The New Financial Order | Robert J. Shiller

Summary of: The New Financial Order: Risk in the 21st Century
By: Robert J. Shiller


In ‘The New Financial Order: Risk in the 21st Century,’ Robert J. Shiller explores the complexities of economic risk and emphasizes the need for innovative financial tools to manage them. Shiller identifies various risks, from career uncertainties to global issues, that go beyond traditional insurance coverage. By tapping into the potential of technology, he envisions a new paradigm where these risks can be mitigated through global risk information databases, indexed units of account, and progressive financial instruments. This summary will guide you through the myriad of ideas and approaches presented in the book, and help you to better understand the often-overlooked importance of risk management in the age of modern finance.

Democratizing Finance

Public officials condition us to believe that the economic progress of the twentieth century made finances less risky. However, many of these risks are long-term in nature, difficult to predict, and not treated seriously by politicians, media or the public. This book advocates for democratizing finance and creating insurance policies that cover risks such as the replacement of human labor with technology, the globalization of jobs and capital flow, and the risk of economic havoc caused by global warming. The author believes that bringing the advantages enjoyed by Wall Street clients to the customers of Wal-Mart can help manage the new risks promulgated by technology itself.

Effective Risk Management

Effective risk management must address human psychology before financial innovations can be accepted. It is crucial to consider the framing of how something is presented, which can strongly influence people’s perceptions. For instance, the US Social Security program uses the term “contributions” to describe mandatory taxes workers pay to support retirees. This terminology makes workers feel like they are contributing to a fund they will later benefit from, resulting in less resentment towards the payments. It is essential to keep in mind that psychological obstacles can hinder risk-management tools’ effectiveness.

The Future of Finance

The book explores how electronic database technology has revolutionized finance, enabling the creation of radical new financial instruments designed to transfer the burden of risks to large pools of investors. The author argues that data is crucial in this new era, requiring every individual to have an electronic ID that tracks their transactions, earnings, career path, purchases, and sales. The information collected could be stored in global risk information databases (GRIDs), which would set the baselines for all types of risk management contracts. The book suggests that legislation and government subsidies may be necessary to ensure privacy standards are met. The author compares this new era in finance to the invention of the telescope in astronomy, asserting that the world of finance is at the cusp of a similarly world-changing revolution.

Revolutionizing Currency with Indexed Units of Account

Fluctuations in currency values have caused economic issues in the past, but indexed units of account can prevent these problems in the future. The importance of currency is decreasing, with the majority of transactions being non-cash. Chile introduced the “unidad de fomento” (UF) in 1967, which has allowed them to avoid the effects of inflation. If the US government adopted similar units, it would legitimize them and open up opportunities for radical financial innovations.

Insuring Against Unforeseen Economic Risks

Insurance policies are common for protecting individuals against death, disability or property loss. However, two economic risks have yet to be covered by insurance: a decline in earning power and a decrease in property value. Livelihood insurance would protect workers from layoffs or specialized professionals from skills that become outdated. Home equity insurance would benefit homeowners and prevent the “white flight” phenomenon from suburban areas seen in the past. These types of policies would transfer risks from individuals to a pool of investors who diversify to mitigate various risks. Such policies would encourage fulfilling careers and homeownership.

A Better Measure of Country’s Economic Performance

Stock markets do not accurately represent a country’s economic performance. Instead, a macro market where investors can bet on the future value of a country’s GDP would be a better proxy. Such a futures market could enable the transfer of economic risks to investors globally and prevent fraud and speculative bubbles. Though no perfect example of such macro markets exists, experiments like the Economic Derivatives Market are in progress. Securities derived from the future value of incomes or homes could be traded through this market, issued by the same insurance companies that underwrite livelihood and home equity insurance.

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