World banks on an empty promise

Jocelyn Pixley's slender volume Emotions in Finance states in its opening paragraph that "money is based on a trust", but she goes on to say that trust "is inherently problematic". She then issues a warning that the world's money is less secure than we think.

Pixley, a senior lecturer at the University of New South Wales, Australia, argues that money is not tangible but a promise based on rarely examined premises - "since the idea of money as a 'promise' is counterintuitive, going against the everyday experience of its tangibility in our hands and wallets, most critics neglect the implied promise that money entails and so leave unexamined the trust on which it rests". And that promise is, primarily, government debt.

In the era of the Bretton Woods Conference (1944), gold standards, fixed currency interconvertibility and the Glass-Steagall Act (which separated commercial and investment banking in America), money was sounder than it is today. Then, in 1971, President Nixon floated the dollar; in 1975 competitive regulations replaced control-type restrictive practices on the New York Stock Exchange; in 1986, London followed with the big bang; and in 1998 Glass-Steagall was rescinded. Since then the risk inherent in all money trades has risen, and "distrust and sometimes fear inspires all financial action".

With $7 trillion in the world today (most of which exists electronically) and with capital markets erratic and herd-like, the basis of the world's money is unclear. Pixley complains, however, that instead of the caution that is proper to such a situation, our era is driven by a utopian assumption that we will all continue to get richer and that we can "de-risk" the future. She suggests that such a panglossian vision is not too different from that of Irving Fisher, who, in 1929, said that "stocks seem to have reached a permanently high plateau". Pixley correctly fears another meltdown as market players lose their trust in US monetary policies.

Even worse, Pixley worries that the instruments the market has generated to increase trust have been counterproductive. For example, share options were introduced to align the interests of managers with shareholders, but they have simply introduced recklessness. That is because managers need not take up their options, but they can be rewarded with big payoffs if they fail, so they have the incentive to take absurd risks because they personally gain most if their companies succeed or fail spectacularly.

It could also be argued that the modern trend to empower non-executive directors simply empowers non-experts to take decisions in fields of which they are ignorant.

The word "credit" derives from the Latin " credito ", I trust, and Pixley interviews a host of authoritative bankers and other financial players in the US, the UK and Australia to determine how we reached our current but dangerous position.

But there is a gap in this book. Nowhere does Pixley make clear her prescriptions for a safer future. For example, she laments the passing of an era when a trader's word was his bond because he knew everybody with whom he traded, but she does not argue that the days of impersonal trust should now be reversed. She laments the loss of regulations, but new regulations such as America's Sarbanes-Oxley Act on corporate governance and financial disclosure have been introduced, although in my opinion they do not go far enough. She does not comment on this and, indeed, Sarbanes-Oxley is not in the index and does not appear to be cited in the text. Further, if the core problem at the heart of the financial nexus is inappropriate government debt, then it needs quantifying.

But perhaps that criticism is not fully justified. Pixley works in a department of sociology and anthropology, so she may be forgiven for simply chronicling the succession of stratagems markets generate as they search, fruitlessly, to reduce risk and foster trust in an inherently risky and dubious world.

As a chronicle of shared financial anxieties, written by an observer from an alien world, this is an excellent book. For a solution, we need to look to other writers.

Christopher Ondaatje is a retired investment banker, an author and a trustee of the National Portrait Gallery.