2009 - A tipping point

Virtually every aspect of life in Australia will be affected by decisions made in China over the next two decades

(pages 58-60 of printed journal)

What did not happen in 2009?

When it comes time to chronicle the big events of the twenty-first century, the year 2009 will be legendary for what did not happen. In my diary, on the final day of this year, I will write that 2009 will be remembered as the year that the Global Financial Crisis did not happen; and the year that we did not get an Emissions Trading Scheme. These are, of course, closely related events. Let me explain.

In this ninth year of the third millennium, consumers in China bought more motor vehicles than consumers in the US. Behind this brutally simple statistic lies a story as powerful and significant as what happened 20 years ago - 9 November 1989 to be precise, the day the Berlin Wall came down. The collapse of the Berlin Wall heralded a memorable - and some would say 'golden' - era. Here are a few of the historical markers of this time:

The reunification of Germany;
The fragmentation of the Soviet Union and the end of the Cold War;
The demolition of South Africa's Apartheid regime; and
The year that the Israeli-Palestine peace process came within a whisker of a negotiated settlement.

The experiences of this past year have been as tumultuous as these historic events, although the inevitable absence of nostalgia perhaps makes it difficult for us to see with clarity and perspective the significance of what is happening around us.

The Global Financial Crisis

It has famously, and amusingly, been said that financial markets have predicted 11 of the past four recessions. But this Global Financial Crisis was neither amusing nor predicted. It was a giant wake-up call, so gigantic in fact, that it destroyed trillions of dollars of pension fund investments and brought the world banking system to its knees.

I was at the Sea World Resort in Queensland on a family holiday in September 2008 when I heard the unbelievable news that Wall Street titan Lehman Brothers had collapsed. And not just collapsed, but was allowed to collapse, perhaps even willed to collapse by the Secretary of the US Treasury Henry Paulson - who perhaps wanted to teach us all a lesson about 'moral hazards'. I suspect it was because I was not wearing a suit that day that the Lehman news dazzled me, and left me feeling punch-drunk. As I sat by the pool in my shorts and thongs, sipping a Corona, my instincts immediately told me that the portents were very, very bad. And indeed, it was so.

Today, happily, we can joke that the Global Financial Crisis was the shortest and shallowest 'depression' in recorded history. We laugh, nervously, that it was a 'near-miss'. But for many months over the past year, the global financial system was in tatters. It was a period when we had to admit we neither understood how the global financial system really worked, nor how to fix it. It was a period when we even doubted our ability to understand, let alone defend, capitalism.

How did we get so close to the precipice? Understanding the 1930s breakdown

Now that the financial storm has receded, I would like to take just a brief moment to offer a view on how we got so close to the precipice - how the global financial system very nearly ate its progeny. I can see the thought-bubbles above your heads saying that it would have been nice to share these insights before the crisis. For the present, I want to limit my remarks to the work of brilliant academics who you may have heard of and perhaps studied in recent years - renowned scholars like Black, Scholes, Merton, Markowitz and Sharp. Their work on quantifying and valuing risk had a profound impact on financial markets over the past decades.

In plain English, their models allowed us to fix a precise price for risk. Indeed, very precisely. And as we all know, once we can price risk precisely, we have 'certainty'! And because we had 'certainty', we took much more risk. This was rational and reasonable behaviour. Or at least it would have been so if the degree of precision was justified. But it was not. The precision was a mirage.

Academic theories

To see through the mirage, we need to get a little closer to these academic theories, and when we do that, we discover that many of the economic theories have their genesis in the natural sciences. It is not too much of a stretch to say that these academic theories assumed that human beings (i.e. investors) would act like molecules in a physics lab - neutral, statistically independent, and rational¹. In short, the theories were fine. The assumptions were precise. But the application of the theories was utterly unjustified.

Millions of column-inches have been written about the Global Financial Crisis, but we still struggle to find the words to explain 'how' we got to this point. This is of course a feature of the human condition - we tend to personalise and trivialise both the good and the bad in our lives. So the next time you hear someone say that the Global Financial Crisis was caused by 'greedy investment bankers', remind them that all would have been well, if only humans had acted like molecules in a physics lab.

The Emissions Trading Scheme

This talk of physics takes me to my second theme, indeed, the second 'near miss' for 2009 - the Emissions Trading Scheme that we did not get. On the Labor side of politics, Caucus unanimously supported the ETS legislation. Surprisingly, there was not a heated and intense debate in the Labor Caucus Room about the Emissions Trading System, one of the most significant and far-reaching pieces of legislation of our generation. Instead, there was unanimity, broad consensus, no cross-factional negotiations. There was agreement 'on all fours', as the legal fraternity likes to say.

