The Real Story of Automation Beginning with One Simple Chart

Robots are hiding in plain sight. It’s time we stop ignoring them.

There’s a chart I came across earlier this year, and not only does it tell an extremely important story about automation, but it also tells a story about the state of the automation discussion itself. It even reveals how we can expect both automation and the discussion around automation to continue unfolding in the years ahead. The chart is a plot of oil rigs in the United States compared to the number of workers the oil industry employs, and it’s an important part of a puzzle that needs to be pieced together before it’s too late.

Source: ZeroHedge

What should be immediately apparent is that as the number of oil rigs declined due to falling oil prices, so did the number of workers the oil industry employed. But when the number of oil rigs began to rebound, the number of workers employed didn’t. That observation itself should be extremely interesting to anyone debating whether technological unemployment exists or not, but there’s even more to glean from this chart.

First, have you even heard of automated oil rigs, or are they new to you? They’re called “Iron Roughnecks” and they automate the extremely repetitive task of connecting drill pipe segments to each other as they’re shoved deep into the Earth.

Pictured: National Oilwell Varco’s AR3200 Automated Iron Roughneck

Thanks to automated drilling, a once dangerous and very laborious task now requires fewer people to accomplish. Automation of oil rigs means that one rig can do more with fewer workers. In fact, it’s expected that what once took a crew of 20 will soon take a crew of 5. The application of new technologies to oil drilling means that of the 440,000 jobs lost in the global downturn, as many as 220,000 of those jobs may never come back.

Now look back at the chart again, and notice how quickly this all happened. It took TWO YEARS. How did it happen so fast? Because the oil industry didn’t really need the workers it lost in the first place. It’s the oil industry. It’s used to making lots of money, and when you’re making money hand over fist, you don’t need to focus on efficiency. Being lean and mean is not your concern. However, that changes when times get tough, and times got very tough for the oil industry as oil prices plummeted thanks to new competition from yet another technological advancement — fracking.

So once it became important to increase efficiency, that’s exactly what the oil industry did. It let people go and it invested in automation. In the summer of 2016, oil prices were no longer under $30 per barrel, and had gone back up to around $50 per barrel where they remain. That’s half of the $100 per barrel they’d gotten used to, which is fine as long as they’re able to produce at twice the efficiency. As a result, like a phoenix rising, they emerged transformed. Oil rigs returned to drilling, but all the rig workers didn’t. Those who were let go became simply unnecessary overhead.

Sleeping Through a Wake Up Call

This is a story of technological unemployment that is crystal clear, and yet people are still arguing about it like it’s something that may or may not happen in the future. It’s actually a very similar situation to climate change, where the effects are right in our faces, but it’s still considered a debate. Automation is real, folks. Companies are actively investing in automation because it means they can produce more at a lower cost. That’s good for business. Wages, salaries, and benefits are all just overhead that can be eliminated by use of machines.

But hey, don’t worry, right? Because everyone unemployed by machines will find better jobs elsewhere that pay even more… Well, about that, that’s not at all what the history of automation in the computer age over the past 40 years shows. Yes, some with highly valued skills go on to get better jobs, but they are very much the minority. Most people end up finding new paid work that requires less skill, and thus pays less. The job market is steadily polarizing.

Source: David Autor

Decade after decade, medium-skill manufacturing/office jobs have been disappearing, and in response, the unemployed have found new employment in new low-skill service jobs. People unemployed by machines still require income, so they end up finding what they can get. At the same time, they are competing against others doing the same thing (as long as the labor market remains involuntary) and thus people are bidding down their own wages and taking any job they can get in a race against the machines. This also serves to make investments in automation less attractive. As an added bonus, the jobs that are being automated are more productive jobs than most of the jobs being newly created. Cheaper human labor and an increasing number of low productivity jobs together then result in a “paradoxical” deceleration of productivity growth. Long story short, the middle of the labor market is disappearing. That’s the reality, and it’s been happening for decades.

A landmark 2017 study even looked at the impact of just industrial robots on jobs from 1993 to 2007 and found that every new robot replaced around 5.6 workers, and every additional robot per 1,000 workers reduced the percentage of the total population employed by 0.34% and also reduced wages by 0.5%. During that 14-year period of time, the number of industrial robots quadrupled and between 360,000 and 670,000 jobs were erased. And as the authors noted, “Interestingly, and perhaps surprisingly, we do not find positive and offsetting employment gains in any occupation or education groups.” In other words, the jobs were not replaced with new jobs.

