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Lord Turner, 60, is a British businessman and academic. He has been Chairman of the Institute for New Economic Thinking since 2015. Prior to that he chaired the UK Financial Services Authority from 2008 until 2013, during which time he played a leading role in the redesign of the global banking and shadow banking regulation as Chairman of the International Financial Stability Board’s major policy committee.
Adair Turner became a member of the House of Lords in 2005. His new book „Between Debt and the Devil: Money, Credit, and Fixing Global Finance” was published in 2015.
There have been several books about the economic crisis. What does your book explain that others don’t? What makes it different?
Many books about the crisis focus on the fact that banks were undercapitalised, and that some were badly managed and took unreasonable risks. And I agree that those facts are important. Most of the policy focus since the crisis, meanwhile, has been on making the banking system safer – with higher capital and liquidity requirements, and actions to reduce risks in “shadow banking”. And I certainly agree those reforms are important: indeed from 2009 to 2013, as chair of the major policy committee of the international Financial Stability Board, I played a major role in designing the new rules. But as my book argues, the causes of the 2008 crisis, and of the long post crisis period of low growth, lie far deeper.
The fundamental reason why recovery from 2008 has proved so difficult and why eight years later we are still stuck with slow global growth, inflation below target and ultralow (indeed sometimes negative) interest rates, is the huge build-up of private sector debt which occurred across the advanced economies in the previous half-century – rising from 50% of GDP in 1950 to 170% by 2007. And since the crisis that debt has not gone away – it has simply shifted from the private to the public sector, and from advanced to emerging economies. At the global level total debt (public and private combined) as per cent of GDP is now higher than ever. My book is focused on why economies are so dangerously debt dependent and what follows for policy.
How relevant is your book for Germany? How do your findings apply to the situation in Germany?
Germany is one of the few countries that did not see an increase in private leverage (i.e. household and corporate debt as per cent of GDP) in the decade before 2008. So Germans often think that German growth, unlike growth in the US, UK Spain, or China, has not been based on unsustainable credit growth. But that is a delusion, since German economic growth was dependent and remains dependent on unsustainable credit growth in other countries.
Germany’s large and continuous current-account surpluses can only exist if matched by large continuous current-account deficits somewhere else in the world, and those deficits are often supported by unsustainable credit growth. We can only understand these issues by looking at nominal demand and debt at the global level. And at the global level, we face a startling and concerning fact – we only seem able to achieve adequate growth of nominal demand by unleashing still faster growth in credit, but the inevitable result is rising leveraged, eventual crisis, and post-crisis recession.
You establish the roots of the crisis in the mismatch between a limited supply of urban land, and the limitless potential to finance rising demand for it. Could you further elaborate on this?
Economic textbooks often describe how banks provide credit to finance new capital investment, thus allocating scarce capital resources between alternative investment projects. And people reading those descriptions often have in mind investment in plant and machinery, or in research and development. But empirical analysis shows that the majority of bank lending across the advanced economies funds real estate. Sometimes that means actual new investment in real estate construction, but actually the majority of lending simply finances a competition between people or companies for the ownership of already existing real estate assets.
And if you look at the value of urban real estate in advanced economies, we find that the majority of it – and by far the lion’s share of the increase in value – is explained not by the constructed value of the buildings, but by the land on which the buildings sit. That land is “locationally specific” with particular locations more desirable than others: and locationally desirable land is in inelastic supply – you can’t just create more “highly desirable suburbs”, more “fashionable central London”, more “prime beach location”, or more “right on the skiing piste”.
So when banks extend more credit against real estate, the only thing that can give is the price, and price increases then make borrowers and lenders believe it would be a good idea to borrow and lend yet more. As a result booms in credit supply in real estate prices, and inevitable subsequent busts, have been not just part of the story of financial instability in modern economies, they are again and again almost the whole story
In your book you are reflecting on the causes of a crisis that you admit you did not see coming. You argue that the problem lies in the nature of credit creation. What is the solution to this problem?
