Development of Central Banks and Governments policy into the Creation of a New Breed of Sovereign Funds with strategic function to rescue and rebuild: Economic Reconstruction Institutions

“Tell us briefly: How did it all happened?”

Concerning the current crisis, many among clients, family and friends asked me insistently: “How did it all happened? And where are we going from here?” The technical explanations seemed to be too long and complex. Many had been provided already. So, I answered with the following parable from the book “The Prophet” by Kahlil Gibran, so that all could understand.

“And a merchant said, ‘Speak to us of Buying and Selling.’ And he answered and said:

‘To you the earth yields her fruit, and you shall not want if you but know how to fill your hands. It is in exchanging the gifts of the earth that you shall find abundance and be satisfied. Yet unless the exchange be in love and kindly justice it will but lead some to greed and others to hunger’”.[1]

The previous piece was published in 1923, thus before the Great Depression, it can be used as a key to interpret how we got to where we are. Yet, understanding the inner reasons that ignited the current financial involution are quite useful. They can serve to seize the opportunities that arise, help us to get out from an extremely difficult situation and to go successfully forward from here. In addition, the recipe to save the economies is composed of ingredients formerly neglected: the return to ethics and to a more sustainable and balanced growth.

Too many are just focusing on the huge disasters brought by the recent events, without noticing the unprecedented opportunities that are equally rising. In my previous article[2], I focused on the strong positives that this crisis unleashes for the Italian economy and for all of those where medium and small size companies (SMEs) have an important presence. These systems are now enhanced by a new operating enterprise model of a dynamic network of firms: the Platform Company[3] and by the comparative advantage of being in a healthy shape vs. an almost bankrupt competition. Thus in the western world, the dynamic interaction of a wide network of small and medium independent businesses (SMEs), often family owned, were key elements that kept us together. The simpler and longer term business models are those to thank for our capacity to endure this unprecedented ‘storm’ that is shaking the western systems from its fondations. The multinationals giants, most of which heavily responsible for contributing to create this crisis and for having had a very bad influence on governments and regulators, were the one to be rescued with public money. A Way Forward for the Western World

Yet, even a healthy independent business, managed in a balanced and profitable way,  can go bankrupt only by a contagion effect, by its bank withdrawing suddenly its credit lines, by its customers not honoring their payments, or by simply not being able to buy anymore… The ‘sheer force of nature’ of the recent events forced the Governments to intervene quickly, and most acted even too slowly and in a confuse way[4].

Now the western world is aware of the absolute necessity to intervene in the economy, re-establishing lost confidence and trust, focusing on restarting the economic engine and resolving the unbalances. Yet, this has to be done differently form the past, history should not be forgotten, and the west has a clear opportunity starting from the USA.

It is easy to understand why Fidel Castro is easily ‘laughing’ in Havana. The current risk is that vast masses in the western world could become much poorer than the average Cuban individual. Castro would argue that our system it’s on the ropes and it does not work anymore. In realty, the proof of the pudding will be a strong readjustment of the capitalistic system, the birth of “a third way”. Unbalances and unsustainable “shortcuts of the economic logics”, lead to an abrupt landing of the American dream, of the sovereign free market economy and imploded into the most serious structural crises ever.

Ethics, respect for the individual, and sustainable growth have been strongly neglected and they can now ‘come back from the window’. There is a better way to operate: an overall revamping process that is now taking shape form the USA. Yet, America will not turn with this into a centrally planned economy. It appears to emerge a more systematic and rational tool to rescue our western economies: the creation of what we could name ‘Institutions for Economic Reconstruction’.

By taking over, or by being ready to take over, ailing financial institutions (namely banks, insurance companies and soon key industrial players), leading western governments transformed “de facto” the function of central bank reserve managers in that of national  wealth managers. This comes close to the model of the existing Sovereign Wealth Funds.

We should note that in the past decade western governments have been showing a deep “crisis of role and leadership”, between following the dictate of strong multinational pressure groups in the name of free market forces and still respecting some elementary forms of economics, democratic principles and of human values. Unbalances have grown to unprecedented levels and it is now evident what that led to.

