Keynote address: financial markets at the end of the 20th century.
It's a pleasure to join you this evening and a privilege to address you on the 100th anniversary of the Department of Economics at the University of Illinois.
On a personal level, today marks a gratifying opportunity for my wife, Joanne, and me to return to a school that holds a special place in both our hearts. Our years here provided us not only with a first-rate education but also with a broader appreciation for accumulated knowledge and culture that has served as a foundation for our professional lives. We were both fortunate to have been taught by people who stimulated us with new ideas, who always expected the very best from us, and who, most importantly, equipped us with the means to grasp the opportunities that life would afford us.
The lessons we learned at the University of Illinois have stood us in good stead. Whether as a student senator, a basketball benchwarmer or as a research assistant for a young economics professor, I learned the discipline of hard work and reasoned argument. I also learned the responsibility to deal with adversity without quitting. In a fundamental sense, these lessons are as important to both of us today as they were 28 years ago. In short, Joanne and I are proud - and grateful - to be Illini.
As you know, the public sector, and public education specifically, is today under attack for its perceived inadequacy in meeting the challenges of our society in the 1990s. Some of this criticism is fair. Our primary public school system has enormous problems, particularly in our cities. The efficiency of the public sector can surely be improved. And there must clearly be a more satisfactory distribution of social labor among government, business and the individual citizen. But none of this should blind us to how valuable strong public institutions are to our country or how important public education is in a democratic society.
In my view, education - particularly public education - is the basis of renewal and progress, for Illinois and the entire country as we approach the twenty-first century. And I'm sure the University of Illinois can and will play a critical role in this renewal. It stands for what is best in public education. The University serves a vital and irreplaceable role by providing quality, educational opportunity to this state's young adults on an affordable basis. Each year, roughly 6,000 undergraduates and 3,500 graduates students matriculate as worthy contributors into a productive society. The University is a byword for excellence in teaching and research, with one major contribution after another in agriculture, computer sciences, physics, economics and other disciplines. Seventeen Nobel Prize winners have graced this campus.
This institution is a clear example of how a very large and diverse population working together purposefully in a non-bureaucratic, creative way can achieve the highest level of excellence. Diversity is and should be viewed as a strength in our society. The University of Illinois teaches this lesson well.
Let me now turn my remarks to a view of the world of economic life from my current position as Senior Partner of an important global investment bank. Let me assure you, the common sense, values and knowledge developed on the farm fields of Central Illinois and at Champaign-Urbana frame that perspective as much as the workings of Wall Street. After all, the essentials of success and productivity in business or academia - whether for an individual or a corporation - are very much the same. Those fundamentals are simple to list. They're a bit more difficult to practice. A commitment to integrity, a belief in intellectual excellence, hard work and an openness to change are all qualifies that any person or business must possess to build a competitive edge and to contribute.
I've come to appreciate these fundamentals even more during my rookie year as CEO at Goldman Sachs. The more complicated life and business become, the more important it is to remember the basics.
Many of you may not know much about Goldman Sachs. Some of you may even entertain notions of investment banks like Goldman as modern-day robber barons - "Barbarians-at-the-gate" to steal a moniker.
Well the truth is a little more mundane. Goldman Sachs is, in a phrase, a provider of services in a society committed to free enterprise. We are a leading global investment banking and securities firm providing a full range of investment, finance and advisory services to corporations, governments, institutions and individuals worldwide. We've been in this business for 126 years. And I like to think we've done it well.
The facts speak for themselves. Today, we operate in 32 countries, have $4.8 billion in capital and employ around 8,000 people of extraordinarily diverse backgrounds, including 60 University of Illinois graduates.
That's what Goldman Sachs does. But what purpose do our activities serve? At one level, of course, we serve the interests of our clients. At another, we generate profitability for our partnership. But at a broader level, Goldman, like other investment and securities firms, provides the intermediation services necessary for the efficient allocation of capital, here in the United States and throughout the world.
