“How would you like to pay for that, sir?” For most of my lifetime, there have been three possible answers to that question: cash, a cheque or a plastic card. Go to Beijing, however, and you will see few transactions in those forms. People pay with their phones, using systems created by the two biggest Chinese tech companies, Alibaba and Tencent.
And not only in Beijing. For the Chinese way of paying is spreading around the world — from taxis in Tokyo to the Harvard giftshop in Cambridge, Massachusetts. I think this is a big deal. Indeed, it could be a much bigger deal than China’s dominance of 5G telecommunications networks.
Since 1971, when Richard Nixon severed the last link between the dollar and gold, the world has been on a fiat monetary system (meaning the money supply is unconnected to any scarce reserve asset such as gold). Because of the size of the American economy and its dominance of financial and commodity markets, the US dollar has been the No 1 currency since that time.
To varying extents, governments abused their ability to print money, leading to an era of high inflation. But gradually a variety of rules evolved (central bank independence, inflation targets) that brought down inflation in most places. Indeed, in the early 21st century, it began to seem as if the central banks had done too well. People began to worry about deflation. That worry intensified after the 2008-9 financial crisis.
The crisis led to monetary policy innovations, notably zero (and then negative) interest rates and quantitative easing. Despite all this, the dollar has remained the dominant currency in international transactions and central bank reserves. Confident in dollar dominance for the rest of history, American policymakers have grown used to exploiting it as a lever of foreign policy. That financial sanctions were a very powerful tool was only really appreciated after September 11, 2001, when US Treasury officials went after the financial supporters of al-Qaeda. People tend to focus on the seeming failure of the military interventions in Afghanistan and Iraq. But the assertion of US financial power after 9/11 was much more effective and less expensive.
Before too long, America was using financial sanctions against other enemies too, notably Russia, Venezuela and Iran, and even against friends (Switzerland, for example) suspected of protecting tax dodgers or other kinds of criminal, not to mention allies that wished to trade with Iran.
Because international payments between banks have to go through a Belgium-based but US-controlled entity known as Swift (Society for Worldwide Interbank Financial Telecommunication), America has the power to kick an individual, company or country out of the cross-border payments system. This power has grown increasingly irksome to other large economies.
Until recently, there seemed to be no real alternative to the dollar. Indeed, the world’s appetite for dollars and dollar-denominated securities has tended to grow even faster than their supply, resulting in a strong dollar and historically very low interest rates (as US bond prices have risen). As Mark Carney, the governor of the Bank of England, said at this year’s Federal Reserve conference in Jackson Hole, Wyoming, this is not a satisfactory system. Donald Trump also finds it unsatisfactory, though for different reasons: he would simply like to see a weaker dollar, but finds that he cannot unilaterally will that.
The advent of various kinds of digital currency creates a new state of affairs. Since the launch of bitcoin, the world has seen a wave of monetary innovation. Cryptocurrencies have proliferated. Many of these, it is true, have been mere experiments. Some have been downright frauds. And maybe it will turn out that blockchain as a technology has more appropriate uses than money. But those who have written off digital money will soon look as silly as the people who said the internet would never replace the fax machine.
The proof is in China, where digital payment systems established by Alibaba (Alipay) and Tencent (WeChat Pay) have grown explosively. Partly because of timing, partly because of regulation designed to protect banks and credit card companies, Americans never switched as enthusiastically to digital payments.
Phase two of this story is the expansion of Chinese fintech. One emerging market at a time, China is building a global payments infrastructure. Right now, the various systems are distinct national versions of the Chinese original. But there is no technical reason why the systems should not be linked internationally. Indeed, Alipay is already being used for cross-border remittances.
If America is stupid, it will let this process continue until the day comes when the Chinese connect their digital platforms into one global system. That will be D-Day: the day the dollar dies as the world’s No 1 currency and the day America loses its financial sanctions superpower.
