1. Fundamental Long-Term Risks And the New Financial OrderProf. Robert J. Shiller
Yale University
2. Financial ModernizationFundamental role of financial institutions
Manage risks
Maintain incentives
Effective financial institutions are found in all successful economies
Institutions must continually be adapted to take account of changing nature of risks, new technology
3. China’s Spectacular Modernization Since 1990Established stock market
Issued shares to public
Established futures markets
Created Insurance industry
Personal credit/Mortgage
4. SpeculationHuman impulse towards gambling, must be directed towards constructive ends
Capitalism is a set of rules that redirects the human gambling urge in constructive directions
Capitalism is vulnerable to market-generated instabilities
5. China’s UncertaintiesWill the spectacular economic growth continue?
As low wage advantage gradually disappears, will be harder to sustain growth
Possible disruptions of smooth-functioning economic system can slow growth.
Growth of 3% a year vs. 9% a year: means China overall catches up to advanced countries in 90 years instead of 30 years
6. Economic InequalityEconomic incentives must allow for some chance of success—and of failure
Some inequality is necessary
Worldwide trend towards greater inequality is seen in China as well
China’s Gini coefficient has risen from 0.33 in 1980 to 0.46 in 2000, not just due to farmers’ incomes
7. Important Reasons for Growing Chinese InequalityTransition to market economy in China is not making everyone successful at once
New information technology appears to tend to concentrate wealth (in China and elsewhere)
Assembly line workers
Translators
Chess players
8. Winner-Take-All Effect of Information TechnologyInformation technology allows search to find the best product, and replication of the best product
Phonographs and singers
Television and actors and athletes
Rapid acceleration of information technology may create the same effect in many more occupations
9. Norbert Wiener on Computers, 1948Computers replace fundamental human abilities
Computer may be “more dangerous than the atom bomb” in that it can destroy jobs and lives
10. Prominent Financial Issues under Discussion in ChinaValuation of the yuan
Nonperforming loans
Capital controls
A second board market
11. Other Ideas for Financial InnovationMany changes should be coming in world financial markets that China should adopt too
China is an innovator in choosing its own path, could set the path for other countries
My books: Macro Markets, Oxford University Press, 1993, in Chinese 2001, and The New Financial Order: Risk in the Twentieth Century, Princeton University Press 2003 and Chinese People’s University Press with Liang Jing Publishing Studios, 2004
12. Ideas for ChinaAn effective progressive tax and wage subsidy system that addresses inequality
Inequality insurance
Electronic money replaces cash
New units of measurement: indexed units of account
A universal social security system that addresses income and health problems
13. Ideas for China ContinuedIntergenerational risk sharing
Macro securities: China sells shares in its GDP to foreigners
Livelihood insurance: encourage entrepreneurship on individual basis
Home equity insurance: manage risks to home values
14. A More Effectively Progressive Income Tax System and Earned Income Tax CreditHigher taxation of successful people used to subsidize less successful
Subsidy of less successful is made in terms of a wage subsidy (EITC) to maintain incentives
15. Inequality InsuranceTax rates could be indexed to a measure of inequality in such a way that inequality is prevented from worsening
Can legislate a tax system that prevents further worsening
Implement a plan for such a tax system that will alleviate income inequality in the future even if the system cannot be implemented for some time.
16. Move towards Electronic MoneyCash transactions are hard to tax
Thoroughgoing use of electronic money in China would make an effective income tax and wage subsidy system feasible
In US, cash transactions are confined to small items, newspapers, candy bars
Electronic payment systems already here in China: need to expand them
17. Indexed MoneyOnce we have a system of electronic money, the money can be indexed
Inflation-indexed debt allows savers to lock in their future returns
Inflation-indexed life annuities allow people to guarantee their retirement
Indexation can be helped by creating new units of measurement: the Unidad de Fomento (UF) of Chile
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20. Social Security System:Old Age InsuranceSocial Security is in ferment around the world today because of declining birth rate
In coming decades, will be large number of elderly relative to working people in China, as in many other countries
21. Intergenerational Risk SharingIn many countries, old-aged pension benefits are indexed to inflation
But that eliminates risk to the elderly, concentrates risk on working adults and children
Social security system must be established on a sound theoretical framework based on theory of intergenerational risk sharing
22. China Should Sell Shares in its GDP to ForeignersChinese uncertainty is borne by Chinese alone today
Believers in the Chinese economy abound, all over the world
China needs to use these believers as investors to manage its risks
China needs to diversify its portfolio somewhat, and a deal can be struck to do that
23. Loans with GDP WarrantsGDP warrants grew out of oil price warrants issued as part of Brady-Bond refinancing for Mexico, Venezuela, and Nigeria
Bulgaria issues warrants on GDP as part of Brady-Bond refinancing, 1994.
Bulgarian warrants, inseparable from discount bonds, have not created salient price discovery for claims on Bulgarian GDP
24. Economic Derivatives MarketGoldman Sachs-Deutsche BankFirst Auction, October 2002, Nonfarm payroll
Auctions in ISM Index, IFO Index planned
Parimutuel Digital Call Auction (PDCA) Longitude, Inc., New York
25. Macro MarketsUS patent #5,987,435 with Allan Weiss (Case Shiller Weiss, Inc.) would to create securities based on income aggregates or real estate prices: “macro securities”
Allan Weiss, Sam Masucci and I have founded Macro Securities Research (1999) and Macro Financial LLC (2004) to promote macro securities
Working with American Stock Exchange, completed legal work, one specialist firm has committed to make a market
26. Macro SecuritiesMacro securities issued and redeemed by exchange only in pairs, one long and one short.
Each member of pair has a cash account made proportional to some economic index (such as GDP) by reallocating across accounts
Each Macro pays dividends equal to interest on their cash account (NAV).
Price of Macro should in equilibrium reflect market valuation of claim on cash flow
27. Declaration of Nuevo LeónAdvocates GDP-Indexed DebtSummit of Americas, Monterrey Mexico, January 2004
Signed by 34 Western Hemisphere heads of state
Tying debt of countries to countries’ GDPs helps insulate their economies from macroeconomic fluctuations
Subject of GDP-Linked Debt will be on agenda of international conferences
28. Livelihood InsuranceReplaces life insurance in dealing with largest risks
Long-term policies based on occupational indexes
Repeated measures occupational indexes: Robert Shiller and Ryan Schneider Rev. Income and Wealth 1998
Powerful impact on conservatism in life’s decisions, makes for more risk taking
29. Home Equity InsuranceRisks to values of homes greater than risks by fire
Oak Park Illinois, 1977
Chicago Home Equity Assurance Program 1988
Index-based insurance, Shiller and Weiss 1994
Yale-Syracuse-NRC program, 2002
30. Radical Financial InnovationInnovation that extends the principles of insurance, diversification, hedging into new directions, covering risks that had not been managed before
Innovation that democratizes risk management, that permits it to be used for the benefit of everyone.
Can cover the big risks that create major inequality in society
31. A Model of Radical Financial InnovationRisk manifestation
Experimentation
Robust reframing
Involvement of existing institutions to promote change