We underwrite equity for new technology companies such as Premisis and Netscape. We provide capital to countries like Mexico, China and South Africa. We help restructure public-owned companies like Deutsche Telecom. This is productive and socially beneficial work.
By the way, the operation of capital markets is something I first studied in Professor John Due's Economics 101 class back in 1967. Of course, some things have changed since Professor Due lectured his students about financial markets. And it's to these changes in the world of finance that I'd like to turn for the balance of my remarks.
Let me begin with a discussion of the key trends that are shaping today's financial markets. In fact, the theme of my remarks is that most of these forces which underlie financial market dynamics are also shaping broader economic life.
Let me overview these forces:
1. Market growth and maturation;
3. The impact of technology;
4. Product innovation; and
5. Market liberalization and deregulation.
The first force, clearly, is the extraordinary growth in the size, diversity and institutionalization of markets. Let me cite some illustrative data. In 1972, there were only 18 million U.S. futures contracts. By 1994, this figure had risen to 426 million contracts. U.S. government primary dealer transactions have experienced a similar exponential growth, rising from only $2.4 billion daily in 1968 to nearly $200 billion daily today. Similar growth in government securities and futures markets has occurred in many regional financial centers around the world, from London to Tokyo to Singapore making for a 24 hour a day system.
The expansion of financial markets has far outpaced the expansion of real global output or international trade. In the 1980s, for instance, world trade grew little more than two times, while foreign currency transactions registered a fourteen-fold increase. Capital movements have moved far beyond their traditional role of accommodating trade imbalances and financing a modest amount of direct investment and international lending. These capital flows have taken on a life and importance of their own.
The real product markets and capital markets have become so integrated that it's not always clear which is the chicken and which is the egg. Similarly, the institutionalization of savings in our society and around the world has sponsored this market growth. For example, in 1969, Fidelity was a $3.7 billion mutual funds group. Today, it manages assets of over $390 billion. Everywhere institutions are accumulating savings, professionally managing the capital, which in turn is fueling secondary market growth.
Moving to the second point, the explosive growth in foreign currency transactions reveals a key trend in financial markets: Globalization.
Let me cite just one startling statistic. Today, there is approximately $1 trillion daily in foreign exchange turnover with roughly a quarter of it done in New York alone. The internationalization of finance is not limited to mature markets like the United States, Japan and Western Europe. Indeed, one of the most important areas of growth today is in the so-called emerging markets, notably in East Asia and Latin America. Anyone who wonders about the international impact of such markets need only recall the Mexican crisis of last December. The collapse of the peso sent tremors and serious capital losses throughout the world's investment community. A prompt and decisive macroeconomic policy response by the United States Treasury stemmed a serious tide of financial risk and the potential for significant harm to the real global economy.
I might also note here that governments have not failed to notice the opportunities offered by globalization. Indeed, the protracted budget deficits run by many governments, including our own, would have been far costlier and perhaps impossible without deep and generally open international markets. At the end of last year, foreigners held nearly $800 billion in U.S. government debt, roughly 25 percent of total marketable debt.
The third key trend is the rising importance of Technology with the accompanying power of open and instant information dissemination.
Recent years have seen the creation of a truly global, 24-hour financial marketplace, something inconceivable without the technology that supports it. Today, in a very real sense, financial markets never close - well, maybe on Saturdays. They merely shift around the globe. And technology has accelerated the velocity at which decisions are made, as markets adjust, nearly instantaneously, to both hard information and sometimes unsubstantiated rumor. Windows of opportunity have grown increasingly narrow. And in many cases, so have profit margins. Adam Smith now works on a 24-hour basis.
Technology also contributed to a fourth key trend: that of Product Innovation. The last 20 years have seen the development of a host of new and often highly technical financial instruments. These are based on complex mathematical and statistical models. Derivatives are perhaps the most well-known, if frequently misunderstood, example of this financial engineering. Mortgage and asset-backed securities and dual currency bonds are other examples of product innovation. All of these are associated with an increasingly customized approach to meeting the special needs of users and providers of capital. The days of a "one size fits all" when it comes to capital market instruments, are long since gone.
