In 1994, Joel Kurtzman — at that time a columnist and the business editor for the New York Times — wrote an alarming book titled The Death of Money: How the Electronic Economy Has Destabilized the World’s Market and Created Financial Chaos. Kurtzman reported that the digitization, or virtualization, of capital was causing a disconnect from reality that threatened financial anarchy… with possible positive and/or negative results.
Given the current market crisis, I thought I’d catch up with Kurtzman. Does he believe that recent events reflect the changes he warned us about back in the mid-’90s? Is money drawing its last breath while you withdraw the last of your savings? Or is something else afoot?
Joel Kurtzman is currently Executive Director of the Milken Institute’s SAVE program, focusing on energy security, climate change and alternative energy.
h+: Joel, you wrote a book about the emerging electronic economy back in 1994 titled The Death Of Money. Are we reaping the harvest of the electronic economy now, or is the current crisis about something else?
JOEL KURTZMAN: In 1994, as I went around the world interviewing people for The Death of Money, few people really understood the power of electronically linking the world’s capital markets together. Computers were not ubiquitous; the internet was nascent; and no one had invented the Blackberry. But one thing that did emerge at that time was that the mobility of money would proceed in a nearly unregulated manner and that volatility would increase. Back then, I examined all the data and saw that as markets connected, volatility rose. The curious thing, however, was this: As market volatility rose, the frequency of recession fell. It was as if the markets had become something of a shock absorber for the real economy.
What do I mean by that? In many ways, for example, some of the forces that put upward pressure on inflation now are channeled into market investments. If we did not have these massive, globally connected markets, the price of real assets would rise as money is created. Now, all that rises — with some exceptions — is the price of stocks and bonds. But those shock absorbers have their limits. In the last few years, the irresponsible use of products like collateralized loan obligations have broken down the shock absorbers. And, while it will take a little time for the system to "reset," it will reset.
In 1994, I speculated that globally connected capital markets could make the entire world rich by making capital available anywhere to anyone with a good idea and a little bit of skill. That fact has proven to be true. Since 1994, many billions of people have risen from poverty into the middle class. If China or India did not have access to global capital they would be growing at 1 or 2 percent a year, not 9 or 10 percent a year.
h+: In that book you also wrote, "Every three days a sum of money passes through the fiber-optic network underneath New York equal to the entire yearly output of all of America’s companies and its entire workforce. And every two weeks the equivalent of the annual product of the world passes through the network of New York — trillions and trillions of ones and zeros representing all the toil, sweat and guile from all of humanity’s efforts." How deep is the disconnect between the movement of conceptual money and the creation of actual wealth on the ground?
JK: We’ve seen something interesting happen. In 1994, I talked about the divorce between the financial economy (money) and products like stocks, bonds and derivatives on the one hand; and the real economy of goods and services on the other. In the interim period, there has been something of reconciliation. Companies like Southwest Airlines routinely use complex hedging strategies to protect themselves against price spikes and valleys with regard to fuel costs. Manufacturing companies, like Boeing and Airbus, use these same strategies to protect themselves against currency risks from managing a global supply chain while pricing their products in dollars. That’s how the financial economy has reconciled with the real economy.
On the other end, with the rise of private equity, the real economy has benefited from the financial economy. Many firms that were public have become privately owned. In the world of finance, that’s like taking the racecar off the track in the middle of the race to have the pit crew work on it. Once the tires are switched, the oil is changed and the car is gassed up, the car goes back on the track. In private equity, public companies are bought by private firms where they are repaired and made more competitive. When that’s done, they’re sold back to the public. Private equity resembles the pit crew. That’s kind of a rapprochement between the financial world and the real world. So, in my view, the disconnect has narrowed.
h+: In your response to my first question, you wrote, "I speculated that globally connected capital markets could make the entire world rich by making capital available anywhere to anyone with a good idea and a little bit of skill." I’d say we’re not quite there yet, but it sounds like the theory of "The Long Boom." Is there perhaps a longer boom in the future? Is there the possibility of a sort of post-scarcity market with almost no ceiling?
Since everyone’s watching everyone else, and because we’re all connected, it’s likely that once a recovery begins it will proceed quickly.
JK: Nothing moves in an uninterrupted direction forever. Least of all the markets. The markets dance an up and down polka. However, while they’re dancing, they trend in a specific direction and the markets are trending up. They trend upward for a number of reasons, including the fact that money doesn’t hold its value for very long. Inflation always looms. Since the markets absorb a lot of inflation’s effect, they tend upward. That trend will continue unless greed becomes so pervasive that the system breaks down.
h+: How long do you think the system will take to "reset"?
JK: The financial system is not backed by anything real. It’s only backed by the confidence we have in the system itself. It’s the old circular argument. That’s because money has been transformed into information and cut off from anything real, like gold, silver or wheat. Because money is information it is a blend made up partly of ideas and partly of sentiment. Investors are like detectives who come across clues, piece them together, and when they think the pieces fit they become wildly exuberant at having done so. In the midst of this crisis, investors are sniffing around, looking at the pieces and trying to see how they fit. Once they think they see a pattern, their emotions will take over and the markets will climb. Whoever glimpses the pattern first will make the most money. How long will it take? If a market tumbles at night in Asia, it is often followed a few hours later by a tumble in New York. In other words, since everyone’s watching everyone else, and because we’re all connected, it’s likely that once a recovery begins it will proceed quickly.
The interesting thing with these markets is that we’re all one — the people who were conservative and prudent have been hurt as badly as the fool who was overly-leveraged.
All the traditional risk models blew apart. Diversification — the cornerstone of good risk management — means nothing when everything goes down. But no risk manager was ever taught that everything would go down at once. Nobel Prizes were awarded to people who said just the opposite.