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G20 in Washington: Waiting for 'Hell to Freeze
Over' won't Solve the Problem
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In April 2011, a G20 meeting in Washington again demonstrated that, despite
hopes to the contrary, progress was not being made in resolving difficulties
associated with international financial imbalances. This implied that it was
likely to be futile to further pursue solutions solely through G20 negotiations
in the face of apparent obstructionism, noting that some major economies (eg
those of Japan and China) appear to
depend on those imbalances
and thus
can't easily adjust to allow
them to be reduced.
Rather those who are economically constrained by imbalances (especially,
but not only, the US) need to take even stronger action than that associated
with the Federal Reserve's quantitative easing to
put pressure for substantive reform on countries whose financial systems are
structured to depend on the imbalances that put global growth at risk - even
though those economies might then be disrupted. Options to increase such pressure
are outlined in
China may not have
the solution, but it seems to have a problem.
Some Observer's CommentsIMF is developing
a framework to help countries manage large capital flows as countries recover
from the global crisis. Studies have been released on
country
experiences and on
tools
that can be used to manage capital inflows. This is part of a process whereby
the IMF evaluates advanced economies where the crisis began. The 'push'
forces that originate capital flows are being studied, and on the spill
over effects on others are being studied for China, euro-area, Japan, the
UK and the US. While capital flows are generally beneficial for receiving
countries, surges can create problems (eg through currency appreciation
and increasing financial system frailties associated with asset bubbles
or rapid credit growth, or the risk of sudden reversal of inflows). The
management of inflows involves many economic issues. Suggested principles
are: no 'one size fits all'; capacity to absorb capital inflows should be
increased; good macro policies are vital; capital controls may need to be
used; remedies must be designed to suit to problem; and others' positions
should be considered. [IMF
develops framework to manage capital flows, 5/4/11]
Deep divisions over sources of global economic
fragility intensified before the G20 meeting. US emphasised inflexible exchange
rates, while China argued that inadequate development of emerging economies
was the key issue. G20 is expected to agree on technical methods to measure
imbalances, though there is not expected to be agreement on enforcement
[G20
gulf widens on source of fragility, 14/4/11]
G20's bickering seems like stalled Doha
round of world trade talks. Five G20 members (Brazil, Russia, China, India
and South Africa) have scheduled a rival meeting, and the G7 organised the
currency intervention to force down Yen after Japan's earthquake. Last G20
meeting failed to even agree on how to assess whether imbalances existed
= because China did not concede that current account position and foreign
exchange accumulation were relevant to this. Major countries do not share
an economic analysis of trade imbalances, or agree on effects of policies
to address them. US believes it has run current account deficit to maintain
world economic activity in the presence of China which saves too much and
spends too little - partly because of undervalued exchange rate. China complains
that US does not take into account the development deficit of emerging economies
- and seeks to export inflation using $US's reserve currency status as a
weapon. Without a shared analysis of the problem, no solution is possible.
None-the-less the effort of addressing this is vital, because unattended
imbalances raise strong possibility of another crisis at some time in the
future. The best outcome to hope for is that collapse of G20 can be avoided.
From US / European perspective there is also a hope that emerging economies
(especially China) will share their view about the inadequacy of export-oriented
growth [Struggle
to keep G20 train on the tracks, 14/4/11)
After years of calls for China to play
a responsible role in international affairs, Beijing has started to comply
- but in an unexpected way. BRICs group (now including South Africa) is
becoming China-dominated forum. The
“Sanya Declaration”, was full of sort of language China uses at home
- and embodied agreement that 21st century should be one of peace, harmony,
cooperation and a century of scientific development'. Harmony and scientific
development are Communist Party's slogans in China. One thing off the agenda
at this meeting was China's currency controls, which are believed to give
China's exporters an unfair advantage. Other BRIC members mainly agree on
the imbalances in their trade with China (ie they export resources, and
import manufactures). China's emphasis is however on building consensus,
toning down differences and finding areas for cooperation [China
cements its role as top of the BRICs, 14/4/11]
G20 will address details of a plan from February
2010 to determine when debt levels, trade deficits or other indicators point
to systemic risk - with a view to naming and shaming countries that pose
the biggest risks [G20
to plan global financial crisis warning system to 'name and shame' risky
countries, 14/4/11]
RBA Governor suggested that US is wrong
about China, and should not just focus on itself. China's imports into US
have mainly displaced those from other Asian economies, while China is a
large market for US. Thus populist China bashing (based on the view that
China is stealing US jobs) is wrong. China has been final cheap labour assembly
point for goods owned ny Japanese, Taiwanese and Korean companies - and
China will now outsource that work as it moves up the value chain. RBA has
become good at putting rise of China into perspective, since realizing that
Australia's economy is Asian. RBA argues that it is wrong to focus on bilateral
US-China relationships, as 20 years ago the focus was on US-Japan relationship.
US trade deficit has been widely spread. Issue must be resolved in multilateral
setting - which makes international financial institutions and G20 important.
[RBA
to USA: Wake up, yer drongos, 15/4/11)
G20 efforts to bolster global growth are
floundering. In September 2009, efforts to rebalance global growth was agreed,
but US deficit and Chinese surplus have remained unchanged. Agreement on
continuing this effort is likely in Washington - but the process has become
bogged down. The best that can be hoped for is a process to measure whether
countries' policies are worsening imbalances [G20
plan to kickstart global economy is floundering, 15/4/11]
IMF recognised that it was wrong to always
advocate free international capital flows, and has now set out a
research framework. Some forms of capital controls
are now part of approved tool kit, as a last resort. For the past decade
capital flows into East Asia have been strong but not overwhelming - and
reversals during GFC did limited damage. Inflows were handled with reserve
accumulation and exchange rate appreciation. Reserves are now adequate.
The IMF analysis sees flows in terms of temporary capital surges - but the
problem may be more structural. Emerging economies will grow faster than
mature economies - and need higher interest rates for equilibrium.
This will encourage greater capital flows, and huge financial portfolios
in North America and Europe only need to be shifted slightly to create disruptively
large inflows. IMF has not yet put forward a convincing policy answer,
but after a wasted decade, has at least made a start [The
IMF's emerging capital idea, 18/4/11]
Agreement by G20 has been seen as major
step towards more sustainable global growth. Finance officials also agreed
to look at currency misalignments. Change came as rising food prices, joblessness,
Middle East turmoil and weak finances in advanced economies seemed likely
to derail recovery. Polices of 7 major economies will be reviewed by IMF
(US, Japan, Germany, China, France, UK and India. Countries would be examined
for economically destabilizing policies such as large budget deficits, high
personal savings and debt, and big trade surpluses / deficits. Methods for
evaluating causes of imbalances and barriers to reducing them. However G20
can't enforce any findings [Reddy S., and Davis B., 'Deal
to avoid another GFC', The Australian, 18/4/11]
Emerging economies rejected IMF proposals
to guide them on managing huge capital inflows - seeing this as a constraint
rather than a help. Proposal was reversal of IMF's traditional objection
to capital controls (because of the effect of huge hot money flows in recent
years), and would have viewed this as last resort. Various emerging economies
have adopted capital controls over past year to limit inflows. This debate
comes amid controversy about who causes flood of capital from sluggish advanced
economies into emerging economies. Emerging economies blame Fed's QE, while
developed economies blame China's tightly controlled currency and to tendency
of capital to flow into fastest growing economies [Emerging
nations rebuff IMF, 19/4/11]
CPDS Comments on the situation and reasons for the above suggestion
include:
- the G20 initially did nothing to address the problem of financial
imbalances (see G20: Avoiding
key Issues,
G20: Peace for our Time'? and Too
Hard for the G20), despite imbalances' apparent role
in generating the GFC and in constraining global economic growth;
- Some progress was being made because that problems now seemed to be
officially recognised [1]. Moreover the
IMF, which long objected to constraints on the free flow of capital, seemed
to have recognised that capital flows could be disruptive [1],
and suggested principles to manage such flows [1].