The fifth and final trend I'll speak to is market Liberalization and Deregulation.
This may be the most important. The most dramatic example of market liberalization has occurred in countries which have turned away from the socialist model in recent years. The states of the former Soviet Union are the most obvious case in point. But there's also a broad range of developing nations, in Latin America and elsewhere, which have moved both to privatize inefficient state enterprises and to develop the liberal regulatory environment necessary to attract foreign capital.
But the trend towards liberalization is not limited to the Second or Third Worlds. Indeed, it began in the advanced industrialized economies, notably in the United States under Reagan and in Great Britain under Thatcher.
And liberalization, under the rubric of "deregulation," continues.
Here in the United States, for instance, the Congress is considering reform of the 60-year old Glass-Steagal Act. This would ease, if not totally eliminate, the traditional barriers between investment and commercial banks and possibly insurance companies. At Goldman Sachs, we think this will happen before year end.
Deregulation has a first cousin called privatization which has also accompanied this liberalization of markets. The fundamental purpose of privatization is to enhance competition, increase efficiency and improve services to consumers. True, privatization of state-owned companies is often associated with painful short-term adjustments, particularly unemployment. But its long-term advantages in terms of growth and lower prices are increasingly clear to governments and citizens around the world. My firm has helped to privatize companies across the globe, from the $3 billion privatization of Tele Danmark, the Danish telephone company, to the $1.2 billion privatization of Indostat, the Indonesian state-owned satellite corporation.
Identifying and describing these liberalization trends is the easy part. Forecasting and planning for them and their attendant consequences is the challenge for bankers, businesspeople and academics. So what are the consequences of these trends for firms like Goldman Sachs and the financial system?
One result is clear for financial firms, and that is intensified competition. There are more providers. There are more products. There's more information available. In short, there are more choices for customers, whether they are individuals, corporations, institutions or governments. And these customers are exercising that choice with increasing sophistication, discrimination and with a clear call for lower fees. The result is that getting and keeping a competitive edge is becoming more and more difficult and costly - with declining margins.
So, competition still works the way the textbooks have always told us. And I have more than a few new gray hairs to prove it. Most would just say I have less hair.
Another consequence of deregulation is perhaps less immediate but not less far reaching. It is industry consolidation. The headline stories of commercial bank mergers is the palpable result of deregulation. The need to reduce cost and create efficient back office structures, while investing in technology, leads to the classic application of the principle of economies of scale for commercial bank strategists. Similar forces of change are driving today's merger mania in other industries as well. This is especially true in businesses like pharmaceuticals, media and telecommunications. And the consolidation march will continue.
In my own corner of investment banking, there will be market niches, both in terms of geographic region and through specialized products. But given the level of international competition and its cost of investment, the number of "global players" willing and able to compete across the board is almost certain to decline, perhaps to a mere handful. Survival will depend on the resources, both tangible and intangible, that individual firms will be able to muster in today's competitive marketplace. These assets include a strong capital structure, an international network, an established base of clients, a reputation for integrity and a well-trained, diverse staff of the very best professionals committed to serving clients.
I'm confident that Goldman Sachs will not just survive, but flourish, during this period of heightened competition and increasing consolidation. But I'm equally certain that, ten or even five years from now, the financial services industry will look very different than it does today. "Big" will be a reality. Assuming that Glass-Steagal reform goes forward, I fully expect to see a "mega-merger" between a top drawer U.S. investment bank and a major commercial bank - American and/or European. Maybe even the "House of Morgan" will be reunited. The European "universal bank," one which undertakes commercial, merchant and investment banking, may well be the model of things to come on this side of the Atlantic as well.
I've mentioned the consequences of the Transformation of financial markets for firms and their customers. But what of the broader impact on the economy of the revolution in today's capital markets?
