This is a content review of Adair Turner's book "Between Debt and The Devil". Mr.Turner is an ex-chairman of Financial Services Authority of England, appointed 5 days after Lehman Brothers collapse. He wrote this book as his perspective of what is happening on financial system right now. The cause, analysis and suggestion given within 15 chapters, 251 pages.
In the beginning, the book depicts that 40 years before the 2007-2008 crisis, finance grew far faster than the real economy, private credit grew faster than GDP, trading volume soared and as a result financial system become more complex. Experts confidently said these complex financial system will lead the market to completion, efficiency and stability. In April 2006, only 15 months before the onset of financial crisis, IMF's Global Financial Stability Report noted with approval the "growing recognition that dispersal of credit risk by banks to a broader and more diverse group of investor, has helped make banking and overall financial system more resilient". This assumption generated by the idea of economic growth driven by credit and control of interest rate from central bank to achieve low and stable inflation. However financial markets are different from other markets, thus even though financial intensity plays crucial role in a market economy, the relationship is not linear and limitless.
Financial Markets have their own hysteria and the volatility is inexplicable in terms of economic fundamentals. Five factors were explained in this book which are irrational decision making, influence of the irrational belief, theory of rational arbitrageurs will bring the price back, irrational result whatever the decision is, uncertain result of mathematical risk model. Financial activity also might burden economy with the dead weight of additional and unnecessary cost. Increasing intensity also generates market volatility or in other ways made the economy less stable.
Debt contract plays an important role in this matter, especially the institution that issues this, Banks. It always seen as a ride of financial system as its liquidity and mobility of the capital. The emerge of Industrial Revolution is a prove that debt contract in capital market, banks and equity market is a good injection for economic growth. However, although debt contract and banks play economically valuable roles, the very character that make them valuable is the reason why it is very harmful. First, debt contract is risk fixed means that it does not depend the value of the underlying asset.Then, it can creates a sudden stop in economics and resulting in depression and deflationary debt overhang effect.
Banks now, on the other hand, have evolve from household saving place to power purchaser by creating credit and intangible money. They make loan to borrowers to be repayable at a later date with some sort of 'risk' payment and use it as their purchasing power. It expand in all aspect of household and business, makes all the transaction is going through banking system. As a result, once bank money has been created by extension of new credit, it is almost certain to remain in the banking system: very little is taken out and used is the form of notes and coins. As a comparison, the money circulation appears in United Kingdom that takes form of notes and coin is only 2% while the rest used in the banking system. This makes 'Too Big To Fail' situation in banking sector while the its role is harmful in the economy.
to be continued.
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