If you raised an eyebrow at Francis Fukuyama’s famous treatise The End of History – his controversial declaration that the triumph of liberal democracy at the end of the Cold War represented the end of mankind’s ideological evolution – you may again be sceptical of accounts offering a definitive endpoint to complex events.
In fact, The End of Money: The Great Erosion of Trust in Banking, China’s Minsky Moment and the Fallacy of Cryptocurrency is more about the evolution of finance – rather than any finality – especially over the last five decades.
David Buckham, Robyn Wilkinson and Christiaan Straeuli track this evolutionary trend alongside a parallel erosion of trust in banking. The step change was the economic crisis of 2007/08 and a realisation of just what the bankers had been up to in their inexhaustible appetite for profit to counterbalance the effects of the 1997 Asian financial crisis.
Banks became embroiled in the sub-prime housing mortgage bubble, creating a derivative market somewhat akin to the children’s game of “pass the parcel”. When the music stopped, the crash was inevitable. Almost overnight, banks themselves lost trust with one another, and liquidity dried up.
The authors write: “It is easy to blame individual bad actors and Wall Street in general for the failure of the US banking system. But the real underlying driver was the political intervention that allowed the banking system to operate in a manner that was ultimately unsustainable – a phenomenon that is mirrored today in the build-up of leverage currently taking place in China.”
Buckham, Wilkinson and Straeuli take us through a brief history of international banking, with the focus on US financial institutions.
They plot its course from the Glass-Steagall Act (a response to the 1929 Wall Street Crash which sought to insulate commercial retail banks from the risks associated with financial speculation of investment banks) to the momentous decision of President Richard Nixon in 1971 to abandon the the US dollar’s convertibility to gold, heralding a new era of freely floating currencies.
But the crux of this revealing book is their none-too-reassuring analysis of China’s banking system.
Dominance of Chinese banks
Using data assembled by The Banker magazine, the authors reveal just how radically the banking landscape has changed, and how dominant Chinese banks have become.
When it comes to the largest banks globally, one nation dominates the list. In fourth place is Bank of China recording total assets of $3.7 trillion – 10% larger than JPMorgan. In third and second place are Agricultural Bank of China and China Construction Bank with $4.1 trillion and $4.3 trillion in total assets respectively.
In first place, by a significant margin, is Industrial and Commercial Bank of China, holding $5.1 trillion in assets on its balance sheet – more than 150% the size of JPMorgan, and larger that Bank of America and Citigroup combined.
These are startling statistics by any measure, but what makes these figures even more extraordinary and alarming is that even a former governor of the People’s Bank of China admitted in 2001 that China’s banking sector had experienced very high incidences of non-performing loans (NPLs).
In 2003, internal (state-controlled) estimates put the NPL ratio of the top five Chinese banks at 23%, while external ratings agencies put the figure at roughly one third of total loans owing.
The Chinese authorities responded by creating four state-owned asset-management corporations (AMCs) to deal with the banks’ bad debt problems, removing NPLs from their balance sheets. In total, the four AMCs assimilated $481bn of “distressed” debt.
“To put this into context,” the authors tell us, “that was twice the size of Portugal’s GDP in 2017.”
Warning signs ignored
The authors conclude that the overlooked warning signs prior to the global financial crisis provide a salutary warning. They write: “In 2001, the data relating to Chinese banking systems and its debt levels alone, should have been sufficient to motivate global attention. “When combined with runaway monetary policy in the US and elsewhere, which is accelerating already worrying inequality in the West, this problem becomes ever more pressing.”
As if that wasn’t enough for policymakers to grasp, the global financial regulatory landscape is also being impacted by the growing influence of fintech and its ability to challenge traditional banking. The book offers a chapter that recounts the sorry story of payments and risk management services provider Wirecard, describing how the firm misled investors into believing that it was engaged in a higher volume of trade than in reality was the case.
This illusion was created by Wirecard entering into agreements to sell and repurchase securities. When Wirecard listed, it did so by buying in 2005 a company already on the Frankfurt exchange, thereby avoiding the scrutiny that would accompany an initial public offering.
But as the authors state: “Wirecard was able to get away with deceiving investors for so long in large part because, as a fintech company that offered both banking and non-banking services, it essentially existed between the systems of regulation and oversight that apply to financial services companies.”
“More than a decade after the Financial Crisis,” Buckham et al observe, “history is in danger of repeating itself in the case of fintechs. These firms have typically marketed themselves as disruptive alternatives to the established global financial sector.”
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The challenge of cryptocurrency
However, fintech is not the only “disruptive alternative” – it can be argued that the growth of cryptocurrency is equally as challenging to the financial sector’s status quo.
The real game-changer has been in the development of blockchain technologies that heralded the rise of the distributed ledger system.
“By 2021,” we learn from the book, “there were more than 10,000 different crypto-currencies in existence, though Bitcoin remained the most popular. For the purists, at the core of Bitcoin’s intrigue is its countercultural ethos – the so-called triumph of being able to bypass official institutions such as banks in transactions.”
And perhaps that is the reasoning behind the book’s provocative title, The End of Money. Yes, the authors have made the case that there has been a destruction of trust in conventional financial institutions, and the rise of crypto and the Chinese banking system offer huge opportunities and enormous systemic risks.
But it is worth remembering that even the rise of cryptocurrencies is expressed in their dollar equivalents. Like history, money might not have reached its apogee just yet.