This, it was suggested, was a start even though not a solution [1];
- However the situation remained highly unsatisfactory. For example:
- despite agreement a year earlier [1]
that the problem required action, nothing had been achieved [1];
The G20 was seen to be becoming bogged down [1]'
- There was disagreement over the source of the problem [1]
- Emerging economies rejected IMF proposals for managing capital flows
[1];
- Agreement was reached to measure the problem, but not to enforce
any conclusions [1];
- Western observers appeared to remain ignorant of the way in which
East Asian
financial systems contain distortions which
contribute to the
problem. For example:
- the US appeared to focus on China's artificially low exchange rate
[1] - though the latter was only a symptom
of a much deeper issue;
-
Japan's role in generating
imbalances was similar to China's - yet the US said nothing about
this;
- Australia's reserve bank didn't understand the problem either. It
reportedly suggested that the US was wrong about China - as the latter's
economy was primarily prospering at the expense of others in Asia [1].
However the RBA did suggest that the US needed to take a multilateral
perspective on the problem, not a bi-lateral US-China view [1];
- China seemed to be adopting obstructive tactics - namely:
- refusing to acknowledge the factors that affect imbalances [1];
and
- seeking to establish its own international forum [1,
2];whose main purpose seemed to be to
frustrate the G20;
- the IMF, which had a mandate from the G20 to investigate problems
associated with the international monetary system, seemed to be adopting
a very superficial approach (ie one that attempted to deal with the symptoms
of international imbalances without considering in depth the characteristics
of East Asian models of socio-political economy (see
below). Moreover: (a) the IMF's proposals
for dealing with capital flows reportedly suggested that the financial
crisis was generated in advanced economies [1],
whereas this was only half of the problem as capital flows directed towards
the US played a major role in the genesis of the GFC; and (b) its proposals
for managing capital inflows seemed to be geared only / mainly towards
the difficulties facing emerging economies.
The Asian Connection in the Public Debt Problems
Facing Developed Economies (email sent 13/4/11)
Carlo Cottarelli,
Director, Fiscal Affairs Department
IMF
Re:
Crashing the US debt party, 13/4/11
Your article outlined the challenge of reducing US government debts
(and those in many other developed economies).
May I respectfully suggest that public debt problems such as those
facing the US probably cannot be resolved in isolation – because they
have been incurred partly to sustain global economic growth in the face
of macroeconomically unbalanced economic strategies in some other countries
(eg Japan and China). There appear to be structural demand deficits
(‘savings gluts) in the latter economies (see
Understanding
East Asia's Neo-Confucian Systems of Socio-political Economy), and
these have required that trading partners (mainly, but not only, the
US) be willing and able to indefinitely incur current account deficits
and increase their public and private debt levels. This situation played
a significant role in the global financial crisis (see
Impacting the
Global Economy). And now, it will be incredibly difficult for others
to reduce their overall debt levels until fundamental reforms are made
in economies with large structural demand deficits. The moment that
countries whose excess demand has been vital to compensate for structural
demand deficits face up to the need for austerity, global demand and
economic growth must collapse.
Thus, as with the international monetary system as a whole, it seems
likely that no satisfactory solution may be able to be found unless
reforms start in Asia (see Should Fixing the International
Monetary System Start in Asia?)
I would be interested in your response to the above speculations.
John Craig
CPDS Reply to Brief Response from Carlo Cottarelli
(email sent 14/4/11)
Thanks for your response. I have no doubt that the IMF takes a
global view of the problem. However financial practices under major
East Asian systems of socio-political economy appear to make it unsafe
for such countries to increase domestic demand to the point that reliance
does not have to be placed on trading partners’ willingness and ability
to sustain large current account deficits and increasing debts.
Following the Asian financial crisis, the IMF pressured countries
in the region to improve their financial systems. However doing so
faced cultural obstacles (see
Understanding
the Cultural Revolution, 1998). The latter referred (for example)
to: fundamental differences in way information is used; the need to
change economic goals from economic 'power' to financial returns;
the inseparability of economic issues from questions of social / political
power; and the lack of appropriate legal systems. In practice, the
general response was quite different to the IMF’s suggestions and
counter-productive ie large foreign exchange holdings were widely
sought as the best means of defence against financial crises (noting
that Japan and China had not suffered from the crisis because they
had this protection). An account by Mikuni of why Japan’s financial
system could not be reformed is in
Why Japan cannot deregulate its financial system (2000).
An attempt to draw these issues together in relation to their effects
on international events is in
An Unrecognised Clash of Financial Systems. Unless and until the
international community starts to consider the problems ‘Asia’ faces
in increasing demand from an ‘Asian’ viewpoint (instead of just assuming
that Western practices can be applied), it seems unlikely that the
problem of global imbalances will be resolved.
John Craig
Economic Recovery is Constrained by Dead Weight Economies
(email sent 10/5/11)
Maurice Newman,
Chairman
ABC
Re:
Hope is not an option when the stimulus runs out, The Australian,
20/4/11
While the gloomy economic outlook portrayed in your article (which is
outlined below) is unfortunately probably realistic, I should like to suggest
another way of viewing the problem that might lead to initiatives that produce
better outcomes. In brief it is suggested in more detail below that:
- The economic constraints implicit in the high debts of many developed
economies are not only due to the costs of meeting community demands and
responding to the GFC. The ‘dead weight’ of structural demand deficits
in economies such as those of Japan and China (which require trading partners
able to continue increasing their debt levels indefinitely) is also a
factor;
- While the G20’s efforts to address the constraints posed by the resulting
international financial imbalances are being frustrated, there are options
available to encourage more serious reforms in countries whose underdeveloped
financial systems currently require large demand deficits and excess savings;
- As your article suggested, serious economic dislocation is likely
over the next few years. However no matter whether or not the particular
scenario suggested in your article emerges, Australia needs much higher
levels of Asia-literacy to cope with its environment.
I would be interested in your response to the above speculations.
