Edward Harrison, partner at Global Macro Advisors and publisher of “Credit Writedowns,” answers in the following exclusive interview questions related to the current state of the ongoing financial / economic crisis, the monetary system, gold / silver, and the growing problems on the energy front.
By Lars Schall
Edward Harrison, born 1969 in Washington D. C., holds a BA in Economics from Dartmouth College and an MBA from Columbia University. He worked for years as a Foreign Service Officer in the U.S.-State Department and speaks six languages, a skill he uses today as a financial commentator to provide a more global perspective.
Currently, Mr. Harrison works as a partner at economic consultancy Global Macro Advisors. He is a banking and finance specialist with twenty years of business experience who focuses on global economics and corporate strategy. In addition, he has held positions at Lion Strategy Advisors, Deutsche Bank, Bain Consulting, the Corporate Executive Board and Yahoo.
In March 2008, Mr. Harrison launched a financial blog called Credit Writedowns (www.creditwritedowns.com). This site is dedicated to bringing a well-informed alternative view of finance, economics, markets and all relevant global events into the global mainstream consciousness. Since its launch, it has become one of the top finance blogs by traffic and has been consistently ranked as one of the best finance and economics blogs on the Internet. Moreover, he is a regular contributor at Seeking Alpha, Naked Capitalism, and Roubini Global Economics.
From an ideological perspective, Mr. Harrison calls himself a libertarian realist with Austrian economics sympathies. He is a firm believer in the primacy of markets over a statist approach. However, in his opinion, often government intervention and oversight is not just wanted but warranted.
Edward Harrison lives in Maryland, USA.
Mr. Harrison, what pieces of recent economic news have made you faint, or nearly faint, from horror? And why?
Well, I don’t know if I would say that I have fainted in horror, but the one piece of news in particular that I found distressing had to do with the ECRI–index and the fact that the rate of growth has been declining in a very rapid way. It is not really that the index itself is declining, but rather that the growth rate has stopped and we’re now actually seeing negative readings on a year-to-year basis. To me what that means is that the recovery is stalling and that’s a bad thing.
Do you feel vindicated more than ever that it is perhaps accurate to say that the recession in the United States has ended, but only insofar the U.S. is actually on the way to experience the second Great Depression?
I’m not sure if I predicted that we’re headed toward a Double Dip recession or something much worse. But I think that people have been very much cheerleaders all along that the problems would be solved by this or that remedy. The reality is that it is much deeper of a problem than has been made out to be.
I certainly want the problems to be less and I leave that option open. But I think that not exploring all the different possibilities and not taking a much more cautious approach to the potential downside leads to what we have seen and that is the sort of weakening that we now observe.
In light of the current crisis, does economist James K. Galbraith use the appropriate words when he writes about “economic theory as a disgraced profession”?2
He definitely does. Basically over the past, I would say, 25 to 30 years, the economics profession has been putting out this sort of economic theory that says that people are very rational, expectations are rational and as a result of this rationality of individuals and markets we can reduce regulation and that markets are self-correcting. Ultimately none of this is true.
There’s some truth to parts of these theories, for instance you can look at the recardian equivalent, which says that people save all of their money that they get from a tax cut, because they know taxes will be increased in the future. There’s some truth to it, some of the money is saved perhaps for that reason. But none of these things are axiomatic, none of them in their strongest forms show any relationship to what happens in the real world.
And when people make modelling assumptions based on these debunked theories, these very strong assumptions, what happens then is that things occur that you would not expect to happen, except once every 1000 or 10.000 years according to your model – and these things happen much more frequently. The result is economic chaos and financial disaster, the exact things we have seen over the last three years.
Why do economists and finance types feel free to ignore control fraud as a major contributor to these crises without ever bothering to learn about the findings of white-collar criminologists? Of course, George Akerlof & Paul Romer (1993) „Looting: Bankruptcy for Profit“ listened to Bill Black and his ilk and learned about actual fraud schemes so that they could write their article. Which leads to the related question, why have economists almost entirely ignored a Nobel Prize winner like George Akerlof?