It’s expected that our industrial robot workforce will quadruple again by 2025to 7 robots per 1,000 workers. (In Toledo and Detroit it’s already 9 robots per 1,000 workers) Using Acemoglu’s and Restropo’s findings, that translates to a loss of up to 3.4 million jobs by 2025, alongside depressed wage growth of up to 2.6%, and a drop in the employment-to-population ratio of up to 1.76 percentage points. Remember, we’re talking about industrial robots only, not all robots, and not any software, especially not AI. So what we can expect from all technology combined is undoubtedly larger than the above estimates.

Automation has been happening right under everyone’s noses, but people are only beginning to really talk about the potential future dangers of automation reducing the incomes of large percentages of the population. In the US, the most cited estimate is the loss of half of all existing jobs by the early 2030s. It’s great that this conversation is finally beginning, but most people have no idea that it’s already happening. And about half of those people who know it’s happening, are relying on magical thinking to support their beliefs that automation is of no concern. To the contrary, it is of massive concern.

Charting the Course of History

One of the most telling statistics I’ve come across in regards to the automation discussion is how almost everyone in the US knows we’ve lost manufacturing jobs over the past three decades. 81% know that very real fact according to a poll of over 4,000 adults by Pew Research. What few people know however is that at the same time the total number of jobs has decreased, total manufacturing output has increased. The US is manufacturing more now than it ever has, and only 35% of the country knows that’s true. The percentage of Americans who know both of the above facts are true is a mere 26%.

Source: Business Insider

Only one out of every four Americans knows that thanks to technology, we’re producing as a country far more with less. Most people don’t know that, or blame things like immigrants or offshoring for job losses, even though offshoring is only possible due to technology improvements and only accounts for 13% of manufacturing job loss. That’s a problem. We can’t make the changes we need to make if people aren’t aware the problem exists, or think the existence of the problem is something to be debated. We can’t agree on solutions like unconditionally guaranteeing everyone a basic income as a rightful productivity dividend if people are actively being unemployed by growing productivity and the discussion is framed as a future danger to our social fabric instead of a clear and present danger.

Consider this: What happens when the next recession hits? Falling oil prices simulated a recession in the oil industry, which responded with mass unemployment and investment in automation. What happens when allindustries respond with mass unemployment and investments in automation? If we look at recent history, each successive downturn has resulted in the permanent shrinkage of the labor market. Peak labor appears to have already occurred back in 2000.

Source: Janus Capital

Meanwhile, technology is only getting cheaper, so each successive drop squeezes out more human labor, and is able to automate more lower-skill labor that is newly more expensive than machines. Expect the next recession to put over ten million of people out of work, and for the economy to realize they didn’t really need those people as workers after all to produce what was being produced. Where 79% of eligible workers aged 25–54 were employed, expect that to fall to 69% or below. The economy simply doesn’t need the number of people it currently employs with the technology we already have available. To add insult to injury, it’s taking longer for the unemployed to find employment, so those suffering next will suffer longer.

Source: Advisor Perpsectives

The Automation of an Increasingly Divided Country

Source: Daily Yonder

To add further insult to injury, the story of automation in America is one where mostly liberal metro areas enjoy the benefits while mostly conservative rural areas suffer the consequences. According to a Daily Yonder analysis, 80% of jobs created in 2016 were in the 51 metro areas of a million people or more. These metro areas gained 1.2 million jobsbetween January 2016 and 2017 — just one year. Meanwhile, rural areas ended up with 90,000 fewer jobs over the same time span.

More than 52 million Americans are now currently living in counties considered as being in economic distress. A report by the Economic Innovation Group (EIG), a bipartisan research and advocacy organization, discovered a close link between community size and prosperity, where counties with under 100,000 people are 11 times more likely to be distressedthan counties with more than 100,000 people.

Understand how automation is helping to divide the country along “red” and “blue” lines, and the growing polarization of our politics will immediately make more sense. This is perhaps the most dangerous effect of technological unemployment of all, the erosion of democracy itself as partisanship tears our nation apart in a process that is difficult to differentiate between that of a living cell mitotically dividing in two.