John Craig
Outline of Article and Detailed Comments
My interpretation of your article: An
economic price is about to be paid for the GFC. The world economy remains
on life support despite a huge fiscal stimulus and monetary easing. US
performance is feeble, while public debts mount. It is much the same in
Britain, Europe and Japan. Social unrest (eg in UK, Spain and Greece)
result from spending cuts. The UK and Japan faced huge public debts even
before the GFC. Japan’s rapidly aging population has lived off its savings,
and its PM has suggested that Japan could face a mess like Greece if its
swelling national debt is not fixed, and the tsunami will make the situation
worse. European peripherals (as well as UK, France and Italy) are in a
poor state. Sovereign risk is increasingly priced into bond markets. Investors
will face losses eventually. Stockmarkets don’t agree (and downplay sovereign
risk, Middle East tensions, rising oil prices and natural disaster) because
the Bernanke put is in place. In the West, governments have been major
employers, and growth rates vary inversely with private sector to government
ratio. The dilemma now is to move to smaller government share in stagnant
economies without making unemployment / growth worse. Many governments
are in minority positions, and have trouble making long term decisions.
After easy money and fiscal stimulus, there is little to show but speculative
rally in risk assets and inflation. What will happen when, as now seems
inevitable, stimulus is withdrawn, How can democracies grow, tax or inflate
their way out of monumental obligations with aging populations and high
welfare dependency. The endgame is nearing (as a result of policy failures,
rising social costs and market action). A fundamental international settlement
will be inescapable – with widespread trade and capital market dislocation.
Afterwards the BRICs will be stronger in G20 and IMF, while Australia,
Canada and Korea also benefit. $US will cease to be reserve currency.
To prepare it is necessary to: de-risk portfolios (ie good balance sheets
with limited leverage); be aware of possible ‘black swan’ events; seek
policies to improve industrial competitiveness (eg structural balance
in budget; no new taxes; reform complex laws; rethink IR; and maintain
comparative advantage in cheap energy). This will be difficult because
of community dependence on government services, income redistribution
and consumer protection. It is not enough just to hope for the best.
There seem to be two primary causes of the predicament outlined in your
article (ie the poor fiscal position of governments in many developed economies
which threatens future economic growth).
The first is the economic dead weight that the global economy suffers
as a result the structural demand deficits that characterise some major
economies (such as Japan and China), which were ultimately a major factor
giving rise to the GFC. An attempt to explain the reasoning behind that
suggestion, which unfortunately is anything but simple is in
The Asian Connection in the Public Debt Problems Facing
Developed Economies.
In brief, the point is that: (a) global demand must equal supply,
if economic growth is to be maintained; (b) the systems of socio-political
economy in major East Asian societies involve financial systems that provide
capital for state-linked industrial investment with limited regard for
profitability; (c) financial crises (like those experienced in much of
Asia in 1997) can only be avoided if demand is suppressed to the point
that current account surpluses are achieved, and there is no need to borrow
in international markets; and (d) this requires that trading partners
(in practice especially the US) be willing and able to run large current
account deficits, and accumulate debts. Growth was sustained for a long
time despite the dead weight of large demand deficits by asset inflation
which encouraged very strong consumer spending, and that asset inflation
ultimately contributed to the GFC. Though other factors are also involved,
recovery (though monetary and fiscal stimulus) continues to be constrained
by the dead weight of demand deficits in countries such as Japan and China,
and the consequent current account deficits that the US (mainly but not
only) experiences. It can be noted that many emerging economies have also
adopted similar necessarily-short-term economic tactics (ie export driven
growth to protect their poorly developed financial systems, because of
the success of this tactic in protecting some major crony-capitalist economies
in Asia (see Who’s Got Superman?)
The second major cause is the difficulty your article identified in the
dependence of democratic societies on high levels of public spending in
an environment in which governments will be forced to constrain public spending
by the high debt levels they suffer as a consequence of (a) community expectations;
and (b) the cost of trying to recover from the GFC in the face of external
‘dead weights’. The fact that truly democratic government first emerged
in the UK at the time of the industrial revolution, partly as a means for
redistributing the wealth generated by capital in industrial economies,
can also be noted. (see comment in
Economic Solutions
Appear to be Beyond Politics).
The outcome suggested in your article is not necessarily the only one
that is possible. While the G20 and the IMF continue to be frustrated by
the intransigence of countries whose structure demand deficits provide a
drag on global recovery, there are probably unilateral actions that could
be taken to encourage them to get serious about reform (see
G20 in Washington: Waiting for Hell to Freeze
over won’t Solve the Problem).
There is none-the-less little doubt that a chaotic international environment
is likely to emerge (and probably in much less than eight years)
Irrespective of what outcome emerges Australia requires a much higher
level of Asia-literacy and more effective methods for economic development
in order to be able to cope (see
Finding Australia's Place in
the International Financial System). There are fundamental obstacles
to economic growth by major East Asian economies (and emerging economies
with poorly developed financial systems elsewhere) if the US loses the ability
to be the world’s ‘consumer of last resort’ (see
Are East Asian Economic Models
Sustainable?), and serious incompatibilities between Australia’s institutions
and society and the sort of ‘world’ that could emerge under the scenario
your article outlined (see
Babes in the
Asia Woods).
Note:
An
email interchange
that arose from one observer's response to receiving a copy of the above
email suggests the complexities that seem to be involved in seeking to
understand East Asian economies in terms of Western economics
Counter-cyclical policy can't solve structural problems
- email sent 31/8/11
Martin Wolf,
Financial Times
Re:
The great contraction struggle, Business Spectator, 31/8/11
Your very useful article points to the risk of an extremely
deep recession because the combination of high private debt levels and weak
asset prices makes recovery difficult (ie attempts to boost growth can’t to lead
to ‘lift off’ if private demand faces those constraints).
While that point is important, might I respectfully suggest
that the problem can only be properly understood by also mentioning the
international financial imbalances that have required deficit countries to incur
ever increasing debt levels simply to maintain economic growth? When there is a
large current account deficit, national income is well below national
expenditure and the demand required to sustain economic activity can only be
provided by increasing public / private debts. And in practice this can only
continue so long as asset values increase faster than debt levels (so that net
private wealth is rising).
International financial imbalances seem very likely to be a
significant (though not the only) factor in the current constraints facing:
- the US because of its long term geopolitical ambition (ie to
promote the worldwide spread of market economies and democratic capitalism by supporting global
growth as the ‘consumer of last resort’). This goal required compensating for
the demand deficits (ie ‘savings gluts’) that have been structural features of
the ‘economic miracles’ achieved in major East Asian economies (see
Impacting the Global Economy) and have also also been a feature of other
export-driven economies (such as Germany and many emerging economies).
Maintaining growth through ever-increasing debts was possible for many years,
but (as your article implied) this can’t be continued if asset values are weak;
- peripheral European economies whose export competitiveness was inadequate to
cope with the strong currency they were tied to (ie the Euro), so that again the
demand to sustain economic growth could only be achieved by increasing (mainly
public) debt levels – and the tax revenues required to support this were simply
not available.
