Looking back at 1968: Responding to the financial crisis requires structural reforms

Like natural disasters, crises tend to erase the past so that life can start anew, perhaps on a poorer but more egalitarian level.

Shen Liantao | wen

This year, my contemporaries, who were born in the post-World War II baby boomers, should commemorate 1968, a full 50 years ago, when many of us were adults.

I was studying at the University of Bristol that year, and it was an eye-opening year — my generation of students protested the Vietnam War in Paris, London and Washington, witnessed the opening of the Chinese Cultural Revolution, and the "Power to Flower" movement in the United States. Bristol was not a place for liberals to gather, but a middle-class "red brick university," but protests there eventually led to students occupying the Senate before Christmas. Two events define my understanding of how the British system works. First, the police negotiated with the students to leave the scene to check for possible bomb threats, and after the inspection, the students reoccupied the building. Second, they turned off the electricity, so after enduring the cold, most of the students went home for Christmas.

Looking back 50 years later, we see yet another generational divide – millennials born after the 1990s enter college and witness a world of increasing inequality and polarization. The White House is still struggling to emerge from the war on terrorism, but is mired in Afghanistan and Iraq and at odds with Iran, Russia, North Korea, China and nearly all of its trading partners, whether allies or not. Everything will depend on the decisive battle between left-wing Democrats and right-wing Republicans, depending on which side will control Congress and the Senate. The United States is also deeply divided, just as there is a lack of consensus between Britain and Europe, but both are worried about immigration, technological advances squeezing jobs, and the longest and hottest summer in history.

1968 was an era before the Internet revolution. There was almost one mainframe computer per university, and they had even smaller memory capacity than the iPhones I use today. Today, social media can spread knowledge and disinformation at a rapid pace. No one could have dreamed of downloading an app online and using a 3D printer to make a gun yourself (which is illegal in most countries).

In those days, we learned in college the deep divergence between monetarism and Keynesian economics. The former holds a free-market view, while the latter advocates stimulating aggregate demand through more government intervention. 50 years later, we realize that both perspectives have their limitations, and are simply simple models that represent what the real world really works. The basic model of monetarists is based on perfect information and rational people, completely ignoring human imperfections, climate change, and bureaucracies or institutions all have their own interests. Keynes himself understood the importance of uncertainty and the animal spirit in human behavior, but in his time, rapid technological progress, enormous human inequality, and climate change were not within his field of vision.

The weakness of both schools of thought is what I call paradigm blindness, because neither theory can explain or predict what will happen in the real world. That's why every scholar, policymaker, or central banker during the 2008 crisis blamed themselves, but rather "radical uncertainty."

The global financial crisis of 2008 was a wasted crisis, as governments in developed countries made fundamental political mistakes in believing that fiscal deficits were preventing them from making fundamental structural reforms, so they left the trouble to central bank governors in order to get out of the predicament. As a result, the balance sheets of the world's top five central banks increased from $6 trillion in 2009 to $20 trillion, a quarter of the world's GDP. Inequality exploded as a result of liquidity flooding the world, creating massive asset bubbles that benefited mainly the rich and savvy investors. Now that central bankers want to exit quantitative easing, interest rates are about to rise.

While trade wars, climate change disasters, terrorism and massive social discontent worsen with global uncertainty, the United States enjoys the longest bull market in history. Thus, the Grey Rhino (high probability, high-impact event) is a rise in U.S. interest rates in response to rising inflation. We have seen Argentina and Turkey plunge into a currency crisis, with interest rates rising by 40%-50% per year. Many will remember the high rates during the 1997-1998 Asian financial crisis, which spread to Russia, Brazil and other countries.

What is really necessary is no longer more monetary or fiscal policy, but a policy that will encounter political difficulties – structural reforms. European Commission President Jean-Claude Juncker summed up the dilemma best, saying in 2007: "We all know what to do, but we don't know if we can be re-elected after doing so." ”

Without reform, crises tend to end all problems in a devouring fashion. The invisible hand turned into a visible panic. The Bank for International Settlements raised a question this week: Will global financial markets suffer a perfect storm? "Smart money" always knows what to do, but what about the rest of us?

Like natural disasters, crises tend to erase the past so that life can start anew, perhaps on a poorer but more egalitarian level. 1968 taught us a generation that finance can be both a creator of monetary wealth or a weapon of mass destruction. We thought we could eat the cake and have it at the same time. It turns out that we have been eating the cake of our descendants.

(The author is a Senior Fellow at the Asia Global Institute at the University of Hong Kong and a former Chairman of the Securities and Futures Commission of Hong Kong.) Translator: Zang Bo, Editor: Yuan Man)

(This article was first published in Caijing magazine on September 17, 2018)