This troubled me. It was too neat. It was too harmonious. The absence of acrimony struck me as being artificial and confected. Call me a sceptic if you must, but the French have a useful expression for this, which loosely translates as 'through conflict comes the truth'. In my view, there was not enough 'conflict' in the Labor Caucus Room to find the 'truth'.

In contrast, there was nothing confected in the Federal Coalition Party Room. The debate was vicious, personal, dogmatic and strident. It was good theatre. But that too troubled me. The debate in the Coalition Party Room was authentic and, I suspect, unique in the annals of Australian conservative politics. Indeed, I cannot recall any issue since Federation where the Conservative battle lines cut across both traditional and non-traditional alliances so deeply. Thus:

Big business supported the Emissions Trading Scheme - whereas small business loathed it;
Farmers supported the Emissions Trading Scheme - whereas the National Party opposed it;
Energy retailers supported the Emissions Trading Scheme - whereas coal fired electricity generators railed against it; and
Liberals in the Lower House strongly supported the Emissions Trading Scheme - whereas Liberals in the Senate comprehensively rejected it. If the French are right, that 'through conflict comes the truth', then the Coalition parties found the truth. And the truth is that Australia - and the rest of the world - is divided on this issue, along both traditional and non-traditional lines. Thus:
There is division between developed and developing countries - as expected;
More subtly, there is division between the powerful developing countries such as China and the politically weak and low-lying developing countries such as Bangladesh and the Pacific Islands; and
There is division and acrimony between scientists.

However, these divisions vary in form, substance and degree. Before the end of 2009 we will see the fruits of Copenhagen, and the same divisions that we are witnessing in Australia will also be on show in Denmark over the next few days.

Concluding remarks

I would like to conclude with a prediction. I feel entitled to do so because I sat in Wilson Hall, where you are sitting now, 30 years ago this week, as a newly-minted graduate of the Faculty of Business and Economics. In the past 30 years, I have generally resisted the temptation to make grand sweeping predictions. But I feel the urge to make a prediction today.

My prediction is that we will look back to 2009 as a 'tipping point'. Sometimes things need to get worse before they get better. And this, I believe, will be the legacy of 2009. Firstly, the Global Financial Crisis made things worse - but the financial architecture, and our financial understanding, will be much better, now that we have exposed some poor foundations and misconceptions. Similarly, opposition to climate change action - both in Australia and at Copenhagen - is reaching a deafening crescendo, which will provide the impetus for the opposite force, namely unprecedented national and international cooperation to deal with the issue.

Finally, what does any of this have to do with consumers in China buying more motor vehicles than consumers in the US? It needs to be said bluntly that the world has changed. Virtually every aspect of life in Australia will be affected by decisions made in China over the next two decades. Thus:

It is because of the Global Financial Crisis that Americans are saving more and the Chinese are spending more;
Asia - notably China and India - will constitute 50 per cent of all global carbon emissions by 2030. Indeed, at the beginning of 2009, China surpassed the US as the largest emitter of greenhouse gases; and
At a geopolitical level, neither the 'G8' nor the more fashionable 'G20' matter as much as the 'G2' - China and the US.

This is a world in flux. I know I will look back on 2009 with great fondness, and a sense of 'history in the making'. I cannot imagine a more exciting time to go into this magnificently beautiful but unpredictable world, with a degree under my arm, than the end of 2009. So, on your way home, please remember to take the long road; the slow road; to reminisce on this amazing year - a historical tipping point in the making. And please feel free to write to me - in another 30 years time - to let me know if my predictions were correct.

¹ Borrowed from Andries Terblanche, Partner, Financial Services, KPMG

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An edited version of his Occasional Address delivered at Wilson Hall, the University of Melbourne, 15 December 2009.

Chris Leptos (chris@leptos.com) holds a BCom and an MBA from the University of Melbourne, and is a member of the University's Faculty of Business and Economics Advisory Board. He recently stepped down from the position of Managing Partner - Government Services at Ernst & Young, and joined the KPMG partnership early in 2010. Mr Leptos is also a Director of Asialink and the Asia Society, a Governor of The Smith Family, and a CFA volunteer fire-fighter. In 2000 he was awarded the Order of Australia for his work in the area of sustainability in the global resources sector.