The only way for the various affected governments to avoid a catastrophe, to reestablish trust without which no modern system can work, has been direct recapitalization, acquisitions of stakes, where necessary taking control of ailing financial enterprises. It will take time for things to go back on track. Probably the same government intervention already applied to banking and insurance will be necessary in other areas like: automotive, airlines and public transport, telecoms. Certainly ‘oxygen’ will have to be given to favor the growth and prosperity of the fundamentally important small and medium firms (SMEs).

Major Economic Reforms are necessary

Yet, western governments have now not only a duty to restore confidence but also an opportunity to recreate a better role for them going forward, to find a way that they seemed to have lost. They need to implement major economic reforms. A fundamental key to this is going to be the creation of Institutions for Economic Reconstruction (IER).

The existing SWFs have different ‘styles’, experienced a recent rapid growth and they are predominantly from the Middle East and Asia as a consequence of their accumulation of surpluses from oil and exports[5].  Most of them were set up for ‘saving for rainy days’, broadly speaking. Very interesting feature is their status as sovereign owned asset pools. That makes their liability profile dissimilar to that of pension funds or of traditional reserve assets. This means that their liability profile is quite unique and allows for a real long term horizon and for a much needed flexibility. Therefore IERs could represent the ideal vehicle to be shaped, managed and directed by wide and commonly acknowledged government policies to rescue national enterprises.

In light of the current economic catastrophic dangers, they could not represent a protectionist way to defend single economies but the opposite. They are a way for each state to care for its economy, to restore long term growth and prosperity, to reduce vicious unbalances in each country, in coordination among different governments and when necessary with reciprocity of action.

An evolution of a Western Central Banks function: the birth of Institutions for Economic Reconstruction From the most abrupt and serious crisis ever experienced by the western economies emerges a historical opportunity. This is the evolution of a Central Banks and of national Governments policy in their strategic function to rescue and revamp our systems with the creation of Entities with the precise tasks that we report below.

The sheer magnitude and speed of recent events was such not to allow anything but a quick emergency rescue action. The predicaments of J.M. Keynes are very much back with a vengeance (if they ever left us).  The set up of this new kind of Institutions appears to be the proper answer, or one of the key answers, to contribute solving the current crisis and to set up solid fundamentals to represent a dynamic ‘engine of growth’.

A strong advantage is going to be the freedom of having a clean slate, to ‘design’ in an efficient and rational way at the outset the broad functions and the exact dynamics that these institutions will have to play. For the western economies the functions that IERs are likely to play will be different from those of existing SWFs even though the ultimate goals will be similar.

These are the main functions to be played by the Institutes for Economic Reconstruction:

  1. Be the first immediate support to strategic sectors of the economy to prevent their collapse which would be catastrophic for the entire system, by taking over preferred shares, so possibly with no voting rights, and taking control only where strictly necessary. The acquired shares would be a midway between shares and bonds.
  2. Acquiring preferred stakes in small and medium size businesses (SMEs) to protect them for being indirect contagion casualties, to also facilitate their financing from local banks, their international development plans.
  3. Acquiring preferred stakes in new enterprises with strong growth prospects to promote new technologies, exports to BRICs, vital sectors of the economy, …
  4. Acting just as a traditional institutional investor in search of long term returns and acquiring assets domestically but also abroad, restoring confidence and stabilizing markets in coordination with the necessary general economic reforms that each of the western countries will have to develop.
  5. Defy fears that external SWFs may have other reasons other than portfolio diversification and that by investing their financial resources in other countries they could take control of crucial national interests, strategic companies, raw materials of influence other sovereign states[6].

In other words IREs would resolve the issues that brought to the agreement on the “Santiago Principles” [7].

For the above reasons we define these new entities as Institutions for Economic Reconstruction of the like of I.R.I. once operating in Italy, a model that can be taken into  consideration and be perfected. French President Nicolas Sarkozy just announced that his government will establish a strategic fund in a few weeks’ time to protect domestic industries battered by the financial crisis from going under.  The French government could potentially inject $130 billion into the fund.[8] This is a concrete example of what said.