Our textbooks suggest that banks take existing money and lend it on. But that is a fiction since banks actually create credit, money and purchasing power that did not previously exist. And it therefore matters hugely how much credit, money and purchasing power they create and to whom they allocate it. That reality, which was central to the economic analysis of early 20th-century economists such as Knut Wicksell, Friedrich von Hayek, or Henry Simons, was strangely forgotten or ignored by the dominant strain of modern economics, making it impossible to see the crisis coming.
In future central banks and regulators together need to manage the total quantity of credit created, and influence its allocation between different uses. That will require much higher bank capital requirements than so far agreed: the use of compulsory reserve requirements to constrain credit creation: and regulatory action to lean against the bias of the system – which will always be towards excessive real estate lending.
You wrote that since the beginning of the crisis debt has only been reshuffled. Does another debt crisis loom?
Since the crisis, total global to GDP (public and private combined) has continued to increase. In the advanced economies there has been some limited deleveraging in the private sector, but public debt to GDP has risen by a more than offsetting amount. And while total debt to GDP in advanced economies has at least grown more slowly than before the crisis, this has been offset by a huge increase in emerging economy debt to GDP, most particularly in China.
In 2009, China unleashed a huge credit financed investment boom to offset the potential impact on demand for its exports arising from private deleveraging in the advanced economies. That credit boom kept the Chinese economy going, but at the expense of massive misallocation of real resources (apartment blocks that will never be occupied) and huge un-repayable bad debts. The end of this credit boom may not produce another financial crisis narrowly defined – since most of the debt is owed by Chinese local governments or state-owned companies to state-owned banks.
But it is already having a huge depressive effect on the global economy, driving down growth in many countries that export to China, and threatening sustained global deflation. Global equity market turmoil in the first three weeks of 2016, simply reflects financial markets waking up to a Chinese construction and industrial production slowdown that has been inevitable for several years
You said that countries should restrict private credit growth and consider allowing the central bank to create money to finance a budget deficit. What does this mean exactly?
We are suffering from sustained post-crisis slow growth and inadequate inflation, with debt levels continuing to rise, because of excessive growth in private credit before the 2008 crisis. Two questions for public policy therefore follow: (I) what should we do in future to prevent excessive credit growth in the upswing of the cycle – indeed what should we have been doing back in say the 1990s to avoid getting into this mess in the first place? (II) what should we now do to deal with unsustainable debts?
On the first, we need to introduce far tighter constraints on the private bank credit creation process, with much higher bank capital and liquidity requirements (e.g. bank capital requirement of say 25 % of assets), and with maximum limits on loan to value or loan to income ratios in residential and commercial mortgages. We also need to address some of the fundamental drivers of the dangerous credit intensity of our economies – in particular rising inequality.
On the second, we must start by recognising that across the world debt levels are now so high, that there is no possibility that they will be reduced simply by “growing our way out of the problem”. There will inevitably be some mix of (I) default/restructuring, which however can have very disruptive effect, (II) a policy in which we keep interest rates very low for many years to make existing debts affordable, but with the inevitable result that that creates incentives to create more debt in the future, (III) the monetisation of government debt, with for instance, the Bank of Japan buying Japanese government bonds and holding them permanently, thus essentially financing either past or future fiscal deficits with central bank money
Hearing that proposal, many people react with horror – fearing that excessive inflation will inevitably result. But there is no technical reason whatsoever why monetary finance needs to produce excessive inflation – it all depends on how much of it we do. And the undoubted political risks of monetary finance – that if we allow it, politicians will want to do it to excess – can be managed by tight rules, for instance by giving to inflation targeting central banks the authority to decide the maximum allowable amount.
And the political risks of monetary finance must be balanced against the risks involved in the other two policies. The blunt fact is that we are in a mess, and that there are no riskless ways out.