Source: Mauro Martino

The Ignored Math of Increasingly Productive New Businesses

Another thing to recognize is that as technology enables businesses to hire fewer workers, that means to obtain “full employment”, where everyone who wants a job has one, the economy requires that everyone work shorter work weeks, or else an ever growing number of businesses is needed in order to employ the same amount of people. If the average amount of people the average business employs is 10, it would take 10 businesses to employ 100 people. Assuming “full-time” continues to be defined as 40 hours, if technology allows 1 person to do the work of 10, the average people a business employs drops to 1, so the number of businesses needed to employ everyone grows to 100. (note: compensating for population growth would require even more than 100)

So is that happening? No. That’s not happening. The reverse is happening. New business creation is slowing, not accelerating.

But the new businesses being created are rising in value every year, which matches what we’d expect to see from each new business using the latest technology to do far more with far less.

Every year there are more new businesses worth over $1 billion. Look at Tesla versus early 20th century Ford Motors, or Instagram versus Kodak, or Facebook versus all the newspapers that used to exist. These companies are worth hundreds of billions of dollars and employ a fraction of the people as the most valued companies of the past once did.

There’s also an assumption that human demand is infinite, and so no matter how many jobs are eliminated by technology, a human demand for infinitely more stuff will always create new jobs. This belief exists alongside continually shrinking discretionary spending as a share of total spending. This should also not surprise anyone. People can’t spend money if they don’t have any.

The More You Know…

Now, let me ask you a question. How much all of the above information were you already fully aware of, to the point none of it was new to you? Now ask yourself why? Automation clearly exists, and clearly is already affecting the economy. So why is the debate about automation even a debate at all? That’s perhaps the scariest thing about the oil rig automation chart, along with the rest of the charts I’ve included here, the fact existing evidence is not part of the debate. Just as climate change has been something we’ve debated for decades while the effects have only grown more extreme, so too is automation being denied as it grows more extreme.

My fear is that ignoring the problem will continue. Why not? We’ve ignored manufacturing being automated. Yes, we know it happened, but we’ve pretended that everyone just went on to find new paid work, without critically evaluating the nature of that paid work. Unemployment isn’t a problem, right, because the unemployment rate is at a record low? Tell that to the person who went from a 40-hour per week career with benefits and a sense of security to three different jobs/gigs without any benefits, working 80 hours per week to earn less total income in a far more insecure life just trying to get by each month. Tell that to the person who feels marriage has become something only the rich can afford any more. Tell that to the person who attempted suicide, or self-medicated their depression with opioids after their town’s manufacturing plant closed down, obliterating their town’s local economy and leaving them with no means of paying others for their own existence.

Technological unemployment is real.The only honest debate to be had is over the nature of re-employment, and all evidence points to a shrinking employment-to-population ratio, a growth in low-skill jobs, a transition to alternative work arrangements like temporary and “gig” labor, rising variance in monthly incomes, erosion of benefits, longer terms of unemployment, and what can only be called a pandemic of economic insecurity as survival — instead of the American Dream — increasingly becomes the primary goal of the majority of Americans.Meanwhile, some other Americans are doing extremely well. Why? Because they own the machines. They own the lobbyists. They write the laws. They write the tax code. They have the power. And so they are now the sole beneficiaries of the machine labor producing greater and greater amounts of national wealth, where once that wealth was more widely shared with those producing it.

Source: New York Times

Hundreds of thousands of jobs were just lost due to oil rig automation and no one (except for those unemployed and their families) batted an eye. Hundreds of thousands of jobs have been lost over the years to industrial robots. Hundreds of thousands more jobs were just lost this year in retail due to the unstoppable efficiency of Amazon and the more than 100,000 robots it employs. And yes, Amazon is creating lots of new jobs too, but for every job it creates, it has eliminated two or more by eliminating its far less efficient brick and mortar competition. Unless you’re talking about net job creation, and the details of those jobs created, you’re dishonestly talking about employment.

