Bicycles and the contra-cycle
Pro-cyclicality is the curse of our times, thanks to the magnifying effects of ill-timed actions and inaction – but not so in Chile and Norway.
Stage 14 of the Tour de France was a case of life imitating art. After a gruelling climb to the summit of Mur de Péguère in the Pyrenees, some fool decided to spread tacks across the road.
Watching, the lyrics of 1980s indie band The Smiths replayed in my mind: "Punctured bicycle on a hillside desolate." This was an act of sabotage, but one that had a broadly positive effect. The peloton paused, waited for 30 or so of their hapless colleagues to have their wheels replaced and only then carried on racing. Sportsmanship won.
If only it was so easy to spread tacks in the path of the business cycle. Instead, there seems to be a collective determination to exaggerate and exacerbate its effects. In boom times, we are told that bubbles can only be seen in retrospect and all you can do is clean up when they burst.
When the bust comes, the cure for prior excess is ascetic austerity. We push on the accelerator when the economy is freewheeling downhill and apply the brakes in the painful climbs, when every basis point of economic growth is hard earned.
However, it is not just politicians who fall victim to the curse of pro-cyclicality. It seems to be a pervasive societal mindset that takes hold. Basle III is compelling the banks to deleverage just at the point in the cycle when we most need a fit and functioning financial system. Solvency II is forcing insurance companies to dump equities when valuations are screamingly cheap.
In April 2007, before the brown and sticky really hit the fan, this column mocked Moody’s for granting triple-A "status to a rag-tag assortment of obscure Nordic credits". They included Kaupthing Bank, which wags have since renamed to reflect its intimate relationship with ordure. Now countries – sovereigns with tax-raising powers and police forces – get downgraded for modest deviations from the path of supposed fiscal rectitude. Consumers that once boasted of maxing out their credit cards have swapped their Audis for Aldi.
There are deep psychological reasons for this behaviour. It is a form of repetition compulsion governed by the prevailing mood. Contrarians are like biblical prophets – they are rarely loved in their own country or time.
However, contra-cyclical policy can be remarkably effective. Chile and Norway offer good examples. These two countries could not be further apart geographically, but have confronted a shared economic problem in a similar, and similarly effective, way. Both are blessed with abundant natural resources: copper in Chile; oil and gas in Norway.
The corollary is that they are also cursed by being exposed to particularly strong cyclical forces. When global economic activity rises, commodity prices tend to be dragged along for the ride. As is the case for all prices that are set by markets, these then tend to overshoot, both on the way up and the way down.
Norway confronted this problem and the threat of what economists call the Dutch disease – easy money from natural resources sapping the rest of the economy – by establishing the Statens Petroleumsfond (now called the Government Pension Fund) in 1990. Once the government balances its books, the taxes and royalties paid by Statoil, the state oil company, flow to the fund, which now manages $611 billion.
Chile’s Copper Stabilization Fund is rather more modest, with assets of $12 billion, but has a similar origin. It is the principal recipient of profits from state-owned copper miner Codelco.
These contra-cyclical funds have helped both economies. While much of Europe struggles with low or no growth, Norway powers on. It has had only one year of recession (2009) in more than a decade.
In the same year of acute global crisis, the Chileans tapped their fund to help pay for various programmes that extended the social safety net. In February 2010, an earthquake measuring 8.8 on the Richter scale devastated the country. There are not many economies in the world that would survive these exogenous and endogenous blows in rapid succession. Chile did. Like Norway, it has tasted recession in only one year (2009) in recent history.
On some wintry days in early 2003, I had the privilege of spending time in Oslo, meeting with officials at the fund and the Norwegian central bank.
In the wake of the Libor scandal and the furore over ‘banksters’, organizational culture has become an issue of defining importance. With something so amorphous, it is hard to spot the good and denounce the bad.
In Norway, I found a dedicated, intellectually engaged and disarmingly frank and open group of people. The fund had an unambiguously healthy culture.
I have not seen them since, but I suspect it is something that is self-replicating and self-reinforcing. It must help that they know they are doing something for the common good, rather than just personal or corporate aggrandizement. That is a good lesson. So is the whole idea of contra-cyclical policy.
There have been too many homilies from politicians about fixing the roof when the sun is shining. They should walk the walk and not just talk the talk. Likewise, it is nonsensical to tear down the roof in a storm. Policymakers, regulators, credit-rating agencies and others should take note.