If America is smart, it will wake up and start competing for dominance in digital payments. The shortest cut to a system to rival Alibaba and Tencent is Libra, the digital currency proposed by Facebook, which, with its 2.4bn active users, is uniquely positioned to create something on a Chinese scale — and fast. This would not be a true blockchain cryptocurrency, but more like a digital currency in the Chinese style, with the difference that it would be backed by a reserve, held in Switzerland, of dollars and other main currencies.
There are many obvious arguments against letting Facebook do this, not least its questionable track record when it comes to harvesting and exploiting users’ data. However, as Carney said in Jackson Hole, something such as this needs to happen, with the sponsorship and regulatory oversight of government.
Right now, the US Treasury is opposed to Libra and the Federal Reserve seems sceptical. But these attitudes seem symptomatic of the risk-aversion that presages decline. From a national security perspective, there is an urgent need to compete with the Chinese before they dominate digital payments globally. And from Trump’s perspective, backing Libra could offer perhaps the only way out of the problem he currently cannot solve, which is the strength of the dollar.
Libra would be partly dollar-backed, not wholly. So it would be a kind of dollar substitute, reducing international demand for dollars. But it would not offer an alternative to Treasury bonds, so it would not reduce the global demand for those.
History teaches us power is inseparable from financial power. The country that leads in financial innovation leads in every way: from Renaissance Italy, through imperial Spain, the Dutch republic and the British Empire to post-1930s America. Only lose that financial leadership — just ask poor Mr Pound, once worth $4.86 — and you lose your place as global hegemon.
The US-China rivalry today (what I call the Second Cold War) is too focused on trade and telecoms. Washington needs to turn its attention, as a matter of urgency, to the race for monetary leadership, which America is in danger of losing.
Niall Ferguson is the Milbank Family senior fellow at the Hoover Institution, Stanford
Edward Lorenz, the pioneer of chaos theory, famously suggested that the flapping of a butterfly’s wings in Brazil could set off a tornado in Texas. Even a tiny disturbance, he argued, can have huge effects in a complex system governed by non-linear relationships.
But since 2016 we’ve seen the opposite. Donald Trump, far from being a butterfly in the Amazonian rainforest, is the 800lb gorilla right at the centre of the world. If anyone can cause chaos — in practice as well as in theory — it’s him.
Elected, unexpectedly, to the most powerful job in the world, he has spent the past 2½ years not just flapping his wings, but wildly swinging his fists, as if intent on starting a global tornado. And yet the consequences of the gorilla’s antics have been remarkable for their smallness. Prophesies of political and financial disaster have proved wrong. Until now.
August is the month when a large proportion of the people in the northern hemisphere (about 90% of the world’s population) either go on holiday or work half-heartedly while listening to Test Match Special. Unfortunately, history consistently refuses to go on vacation in August. Indeed, I increasingly suspect history of having become a workaholic.
This August has produced a mighty storm of geopolitical and economic mayhem. You can consider each local difficulty in isolation, if you like. Alternatively, consider the possibility that these are all delayed consequences of the 800lb gorilla’s fist-swinging. It has taken longer than expected for him to smash what is sometimes (misleadingly) called the liberal international order or the Pax Americana. But he has done it now. Or so it seems.
In Asia, Hong Kong teeters on the brink of disaster. As the pro-democracy protests continue, the Chinese president, Xi Jinping. weighs up whether or not to send in the People’s Armed Police from the mainland. This has the potential to be another Tiananmen Square massacre. Meanwhile, North Korea is firing rockets like a drunk teenager on Bonfire Night. War over Kashmir looms. And in the Middle East, rumours abound of a showdown between Iran, and Israel and its allies.
These political risks coincide with multiple signs of a global economic slowdown. Britain’s economy shrank in the second quarter, but don’t blame Brexit because so did Germany’s. Trade within the eurozone is down sharply.
Most worrying is the fall in long-term interest rates. Last week the yield on 30-year US government bonds fell below 2% for the first time. Long-term bond yields are now below short-maturity debt — an inverted yield curve, in the argot of Wall Street.