The question is, at what point will enough people recognize that automation is a very real problem that must be confronted immediately. When millions of trucking jobs are automated? When millions more retail jobs are automated? How many jobs need to be erased before we collectively create the will to do something? And at what point will we recognize that the problem of automation should not be a problem at all, and that we want as much work automated as possible? When will we realize that automation is a blessing, not a curse, and that the benefits of machine labor should be spread across all of society instead of concentrated in the hands of a relative few, especially when all the technology originated from taxpayer-funded R&D and represents a technological inheritance from those long dead who passed their knowledge down to us generation after generation? And when will the so far sole beneficiaries of that inheritance realize that although they need fewer laborers, they still need consumers?

I hope that time is soon, very soon, because I look around at our reality, and I wonder if we’re going to get our act together before it’s too late, if it isn’t already. As long as we force each other to work for money in order to live, automation will work against us instead of for us. It is a civilizational imperative that we decouple income from work so as to create economic freedom for all. Without an unconditional basic income, the future is a very dark place. With unconditional basic income, especially one that rises as productivity rises as a rightful share of an increasingly automating economy, the future is finally a place for humanity.

How should recessions be fought when interest rates are low?

ONE day, perhaps quite soon, it will happen. Some gale of bad news will blow in: an oil-price spike, a market panic or a generalised formless dread. Governments will spot the danger too late. A new recession will begin. Once, the response would have been clear: central banks should swing into action, cutting interest rates to boost borrowing and investment. But during the financial crisis, and after four decades of falling interest rates and inflation, the inevitable occurred (see chart). The rates so deftly wielded by central banks hit zero, leaving policymakers grasping at untested alternatives. Ten years on, despite exhaustive debate, economists cannot agree on how to handle such a world.

During the next recession, the “zero lower bound” (ZLB) on interest rates will almost certainly bite again. When it does, central banks will reach for crisis-tested tools, such as quantitative easing (creating money to buy bonds) and promises to keep rates low for a long time. Such policies will prove less potent than in the past; bond purchases are less useful, for instance, when credit markets are not impaired by crisis and long-term interest rates are already low. In the absence of a solid policy consensus, the use of any unorthodox` tool is likely to be too tentative to spark a fast recovery.

The Next Generation of Currency Wars: Private vs. State-backed Crypto

Recently Russia announced that it will be unleashing a CryptoRuble, just a week after Vladimir Putin strongly criticized Bitcoin and other private cryptocurrencies. When announcing the move, Minister of Communications Nikolay Nikiforov acknowledged that it was in part inspired by the aim of getting ahead of other governments:

I confidently declare that we run CryptoRuble for one simple reason: if we do not, then after two months our neighbors in the EurAsEC will.

In doing so, Russia is following the lead of another country that too has become hostile to private crypto, China. Last July the People’s Bank of China became the first central bank to announce it had developed a crypto-prototype that it plans to offer alongside the traditional renminbi.

That the first forays into state-backed cryptocurrency come from two countries with a history of restricting a free and open internet is not surprising. While Bitcoin originated as a way to opt out of government control of money supply, increasingly governments see the underlying technology as a way to increase their control of the economy.

As Xiong Yue explained:

For example, if the government plans to subsidize certain farms, say some corn farms, to support this sector of agriculture, they can directly add a certain amount of money to the wallets of some farms, for instance 100 million dollars and program this money to be sent to certain fertilizer merchants at a certain time, and that each can only spend maximum of 10 million dollars per year, and in this way, they can make sure that the farmers won’t squander the windfalls, and that this money won’t flow to other sectors, for instance, the stock market or real estate market.

Even though this kind of monetary policy is bound to fail, from the perspective of government officials, CBDC provides them a better tool. For them, with the help of the CBDC, they can plan and manage the economy better.

Not to be left behind, the IMF – who some analysts, such as Jim Rickards, believe is prepared to step up to replace the US dollar as the next global reserve currency – recently opened the door to issuing their own cryptocurrency in the future. While some crypto-advocates have naively celebrated recent comments by Christine Lagarde on the future potential of digital currency, such praise simply reflects the increasing awareness of technocrats that the finance is changing and they must be prepared for it. Considering central banks around the world have continued to advance their war on cash, it is not surprising to see Lagarde and others come adapt to the concept so quickly.

Exchange Regulation

The usefulness of state-controlled crypto is why we should expect increased scrutiny and regulation on private cryptocurrency exchanges.