For individual governments, I believe, today's markets are a mixed blessing. On the one hand, they permit borrowing at a cost and scale otherwise unavailable. But frequently because of that same deficit financing, governments are subjected to the harsh discipline of the marketplace. Just ask our friends in Mexico. Even the United States is no longer totally immune to the sort of financial "run" that has long afflicted other countries with far less proportionate exposure. Markets put clear, sometimes onerous, limits on the ability of governments to pursue important domestic objectives.
What can governments do? The status quo is neither appealing nor particularly probable. Governments can and must act to reduce instability in financial markets. For instance, they should seek closer short- to medium-term coordination of economic policies through the G-7 and other international forums. Some progress on this front appears to have developed in recent months with respect to currency and trade stabilization efforts. Public policy makers need to work to reduce major structural imbalances, like the asymmetry of savings rates between the United States and Japan, that serve as long-term sources of instability in international financial markets. It appears a similar asymmetry has now developed between the United States and the Peoples Republic of China.
But most importantly, governments need to work to reduce their own budget deficits. This would both reduce their exposure to market volatility and liberate significant savings for use in productive private sector investment.
This is not just an issue for the United States, but a far more demanding one for developing countries, and for many Western European nations with huge structural unemployment.
What of the financial system itself? Again the consequences of the revolution in capital markets are ambiguous. On the one hand, state-of-the-art technology has generally reduced the chance of a systemic collapse by creation of control, information and analytic systems that have reached high thresholds of precision. But should a crisis occur, it might actually be more severe because the interconnections within and between markets are much greater today than ever before. The time for crises managers to think through solutions and respond has been shortened dramatically, thereby, potentially increasing the risks of misjudgments.
It's an open question, for instance, whether the world's financial system could recover more easily today from a shock like the stock market crash of October 1987. This is not a scenario that I'm particularly eager to see tested in reality. Integration builds interdependencies. Technology has led to instant responses.
Given broad systemic risk, there's a clear need for a joint effort, among international institutions, governments and financial intermediaries, to improve the efficiency and transparency of international financial markets. The Basel Group of central bankers has done much good in this regard. But much greater coordination and consistency of global regulators is necessary for free markets to achieve optimum efficiency. World financial markets depend on clear, coherent and enforceable rules to safeguard their health. Systemic crises are in nobody's interest, not least the billions of people around the world, many of them poor, who live in a world increasingly shaped by financial markets.
This is a particularly critical point, and one on which I'd like to end my remarks.
We all know the old economic truism that global investment equals global savings, and only deep and efficient international capital markets can mobilize these savings and maximize their productive potential. What does this really mean? In the real world, efficient markets and the attendant allocation of capital to lead to higher productivity, greater real growth and rising standards of living, in a word, better lives.
I'm not suggesting here that businesspeople are or should be altruists in their professional lives. We aren't. Isn't that what Adam Smith's invisible hand is for? I do want to suggest that businesspeople, like economists, must always be aware of the broader consequences of our work.
Free enterprise is, at one level, the expression of individual initiative and choice but we should never forget, it is also a social means to advance the common good. It always has, and does today, require a sense of responsibility.
Like free government, free enterprise requires checks and balances. Some of these checks and balances are provided by the market itself. Some are not. Some checks can include non-intrusive regulatory oversight by public institutions. Others flow from disciplined management by corporate executives.
But the most important check of all is personal integrity by those who work in markets day in and day out. Too frequently, we read about the breakdown of personal integrity destroying market value and undermining market credibility. Daiwa, Barings and Orange County are vivid headline examples of this problem.
Markets are not just places in which businesspeople work. They are places for which we are all responsible, if only because of their real impact on everyday life.
At the beginning of my remarks, looking back on my time here as a student, I mentioned how easy it is to forget the basics in today's complex and uncertain world. Well, this concept of responsibility - of stewardship if you will - for the workings of the market is surely one of those basics.
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|Title Annotation:||Illinois Centennial Essays on Economics; Goldman Sachs Chairman Jon Corzine speech|
|Publication:||Quarterly Review of Economics and Finance|
|Date:||Jan 1, 1995|
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