Sunday, March 15, 2009

Hernando de Soto is the Man for sorting the economic mess

Wahey! Page 3 of Observer Business and media has a piece on Hernando de Soto, (Hernando de Soto Polar, to give him his full moniker, so as not to confuse him with the Spanish Conquistador, nor with the Austrian school economist Jesús Huerta de Soto). Our Hernando is a highly regarded 67 year old Peruvian economist who speaks up for the poor and the informal economy.

He believes Gordon Brown's low interest rates and quantitative easing will fail unless he also tames the derivatives.

First, his numbers:
$13 trillion in notes and coins in the world
$170 trillion of credit in bonds and equity
$600-1000 trillion in derivatives (this aligns with the unsubstantiated figure of 1.4 quadrillion which was floating about last year).

13, 170, 1000. Derivatives out-scale physical money by up to two orders of magnitude.

The Observer report continues "What dramatically undermined capitalism since about 2000 was the growth of unregistered assets - derivatives. Now that those have turned toxic, as the loans attached to them have been defaulted on or have come to be regarded as worthless or significantly devalued, we do not even know how big the problem is. We do not know where it is either - mainly because the banks have been reluctant to reveal the truth. Many of the derivatives that have caused the crisis are bearer bonds, and there is no worldwide register of them...

De Soto is used to living in a country which is about 60 per cent a hidden - or shadow - economy; the black market accounts for most trade and most people have no title to their home. His work is about empowering people by recording their entitlement to certain assets (most obviously their homes), thereby, enabling them to borrow, trade, receive letters and conduct other basic commercial transactions through those assets.

The UK and the US have become shadow economies ... through the toxic asset crisis. Both have now started detoxification programmes, but in a rather wobbly fashion. ... It is only when all banks with significant problems sign up, make honest declarations and the toxic assets are taken off the books that they will start lending normally to each other and businesses once more, says de Soto.
"You will end up there," he says. "But it's very frustrating to see this from the outside. The whole source of the debacle is the US and the UK. And it is tough to watch you not getting to the centre of the issue. There is an intellectual lag. But this is a problem that can't be dealt with in terms of traditional monetary policy.
Detoxification is a process we have more experience of than we realise. When East and West Germany reunited in 1990, the East German currency had to be detoxified and de Soto believes that the work of the 300 or so experts involved in that programme would provide useful insights now.
But once detoxification happens, results could be seen quickly: "This [detoxification process] is something that could be done in two or three months. It will be a painful exercise but, once you have found a way to take the detoxification out of the system, you are going to be able to free up credit." [emphases added]
So in a nutshell, Brown has first to register the derivatives, and then to neutralise them, otherwise all the taxpyers' money, and new money that he has thrown at the problem will be wasted.

Regular readers of this blog will be relieved, as indeed am I, that all the obsessing about derivatives that has been going on here since last October has been valid. I am not an economist, thank god, but I have picked up on Willem Buiter, who has been saying the same thing, and wrote to the Treasury on October 13th 2008, urging action on the Toxic Assets (complete ignoral). You do not have to be clever or even smart, you just have to look at the figures for the volume of the derivatives relative to the real economy.

The Green Party, indeed, all sentient beings capable of written communication, should be calling on Alistair Darling to listen to de Soto and Buiter, and demand that the banks register their toxic assets. This is in fact on Darling's agenda. He is proceeding along the time honoured lines: "When all else fails, RTFN"*

Trouble is, people are rabbitised by the headlights of the credit crunch, believing it to be beyond ordinary mortals to understand. It is not.

Why has Darling not done this already? The answer must be that he is still in awe of the banksters, because they have been pushing Governments around for more than 100 years. Wake up Alistair! Banksters are no longer the Masters of the Universe, they are just a lot of Very Naughty Boys.

*read the fine manual.


scott redding said...

That's a very interesting insight about lessons to be learnt from German unification.

Benjamin Wright said...

Part of the issue with the recordation of derivatives is that technology (e-mail, text message and so on) has made the formation of legally-binding contracts very cheap and easy. Efforts to promote better documenation on derivatives (advocated by both de Soto and Geithner) will provoke massive campaigns to capture, archive and comprehend electronic financial records. See Details --Ben

DocRichard said...

Thanks for the helpful comment, Ben. Yes, it is going to be a helluva big task to record all these contracts, and to trawl over them to sift out the illegals. But it will be jobs for the redundant hedge fund managers, no? And the Bernie Madoffs of this world could do it as community service...