Turner, Between Debt and the Devil

Adair Turner, the former chairman of Britain’s Financial Services Authority and described by The Economist as a man for all policy crises, upends financial orthodoxy in Between Debt and the Devil: Money, Credit, and Fixing Global Finance (Princeton University Press, 2015). He argues that nothing regulators have done thus far has addressed the fundamental underlying cause of financial instability: that “modern financial systems left to themselves inevitably create debt in excessive quantities and in particular debt that does not fund new capital investment but rather the purchase of already existing assets, above all real estate. It is that debt creation which drives booms and financial busts: and it is the debt overhang left over by the boom that explains why recovery from the 2007-2008 financial crisis has been so anemic.” (pp. 3-4)

For 50 years private-sector leverage increased as “credit grew faster than nominal GDP. In the two decades before 2008 the typical picture in most advanced economies was that credit grew at about 10-15% per year versus 5% annual growth in nominal national income. And it seemed at the time that such credit growth was required to ensure adequate economic growth.” (p. 7) If that theory is in fact correct, we’re condemned to financial instability and crisis. But, Turner argues, we can develop a less credit-intensive growth model if we address the three drivers of credit intensity: (1) the increasing importance of real estate in modern economies, (2) increasing inequality, and (3) global current-account imbalances unrelated to long-term investment flows and useful capital investment.

One policy initiative we should be willing to use in moderation, although Turner admits it will horrify central bankers, is fiat money creation, “using central bank-printed money either to finance increased public deficits or to write off existing public debt.” (p. 12) This action, though reminiscent of a cautionary tale in Goethe’s Faust in which Mephistopheles tempts the emperor to print and distribute paper money, is necessary to escape the debt overhang.

Demonstrating the increasing complexity in the financial system, Turner points to the shift in typical bank balance sheets. In the U.K. in 1964, more than 90% of aggregate bank balance sheets were made up of loans to the real economy plus government bonds and reserves at the Bank of England. By 2008 “much more than half the balance sheets of many of the biggest banks in the world … were accounted for by contractual links, whether in loan/deposit or in financial derivative form, between these and other banks, or between them and other financial institutions, such as money market funds, institutional investors, or hedge funds.” This shift, he notes, reflected in part the dramatic rise in trading activity. “The value of oil futures trading has gone from less than 10% of physical oil production and consumption in 1984 to more than 10 times that of production and consumption now. Global foreign exchange trading is now around 73 times global trade in goods and services. Trading in derivatives … now dwarfs the size of the real economy; … the total notional value of outstanding interest rate derivative contracts had soared by 2007 to more than $400 trillion, about nine times the value of global GDP.” (p. 25)

I could go on and on (and in fact I have pages of notes), but there is no space here. Turner’s book is tightly argued and is packed with insights about the financial markets as well as the real economy. For example, he lists five factors that explain why market bubbles and subsequent crashes are inevitable and five features of debt contracts that make them potentially dangerous. He explains why fixing the banks will not fix the economy. He argues that, if it is to succeed, the eurozone must become a complete currency union and hence a political union and that if this cannot be done, “eurozone breakup is likely to be inevitable and is preferable to sustained stagnation.” (p. 159) He explains in what sense less liquid and less complete markets can be good. And these examples represent but a tiny fraction of the issues Turner tackles in his book.

We know that we still have a long way to go to recover from the financial crisis and that we’re slipping back into some of the practices that gave rise to it in the first place. Turner’s book is both a critique of the status quo and a set of suggestions for getting out of the morass without precipitating yet another crisis. It will, and should, be controversial, but Turner is a worthy adversary.