Purely counter-cyclical policies (ie stimulating growth by
fiscal or monetary policies) in countries facing large current account deficits
cannot overcome the constraints implicit in financial imbalances unless asset
values recover strongly (as current account deficits must continue to force
public and / or private debt levels higher, thus reducing net private wealth and
demand if asset values remain weak).
Preliminary speculations about structural (rather than counter-cyclical)
steps that might assist in overcoming the obstacles to economic recovery are
referred to in
Preventing Economic Stagnation – though there is no doubt that the issue is
extremely complicated.
John Craig
Sustainable World Growth Requires More than Counter-cyclical Policies
- email sent 23/5/12
Professor Thomas Clarke,
University of Technology Sydney
Re:
Why do our world leaders cling to the dismal politics of economic austerity?,
The Conversation, 22/5/12
I should like to submit for your
consideration that the ‘austerity’ issue is more complex than your article
indicated – because structural problems that have given rise to international
financial imbalances mean that sustainable economic growth can’t be achieved by
traditional counter-cyclical stimulus.
Your article suggested that:
“In responding to this crisis originating
in the Western finance markets, the G20 revealed considerable resolve in
employing public funds to rescue the private financial institutions facing
bankruptcy. As the global financial crisis has morphed into the sovereign debt
crisis, this resolve to apply a counter-cyclical stimulus has disintegrated, as
self-interest has taken hold, and widespread austerity measures introduced to
reduce public deficits.”
The current situation needs to be seen in
context. ‘Austerity’ has been practiced for many years (sometimes decades) by
countries whose economic growth strategies have relied on suppressing domestic
demand in order to achieve current account surpluses, and thus avoid the
financial crises that would otherwise affect their poorly developed financial
systems. The main offenders have apparently been:
The demand deficits that this involves (and the demand
deficits associated with the current account surpluses that major oil exporters
and also Germany achieve) have had to be compensated for by excess demand
elsewhere (or else the global economy would stagnate). That excess demand (ie
the stimulatory measures that have been in place over the past couple of
decades) has been provided by:
- Consumers in the US (mainly) and other developed economies who
(prior to the GFC) enjoyed rising asset values that were the result of very easy
money policies (sustained by Reserve Banks and carry trades) that gave
rapidly-increasingly-indebted households the impression of growing net wealth
(eg see
Financial Imbalances, 2007 and
Impacting the Global Economy, 2009);
- Governments, in the second phase of the GFC, after the ever rising
asset values needed to sustain perpetually increasing debts ceased (eg see
Comment on the European Sovereign Debt Crisis). It can be noted in passing
that the ‘sovereign debt’ crisis is likely to migrate from peripheral Europe
(and Japan) to the United States after it goes over its so-called ‘fiscal
cliff’.
- [Note added later: The 'fiscal cliff'
involves expiry of authorization for many US federal spending programs which
would have significant adverse effects on demand / economic growth, unless
approval is gained for significantly increasing: (a) taxes - which would have
similar macroeconomic effects to reduced spending; or (b) approved government
debts which would restart concerns about the US's sovereign debt status and
the $US's role as the global reserve currency];
- Reserve Banks through Quantitative Easing – to ensure against a
lack of liquidity and a collapse in money supplies, and also perhaps to try to
reduce financial imbalances (see
Currency War? ).
While Western financial markets have been
involved in the crisis, there seemed to be many other factors at play (eg see
GFC Causes), and financial imbalances associated with the macro-economically
unbalanced strategies pursued in Japan, Germany, and many emerging economies
(notably China) have arguably been more significant. Moreover the G20 seems to
have been totally at a loss in terms of trying to deal with this (eg see
G20: AnnouncingPeace for our Time'?, 2009 and
G20
in Washington: Waiting for Hell to Freeze Over?, 2011)
because conventional macroeconomic measures cannot deal with the structural
problem. For example, major cultural obstacles confront East Asian economies
with an ancient Chinese cultural heritage if they are to avoid ongoing reliance
on current account surpluses and on the willingness and ability of developed
economies to incur ever increasing debt levels (eg see
The Cultural Revolution needed in 'Asia' to Adapt to Western Financial Systems,
1998).
Various observers have recognised the role that financial
imbalances have played (eg see
G20: AnnouncingPeace for our Time'?,) and pointed to the
need to increase demand (ie emphasize anti-austerity programs) in countries with
current account surpluses, rather than hoping that the problem can be solved by
‘counter-cyclical’ spending in countries with current account deficits and large
existing public and private debts. A recent article by Michael Pettis is
instructive in this regard, though it did not mention the East Asia dimension of
the problem (eg see
All roads lead to Spanish pain, Business Spectator, 21/5/12).
The emerging debate about ‘austerity’ versus ‘growth’ (if
the latter is expected to merely require counter-cyclical policies) seems likely
to be futile. Some suggestions, with a US orientation, about the sort of changes
that might force real attention to the structural problems are outlined in
Getting out of the Economic Quicksand (2011).
I would be
interested in your response to my speculations.
John Craig
Progress Towards Ending the Global Financial Crisis?
[Working Draft]
In November 2011 an experienced economist (Professor Joseph Stiglitz) presented
an assessment of the global financial crisis (GFC) in a web-cast that seemed a
useful advance in the debate (as outlined
below). However the web-cast also arguably showed that some
critical gaps still need to be filled to gain the understanding
required for a solution.
Outline of
Stiglitz J,
The global economic situation and sovereign debt crisis, UN Webcast,
24/11/12.
The financial crisis started in the US, and was then exported to the world.
Europe is now returning the favour. Much of the rest of world have been innocent
victims. Because of the international linkages involved, this question needs to
be addressed globally. Many countries are going in wrong directions.
Before the crisis, the prevailing theory was that economic integration would
reduce risk, by spreading financial risk around the world. However integration
caused Europe to buy toxic mortgages from the US. An analogy with an integrated
electricity system can be considered, as a breakdown in one part can bring down
the whole system, and a system that is highly integrated can be unstable. After
the crisis the IMF recognised the need for capital controls. As in the Great
Depression there have been several (ie economic / monetary / financial problems)
dimensions to the crisis, and capital market integration has spread these
problems.
During the Great Depression US monetary authorities were criticised for not
increasing money supply fast enough. But this time money supply was increased
very rapidly by Benanke (a student of the Great Depression). But the US economy
has not recovered – despite labour market flexibility. Demand and supply are not
working as they are supposed to.
It is impossible now to go back to 2007. In 2008 it was recognised that there
was a financial sector crisis, and it was assumed that repairing this would
avoid an economic crisis. Money was given to banks without conditions – but was
poorly used (ie for dividends not lending). Now the banking system has been
repaired. The problem is that before the crisis, the economy was sick and
sustained by a bubble that led to high rates of consumption. Several reasons for
this were identified by UN Commission of Reform of Global System.
One issue was structural transformation, as in Great Depression. In early 2oth
century there had been massive increases in agricultural productivity, and
agriculture was displaced by manufacturing as a major component of the economy.