The detractors of the creation of these new institutions seem to ignore that; a) the governments had to intervene already (with the taxpayers money) massively to rescue several financial institutions, among banks, mortgage lenders, insurance companies; b) each single nation has the duty to take its responsibility to counteract this dangerous financial involution; c) the danger of these new Institutions to promote a new wave of economic isolationisms and protectionisms are equivalent to the fear that the Middle Eastern Sovereign Funds would interfere and influence entire nations by taking over companies in strategic sectors. This was taken care by setting agreement on the “Santiago Principles”[7].

In reality, the SWFs have plaid a useful role so far and, as in everything, it always depends on how we use things. The detractors seem also to ignore that SWFs have already acted to stabilize markets[9] and they saved some national institutions and to avert a catastrophic crisis.  Now it is the duty of each nation to commit sustaining its own industries and enterprises in a way that only each individual country can and must do.

Conclusions

There are reasons to be optimistic and estimate that the new breed of Institutions for Economic Reconstruction will be set up properly, with professionalism and a good balance between economic principles, sustainability, and a new growth stimulus. There are skills that have to be used in the constitution, design and management of such funds. It is relevant to make sure that IREs will produce the required outcome with the understanding that the general community will benefit from a stronger and more balanced economy, and lastly from the surplus generated by the difference between the purchase price of the stakes acquired and the selling price obtained when the market conditions will be appropriate.

Many asked me that if the public sector takes over banking and insurance, then soon it will be forced to take over some important industrial sectors.  Are important sectors like health care, education, research, transport, going to be fully back in public hands?

Well, I will be glad to continue my analysis and provide a comprehensive answer to these queries. For now, the purpose of this brief article is to start analyzing the opportunity that opens up with the creation of Institutions (IREs) to reconstruct the affected economies. This will happen starting from the USA that will set a first example on how best to implement reconstruction strategies and the institution of the necessary economic reforms.

For the past 15 years, except for the last of course, governments in the western world enjoyed an unprecedented continuous economic growth but developed deep contradictions, leaving everything else to the free market. It is now time to put the house in order. I find inspiration again in the words of “The Prophet”. “When in the market-place you toilers of the sea and fields and vineyards meet the weavers and the potters and the gatherers of spices,- Invoke then the master spirit of the earth, to come into your midst and sanctify the scales and the reckoning that weighs value against value. And suffer not the barren-handed to take part in your transactions, who would sell their words for your labour. To such men you should say: “Come with us to the field, or go with our brothers to the sea and cast your net; For the land and the sea shall be bountiful to you even as to us.” And if there come the singers and the dancers and the flute players, – buy of their gifts also. For they too are gatherers of fruit and frankincense, and that which they bring, though fashioned of dreams, is raiment and food for your soul.”

This recent period of deep economic dislocation and disruptions will result as the best reality check, as the soundest wake up call to the western governments, financial authorities, regulators, and to the people. Excesses will be rectified and solved; the balance between a free market and general economic and human principles will be reinstated; commodity prices will be closer to their economic fundamentals and they will guarantee stability and absence of inflation.

Last but not least, ethical and sustainable growth considerations will play a role. Markets will come out from it different but ultimately stronger. We have the funds, the expertise, and now the will and a good impending reason to make it happen.

“And before you leave the market-place, see that no one has gone his way with empty hands. For the master spirit of the earth shall not sleep peacefully upon the wind till the needs of the least of you are satisfied.[10]

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[1] K. Gibran: The Prophet, 1923
[3] GaveKal-Dragonomics: A. Kaletsky, L.V. Gave: A rodmadmap for troubling times; our Brave new World; The End is not nigh; www.gavekal.com
[4] Britain earmarks $87 billion to bail out banks,By Landon Thomas Jr. and Carter DoughertyPublished on Herald Tribune, October 8, 2008; http://www.iht.com/articles/2008/10/08/europe/09britain-fw-2.php
[5] Who holds the wealth of Nations? by A. Rozanov, 2005. http://www.ssga.com/library
[6] International investment of sovereign wealth funds: are new rules needed? OECD http://www.oecd.org/document/43/0,3343,en_2649_34887_39641259_1_1_1_1,00.html
[9] H. Al Suwadi: Wealth Funds’ Long-Term View May Help Stabilize Markets IMF Survey;    http://www.imf.org/external/np/sec/pr/2008/pr0897.htm[10] Kahlil Gibran, The Prophet, 1923.