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Category: Economics

Why we may be on the cusp of a new economic era

Renown economist Eric Lonergan...

19 September 2017


Renown economist Eric Lonergan speaks to Glint, highlighting the economic baselessness of populism, the challenges for money monopolies and why we may be on the verge of a “possibly era defining, new regime”

The chapters of economic history are hard to define, let alone write. Yet hedge fund manager, government adviser and economist Eric Lonergan, might just be one of the few contemporary names qualified to do just that. The author of Money has identified a number of significant “regime changes” that have framed the political and economic landscapes of their era and, he believes, we might just be due an earthquake.

The last one, he says, occurred in the early 1980s, marking a shift from government-directed, Keynesian economics to the “neoliberal” era: the new economic makeup epitomised by thinkers such as Milton Friedman, a Chicago School economist and consigliare to Reagan and Thatcher. Neoliberalism is broadly defined by a universal shift towards globalisation, free markets and deregulation; a radical switch in economic thinking. For instance the Phillips curve, where economists had believed you could tinker with unemployment levels and inflation to get desired results, was debunked: “Friedman’s whole critique of it was devastating and he was vindicated in the 70s, having not been listened to in the late 60s,” says Lonergan. “The system just gets used to the inflation: you can’t trick people and it breaks down. His solution was to just deregulate everything and the market will deliver lower rates of unemployment.”

However, Lonergan acknowledges neoliberalism was only half Friedmanite, as it was more about government’s role in the real economy, rather than in a monetary system which Friedman also targeted — saying of the Federal Reserve Board that “no institution in the United States had such a high public standing and such a poor record of performance”. Arguably Friedman’s contempt for central monetary policy has now become a cause célèbre as the emergency measure of quantitative easing has become the norm since the 2008 financial crisis. Central bankers now find themselves reactionary conductors, rather than impartial guardians; a position Lonergan believes has parallels in the loss of contemporary political identity.

Lonergan notes that the Cold War era, where capitalism vs. communism was the main ideological clash, gave us a “very simplistic view of market vs. state in the Western World. Although, I think the institutional organisation is much more complex. However, the old left-right economic divide, even if it was a simplistic set of economic beliefs, gave people a sense an altruistic identity, because at least they were identifying with a universal set of values. They’re both supranational idealistic perspectives and ethical arguments. So at least they were saying I believe in the common good and solidarity as a socialist, or I believe in free speech and that society is freer with private property.”

However, since the end of the Cold War the progress of society under a vaguely neoliberal hegemony seems to have led to an ideological decay, giving rise to more unpleasant forms of politics. “When you have a Tweedledum Tweedledee political system where everyone is the same, nobody feels politically motivated, and that’s the vacuum where nationalism emerges,” says Lonergan. “You revert to an older type of instinct, which is not an ethical, universalist, one but is a very naive tribalistic set of values. It just says ‘I’m part of this group, you’re part of that group, this one is better than that one’. That’s the SNP, that’s Farage. It’s in an awful lot of political discourse right now, which has just reverted back to pre-ideological, nationalistic, tribalistic language.”

What’s interesting, however, is that we don’t see the emergence of a corresponding economic ideology that defines what Lonergan is calling this new “neo-nationalism”. While Nigel Farage is an admirer of Margaret Thatcher, Brexit had a variety of different ideological supporters. Marine Le Pen in France wants to fund state programs with money printing, and is economically a “socialist”. This aforementioned intellectual vacuum is “fertile ground to get the new prize, that being the creation of the new economic consensus” to fit the “economic reality”.

Lonergan sees Brexit as “bizarre, in many ways”. Contrary to the heated discussion that surrounds the issue, he takes a signature observational, curious position. He thinks the main effect will be a “huge administrative bureaucratic process”, and the winners and losers will be randomly distributed. The current losers those whose lives are wracked with uncertainty, such as EU citizens living in the UK and UK citizens living in the EU.

“In hindsight we may conclude that it doesn’t really matter either way, although we will have wasted a lot of resources in managing the transition. It’s a big argument among politicians, but if you asked people to rank what they care about it would be education, healthcare, and economic management. The relationship with the EU would come quite low. However if you asked them what that relationship should be, it would be leave. The weird thing about the political system is that everything has been hijacked by a low-preference belief.”

Preference for ideological distinction is also low it seems. The framing of last year’s American presidential election as Clinton the establishmentarian versus Trump the radical outsider is overstated, says Lonergan. “When you put it into historical context I think the jury is massively out as to whether there’s any difference between Clinton and Trump, or whether the differences are entirely superficial. A lot of people would take issue on that with regard to social values, and I think that’s the most legitimate difference, but on economic policy we have no idea whether there’s any material difference between the two.”

Trump put protectionism back onto the political table against Clinton’s supposed support for globalised treaties such as NAFTA. This is seen by some as a backlash against years of neoliberal economics. But Lonergan says people forget historic American political moves: “There’s nothing at the moment that Trump has done that is unusual within the context of Republican policy making of the last 20 or 30 years. So he’s talking nationalism, but the evidence as to whether he is in any way a break with Bill Clinton on economics is not at all clear. I don’t think back tracking from the odd trade deal is particularly significant.”