Such an inversion has preceded every US recession since the 1960s. The fact that
$16 trillion (£13 trillion) of bonds around the world have negative yields — you are guaranteed to lose some money on the investment, but at least you know how much you’ll lose, unlike with the stock market — tells us that something is badly amiss with the world economy. The only people who seem not to have noticed are American consumers, still shopping till they drop, according to the latest retail sales data.
So is chaos coming to Main Street? Back to Professor Butterfly. Lorenz was one of those self-effacing geniuses you often meet at the Massachusetts Institute of Technology (MIT). His discovery of the butterfly effect came in 1961, when he was experimenting with a computer model he had designed to simulate weather patterns. He was repeating a simulation he had run before, but rounded off one variable, from 0.506127 to 0.506. To his amazement, this minute change drastically transformed the simulated weather generated by the computer.
Almost no one read Lorenz’s path-breaking paper on the subject when it was published in 1963 in the Journal of the Atmospheric Sciences as “Deterministic Nonperiodic Flow”. It was not until nearly 10 years later that Lorenz translated his insight into layman’s language in a lecture with the title: “Predictability: Does the Flap of a Butterfly’s Wings in Brazil Set off a Tornado in Texas?”
“Two particular weather situations,” he argued, “differing by as little as the immediate influence of a single butterfly will generally after sufficient time evolve into two situations differing by as much as the presence of a tornado.”
In his 1972 lecture, however, Lorenz added an important caveat: “If the flap of a butterfly’s wings can be instrumental in generating a tornado, it can equally well be instrumental in preventing a tornado.” In Lorenz’s view, this was what made long-range weather prediction so difficult.
The same applies even more to economic forecasting. In 1966, the Nobel prize-winning economist Paul Samuelson joked that declines in US stock prices had predicted nine of the past five US recessions. I know economists with much worse batting averages. They predict a financial crisis every year and once a decade are right, at which point the media hail the stopped clock as a prophet. Economic forecasters are far worse at their jobs than weather forecasters.
Of 469 downturns in national economies since 1988, according to Andrew Brigden of Fathom Consulting, the International Monetary Fund had predicted only four by the spring of the year before they began. As for the great financial crisis of 2008-9, just a handful of economists saw it coming.
That means that we should treat with scepticism those who confidently predict a US recession next year. And, if there is one, we should treat with even more scepticism those who blame it on Trump.
The real point about the gorilla effect, remember, is how little the swinging of the gorilla’s fists has really mattered since he climbed atop the White House. Just like the butterfly, the gorilla may have prevented as many tornadoes as it caused. Indeed, Trump’s economic policies have almost certainly been, on balance, more conducive to economic growth than the opposite. True, he has imposed tariffs, but he has also presided over a sugar-rush of deregulation, deficit spending and monetary easing.
As the sugar wears off, and America follows the world into a slowdown, if not a recession, all Trump’s opponents will have an incentive to blame him. But perhaps the truth is that the gorilla and the butterfly are not so very different in our complex, interconnected world. The only difference is that the gorilla insists it’s all about him.
“You have no choice but to vote for me,” Trump declared at a rally in New Hampshire on Thursday, “because [otherwise] your 401(k)s [retirement savings plan] — down the tubes. Everything’s going to be down the tubes. So whether you love me or hate me, you’ve gotta vote for me.”
That’s a line that could come back to haunt Trump if everything goes down the tubes before November next year, when Americans will decide if he’s a one or two-term president. But if he gets lucky, and the economic weathermen are wrong again, it might just get the 800lb gorilla four more years of fist-swinging.
Niall Ferguson is the Milbank Family senior fellow at the Hoover Institution, Stanford.
There was a time, in the aftermath of the financial crisis, when central bankers were “the only game in town”. In a book with that title, published in January 2016, the economist Mohamed El-Erian warned that, with their exotic crisis-fighting measures — zero interest rates, quantitative easing, forward guidance — the central bankers risked overreaching.
This was prescient. Three years on, the men and women who make monetary policy are very far from the only game in town. Now they’re the ones being gamed.