As manufacturing has become more productive, manufacturing jobs are down
worldwide. There is now a need to move to move into services. However adjustment
is a problem if incomes fall so low that people can’t move. In the US in the
1920s agriculture fell from 30% to 25% of workforce, but from 1929 to 1932 there
was no movement out of agriculture as incomes went down. Incomes in agriculture
fell 50%. There was no demand for manufacturing, and thus unemployment grew.
Government’s role is important in stimulating the economy to help in the shift
to a new sector (ie from manufacturing to services now). This is a hard task and
high levels of unemployment trap people in the old sector.
There are four other problems: (a)
Globalization and changes in comparative advantage have led to a shift in
manufacturing away from US / Europe, and this compounds the problem of
increasing productivity; (b) growing inequality is a problem because those at the top consume less than those
at bottom, just as before the Great Depression. This happens world-wide; (c) global aggregate demand is an issue, because the failure of the IMF and others
to manage the East Asia crisis caused countries to build up reserves (as
otherwise they risked losing their economic sovereignty). For each country this
makes sense – but this involves not spending – and thus creates a lack of global
aggregate demand. Countries that did best were those with the most reserves; and
(d) income has been redistributed from oil consumer to producers, and this
suppresses demand, as producers have high savings rates.
Responses to the financial crisis have not dealt with these underlying problems.
Thus even if the financial system is completely fixed, problems will remain.
Where could the global demand previously provided by the bubble come from? Even
after deleveraging the US can’t go back to expecting the bottom 80% of
households to consume 110% of their income. On top of this there a crisis in
Europe – even though debt GDP / ratio is less than in US (and Greece is small).
The euro created a monetary system that leads to problems –as it has no fiscal
framework (and frugality is not enough). Spain / Ireland had fiscal surpluses –
and allowed a bubble to grow through market liberalization. The problem in
Europe could be solved if there is cohesion, but otherwise there will be a
serious global problem. Europe has effectively created a new equivalent of the
gold standard that inhibits adjustment.
The US also contemplates austerity. Reducing deficit would be easy if this was
the only issue. Four things changed US fiscal position: (a) tax cuts for rich;
(b) expensive wars – that don’t increase security; (c) deals with drug companies
that leads to high prices; and (d) recession. Reversing these would solve the
fiscal problems. Getting back to work is vital. Austerity will compound problems
in US, and worldwide. The US has under-invested in infrastructure / technology /
education for 20 years, so high returns could come from such investments. Yet
the US talks about cutting this back.
Direction of global economy is now exacerbating difficulties, as concerted
austerity is a recipe from global economic suicide. After Lehman Brothers’
collapse, the world came together and recognised the need for stimulus. Stimulus
worked – but was too small. If there had been no stimulus, US unemployment would
be over 12%. The same applies globally.
Many worldwide are using the crisis to pursue other agendas (eg downsizing
government).
But, given a balanced budget, increases in government spending increase GDP /
jobs (ie if tax those at the top, and spend on areas with high multipliers). The
balanced budget multiplier is over 2-3. Reducing tax system progressivity is
dangerous, because growing inequality is already a problem. Before the crisis
the economy was artificial (ie a bubble) – and the US can’t go back to this.
Financial system is now partly repaired, and returns are near normal. But
underlying problems remain. Too-big-to-fail banks continue. Non-transparency
remains (eg involving derivatives), and is a problem as no one can tell if
institutions are sound. Banks failed in Europe after stress tests. Thus ordinary
investors can’t tell, and confidence can’t be recovered. Forecasts of recovery
have low credibility. Thus there are still financial system problems. Bank
concentration has increased.
An agenda for reasonable economic health would involve: (a) countries with
finance spending more; (b) addressing problems of inequality; (c) facilitating
structural transformation; (d) reducing fossil fuels demand (as challenge of climate change
needs a solution). But most likely prospect is long Japan-style malaise. This is
a global crisis, because of interdependencies. Emerging markets have done well.
Many grow despite turmoil in Europe / US. But if the latter did better this
would enable world to do better. Thus need cooperation. Frameworks are
inadequate to arrange this. There is a need for a coordinating council.
The web-cast was useful progress because it recognised that:
- the GFC is a global phenomenon that has many causes [see above for the present
writer's version of these causes];
- economic recovery has not occurred though policy
actions suggested from experience of the Great Depression were implemented;
- it is impossible to go back to the distorted economic conditions that
existed prior to
the
GFC (eg when the US economy was sustained by asset bubbles
that encouraged high rates of consumer spending);
- recovery is constrained by a lack of global demand due to: (a)
globalization and impediments to adjustment in developed economies; (b) growing inequality; and (c) high savings rates
by oil
exporters and by countries at risk of financial crises (eg in East Asia and
emerging economies elsewhere);
- There are serious problems in Europe, and these
put the world economy at risk. Countries that followed
conventional economic wisdom (eg Ireland and Spain) were adversely affected, and the euro
is a
constraint on recovery equivalent to the gold standard in the 1930s. Austerity
is not a solution;
- the US (where austerity is also being considered) suffers fiscal
problems with four main causes: ie: (a) tax cuts for rich; (b)
expensive and futile wars; (c) high pharmaceutics costs; and (d) recession;
- There could be high returns from public investment
in infrastructure / technology / education - because these have been neglected
for two decades;
- Stimulus spending by countries that
can afford this would be useful;
- There remain underlying problems in the financial
system (eg lack of transparency / confidence).
However in a number of respects there is a need to broaden the analysis
presented in the web-cast (ie the GFC did not
just start in the US; government fiscal problems
can't be resolved without redressing international financial imbalances;
productivity can be a constructive goal; and
there are better options to facilitate economic
adjustment than those linked to monetary and fiscal policies).
First, it was simplistic to suggest that the
GFC originated in
the US and was then exported to the world, because international financial
imbalances were a prior and very significant factor. In particular:
- as the web-cast noted, high savings rates well in excess of investment (and consequent demand deficits)
have characterised major oil exporters and countries at risk of financial
crises since 2008, and these demand shortfalls are an obstacle to global growth. However this
constraint had existed
for decades prior to 2008 (especially as a result of excess savings / demand
deficits by Japan, China, and major oil exporters) and this gave rise to
international financial imbalances. Large demand deficits (which, as noted
below, reflect structural features of East
Asian economies) would have stifled global economic growth if they had not
been counter-balanced by their trading partners' (mainly the US's)
willingness and ability to absorb excess savings and provide excess demand.
