I missed this program on the ABC but I recommend it highly. Paul Woodley is a guy with a good grasp of economic theory who’s spent a lot of time in the markets and has come to the simple conclusion that financial markets seem to be dysfunctional. He’s presumably made a packet in the market as he appears to have endowed The Paul Woolley Centre for the Study of Capital Market Dysfunctionality.
I rate his comments much more highly than Joe Stigltz saying the same thing, because although Joe S is no doubt much cleverer than Paul W, I put a high premium on the combination of theory and practice – on applied intelligence. Joe S’s pieces make a little too much of his own bits and pieces of theory – asymmetric information and all that. Certainly some of the basic facts are persuasive.
By most measures finance has become the dominant industry sector accounting, for example, for between 30% and 40% of the aggregate profits of the quoted corporate sector in the US, UK and globally, compared with only around 10% forty years ago.
He points out that the optimal strategy in markets – at least as he was forced to adopt it – was a combination of ‘fundamentals’ and ‘momentum’ trading with the former being a case where self interest and social interest are aligned, and the latter where they remain in contradiction. He tried to stick to the former, but was forced to hedge his bets by combining it with the latter. I expect there are plenty of sensible things we could do to make things better, but they would require steady institution building, rather than populist appeals to ‘people not profits’. I think that’s not only possible, it’s inevitable, but the real question is whether it will take 5 or fifty years to really get going. For instance the Norwegians have a huge fund which is managed well at just a few basis points. Sovereign wealth funds managed at arms length can be some part of the solution. So too could specific instruments developed by governments to get value through to investors. It’s strange isn’t it? If you’re a punter being forced to save 9% of your wage, there’s no place you can go where you can be confident that someone of expertise without any over conflict of interest can say to you “Invest here. If you invest in the long run, it may not be the best return you could possibly have made, but it will be as good return as can be guaranteed by good professional management and low fees, and you won’t get ripped off.” Shouldn’t a product like that be available to Australia’s workers? To some extent it is via industry funds. But the government could also develop innovative financial products for retail investors. Paul Woolley suggests one.
Fortunately there are steps that can be taken that meet the twin objectives of private and social gain. One of these might be to encourage governments to issue a new class of investment, GDP bonds, that would give a return equal to the growth of real GDP. Capital markets have failed to develop an asset class that truly matches investors needs. Most investors seek three objectives: long term growth, inflation protection and low price volatility. Conventional bonds give a fixed money return but no protection against inflation. Equities offer long term growth and the prospect of a higher overall return but at the cost of excessive volatility. Index linked bonds hedge inflation but are without growth. Investors are engaged in a perennial search for some combination of the three that they hope will fulfil their needs. They lurch between them as economic conditions and conventional wisdom dictate, collectively provoking the extreme price volatility that each is aiming to avoid. GDP bonds would be alone in offering the attributes of growth, inflation-protection and stability. As such they would appeal to personal savers, pension funds and other long term investors. The attraction for issuers is that the servicing costs of GDP bonds rise and fall in line with tax revenue. There are technical issues to be overcome but work is going on to overcome them. It really is worthwhile since GDP bonds offer the ultimate passive investment.
There are ways in which governments could;
- increase their citizens wealth and security,
- make money for themselves and
- improve the economy’s performance.
But we’re not considering them. But read Woolley’s article. It’s unusually well balanced for someone who is uncovering so much that doesn’t seem quite right.