A Paradox of Risk Aversion is haunting the global economy: Rob Johnson’s poignant warning against both bubbles and austerity

We keep forgetting that every Crisis, like a coin, has two faces. One is the mountain of debt and losses that is crushing states, people and banks. The other is an equally imposing mountain of accumulated savings that are to ‘frightened’ to fund investment, thus remaining idle and frittering away. Keynes famously invoked the Paradox of Thrift in order to explain this unhappy co-existence of intolerable debts and idle savings; a symbiosis fuelling the Depression. Rob Johnson, in a recent book chapter, adds another dimension to this situation; one that is new and just as scary: The Paradox of Risk Aversion. (Here is the full chapter entitled Paradox of Risk Aversion: Structural uncertainty and a dysfunctional international monetary system)

Rob Johnson’s main point is that, following the Crash of 2008, our world is in a state of structural disequlibrium (which is pretty much what I have been arguing in my Global Minotaur). In this disequilibrium state, there is a global excess demand for ‘safe assets’. And since we cannot ALL own safe assets at once (just like not all nations can have, simultaneously, a trade surplus), unless investors find the courage to invest in less than perfectly safe assets, then no assets will be safe, all assets will wither, and a new Global Depression will be upon us. Moreover, given the oligopolisation of savings, due to the concentration of global savings in a small number of sovereign wealth funds, the risk aversion of the sovereign wealth fund managers is threatening to undermine any chance of the global rebalancing which is, whether we like it or not, a prerequisite for a Global Recovery.

Here is Rob’ conclusion of what is needed if the global economy is to have a chance of rediscovering its poise:

“What is needed is not bubbles or austerity but a policy constellation directly targeted on investment spending, human capital investment, modernisation of the supply side, and a focus on productivity growth to inspire confidence that the sovereign-debt-to-GDP ratios can be managed sustainably and be consistent with ecological concerns.”

And how will this be achieved? Rob’s answer is predicated upon the thought that sovereign wealth funds must play a major role in effecting such investment spending. I think he is right. And this is precisely why Stuart Holland and I have been insisting over the past two years that, at least in Europe, we desperately need a combined effort by the European Investment Bank and the European Central Bank (utilising EIB-issued and ECB-issued bonds) to harness the capacity of the sovereign wealth funds and mobilise idle (risk averse) savings in the context of a Social-Green Investment-led Recovery Program – a New Deal for Europe. Rob Johnson’s point is that we need something like of the sort not only in Europe but also in the United States. He is spot on.