It's been reported that the Chinese government, which shut-down private crypto-exchanges in September, is looking into reopening exchanges with increased regulation. Russia, too, is working on exchange regulation, rather than an outright ban. This apparent change in direction may be the consequence of China’s exchange ban resulting in an increased use of peer-to-peer platforms in the face of the government crackdown.

For the same reason that government prefers regulated bank accounts to cash and safes, state officials may recognize the benefit to propping up licensed exchanges. Already we have seen numerous cryptoexchanges be willing to collect and hand-over sensitive customer information in exchange for government-issued licenses. Much like banks, these exchanges are increasingly being enlisted as tax collectors for the government.

Calm Before the Storm?

While this loss of privacy may outrage Bitcoin’s initial supporters, it’s understandable why many current holders may be perfectly happy with these developments. After all, while much of Bitcoin’s initial appeal was its usefulness in black markets, a major reason for its astronomical rise in value is its increasing appeal among average customers who were never all that concerned with financial services regulation. Not only has it helped its appeal as an investment, but also its daily use. Japan, for example, saw a major surge in retailers accepting Bitcoin once a firm regulatory framework was implemented.

It is worth wondering whether this harmony between government and consumers will continue, however, once state-controlled crypto truly ramps up.

After all, we’ve already seen government rely upon traditional boogeymen of terrorists, drug dealers, and other criminals as justification for their increased control. The increasing use of Bitcoin by hackers and extortionists provides a modern-day twist to these age-old scare tactics. Is it all that difficult to foresee a scenario where governments attempt to freeze all regulated exchanges in the aftermath of some terrorist attack or another scenario? Or go one step further, and legally mandate replacing a privately-held asset for a government-issued currency?

The example of China demonstrates the inherently decentralized nature of Bitcoin will likely always ensure a degree of functionality beyond the reach of government. At the same time, however, the increased popular appeal of crypto-currency also means increasing reliance on third-party services, and fewer individuals securing their investments in private wallets. Since the most popular – and thus most lucrative – exchanges and other services have an inherent incentive to maintain a good relationship with legal authorities, it is easy to see how this easily plays to the benefit of government officials.

Already within the industry debate is raging between those who prioritize “efficiency” and mainstream appeal – even at the expense of crypto's decentralized-origins. Luckily, Bitcoin’s original Austro-libertarian ethos means that we are likely to see major industry influence pushing back on state-control.

A Preemptive Strike for Monetary Freedom

In the meantime, this is yet another reason why what little political capital libertarians on monetary policy have should not be wasted pursuing moderate reforms such as forcing the Fed to embrace rules-based monetary policy. There is no hope to ever transform the Federal Reserve into a useful – or even non-harmful – institution. That hope does exist, however, in crypto.

As future monetary policy is soon to become a major topic of conversation as President Trump rolls out his Federal Reserve nominations, it would be a major loss for the cause to not see Senator Rand Paul and other Fed-sceptics use the opportunity to push discussion about the need for competition in currencies. Further, the recent surge in states that have legalized the use of gold and silver for the payment of debt means there has never been a stronger political case for the elimination of legal tender laws and the taxes imposed on alternative currencies like Ron Paul proposed when in Congress. Such a move now could help set the stage for America being a true safe haven for private crypto in the future.

Doing so may give the cryptocurrency industry the freedom to give us a fighting chance to truly end the Fed and their clones around the world.

2017 – The Year Without Corrections – Echoes of 1995

How rare is a year without corrections of more than 3%? 1995 was the last period of incredibly persistent optimism without a hiccup in price to afford a paltry decline beyond 3%. Most consider a pullback of 5 to 10% to be modest and a normal expectation at least once a year. A 3% drop is hardly more than a blink of an eye in a bull market. For the past 12 months, we have not teased the bare minimum 5% drop in the stock market to give investors a chance to climb aboard this runaway train powered by earnings and increasing economic optimism. 

No correction for 12 straight months is impressive, but in 1995 stocks ran higher for 15 months without exceeding a 3% correction before scaring traders with a 3-week plunge of over 11% intraday. A similar replay of 1995 would keep the buying frenzy going until about January 2018 before a “real” correction begins.

