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Prêt-à-Portes

The economist Richard Portes looks at lessons from the crisis, the reality of risk, the danger of forecasting and much more.

By Stuart Crainer 06 March 2015

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It is lunchtime. Richard Portes, the eminent economist, is at his desk munching on an apple. Within five minutes the conversation covers the merits of assisted dying, the tradition of dining at Oxford colleges, the abstract artist whose work is on the office wall, the European Systemic Risk Board of which Portes has just become a member, Paul Volcker’s line about ATMs being the greatest contribution to finance over the last 25 years, and more.


American-born, educated at Yale but long-time resident in London, Portes retains an American burr. Now in his 70s he is, he observes with a smile, “unrestrained”. The tethers of ambition and status have, it seems, been cast aside. In his cheerful firing line, as he contemplates the day’s headlines, are bitcoins. “The idea that you don’t really want governments to have control of money…” he pauses to consider the sheer recklessness before sharing his conclusion. “Of course, you want governments to have control of money. That’s exactly what we learnt through all these painful experiences. You want responsible governments to have control of money. Right now we’ve got excessively responsible central banks controlling money, particularly the European Central Bank, but not with bitcoins. 

“Bitcoins will disappear. Just today there was another report of one exchange cleaned out by hackers. There’s an interesting contradiction when you think that a lot of people say that hyperinflation is around the corner thanks to a debasement of the currency due to quantitative easing by central banks. Of course the inflation doesn’t happen – it’s never going to happen – but what they’re ostensibly concerned about is instability in the value of money. Well, what’s been the most unstable money around since it started to take off? With the price of bitcoins we’ve seen these big ups and downs. What could be more unstable? So, it’s not a particularly attractive store of value, unless you think of it as a speculative medium. If you want to speculate go ahead, but don’t tell me that this is a medium of exchange, because with a medium of exchange and unit of account, you expect a certain stability and when you lose that stability, then you’re in Zimbabwe or somewhere similar.”


Hands up


Portes switches between opinion and contemplation with amused – and amusing– ease. The apple, he explains, is part of a health kick, a determined effort to look after himself and justify his liking for fine wines. “I read that every day we liveincreases our life expectancy by four hours. I am jealous of demographers. The data is all there for them! And yet they didn’t foresee increases in longevity.” What economists did and did not foresee of the financial crisis is, of course, an inevitable talking point – even now. What they have learned from it is, perhaps, more useful. Portes would, I feel, hold his hands up and say mea culpa. The apple is still being munched, so he settles for an accepting shrug. “First I, like many others, realised fairly soon the close relationship between macroeconomics and finance and we really didn’t have any clue of this before, honestly. There were some people who thought a little about it and some claim that if you go back far enough, you’ll find the right perspective. But actually if you think about the top people in the profession, whether economics professors or finance professors, none I think really understood very well these connections, and we certainly didn’t have many good tools to model them or to think about them.


”Portes’s first reaction to the financial crisis was to look at it from a global macroeconomics perspective. His research focused on the role of huge current account surpluses and deficits with the associated flows of capital flows in creating the crisis. His conclusion was that the financial systems simply couldn’t cope with such enormous flows of capital.


“Even the very sophisticated financial intermediation systems of the United States and the UK could not cope with the volume of capital flows that were coming in,” he observes. “Those capital flows were partly the result of the so-called search for yield –everybody looking around for an extra ten basis points or something similar. It was also partly the result of some countries’ reserve holding policies – their balance of payment or exchange-rate policies – and the consequences of that for building up foreign exchange reserves. The Chinese case is the one most people think of. The numbers were indeed very, very big. Their central bank bought lots and lots of US treasury bonds. But I think that wasn’t so much the problem.”


Portes points the finger of blame at European banks flush with funds buying bad securities manufactured in the name of financial innovation. Domestic financial systems simply didn’t have the expertise to intermediate those flows without taking on excessive risk. It became a risk too far. Indeed, he believes that consideration of risk had been lost along the way as financiers congratulated themselves on their own innovativeness and sheer smartness: Investors who were putting this money across weren’t looking very closely at the risks. They saw a few extra basis points, they saw credit ratings that were fraudulent in many cases; they relied on those ratings, but didn’t investigate them.” Figuring out the causes and fallout from the crisis will keep economists busy for years to come. It pushed him to look closely at the credit rating agencies and their behaviour. “The dysfunctionalities in that sector are enormous. They’re very difficult to solve, but nobody’s really tried to do anything about it and that’s a mistake. I think there’s some evidence of these problems coming back.”


Proposals fought


In retrospect, he admits that the crisis probably shouldn’t have taken him by surprise. After all, in 1977 he forecast that rising sovereign debt burdens in several eastern European countries would come to a bad end. In January 1981 Poland stopped paying and subsequently defaulted. “It was the only forecast I ever made,” he says. “I figure one’s enough. If you get it right, you stop. Forecasting is a mug’s game.” And then came the Latin American debt crisis in 1982 which dragged in Mexico and Brazil, among others. This led Portes to begin research into sovereign debt. Later he and his co-author were invited by the UK Treasury, the Foreign Office and the Bank of England to apply what they knew about sovereign debt to see how best to forestall and deal with such crises. The authors recommended changes in the contracts for sovereign debt and the financial sector. The Institute for International Finance, an organisation of big banks, fought the proposals very hard and managed to fend them off for several years. Now, however, so-called collective action clauses are standard and required by the European Union.


European American


An American living in Britain (with dual nationality) and married to a French woman, Portes is strongly in favour of European integration in all markets – labour, capital, goods and services.


He has been, and still is, a strong supporter of economic and monetary union but concedes that the current system contains flaws made dramatically apparent by the biggest financial crisis since the 1930s. “There are real difficulties, at least under extreme conditions such as those we’ve faced since 2008, and these have to be addressed, but I still believe that the single currency is right. It is a very positive thing in economic as well as political terms.


“Of course, there are trade-offs and for me the advantages of having a single currency are substantially greater than the costs. But those costs right now, over the past couple of years, have been heavy, partly because of major policy errors similar to those in this country. The problems that have been addressed I don’t think are being dealt with in the right way yet, but we’re making some progress.” While his work on sovereign debt and the Eurozone crisis has taken up most of his time since 2010, Portes’ research ranges widely. “There’s a set of issues where I’m in the clear minority, although not a minority of one,” he observes wryly. 


He is, for example, sceptical of concerns about the actual or potential shortage of safe assets – to which he speedily adds the descriptor “so-called”: “There is no such thing as a true safe asset. Even short term US Treasury securities carry exchange-rate risk, and even default and liquidity risk”. In the same way as the best war correspondents inevitably find themselves crouching as bullets fly around them, the best economists appear to attract economic turbulence. Portes was at a conference at the Chicago Fed in October 1998 (the fifth of the month, he recalls) when trading in US three-month T-Bills on the Chicago Exchange stopped for half an hour. “Even the most liquid security in the world turned out to be illiquid for a short period because of fear: everybody wanted cash,” he says.


“So, there is no true safe asset and the question then is what people mean by a shortage of safe assets. A lot of papers have been written about this or postulating a shortage of safe assets and then saying this is what we’re getting into and these are the likely negative consequences. I am very sceptical of this line of argument.”


Meanwhile, he continues to explore macroeconomic flows, capital flows, financial intermediation and credit default swaps and the possible dangers which continue to exist: “I am convinced that these instruments have destabilised. For a while it was just conjecture, but we now have some evidence and some theoretical modelling that suggests my original ideas about this were not on the mark.”


He pauses, then concludes: “What goes around, comes around.”

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