Trump and Clinton

Despite a deeply divisive election campaign Lonergan does not draw a big economic distinction between Trump and Clinton

Nor does Lonergan seem to think that Trump’s actions indicate that he is the fascist he’s portrayed to be in the media: “The real important issues are whether he becomes genuinely nationalistic and starts reversing globalisation or genuinely challenging the judiciary. And I don’t mean him verbally challenging them publicly, but actually challenge them in a way that’s actually significant”.

Lonergan looks back to the 2008 financial crisis that has, arguably, prescribed so much of this political temper: “We let go of the banks and allowed them to get leveraged up to the hilt on a number of spurious measures of risk. You had all these risk-adjusted complicated measures of assets when there should have been simple rules of thumb. It’s the old story: when banks’ returns go down, if they aren’t regulated they’ll expand their balance sheet to make profit.”

He does, however, believe in the idea that governments can minimise these cycles, and that the great moderation was correct if “the banks hadn’t been allowed to go crazy”, citing Australia and Hong Kong as examples of “good regulation, with a small amount of profitable banks and no recession despite commodities booming and busting”. Lonergan is puzzled by how simple it all seems: “there’s nothing new about it — just high capital and liquidity ratios, and we’ve known since time immemorial that that’s the right thing to do. I don’t mean really complicated regulations, I mean really simple rules of thumb. Heavy regulation could be done by five people and punchy numbers.”

The reason is, perhaps, that people forget the basic principles. “The problem is we’re human beings, and the longer we go from a banking crisis we start to forget it. Hong Kong doesn’t forget it because they have frequent volatility of asset prices. One way to remind people how banks work would be to have house prices booming and busting quite frequently; almost like creating instability to create a well capitalised banking system, although I don’t recommend that!”, he jests.

He does view finance as unnecessarily messy though, and doesn’t think that is being remedied: “In most areas of our life we know broadly what we want, how to obtain it. We may not be able to afford it but we know the things we’re looking for. The problem in finance is that a lot of people don’t know anything and it’s too much hassle to devote resources to understand it and achieve certainty; half the time you’ve already lost them.”

Perhaps that’s why, when asked about such financial vehicles as private competing currencies, and fiat and commodity money, his reply boils down to a few basic concepts:

Money is validated by the common network effect, he says, and that breaks down when you have competition; it has nothing to do with the qualities or nature of the substance that gives it its place as money. “Nobody says ‘sterling is the best money’: we use sterling because other people use sterling. So because its use depends on other people’s use, it becomes incredibly resilient and tends towards a monopoly. It’s like private courts and law — why don’t we have those? It’s because it’s worthless unless everyone adheres to it.”

“The difficulty I’ve always had with competing private currencies is that I think there are network externalities; there are huge scale economies. So I use the language analogy — why don’t we have private languages? The problem with a private language is that it’s not useful unless other people speak it. So how is it established? It’s probably going to be some kind of monopoly because of the network externality dimension to it: its use to me depends on its use to you, even if it’s not a very good language. English isn’t a perfectly efficient language, but it’s dominant. I see this happening with money.”

Enforced monopolies will require intervention, then, such as the case of the Italian government standardising Italian through the state education system. “Once you’ve done that it’s incredibly difficult to go backwards. When I was growing up in Ireland they tried to force people to speak Gaelic. It was a huge effort when everyone else speaks English.”

Lonergan emphasises the power of these networks against the “intrinsic value” that proponents of commodity money often argue in favour of: “the value of money has nothing to do with intrinsic value, it has everything to do with other people accepting it. If you collect commodities and claim you’re collecting money, you’re not; money only has a social value, just like language — if you woke up tomorrow and everyone had switched language, English would be worthless. When I go out for dinner with my South African friends who are goldbugs, I find it amusing that they use fiat money — they have no confidence in fiat, yet they still use it; you don’t need confidence, as long as people use it.”

Is commodity money worth no more than fiat, then? It depends on how you define value: chronic debasement and inflation may reduce the economic value of money, but it still has a social value as a money qua money despite this. “Theoretically that network can be lost if the money is badly managed. But it has to really be catastrophically shambolic for that to happen. Even during hyperinflation in places like Brazil, the network is so valuable that they still keep using it, despite grotesque mismanagement. That’s one of the more powerful arguments; even in the case of sterling, which has had really quite poor mismanagement, we still use it.” Lonergan has alternative view of the more important use of commodity money, noting that “it’s actually the way to start the network. If you’re starting out as a state, you may well tie your money to a commodity as otherwise people are going to mistrust you. ”

Those premiums of networks and value, have also been identified by fintechs, which allow users to transcend barriers of currency exclusivity and provide access and payment by commodity. So what else should we expect of the future? Lonergan is optimistic about the overall progress of technology, saying “Luddite” technophobes can be discredited with basic economic concepts that apply to every area of innovation. “Most technological innovation is a good thing, and most anti-technology arguments are just wrong.”

Whether such optimism marks the latest “neonationalist” economic and political “regime” remains to be seen, but the variables given to finance and money by technology may make it the most interesting yet. Lonergan’s commentary may never be more valuable.

Eric Lonergan is an economist and the author of  Money. He is also a fund manager for M&G Investments

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