It’s because the Obama Administration in particular has been very much focused on moving forward as opposed to looking back. Moreover, many of the people in the Obama Administration were part of the whole nexus of individuals arguing for the type of regulatory remedies that created the control fraud we saw to begin with. At any problem you might have, there are always people with a vested interest in not uncovering the mistakes they have made in the past, and then the stakes are high that those problems will not be uncovered. That is certainly part of the problem.
I think it’s very wrong, because there were crimes committed, and unless you’re going to remedy those crimes or at least recount them, you really just letting off people in a way that is going to cause them to repeat and do the same in the future. It’s a big mistake and a lot of it has to do with the mind set of the Obama Administration. Some of it has to do with the fact that the power of the financial lobby is so great that they’re able to stop these kinds of investigations from happening.
What is your take on the regulatory bill that passed Congress a few days ago? Is it enough?
I don’t think it’s going to get the things done that we need done. When you talk about control fraud, in particular, I think you should definitely addressing that William K. Black, who is a leading expert in terms of white-collar crime and control fraud, has been saying that none of these issues of control fraud are addressed in any of the legislation. So going forward you should expect that the same types of fraud issues will crop up again.
Thus in respect to the control fraud issues it is definitely not enough. It is certainly a first good step in many cases, but it is not enough in many others, and yet more when you have the Federal Reserve as the systemic regulator and we have huge amounts of power given to the Treasury Department, I think it is a misguided way that we take.
A false sense of recovery in the U.S. is related to the appearance of the stock market. Is the Dow Jones of today trustworthy or rather a deception by omission? When you take for example a look at this Real Dow/Real Homes charts by Edwin Hamilton under:
do you think the characterization “The past is dominantly serial herd behaviours” is fair?(3)
Yes, inflation adjusted the Dow is back to were it was 10 to 12 years ago and we haven’t really gone anywhere. We’re definitely in the middle of a secular bear market. You could see the same thing happen in the 1970’s.
If you look at the 1970’s on a nominal index basis from 1966 to 1982, we went from 1000 down to 600, back up to 1000, down to 600 again, and so forth. There was a huge rate of inflation at that time, so on an inflation adjusted basis there were enormous losses, even though the index itself really didn’t lose as much money throughout.
The same is true here again that the index on an inflation adjusted basis has been treading water, because we’re in a secular bear market, one that is still continuing and a product of a lot of money printing and liquidity from the Federal Reserve and fiscal stimulus.
And why do you suppose these simple, real asset value pasts are little-apparent to the people? Why does mainstream media ignore this and play its part in the above mentioned deception by omission?
Well, I look at asset prices and consumer prices as to similar inflating values, whereas I think that the average person look at it differently. The reason is because consumer prices are the price that we pay for things. The people who sell those things to us like prices to go up, because they make more money, generally speaking. Whereas we don’t like those prices going up, because we are buying those things. If you are the seller of an asset, you like the price to go up. If you are a buyer , you don’t like the price to go up.
In the case of stocks and financial assets, most people who are owners of the assets are the sellers, therefore they like those prices to go up. But the buyers don’t like that price to go up. The difference between consumer prices and asset prices is that assets can be resold, whereas consumption goods aren’t resold, they are used for final purposes. So not only do you have sellers of the assets very excited about the price going up, but the buyers are actually often times buying the same asset only to resell it at a later time, which is, as you know, the hallmark of Ponzi finance: that there always will be someone there that sell it to a higher price.
From my perspective it’s the psychology of man, it’s the normal thing that sellers of an asset like it more when it goes up than buyers of an asset . And with regards to financial assets, because financial assets can be resold at a later point, you have the makings of some sort of a bubble. The mainstream media amplifies this. What they understand is the psychology out in the general public.
More and more, Goldman Sachs comes into the spotlight. Why is it in your opinion important not just solely to concentrate on the fact that GS is “allowed to game the system,”4 but to point ones finger at the U.S. government?5
It is very important to not letting the US-government off the hook in its desire to say: Look at these Fat Cats on Wall Street and what they have been doing. It is important to realize that these Fat Cats on Wall Street, as they are called by the President, they were allowed to do what they’ve been doing, because government wasn’t taking its role and responsibility as regulator seriously. If we wouldn’t have seen anti-regulators in the positions of power the last number of years, then none of these activities would have happened.
