Bank on Bootle

Pay attention to Roger Bootle - in the past his economic analysis has proved to be fairly spot on. So, when he argues for radical reform of financial systems, we should take notice, writes FRANK DILLON

AS ONE of the city of London’s top economists and a man who accurately predicted the death of inflation and the collapse of the property market, Roger Bootle is someone worth paying attention to. A former group chief economist at HSBC and one of the so-called “wise men” group of economists to the last Conservative Chancellor of the Exchequer, these days he makes his living running his own consultancy, Capital Economics, and writing books on economics and a column for The Daily Telegraph. His latest book The Trouble with markets – saving capitalism from itself argues for radical reform of the financial system and provides a possible pathway out of the world’s economic woes.

Dismissed by many as an alarmist when he warned of the growing property bubble, Bootle’s analysis has proved to be on the money. A certain amount of smugness could perhaps be forgiven then. Refreshingly, however, on a recent visit to Dublin, he is quick to point out that his analysis of the problem went only so far.

“I called the housing bubble early, but I regret that I didn’t carry through my thinking of the consequences of this for the wider banking system. In hindsight, I could have imagined more but like a lot of people I didn’t join the pieces of the jigsaw together,” he admits.

Economists in general have a lot to answer for, in Bootle’s opinion. It is they who first propounded and then disseminated the ideas that underlay the financial disaster; the idea that markets know best, that bank bonuses were not a problem, that bubbles cannot exist, that humans are rational creatures, that China’s excessive saving was not a problem and that the past was another country.

According to Bootle, the key economic villains hang out in Chicago. A big fan of Keynes, he says that many of the top professors in Chicago University rubbished Keynes’s idea and nurtured monetarism, the economic philosophy championed by Milton Friedman that proposed the efficient markets theory.

Supporting his argument, he tells the apocryphal story of a professor of finance taking a stroll with one of his students. The student gets excited when he sees a $10 bill lying on the ground and tells the professor he intends to pick it up. “Don’t bother,” replies the professor. “If there had been a $10 bill on the ground, it would have been picked up already.”

The trouble with the efficient markets theory, he expands, is that it provides an incentive and excuse for investors and regulators to do no serious analysis or due diligence because they believe it has already been done in the market. “For the efficient markets theory to work, there must be many powerful players operating in the market who do not believe in it and who are prepared to put their money at risk in the belief that it is wrong. Incredibly, this is the theory that has dominated the actions and more importantly, the inactions of both market people and policy-makers for three decades.”

It is not true to assert that nobody foresaw the problem. As he notes in his book, the scale of international imbalances in trade and the precarious nature of the US economy had long worried many commentators. The American economist Nouriel Roubini had issued repeated warnings while William White at the Bank for International Settlements had warned that monetary policy was too loose because policymakers were paying insufficient attention to asset prices.

Apart from the obvious ones in the banking community and regulatory sectors, there’s another villain in Bootle’s gallery of rogues: China. If China had not built up such a massive trade surplus over recent years, the effects of the crisis may not have been so severe, he argues. The pace and strength of international recovery will depend on China stimulating world growth by spending some of its massive surpluses.

“Saving is very deep in the culture of China and there are political reasons why China wanted to do what it has done – large parts of the savings are directly in the hands of the state.”

The strategy of the Chinese is understandable at one level in that they have pursued policies that appear successful, he says, but in the medium to longer term, collapsing world demand and a return to protectionism spell bad news for China too. “Increased protectionism is already a feature of current US policy and there are increasing signs of EU isolation as well,” he notes. Drill down into the figures of EU trade balances, which are broadly equal overall, and you will find large trade surpluses in Germany for example, he notes.

For a former hand-picked adviser to the Tory Government and a Daily Telegraph columnist, Bootle’s thinking appears surprisingly left of centre. He is in favour of large injections of public money to stimulate the economy, supports greater bank nationalisation and favours a major row-back on financial deregulation. He believes that the big bang of 1986 in the city of London, when the once discrete functions of jobbers and brokers were integrated, was a mistake in hindsight.

Nonetheless, Bootle is keen to stress that he has not lost faith in capitalism – especially not its pure old-fashioned form. “In the 19th century when capitalism took off, the owners and managers of businesses were in the main the same people. The employment of the capital of others in business is a much more recent phenomenon. It was well past the second World War before we got to the stage where outside shareholders and their interests dominated and supported the flawed models that have been allowed to develop,” he says. “Socialism doesn’t work but allowing the financial markets to operate in a laissez faire fashion doesn’t work either.”

So what solutions does he propose? Bootle says that there are four components to recovery: rebuilding the banking system and its ability to lend, boosting income, wealth and liquidity, stabilising the public finances without a huge cut in personal incomes and restoring confidence. Notwithstanding the complexity of this challenge, Bootle remains optimistic. A long period of suffering and misery is not inevitable, he says, “given that nothing real has been impaired”.

Does he believe that governments have responded well to the international crisis? Bootle says that, if anything, governments should have intervened more and that the core of the banking system should have been nationalised. There is a danger in socialising the losses, without a corresponding positive flipside, he says. “There has been a lot of talk about bad banks but there has been far less talk about the formation of good banks.”

Bootle says that central banks are obsessed with the dangers of inflation but that this fear is misplaced. He also fears the central bankers will not be patient enough to allow stimulus packages to have their full effect before putting the brakes on growth. “I hear inflation anxiety all the time but they have not given enough thought to the possibility of deflation which I believe is a much more serious threat.”

The Trouble with Markets, saving capitalism from itself

is published by

Nicholas Brealey Publishing

. Price £18.