Non-stop rallies in the stock market without a normal correction pushes volatility (VIX) premiums lower. In 1995, volatility remained depressed all year at which point the persistent uptrend in stocks slowed and deeper pullbacks began.

Like 1995, the VIX has also stayed down throughout 2017 reaching historically low readings this month. Each time the VIX is at low tide and we move beyond the peak quarterly earnings release (10/24 – 11/09) the risk of volatility spikes and meaningful stock market corrections rise.

The classic Exchange Traded Fund (ETF) that has been increasingly utilized to profit from this record-setting depression in the VIX is its inverse, symbol XIV. When the stock market blasted off on election day last November, we often said that there could not be a serious correction until prices had moved far enough above the S&P 2200 breakout level so that any price drop didn’t damage the new up-cycle. While the S&P 500 Index has gained almost 15% this year, the volatility loving XIV has risen almost 130% (over 650% since 02/2016). It’s far too late to invest in the XIV, although the futures premium decay gives it a favorable longer term bias “after” price corrections compared to the VIX (VXX) which appreciates “while” prices are falling.

Longer term, there are no signs the economy, optimism, or stock market earnings will cease providing fuel for this bull market run, possibly well into 2018. If the low volatility wave can continue into the first quarter of 2018, then we will be be matching the 1995 proxy and look for deeper corrections then.

Saudi Aramco’s IPO is a mess

It is suffering from the whims of a capricious crown prince

THE proposal to sell shares in Saudi Aramco, the world’s biggest oil company, stunned the financial markets last year. Muhammad bin Salman, now Saudi Arabia’s crown prince, promised that it would be the biggest initial public offering (IPO) of all time, valuing Aramco at $2trn. It was to be the centrepiece of his plan to transform the Saudi economy, reducing its dependence on oil. It was meant to foster financial transparency and accountability in one of the world’s most hermetic kingdoms. Above all, it would cement the young prince’s image as a bold moderniser soon to inherit the throne.

Alas, youthful impatience appears to have got the better of him. His tendency to micromanage the IPO and vacillate over where Aramco should be listed has caused delay and confusion. Matters came to a head this week when advisers, speaking anonymously, and company executives doing the same, gave conflicting reports, suggesting a mutinous atmosphere.

The kingdom’s advisers say privately that the decision to list in New York or London has been postponed, and that the plan “for now” is to issue shares on Riyadh’s puny Tadawul exchange, with a private placement possibly to Chinese investors. But Khalid al-Falih, the oil minister and Aramco’s chairman, insisted the IPO would go ahead at home and abroad next year as originally planned. Company officials scorn the idea of listing only on the Tadawul, which would be swamped by an Aramco IPO.

The confusion appears to have originated from the royal palace. From the outset, MBS, as the crown prince is known, has insisted that the firm should be valued at no less than $2trn, and that the IPO should happen next year. He had not fully appreciated either the threat of lawsuits related to the terrorist attacks of September 11th 2001 that could result from listing on the New York Stock Exchange, or the complexities of issuing shares on the London Stock Exchange, where institutional investors are angry about efforts to water down listing rules for Aramco. He wrongly assumed that, given the huge fees promised to bankers and advisers, other actors in the world of finance would bend the knee.

Listing initially on the Tadawul only, as well as doing a private placement, may be a misguided attempt by MBS to skirt some of these difficulties, advisers say. It is seen as a way to promote the Saudi capital markets, and avoid the impression of selling off the family silver to foreigners. But with a limited pool of capital in the kingdom, some say a listing there could never raise the $100bn that MBS needs for his so-called Public Investment Fund to bankroll non-oil investments in the country.

Advisers say the kingdom is also considering recent expressions of interest by Chinese oil companies and other Asian investors, who are keen to take up to a 5% stake in Aramco. The attraction is that it would further cement ties between the world’s biggest producer and huge consumers of oil. But it would be unlikely to give the crown prince the $2trn valuation he wants, unless he guarantees large supplies of cheap oil as a side deal.

The confusion is uncomfortable for Aramco, which, as national oil companies go, should be an attractive bet for investors. It has 15 times more reserves of oil and gas than ExxonMobil, its biggest private competitor, higher production, fewer employees and lower costs per barrel. It also has an abundance of young (including many female) engineers, and technology that can almost visualise the sea of oil beneath the desert sands. Its executives say that efficiencies inherited from the days that it was American-owned persist. Many Aramcons, as company officials are known, appear to view the IPO as an unwelcome distraction, but are at least mollified by the prestige they think an international listing would confer.