A perfect example is the big four brokerage firms, Bear Stearns, Lehman Brothers, Goldman Sachs and Morgan Stanley. There were controls on their leverage ratios, 12:1, as I recall, in 2004. They asked for and received the opportunity to leverage up to 30:1 times, meaning that every general loss in their asset book of more than 3 1/3 percent would have wiped their capital out completely. And yet the regulators, who were there in order to stop this kind of thing from happening, to stop excess of leverage from taking down the system, especially with well connected “too big to fail” institutions, they completely advocated their responsibility and in fact they aided and embedded the excessive leverage that lead to the financial collapse.
That to me is the perfect example why we can’t point the finger at Goldman Sachs, but we also have to look at the government’s role in lax regulation allowing these events to take place.
Recently the European Monetary Union (EMU) went through a huge solvency crisis. Over here in Europe, there is the widespread perception (fed by the media) that the EMU is under the attack of speculators and hedge funds based in New York City and the City of London. Do you agree on that impression that there’s a war going on against Europe by financial means?
No, I don’t think there is a war at all. The financial markets react to what they see in the real world and what they see is weakness. They see that the European Monetary System is flawed and the flaws have been exposed now in this deep downturn and financial distress. As a result of that, the weakest nations will come under attack.
The EU is a political body. Equally the euro is a political construct. It’s there because of the desire for political cohesion. But none of the mechanisms in order to create a more stable economic unit have been implemented. Like a treasury as an example, or some sort of mechanism to stop current imbalances of both, surpluses and deficits.
And so now we see problems and the markets react to those problems. These are real problems, they were not fabricated ones by the market.
The Europeans feel also unfairly treated by the three big rating agencies. Are they “home biased”? Or why is it that they treat the U.S. and the UK much friendlier although the general perception is that they have even bigger problems given the dynamic of their bigger debts, budget deficits and the structural deficits of their foreign trade balances?
My understanding first and foremost is that Germany, as an example, has a bigger deficit than even the U.S. and the UK. It may be actually that the UK has a greater debt to GDP, but in absolute terms Germany has more debt than the UK and they have a greater debt to GDP than the United States. So I don’t think it’s true that the euro-zone is less indebted than the U.S. and the UK. Across the board, the average indebtedness of the euro-zone is as high as it is in the United States. That’s number one.
Number two is: the countries within the euro-zone are users of currency and not the creators of currency. That means that they are constraint in a liquidity crisis. The consequence is that default is much easier and much more probable in their cases. The perfect example here would be Japan, which has, I believe, a AA+ rating. Yet Japan has a debt to GDP of 200 percent. They can fund their debt internally through the savings of the companies and the individuals in the country.
It’s a big difference to be the creator of currency and to have your own sovereign currency through which you issue your debt.6 This is true in Japan, in the United States, Canada and the UK. It’s not true in the euro-zone and that’s a huge problem for the euro-zone. It’s one of the institutional flaws of the EMU, especially given the stress that we see with countries like Greece. For these reasons I don’t think that the rating agencies are not biased whatsoever.
As a consequence of the bailout activity in the EU, you have written recently about “a depressionary relapse” in Europe and “Intra-Eurozone Trade wars.”7 What do you mean by that?
What’s happening basically is the euro-zone is not a politically common unit. In the United States the difference between Georgia and New York and California are less severe than they are between the parts of the euro-zone. So when economic calamity hits, like the one we see now, you have all of these countries under the same currency. As a result of that there’s tension. But there is no way to alleviate that tension through automatic stabilizers and through a common treasury like in the United States.
The consequence of this therefore is that the countries that are the most vulnerable are forced into austerity in order to make sure that they can continue to receive funding. This creates acrimony that usually is directed towards foreigners outside, who supposedly created the problem. I think most of the acrimony is directed towards Germany. You have a core Europe of Germany, the Benelux and France, versus the periphery and that sort of tension in euro-land between those countries. I believe that the austerity leads to a depressionary relapse in countries like Ireland and Spain, where you already see depressionary statistics in terms of unemployment. At the same time someone has to take the blame for that and generally speaking I think most of it is directed towards Germany.