The US played the role of the 'consumer of last resort' while seeking to
support the global spread of market economic models. Excess
demand was sustained by domestic easy money policies and capital inflow that stimulated property
inflation (which in turn encouraged very high levels of consumer
spending as the web-cast noted) until the bubble burst and gave rise to the
GFC, at which stage the major burden of borrowing to sustain domestic and
international demand shifted to the US federal government (eg see
Structural Incompatibility Puts Global
Growth at Risk, 2003 and
Impacting the Global Economy, 2009);
- there are cultural factors which have
encouraged major East Asian economies (eg Japan and China) to accumulate
high levels of foreign exchange reserves (and thus run current
account surpluses) in order to protect against financial crises. This
is not easily understood from a Western perspective, but progress is
possible by recognising that the traditional purpose of providing information in East Asia
(which has no classical Greek heritage) is not to
enable individuals to understand as the basis for independent rational
decisions. Rather the purpose is to stimulate others to take actions that
are likely to benefit the providers' ethnic community (see
Why Understanding
is Difficult). 'Information' can be likened to propaganda, rather than
being expected to be 'truth'. This approach to 'information' is economically significant when
applied to official
statistics and to the financial performance of banks and businesses, and
thus:
- the problem of non-transparent financial arrangements (which the
web-cast described as serious in a Western context) is arguably more
extreme in East Asia than anywhere else (see
Evidence);
- affected economies risk financial crises if investment is
financed from borrowing in international profit-focused financial markets,
rather than by suppressing demand and generating saving
which exceed those needed for investment (see see
Understanding East
Asia's Neo-Confucian Systems of Socio-political Economy);
- the resulting financial imbalances reflect not only a 'clash' of financial systems,
but also a broader 'clash of civilizations', that has arguably affected
recent history though it has been almost invisible to
Asia-illiterate Western economists and defence analysts (see
An unrecognised
clash of financial systems, 2001+;
Babes in the
Asia Woods, 2009+; and
Comments on
Australia's Strategic Edge in 2030, 2011);
- Europe was badly affected by the financial crisis, not only because of
the effect of the euro and domestic problems in various countries, but also
because 'safe' investment of foreign exchange reserves by many major oil exporters
favoured Europe (due to political objections to investing in the US).
European financial institutions then often had to redirect those funds to the US (which had the
world's deepest financial markets) in order to prevent a significant
appreciation of the euro, and a loss of export competitiveness (see also
Sovereign Defaults: Stage 2 of the Global Financial
Crisis). Because of this Europe's banking system appeared to be heavily
exposed to financial products that turned 'toxic' when the GFC started and
to incur
losses that were at least as serious as those in the US.
The losses incurred by European banks also seemed to be confronted and
written off much more slowly.
Second, there can be no economic solution by increased
government spending without dealing with
international financial imbalances - as the latter produces demand
deficiencies in many developed economies and are major factors in government
fiscal constraints.
While it may make sense (as the web-cast suggested) for
governments who can afford it to provide a stimulus when other demand
is weak, the international financial imbalances that were mentioned
above imply that almost no one can now do
so - because the public and private debt levels of deficit economies are
already high, while surplus economies can't move into deficit if their
financial systems remain under-developed.
While it is possible to debate the effect of fiscal austerity in Europe,
there is little prospect of government stimulus spending in many of the
countries that are suffering the worst recessions.
The US's 'fiscal cliff' can also be considered
- the 'cliff' being an economically-disruptive and mandatory set of severe tax
rises and spending cuts that were put in place in 2010-11 to force serious
action before 2013 to redress the US federal government's escalating debt
levels. The fiscal problem might, for example, be temporarily 'resolved' by ignoring
rising government debts (ie by continuing spending well in excess of
revenues). This could be expected to lead to another downgrade of the US's
credit rating [1] with disruptive effects on financial markets (as in 2011) and
perhaps higher interest rates on US government debts, which could then
compound the fiscal problem into a crisis in the new year or two.
Alternately the US's fiscal problem might be resolved, as far as government is
concerned, by increasing taxes and / or reducing spending, so as to stabilize
government debts. However, if the US is to maintain current account deficits
(to accommodate excess savings elsewhere by continuing to act as the world's
'consumer of last resort'), it must maintain a capital account
surplus (ie import capital / increase someone's debt levels). Any fall in government deficits will
simply shift the need to borrow onto households and the private sector - if total
demand is not to fall and cause a serious recession. If other sectors are
unwilling / unable to significantly increase their borrowing, then resolving
the US 'fiscal cliff' by balancing government budgets is likely to be recessive for
the global economy. And it can be noted that: (a) households are in a
de-leveraging mode because of historically high debt levels and stagnant asset
values; and (b) business generally does not seem to have the confidence to
invest.
Without rapidly rising asset values households and businesses in the North
America,
Europe, Australia etc can't provide the
excess demand that is needed to sustain structural demand deficits in East
Asia, emerging economies elsewhere and major oil exporters. And, if rising
asset values were again to be stimulated by easy money policies so as to provide the basis for spending well in excess of
income, this would recreate conditions like those prior to the GFC and
presumably lead to another crisis.
On the other side of the imbalance equation, major East Asian economies (ie
Japan and China): (a) seem to be under immense pressure; (b) may have unsustainable
financial and economic systems; and (c) could thus experience breakdowns that trigger
Stage 3 of the GFC
(eg consider
Are East Asian Economic Models
Sustainable? and
China:
Heading for a Crash or a Meltdown?).
Japan has been involved in stimulus spending for two decades and has
government debts that exceed 200% of GDP. China has been engaged in massive
stimulus spending (partly through easy credit for property development) since
the GFC started. The more such stimulus is continued in the absence of strong
demand elsewhere, the greater the risk of generating current account deficits
and thus financial crises.
As suggested below, resolving the economic
impasse is likely to require much more than debates about governments' fiscal
constraints and options. Structural changes (rather than counter-cyclical
fiscal and monetary policies) will be needed as (for example) the US
relinquishes its role as the developing world's 'consumer of last resort'.
Third, suggestions in the web-cast about productivity as an obstacle to structural transformation
(and thereby creating new economic / employment opportunities in developed
economies)
are suspect.
It was suggested that increasing productivity causes industries to decline.
This is certainly correct if 'productivity' is defined as ratio of output to
inputs (eg inputs of labour). For example, if mechanisation (which has typically
been mainly associated with significant increases in fossil fuel consumption)
allows workers to each produce (say) 10 times as much food, and if demand for
food is limited, then (by definition) 'productivity' will have reduced employment (and thus be associated perhaps
with a decline in agricultural employment from 50% of a workforce to 5%).
However productivity is more usually defined in terms of increased economic value added
relative to economic inputs (ie to over-simplify this means (sales – costs) /
costs). The latter definition of productivity tends to be associated with rapidly growing economic activities. Though
reducing input costs per unit of output implies reduced labour, significant reductions in prices can lead
to large increases in demand, so that though the number of jobs / unit of output
fall, the total number of jobs increases – until increased competition causes an
over-supply relative to demand and a need thus arises for innovation and the
development of new areas of opportunity.
While there are certainly constraints on the use of financial criteria as a basis
for guiding economic activity, there are also significant advantages (see
The Advantages and Limitations of Financial Criteria). And there are
also disadvantages in alternative methods (eg neo-Confucian social networks in
East Asia) as
noted above.