  • History lessions are always useful…


    Bankers at the gates

    By PETER FRANKOPAN Oxford, England

    FEW Greeks have a good word to say about the European banking system these days. They believe it’s the real reason for their current crisis, having pushed easy money on their politicians and now demanding a pound of financial flesh.
    It was the same story 800 years ago. The men of the Fourth Crusade, who had originally set off to fight for Christianity in the Holy Land, found themselves instead ransacking Constantinople, the capital of the Greek-speaking Byzantine Empire, because of enormous debts that had been racked up in the West.
    The way Europe has behaved over the current Greek crisis is scarcely less shameful than the way those crusaders behaved all those centuries ago. If nothing else, that dark spot on the West’s historical record should be a warning to the bankers and politicians who would rather watch Greece fall apart than take responsibility for their own profligacy.
    Greece may be on Europe’s periphery today, but in the 12th century Constantinople was the gateway to a lucrative trade in spices, silks and luxury goods coming from the east. This trade had made fortunes for men across Europe —as the economies of Greece, Spain, Portugal and Italy have done over the last two decades. Traders from places like Venice, Genoa and Pisa in the late 12th century managed to win for themselves the sort of advantages and loopholes in Constantinople that bright young fund managers would kill for today: they negotiated positions that allowed them to undercut local traders, alongside smart commercial treaties that let them minimize or even sidestep their taxes. As with modern Greece, this led to a flow of cheap foreign capital into the markets. Around 1200, though, things went sour. A sharp contraction of trade in the Byzantine Empire was exacerbated by wild overspending by Venice, the medieval equivalent of a European central bank. Almost overnight there was a switch from the easy money, where everyone was a winner, to the dark arts of debt collecting. As with Athens since the financial crisis took hold, it became clear that no one would take responsibility for lending too much, for basing forecasts on only best-case scenarios. Someone would have to cover the losses, and Venetian merchants were adamant that it would not be them.
    Constantinople and the Greek-speaking empire, riven by internal divisions, was the obvious mark. Eventually, one of the rival factions in Constantinople offered a deal with Venice: in exchange for covering the Most Serene Republic’s losses, the faction would receive Venetian military muscle to secure its claim on the Byzantine throne. Venice jumped at the deal. But Constantinople had vastly underestimated the size of its new debt obligations —and overestimated the stabilizing effect of Venetian arms. Financial obligations mounted abroad, while political paralysis deepened at home. Everyone from the pope to the kings of Europe knew about the pressure building against Constantinople. One Western delegation after another told the Greeks to get their act together —or, to put it more bluntly, to pay up. The crusaders, under the sway of Venice, lay siege to the city. Eventually, the Westerners had enough of the procrastination. Seizing their chance, the knights stormed Constantinople. What happened next was a disgrace: the prize assets of the empire were looted at will, seized as collateral by a mob that behaved with no concern for the city’s inhabitants, its culture or its history. According to one account, prostitutes danced on the altar of St. Sophia, the most beautiful church in the whole of Christendom. Palaces, gardens and holy places were ransacked, with treasures taken off by the cartload. The great collections of relics held in the imperial capital were seized by the Westerners to adorn cathedrals and churches across Western Europe; to this day four bronze horses, stolen from the hippodrome of Constantinople, stand atop the Cathedral of St. Mark in Venice. Judging the Greeks fiscally and politically incompetent, the conquerors appointed a regent. Baldwin of Flanders, crowned emperor of Constantinople in 1204, was a classic I.M.F.-style appointee: a safe pair of hands, someone with whom other Western leaders could do business. Meanwhile, the noblemen leading the Crusade, many of whom had brought ruin in the first place with their reckless promises, took control of whole areas of the city and empire for themselves —a classic case of getting in at rock bottom. (So keep an eye on those bankers and their villas in the Aegean; you don’t need to be a historian to know it is a buyers’ market.) The new Latin Empire of Constantinople lasted just 50 years before the Greeks returned to power. The story is the same as then: cheap money brings handsome rewards but guarantees crisis, while the pain falls solely on the Greeks. Constantinople and Athens may have become addicted to easy money, but the West was their dealer.

  • No, no, no! NOT more government controlled investments. Why is there risk aversion? Because markets are dysfunctional, normal captilastic reasoning no longe predicts rewards and failures. governments keeping interest artificially low and directing large sums to failed banks, all these factors make an investor knows one thing for sure: don’t put your money on risky ventures, instead choose gold. The markets are run by croony big business / state conglomerates that have carefully shifted the risks of bad outcomes to citizens and small businesses. Dont become their prey. Forcing investements by government dictats solves nothing, in fact makes things worse so.

  • I’m curious about comments made by Bernard Lietaer, doyen of complimentary currencies, relating to a “golden age” of cathedral building and long-term investment in the thirteenth century financed by a new type of currency: one with “negative interest” or demurrage which might effectively separate the means of exchange function of money from the store of value function and encourage sustainable finance. Apparently the Egyptian economy which endured for so long was based on similar principles. (The Automatic Earth is running a series of posts about “freegold” at the moment – a modern solution along these lines?).

    Anyhow, the reason I bring this up is the thought that the financial collapse described by the comment above seems to neatly precede the aforementioned “golden age” and I wonder if that is a coincidence…

    • I dont think it is a coincidence. That pile of money went north, thats for sure..

  • All of you wise people. The one thing that everyone seems to be overlooking is the ‘fear factor’. In countries like Greece entrepreneurs have no confidence right now. Of course it will come back but it will take at least two to three years. Money that is now hived away will not be allowed to see the light of day for a good while. Meanwhile everyone is singing the mantra of growth, growth, growth and repayment, repayment, repayment. Only activity brought about by public investment projects will start the engines working pretty quickly.

    Not only Greece. Throughout 2012 in other European states watch consumer spending indicators such as holidays abroad and new private (non fleet) car sales.

    Don’t assume that once issues have been resolved- we hope and pray- that business activity will turn on like a light being switched on.