Do you foresee an international debt settlement conference?
It depends on how difficult things get. Hopefully they won’t become like the Great Depression again. But obviously if Greece defaults and we see other defaults down the line, then yes, we would need this to happen.
Isn’t the problem that all major fiat currencies of the world face today the logical end of a monetary system that creates money a) as debt and is b) connected to the exponential growth of compound interest?
I’m not really sure about this particular question. My problem with regards to the monetary system has more to do with the fact that there is no check on what a government can do in terms of how much it can print and how much debt can occur. As a result of that you see a lot of mal-investment. You see very poor industrial organization within a country. And you see a significant gap in terms of current account deficits on the hand, and current account surpluses on the other.
So when a recession hits, especially if it’s a synchronized recession, you have these huge imbalances that build up, and that creates even more tension and the potential for conflict, both military and trade conflict. In my view that is an integral facet of fiat currency. You certainly had this on a gold standard, let’s be clear, during the Great Depression. But there must be a way to stop these imbalances from building up, so that we don’t have a situation like the one we have today, where there are multiple places where you can have these conflicts.
Fears about a collapse of the euro sparked recently panic buying of gold.8 Do you see this as part of a larger trend that people begin to focus much more on gold and silver?
I think your questions about the fiat currency is definitely related to this.
People are starting to become sceptical about fiat currencies in general. They are wondering what is the intrinsic value of these currencies, now that we see that they can be printed at will and that they are used to bailout countries that have engaged in all sort of fiscal profiligacy. That’s in particular the claim related to Greece. And I think that people are worried, and justifiedly so, that the value of these currencies is decreasing, because of the need to monetize debt in order to make the real value of debt less. And that means that they are searching around for other places to put their money. Gold and silver are two places that in the past have been very good in these kinds of times, whether you talk about deflation or inflation, by the way.
Not just the gold price is rising, but also the price of oil. What causes do you see for that development and what does it mean for the ambitions to make a recovery happen? Was there a lesson to be learned in 2008?
My general thinking on oil is that we’re hitting the point where the cheap oil is gone and that it is gonna be more expensive to extract oil. So to the degree that demand rises from here, from this point forward, the elasticity has changed. Any increase in demand will cause a much greater increase in the price. That means, when demand falls, you get a massive down-shift in the price, as we saw during the 2008-09 period. But once demand comes back, then you get a massive up-shift in the price. I see oil as fundamentally in a supply and demand imbalanced situation where the supply of cheap oil is dwendeling.
So you would say that Peak Oil is a fact, and if yes: what does it mean to you as an economic consultant?
Well, I definitely think it’s a fact based on what I’ve just said. What I think what is happening is that we’re hitting this Peak Oil point and that means greater volatility but also it means higher and higher prices. You go from something like 10 dollars at the low and 28 dollars at the high, as we saw early last decade. Then it will revolve up to something like 40 dollars at the low and 100 dollars at the high, and then it goes to 150 dollars. But every time you see the revolving up of the price to almost unlimited numbers, it creates a recession.
Every single recession that we had since the end of the gold standard – ’73, ’79, ’90, 2001 – all of these recessions were precipitated or preceded by huge increases in the price of oil. I don’t think this is a coincidence. It’s a fact that oil is a major input into societies function, into the industrial economy. If you have this peak oil happening, these huge spiking, then volatility creates more volatility in terms of economic performance. That means more recessions and shorter business cycles.
Oil is the most important economic weapon in the world. Do you see a cold war happen between the United States and China for oil? And how do you judge on their different approaches in that cold war?
I personally find it difficult to hypothesize about those kinds of actions or activities in terms of the military-industrial complex and geopolitical tensions. However, I do see greater tension on that front between the US and China in particular. But there are different avenues that it can take. You have the non-OPEC oil producers that China is trying to get into bed with, places like Argentina, Angola Nigeria. But you also have the Middle East and the Central Asian countries, where there are a lot of oil deposits. And of course you have the Russians involved in both of these spheres as well. The question is if a point in time comes when it is obvious that the price of oil is rising, because Peak Oil has come, what will the largest countries do? What will the United States, China and Russia do? I think it’s unclear, whether it will be a military confrontation or a cold war type of period, but certainly the possibility is there.