Finally, there are better options to facilitate economic adjustment
than those involving monetary and fiscal policies: Some
suggestions about this are in 'China may not have the solution,
but it seems to have a problem'. These include:
- recognising the obstacle to global growth that structural international
financial imbalances create;
- constraining the availability of credit for consumption in deficit
economies and the development of complex financial products and systems,
while:
- boosting productivity, incomes, equality and tax revenues through
novel approaches to accelerating market-oriented economic adjustment;
- reducing the need for defence spending (eg by increased emphasis on
discrediting the ideology of groups seen to pose a security risk) and for
some forms of welfare entitlements;
- strengthening the ability of governments to act competently in the
general community interest;
- encouraging and supporting the development of reliable and transparent
financial systems in countries (most notably Japan and China) that currently generate dangerous financial
imbalances because of their risk of financial crises.
It can be noted that, while there may be large benefits from constructive
public investments (eg in education, infrastructure and technology), this can
only be put into effect if governments are more competent than many have been
allowed to become over the last couple of decades. Possible means of improving
government competence that were referenced above were written in an Australian
context - and will thus not be of universal relevance, though there will
presumably be parallels.
Sovereign Defaults: Stage 2 of the GFC?
[<]
Increased concern was also expressed from 2010 about the unsustainable debt
levels facing peripheral governments within the Eurozone, especially the so-called PIIGS
(Portugal, Ireland, Italy, Greece and Spain). This was seen as potentially
leading to sovereign defaults that could trigger further international
financial and economic instabilities.
However other governments faced (especially Japan) faced very high debt /
GDP ratios, while the US's ability to maintain very high government deficits
and high debt levels (see below) appeared to
depend on the $US's status as the world's reserve currency.
It was the the present writer's expectation in mid-late 2009 that further
stages of financial and economic crisis were likely which had been
overlooked in coordinated efforts by governments through the G20 to deal
with the GFC (see
Unresolved Problems and
Coming Crises) Factors in generating the
problem in Europe apparently included:
-
the dislocation of previously successful economic strategies as a
consequence of the first stage of the GFC. For example:
Ireland in 2010 faces 10%
interest rates on government debt, and is expected to be unable to borrow
from next May. Ireland, til recently, was the best place to live - with a
high growth rate and an unmatched quality of life. Ireland adopted euro in
1999 giving it access to much bigger capital market, halved taxes, cut
import duties and encouraged foreign investment. Many major companies
adopted Ireland as their base in eurozone. By 2003 GDP / capita was 136% of
European average, and unemployment was down from 17% to 4%. Emigration
turned into net immigration. Government could increase spending
dramatically, and still run surpluses. When inward investment / export-led
growth slowed, government decided to boost property market with tax breaks,
and encouraging banks to provide easy credit to house-hungry consumers.
Ireland's construction industry boomed, Successful developers started
acquiring property elsewhere. Bank lending for property increased 30% pa.
When banks ran out of money to lend, they borrowed from Germany. At height
of boom in UK, property industry accounted for less than 10% of economy, but
in Ireland it was 25%. When Lehman Bros failed, asset values collapsed.
Banks were bailed out, but Ireland went into recession. Supporting banks
costs government 32% of GDP. More mortgages defaults are expected as
unemployment rises and house prices fall. (Arlidge J.,
'Irishman walks into a bubble', The Australian, 17/11/10)
-
the failure after 2008 to clean up
the balance sheets of European banks by writing off all GFC-related losses;
The core of global problem in 2012 is that European politicians and central bankers
failed to recapitalise their broken banks. Europe's banking system is globally
important. When a country undertakes austerity program its economy slows, asset
values fall and this imposes losses on banks. This reduces banks' ability to
obtain capital, and worsens the problem - as does risk of break-up of eurozone
and ECB lending to troubled banks while encouraging them to gamble on bonds in
countries that may be unable to repay debt. Stress tests on Europe's banks were
selective and concealed problems. Thus attempts to rescue European banks have
failed to address core problem [ 1]
Spain could be too hard for Germany and northern European countries to rescue.
Its crisis did not result from government overspending (noting its budget
surpluses and low debt to GDP ratio). Wealthy foreigners had rushed to buy
second homes in Spain prior to GFC, and when the value of these collapsed,
Spanish banks were left with large losses. This was like the situation in US,
but because it was involved in EU Spain could not take measures to write off
those losses, and ECB could not provide support (like US Fed did) because of its
lack of regulatory control over Spanish banks [1]
- features of the European Monetary Union (EMU), for example:
- under the EMU 'Club Med' countries with
relatively weak economies had
the same currency as those in the centre / north of Europe. This
arrangement improved
the competitiveness of countries with well developed export capabilities
(especially Germany), but it severely limited the competitiveness of the
peripheral economies and required heavy government spending to maintain
economic growth and employment;
- automatic mechanisms to adjust for international currency flows
resulted in Germany's central bank (the Bundesbank) being heavily
exposed to potential losses elsewhere because it provides funds to the
ECB to cover interbank transfers from (say) Greece to Germany [1].
- democratic demands for welfare arrangements (exacerbated by aging
populations) that those countries could not afford.
In 1984 the US was about to benefit from
the ‘demographic dividend’ as baby boomers boosted labour supply and national
productivity. But baby boom does not last forever – as baby bulge reaches
retirement age, labour supply stops growing, older workers start spending their
savings, national savings runs down. Strong growth is still possible, but
requires increased productivity, longer hours. This is what is now affecting much of southern Europe. The first serious strains in European budgets are
showing up in welfare – because pension schemes offer defined benefits paid out
of future tax revenues. (McArdle M., ‘The boomer bust’, AFR, 25/5/12 -
from
Europe’s real Crisis) Europe faces a civilization crisis - related
to overspending governments and over-regulated economies. Normally
this could be solved by slashing taxes and red tape, but Europeans are
addicted to entitlements (eg welfare, early retirement) and so resist
such reforms (Stephens B.
'Europeans addicted to what ails them', The Australian,
11/6/12)
[This issue does not seem to be confined to Europe as it is also reflected
(for example) in: California's incompatible referenda to limit taxation
and increase public spending, and in disputes concerning US federal budget
deficits in 2011 that seemed likely to re-emerge in 2012 as the US
approaches its so-called 'fiscal cliff', which could result on 4.5% of GDP
in tightening [1]];
- the apparent presumption by lenders that peripheral European economies
could be provided with ready access to loans despite their increasing
debts, because of the assumption that governments in the eurozone would
not be allowed to default;
- policies involving fiscal and monetary contractions affecting
countries (eg Spain) suffering housing busts [1];
Spain's collapse is inevitable result of monetary and fiscal contraction on an
economy struggling to deal with housing bust. ECB monetary tightening caused
Spanish real M1 deposits to fall 8% in late 2011 (and also caused broader M3 for
Europe as a whole to fall during 2011). This was incompetence [ 1]
- international financial imbalances.
Financial Imbalances and the European sovereign debt crisis:
Though the situation is complicated, it is clear that the financial crisis
threatening Europe from 2010 (as did the US-centred GFC in 2008) had its origins
partly in
the difficulties of finding safe / production domestic uses for the huge
quantities of capital that accumulate as a result of excess savings in
countries with under-developed financial systems (eg see
Understanding East Asia's Neo-Confucian Systems of
Socio-political Economy and
Leadership by
Emerging Economies?).