On Wednesday, the Federal Reserve’s chairman, Jerome “Jay” Powell, explained at a press conference why he and his colleagues had decided to cut US interest rates by a quarter of a percentage point. Given that America’s economy is still growing at a reasonable 2.1% and has the lowest unemployment rate since December 1969, the decision took a bit of explaining. Powell’s best argument, aside from persistently low inflation? “Trade policy uncertainty”, which he referred to at least two dozen times, twice as often as the other excuse (“weak global growth”).
Over the past year, Donald Trump has repeatedly criticised the Fed for wanting to hike rakes and then for not cutting rates enough. His response to the Fed’s quarter-point cut was swift. The very next day he tweeted his intention to “start, on September 1st, putting a small additional Tariff of 10% on the remaining 300 Billion Dollars of goods and products coming from China into our Country”.
New York and Washington are full of commentators who went to Harvard, Yale and Princeton (which Powell attended) and consider themselves much smarter than Trump. They snigger when he calls himself a “stable genius”. But this president is crazy like a fox — an old American phrase that I never fully understood until last week. His behaviour may seem nuts or just plain dumb, but it is in fact calculated to outsmart the Ivy League types.
The Fed says it’s cutting rates because of trade uncertainty that Trump himself has almost single-handedly caused. But it’s only doing a lousy quarter-per cent. The crazy-fox response is to threaten yet more tariffs on Chinese goods on September 1, two weeks before the next meeting of the Federal open market committee, which sets the Fed’s interest rate.
Now tell me who is the only game in town.
In 2016, the central bankers seemed all-powerful, the high priests of the policy establishment. They played a leading role in the technocratic elite’s opposition to all things populist, not least Brexit and Trump. But today the former monetary maestros have become the unhappy helpmeets not only of Trump but also of Boris Johnson, not to say Matteo Salvini and Jair Bolsonaro, their Italian and Brazilian equivalents.
Officially, the readiness of central bankers to cut rates pre-emptively to avert recession, or at least to scrap rate hikes and further “quantitative tightening”, reflects a fundamental shift in economic thinking. The post-2008-9 assumption was that the goal was to fight the crisis and then “normalise” — that is, get rates back up to pre-crisis levels. But the counter-argument — that we face a problem of secular stagnation, not just a cyclical hangover — appears to have won the day. No one now believes interest rates can return to where they were before 2008.
At the same time, there has been a widespread abandonment of the old principles of fiscal policy. Now even Olivier Blanchard, formerly chief economist at the International Monetary Fund, says that rising public debts are less of a problem than used to be thought. This is not something I expected to hear from a senior fellow of the Peterson Institute for International Economics, but then Peter Peterson — the lifelong fiscal conservative whose name the institute bears — died last year.
These shifts in monetary and fiscal theory are a huge stroke of luck for populists in power. (I refuse to countenance the disgraceful idea that they are in fact a rationalisation of the central bankers’ rapidly dwindling political independence.) For whatever reason, the Federal open market committee has become the committee to re-elect Trump. This isn’t because he has successfully browbeaten the Fed staff with his tweets, or so they insist. It’s because their estimates of the “natural rate of interest” are just really, really low.
Something similar applies in the case of the Bank of England. It is no secret that Mark Carney was an opponent of Brexit in 2016. He has not become more enthusiastic in the intervening period. And on Thursday he was predictably grim-faced about the chances that a no-deal departure from the EU on October 31 might cause a recession in the UK. Yet he knows that the Bank will have to cut rates if no way is found to avoid the Halloween cliff-edge. Sterling is going down, down, down: that was Carney’s message last week. And in due course we can expect the new chancellor of the exchequer, Sajid Javid, to unveil more plans to spend, spend, spend.
As for the European Central Bank, the appointment of Christine Lagarde as successor to Mario Draghi is just what Salvini, the Italian interior minister (and de facto prime minister) needs. Lagarde disdains populism as much as her American or British counterparts. But she also understands, as they do, that the technocrats’ duty is to mitigate the economic shocks the populists keep generating. So what if Italy’s budget deficit balloons? The technocrats wish the Germans would follow Salvini’s example.