I think for the well-being of us all it is essential to end this collision course. How does for example the conflict with Iran fit into the picture? Is it really about an A-bomb, or is it about the huge oil and natural gas reserves there?
It’s about balance of power to a certain degree. The United States is fine with Israel having nuclear weapons, because Israel is an ally of the United States. That helps the United States to control the balance of power within that sphere, where there are lots of oil. You have Saudi Arabia, Iraq, Iran with great oil deposits. Ultimately the United States wants to make sure that there is no one in that sphere other than its own allies who has economic or military power. So for Iran in the past they have been very powerful in the Middle East. Therefore the United States sees them as a contender of the throne, if you will. Not allowing them to have nuclear weapons is certainly very important from a strategic perspective for the United States.
Mr. Harrison, we’ve talked about the problems of debts, energy and war. Seen under this perspective, the United States have:
– the largest military-industrial complex in the world,
– the largest military budget in the world,
– the most military bases in the world,
– the single largest energy consumer of the world, the Pentagon,
– a perpetual war against a phantom called “international terrorism”.
Wouldn’t it be good to reduce all of this a bit and instead invest a bit more in civilian projects, products and industries?
I think it would be good to shift real resources in the United States away from the military-industrial complex. If you take a look at any other country in the world and the percentage that they spend of their economies for various purposes, the United States spends by far the largest percentage on military spending. Those are real resources which are ciphened off into something that ultimately doesn’t add any productivity and innovation to the rest of the economy. Sure, there are technological improvements that move from the military side over onto the rest of the economy. But on the whole what you would like to see is the innovation in technology being developed directly through the resources redeployed to other more beneficial uses throughout the U.S.
Thank you very much for taking your time, Mr. Harrison!
compare Edward Harrison: “The recession is over but the depression has just begun“, published at Credit Writedowns on October 1, 2009 under:
2 compare: James K. Galbraith: “Why the ‚Experts‘ Failed to See How Financial Fraud Collapsed the Economy”, published at AlterNet on May 15, 2010 under:
In his written statement to members of the Senate Judiciary Committee, James K. Galbraith stated: “I write to you from a disgraced profession. Economic theory, as widely taught since the 1980s, failed miserably to understand the forces behind the financial crisis. Concepts including ‘rational expectations,’ ‘market discipline,’ and the ‘efficient markets hypothesis’ led economists to argue that speculation would stabilize prices, that sellers would act to protect their reputations, that caveat emptor could be relied on, and that widespread fraud therefore could not occur. Not all economists believed this – but most did.”
3 compare also E.S. Browning: “Adjusted for Inflation, Dow’s Gains Are Puny”, published at Wall Street Journal on December 28, 2009 under:
Stephen J. Dubner: “The Quiet Danger of Non-Inflation-Adjusted Stock Returns”, published at New York Times on December 28, 2010 under:
Ryan Chittum: “The Real Dow”, published at Columbia Journalism Review, January 5, 2010 under:
4 compare Edward Harrison: “Why is Goldman allowed to game the system?”, published at Naked Capitalism on October 5, 2009 under: http://www.nakedcapitalism.com/2009/10/why-is-goldman-allowed-to-game-the-system.html
5 compare Edward Harrison: “Forget about Goldman”, published at Credit Writedowns on July 2009 under:
6 see for this topic for example Ellen Brown: “Why the U.S. need not fear a sovereign debt crisis: Unlike Greece, it is actually sovereign”, published under:
7 compare Edward Harrison: “The mindset will not change; a depressionary relapse may be coming – European version“, published at Credit Writedowns on May 17, 2010 under: http://www.creditwritedowns.com/2010/05/the-mindset-will-not-changea-depressionary-relapse-may-be-coming-european-version.html
8compare Sam Fleming:”Euro collapse fears spark panic buying of gold”, published at Daily Mail on May 14, 2010 under: http://www.dailymail.co.uk/news/article-1278186/Euro-collapse-fears-prompt-panic-buying-gold.html