To achieve that goal, MBS may need to reflect further on what an IPO means. His government is Aramco’s only shareholder and should, of course, have the final say. But unless he is prepared to loosen the reins, allow the IPO to advance at a prudent pace, and let investors decide what the correct value is, he might do better to scrap it altogether. His attitude so far suggests too little faith in the market forces that he wants to unleash.

The finance industry ten years after the crisis

MANY people complain that the finance industry has barely suffered any adverse consequences from the crisis that it created, which began around ten years ago. But a report from New Financial, a think-tank, shows that is not completely true.

The additional capital that regulators demanded banks should take on to their balance-sheets has had an effect. Between 2006 and 2016, the return on capital of the world’s biggest banks has fallen by a third (by more in Britain and Europe). The balance of power has shifted away from the developed world and towards China, which had four of the largest five banks by assets in 2016; that compares with just one of the biggest 20 in 2006.

The swaggering beasts of the investment-banking industry have also been tamed. The industry’s revenues have dropped by 34% in real terms, with profits falling by 46%. Return on equity has declined by two-thirds. Staff are still lavishly remunerated, but pay is down by 52% in real terms. (Perhaps it is time for a charity single: “Buddy, can you spare a Daimler?”) The relative importance of different divisions has also shifted, with the revenues of the sales, trading and equity-raising departments shrinking more than the merger-advice or debt-raising divisions.

This last change reflects market developments. In 2016 stockmarkets were smaller, as a proportion of GDP, than they were in 2006, despite the record highs on Wall Street; that was because Europe and Asia have not performed as well. Both government- and corporate-bond markets were bigger than they were a decade earlier. Although the crisis started because of overindebtedness, corporate-bond issuance has doubled in real terms over the decade, while the volume of stockmarket flotations has fallen by half.

Meanwhile the game of “pass-the-parcel” of assets around the markets has speeded up; trading volumes in equities, foreign exchange and derivatives have increased in real terms. In the corporate-bond market, trading in American securities has grown but trading in European debt has declined.

In the midst of the crisis, central banks stepped in with quantitative-easing programmes to buy financial assets. This has had profound effects, most notably in the bond markets, where yields have fallen to historic lows (and hence prices have risen). In contrast to equities, the value of both corporate and government bonds is significantly higher, relative to GDP, than it was ten years ago.

This has proved to be a pretty decent climate for money managers, who earn fees based on a percentage of the assets they invest. The industry’s pre-tax profits rose by 30% between 2006 and 2016, despite the growing market share of low-cost index-tracking funds at the expense of actively managed ones. At the other end of the cost spectrum, hedge funds, private equity and venture capital have all increased their assets, relative to GDP. The asset-management industry has become more concentrated. The 20 largest firms control 42% of assets, up from 33% a decade ago.

Overall, the authors of the report remark that “it is perhaps surprising how little has changed”. It may be less surprising if you consider that finance has two faces: first, as a driver of the economic cycle via credit expansion; and second, as an instigator of crises when creditors lose confidence. If markets are plunging and banks failing, as they were in 2008, it is understandable that the authorities do all they can to stabilise markets and rescue banks. As Tim Geithner, a former treasury secretary in America, put it: “The truly moral thing to do during a raging financial inferno is to put it out.”

By making the banks take on additional capital, the authorities have at least made the system less likely to suffer an exact repeat of the last crisis. But the world is still marked by a combination of high asset prices and high levels of debt. Outside the financial sector, there is even more debt than there was ten years ago; the combined total of government, household and non-financial debt levels are 434% of GDP in America, 428% in the euro zone and 485% in Britain.

In other words, the borrowing has been shifted to other parts of the economy; but that makes the finance industry no less vulnerable. A sudden fall in asset prices, or a sharp rise in interest rates, would reveal the jagged rocks beneath the surface. Central banks know this; that is why they are so cautious about unwinding monetary stimuli. At the heart of the next economic crisis will be the finance business; that is something that has not changed in the past decade.