In Brazil, it’s a similar story. Bolsonaro says he’s in favour of central bank independence. But that hasn’t stopped him proposing a monetary union with Argentina and, pour encourager les autres, effectively firing the head of the Brazilian Development Bank. Last week, the central bank gave the president what Trump wanted from the Fed: not just a quarter-point cut but a full half.
Give the populists their due. They intuitively knew there was something crazy (in the non-fox-like sense) about raising interest rates and trying to balance budgets in the post-crisis world, just as they understood voters had tired of ever-freer trade and rising immigration rates. It was the eggheads (myself among them, I admit) who wanted sound money and austerity.
Could anything break this trend, whereby falling interest rates and painless deficits help populists stay in power? One answer I can think of is a large-scale war, which has tended to be the thing, historically, that drives inflation expectations and interest rates upwards. But that, too, is something the populists have pretty much ruled out. They saw what became of another set of eggheads — the neoconservatives — when they decided to revive war as an instrument of policy after September 11.
Another game-changer would be an election surprise. Markets seem to love a right-wing government unconstrained by monetary and fiscal rules. They may feel differently if a left-wing government inherits this lack of constraint. The difference between technocracy and democracy is that there’s always more than one game in town. And not all crazy foxes are on the right.
Niall Ferguson is the Milbank Family senior fellow at the Hoover Institution, Stanford
A man leaves the Deutsche Bank building in central London after the company announced the first of 18,000 job cuts globally LEON NEAL
Ten years ago, few people would have predicted that in the summer of 2019 Donald Trump would be campaigning for a second term as president of America. The idea that Boris Johnson would succeed Theresa May as Britain’s prime minister would have seemed deranged.
Yet it was not so hard to foresee that there would be a political backlash in the aftermath of the global financial crisis — a backlash as momentous and enduring as the economic repercussions, which continue to make themselves felt, not least on battered banks such as Deutsche Bank, which made the first of 18,000 planned job cuts last week.
“There will be blood,” I told an interviewer in February 2009, “in the sense that a crisis of this magnitude is bound to increase political as well as economic [conflict]. It is bound to destabilise some countries. It will cause civil wars to break out that have been dormant. It will topple governments that were moderate and bring in governments that are extreme. These things are pretty predictable.” I also hypothesised that some governments — notably the Russian — might resort to foreign aggression, though I reasoned wrongly that President Vladimir Putin would be deterred from invading Ukraine by the economic costs of doing so.
In 2011, as the crisis was spreading across the Atlantic to Europe, I added some more political predictions. The eurozone would not break up, I argued, but add new members. However, Britain would vote to leave the EU. And conflict in the Middle East would escalate.
The financial crisis did indeed have profound political consequences. In a number of Arab countries — notably Tunisia, Libya, Egypt, Yemen, Syria and Bahrain — there were revolutions, mistakenly dubbed an “Arab Spring” when they began at the end of 2010. In nearly all western democracies — Germany was a rare exception — incumbent politicians were displaced, often by younger figures less tainted by association with the financial elite and the policies it had favoured. In February 2014, following mass protests in Kiev and the flight of the country’s corrupt president, Viktor Yanukovych, Russian forces and pro-Russian separatists seized control of the Crimean peninsula and later the Donbass region.
In 2016, the unexpected results of Britain’s referendum on EU membership and America’s presidential election led many liberal journalists and academics to write fearfully about a general crisis of liberal democracy — a “democratic recession”, in the words of the Stanford political scientist Larry Diamond. A “deep gloom . . . arrived in September 2008”, wrote the New York Times columnist Frank Rich last August. “When the collapse of Lehman Brothers kicked off the Great Recession that proved to be a more lasting existential threat to America than the terrorist attack of seven Septembers earlier. The shadow it would cast is so dark that a decade later . . . one conviction . . . still unites all Americans: Everything in the country is broken. Unlike 9/11, which prompted an orgy of recriminations and investigations, the Great Recession never yielded a reckoning that might have helped restore that faith. The Wall Street bandits escaped punishment, as did most of the banking houses where they thrived. Everyone else was stuck with the bill.”
