they enjoyed back before the EU took away their artificially cheap funding”. (That’s another point of difference between Deutsche and the LBs, BTW: Deutsche and the other German commercial banks will have been very pleased indeed when the LBs lost the benefit of Gewährträgerhaftung and Anstaltlast.)

9

HH 03.25.08 at 5:20 pm

Regarding #4, the STUDY of trust is insufficient; it is the SYNTHESIS of trust that we desperately need. Academic approaches to Trust Studies are bogged down in observation. Now, it may be that decades of close study are required before we can find the atomic table, but I doubt it.

What we need is the F.W. Taylor of Trust Studies, not another Aristotle. We need to know how to rebuild a trust structure in an ethically bankrupt institution or workgroup. We need to know how to identify and promote high-trust individuals at every stage of their careers. We need ways of defusing trust-destroying propaganda tactics. We need textbooks with titles like “Principles of Trust Engineering” and “Applied Trust Structure Design.”

The deadline for solving this problem is the next major petroleum war and the subsequent nuclear winter.

10

Alex R 03.25.08 at 5:21 pm

In context of the current crisis, I’ve heard claims that calls for reform/further regulation of American financial institutions should be resisted, because it will reduce our competitiveness with financial centers outside the U.S. — usually, London.

But the Clemons piece suggests the opposite may be true: we need enough of a regulatory infrastructure in the U.S. to encourage investors to trust our institutions, and the our competitiveness should be enhanced by increasing — or at least improving — our regulations, rather than by resisting and reducing them.

11

Steve LaBonne 03.25.08 at 5:29 pm

… yet another enormous blow to America’s ability to compel other nations to do as we do, or as we want.

So at least there’s some benefit to the whole mess!

Sadly, we’ll never get our own house in order unless (until?) we suffer a collapse on the scale of the Great Depression. Too much “free market” koolaid has been drunk by too many voters, on top of their already unshakable conviction that the US is by definition the bestest most awesome country ever.

12

HH 03.25.08 at 5:32 pm

It is amusing to consider the creeping socialism implicit in the nationalization of mortgage debt. When Bernanke starts buying junk mortgage securities and renegotiating or forgiving the loans, he will be providing housing subsidies on a vast scale. This sounds like the Old Europe.

13

lemuel pitkin 03.25.08 at 6:23 pm

Sadly, we’ll never get our own house in order unless (until?) we suffer a collapse on the scale of the Great Depression.

Right, because the entire history of the past 70 years in the US is one long monotonic slide toward greater deregulation, with no significant expansions of the welfare state, invcreases in regulation, or strengthening of the public sctor along the way. Uh huh.

14

Stuart 03.25.08 at 6:54 pm

Not a monotonic slide, there have been a couple of prevailing trends – one trend would be creeping regulation followed by massive market inefficiencies, until a breaking point is reached and a bunch of deregulation happens haphazardly to try to reboot the markets in question. The other trend would be piecemeal deregulation followed by bubble/crash, and then some kneejerk regulation in response to the lastest crash (which will later be detoothed if the trend continues of course).

I wouldn’t say in either case politicians have much incentive to get their house in order in the first place, rather they generally just vote their political philosophy (or financial self interest) until it goes too far and they have to fix things because the market in question is falling apart (in one way or the other).

15

Ginger Yellow 03.25.08 at 7:36 pm

Funny you should call it Rhineland capitalism. The ABCP conduit that brought down IKB Deutsche Industriebank was called, you guessed it, Rhineland Funding.

16

Anon 03.25.08 at 8:01 pm

“Mumbain”?

Must have been some trip! I wonder what they the good financial folk of Mumbai might have had to say.

17

bjk 03.25.08 at 8:10 pm

The Europeans are just ticked off they bot all this mortgage debt without bothering to ask what it was made out of.

18

geo 03.25.08 at 9:22 pm

#13: the entire history of the past 70 years in the US is one long monotonic slide toward greater deregulation, with no significant expansions of the welfare state, increases in regulation, or strengthening of the public sector along the way. Uh huh.

Make that “the past 30 years,” and your sarcasm would seem to fall flat.

19

Detlef 03.25.08 at 9:34 pm

Henry,

Right about Muenchau in the past.
Did you see this post from Muenchau too?

I do not want to discuss the merit of this particular statistic – which I cannot – but I believe strongly that the Fed is absolutely wrong to target a core-inflation index (and it is not even doing that with any great conviction and success). Core inflation is supposed to be more stable, as it excludes volatile categories of food and energy, but both categories have not been volatile, but persistently rising. To exaggerate a little (well, ok, a lot): All the troublemakers are taken out of the basket, the rest is adjusted.

One reader wrote to me that the 8% estimate for US inflation is probably still too optimistic, as it does not fully take into account the rise in wheat and other commodity prices, for example. Another important side effect of a potentially misjudged inflation series is that US growth is actually not higher than European growth – a claim that has lead to much soul-searching over here – as we are deflating nominal GDP growth by an excessively modest indicator. As for the apparently superior performance of the British economy, just try to deflate all those nominal prices by RPI, not the actual GDP-deflator used, and the economic miracle disappears.

Is he already a heretic? :)
Questioning the superior performance of the US and UK ecnomies in the last few years?

Concerning the “Landesbanken”.
Mrs. Tilton already gave an overview.
Actually they are pretty useless today, I´d say. That´s maybe the reason why some of them went so eagerly for these toxic investment “opportunities”. They lost their reason to exist when the EU went after their public “backing and guarantees”. The reason why they could get loans cheaper than “private” banks.
That was phased out in the early 2000s.
(The banks that were bailed out till today (IKB, Sachsen LB and West LB), were bailed out because German aauthorities didn´t want to see a German bank fail. Probably wrong in my opinion. They should have let at least IKB go bankrupt.)

20

michael e sullivan 03.25.08 at 9:38 pm

18:

No, it still pertains even over 30 years. The government has grown in influence and control over the eoconomy in the last 30 years despite the “free market” rhetoric of most leading politicians.

If the welfare state includes SS and Medicare, even that qualifies as expanding in the last 30 years.

What has been very consistent for most of the last 30 years is that the wealthiest and most politically connected americans have experienced declining tax rates, less and less regulation, and *more* access to government funds and benefits.

It’s crony-plutocracy billed as free market capitalism.

21

Mrs Tilton 03.25.08 at 10:33 pm

Detlef @19,

the LBs might still be useful in some roles, e.g., as wholesale banks to the savings banks that (to a greater or lesser degree) own them. Certainly I can think of at least one LB that is very well run (and has recently profited from the mistakes of its less prudent sisters).

I agree with you about IKB, though for clarity would point out that it is not a Landesbank. (However, the federal government is heavily invested in it through KfW, Germany’s development bank.)

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