Left-wing politicians like Jeremy Corbyn called for bankers to be jailed for their role in the crisis
Left-wing politicians like Jeremy Corbyn called for bankers to be jailed for their role in the crisis PETER SUMMERS/GETTY
Yet the relationship between financial crisis and politics was not so straightforward. If it were, surely Bernie Sanders would now be president of America and Jeremy Corbyn prime minister of the UK. After all, they and left-wing politicians like them were the ones who called explicitly for bankers to be jailed for their role in causing the crisis. “It is an outrage that not one major Wall Street executive has gone to jail for causing the near collapse of the economy,” Sanders said in a statement published in October 2015.
This was a recurrent theme of his campaign for the Democratic Party’s presidential nomination the following year. Yet it was Hillary Clinton who won that contest — a candidate whose leaked speeches for Goldman Sachs and the fees she received came as no surprise to those familiar with the Clintons’ many years of sweet-talking Wall Street.
She in turn was defeated in the presidential race by Donald J Trump, a candidate who boasted in a May 2016 interview, “I am friends with all the major banks. They are dying to do business with me,” and proceeded to appoint Goldman Sachs alumni to key positions in his administration, including Treasury secretary, director of the National Economic Council and chief strategist. The self-proclaimed “king of debt” had not seemed self-evidently likely to be the beneficiary of a backlash against the financial system — which was one of the reasons so few professional pundits foresaw his victory.
History helps explain why the financial crisis was so much more beneficial to right-wing populists than to their left-wing counterparts. “Jail the bankers!” no doubt has its appeal as a slogan, but blaming economic hardships and disappointments on immigrants and foreigners would seem to be a more politically potent strategy.
Likewise, while “Regulate Wall Street more tightly again” resonates with some voters, “Make America great again” resonates with more.
There have been many financial crises in the western world since the first era of globalisation in the late 19th century. In most cases, right-wing populists have been the political beneficiaries. The best explanation would appear to be the greater psychological power of their arguments. The main losers of a financial crisis are a heterogeneous group, after all: they are not the welfare-dependent underclass, who had relatively little to lose, but the financially exposed or precarious middle class. People who have lost homes they owned or white-collar jobs that conferred status and income are not especially receptive to a classical socialist message of increased government control and fiscal redistribution. They are more likely to respond to the right-wing populists’ arguments for immigration restriction, trade protectionism or a departure from monetary orthodoxy.
On closer inspection, the populist backlash that produced not only Brexit and Trump but also six different populist or partly populist governments in Europe and twice as many successful populist parties was the result as much of increased immigration and increased inequality (or the perception of increased inequality) as it was of the financial crisis per se. In the case of America, the rise in the share of foreign-born workers in the population, the increase in the proportion of income going to the top 1% of households, the stagnation of the average household’s inflation-adjusted income, and the decline of prime-age male participation in the labour force were all trends — like the shocking increase in mortality rates for middle-aged non-Hispanic whites — that dated back to the turn of the millennium.
The financial crisis may have acted as a catalyst for popular revulsion against the political establishment, but it was by no means the sole cause of the “great revolt”. This helps explain the apparent paradox that the principal political beneficiaries of this revolt — the Brexiteers and the Trump economics team — were proponents of financial deregulation.
History loves irony. The financial crisis was predicted by few economists. Even fewer political commentators foresaw its consequences. But financial history is a better guide than economics or political science. A decade ago, the horses to bet on were the wild ones: the right-wing populists whose slogans were “America first” and “Take back control”. Today, I’ll place another bet: that these wild horses, with their shaggy blond manes and galloping deficits, are pulling us all towards the next financial crisis.
© Niall Ferguson 2019. Extracted from The Ascent of Money: A Financial History, an updated edition published by Penguin at £10.99
Niall Ferguson is the Milbank Family senior fellow at the Hoover Institution, Stanford