The demand deficits associated with excess
savings in East Asia (and in other surplus countries such as Germany and
major oil exporters) had to be offset by excess demand elsewhere if global
growth was to be maintained. Much of the excess demand was provided by US
consumers on the basis of perceived wealth associated with a pre-2008
asset bubble and when this burst losses by financial institutions were
partly shifted to US governments (see
Getting out of the Economic Quicksand).
In relation to the role that international financial
imbalances played in the financial crisis that emerged in Europe in 2010, it
can be noted that:
- financial imbalances did not only adversely affect the US. In
many countries (including major European economies such as France, Germany
and Italy) large fiscal deficits had been needed to achieve sufficient growth
to keep unemployment under control (see
Structural Incompatibility Puts Global Growth at Risk,
2003). In late 2011 one observer suggested (in relation to the European
debt crisis that by then was seen as a major economic risk) that:
"Germany has kept the focus exclusively on fiscal
deficits even though everybody must understand by now that this crisis was
not caused by fiscal deficits (except in the case of Greece). Spain and
Ireland were in surplus, and Italy had a primary surplus.
As Sir Mervyn King said last week, the disaster
was caused by current account imbalances (Spain's deficit, and Germany's
surplus), and by capital flows setting off private sector credit booms." [1]
- current account surpluses associated with
Germany's export-based economy and foreign investment in European
financial institutions (eg by Middle Eastern oil exporters who objected
for political reasons to
investing in the US) created a
requirement for large-scale external investment by European financial institutions (as
otherwise economic competitiveness would have been severely eroded by increasing currency values). A great
deal of that capital had been passed to US financial institutions (an economy
well equipped to absorb it) - and thus
became embroiled in the asset bubbles whose bursting led to the GFC. Thus European financial institutions appeared as badly or
perhaps even worse
affected by the GFC contagion, than those in the US in 2008. Other excess
capital that accumulated in the European core was directed to Eastern and Southern Europe - and in
turn generated large losses for European banks, and a need for
governments to add to their existing high debt levels by protecting them
from failure (eg by guarantees on sovereign debts of troubled EMU member
countries such as Greece)
In 2012 the link between financial imbalances and
problems in southern Europe were being publicly discussed.
Peripheral European countries (such as Spain) which
are uncompetitive, have high debt levels and savings rates that have been
forced down to dangerous levels could leave the euro. Spain's position is
stronger than many others, while France's position is marginal. Either
(countries like) Spain must leave the euro or Germany must leave because of
balance of payments problems and internal processes leading to financial
crises. Spain has become uncompetitive due to excessively loose monetary
policies driven by Germany's needs - and thus suffered current account
deficits. Its savings rate collapsed, costs rose, debts soared and
unproductive projects attracted investment. Spain must reverse its savings /
consumption balance and get its current account into surplus - or else will
continue struggling with growth and rising debts. There are three ways to do
this: (a) core countries (eg Germany) could cut consumption / income taxes
so as to reduce savings, increase domestic consumption, and reduce its trade
surplus; (b) Spain can force austerity / high unemployment for years until
wages are pushed down (a process that could be aided by other measures to
facilitate business); and (c) Spain could leave the euro and devalue. The
first option would be the best but is unlikely because Germany has potential
huge debt problem on its balance sheet due to consumption-repressing
policies over past decade which generated capital for offshore investment
(mainly in Europe). A wave of defaults across Europe now would lead to a
need for state bailout of Germany's banking system. Germany's
anti-consumption policies are leading to the same sort of debt problem that
the US did in the late 1920s. Germany's efforts to boost its
credit-worthiness are likely to be counter-productive. Without a major
reversal of Germany's current account position, net repayments from
peripheral countries are impossible. Germany is presumably hoping that if
crisis is prolonged it will be possible to recapitalise European banks
sufficient to allow them to cope with losses (as US did with Latin American
in the 1980s). However this won't work as: (a) the European banks losses are
much more severe; and (b) Europe's political systems are less able than
Latin America's to allow costs of adjustment to be forced onto communities.
This is the reason that Spain can't follow the second path (ie carry the
full cost of adjustment itself). Doing so would raise problems in: (a)
reducing wages and prices; (b) coping with domestic debt burden (eg by
confiscating middle class wealth). As other options are impossible, Spain is
left with no choice but to abandon the euro [1]
It would be better for peripheral European
economies facing debt constraints to stay in the eurozone and face up to
reform because all parties will lose from a break-up of the eurozone. The
eurozone's stronger economies had been financing the current account
deficits of the weaker ones, which were losing competitiveness as their
relative wage costs increased and as northern firms took advantage of the
scale economies the move to a single currency allowed. Leaving with create
severe problems for 'club med' economies - while also requiring recognition
of substantial losses by banks in the European centre, and Germany's loss of
its ability to achieve current account surpluses through exports to the
periphery [1].
China and Japan Need to Do More Than Contribute to Europe's
'Begging Bowel' - email sent 20/6/12
Richard Gluyas,
The Australian
Re:
Shifting power balance sees China, Japan dig deep to save the West, The
Australia, 20/6/12
Your article suggested that the arrival of the Asian
century is underscored by the funding committed by China and Japan to the IMF
(which is now in effect ‘Europe’s begging bowel’) while the US did not do so.
However this is just a continuation of the practices that
got the world economy into its current mess. Suppressing domestic consumption so
as to generate savings which have to be exported and thus boost demand (and
rising debt levels) in trading partners has been foundational to the systems of
socio-political-economy that have been the basis of economic miracles in East
Asia. Such countries have needed to protect their poorly developed financial
systems, and this resulted in the international financial imbalances that played
a major role in generating the global financial crisis (eg see
Structural Incompatibility Puts Global Growth at Risk,
2003;
Understanding
East Asia's Neo-Confucian Systems of Socio-political-economy,
The Asian Connection in the Public Debt Problems Facing Developed Economies;
and
GFC Causes).
The G20’s failure to understand / confront East Asia’s
cultural problem, and the West’s futile hope that the financial crisis can be
fixed by countercyclical fiscal and monetary stimulation of domestic demand in
countries which already have large current account deficits and debts, is one
reason that the crisis has continued to get worse (see
G20 in Washington: Waiting for Hell to Freeze Over? and
Sustainable World Growth Requires More than Counter-cyclical Policies).
While the financial problems facing some peripheral
economies in Europe have many causes, in relation the availability of credit
their problem has not been a lack of credit, but rather excessively easy credit
(see
Comment on the European Sovereign Debt Crisis). Heavily indebted economies
need to be stimulated by external (rather than by artificially generated
internal) demand.
Thus, if countries such as China and Japan really want to
help, they would reform their financial systems so that they would not be at
risk of crises if they allowed domestic demand to rise, and thus faced current
account deficits. It is in Asia that financial system reform is most necessary
(see
Should Fixing the International Financial System Start in Asia?). If such
countries do not want to help solve the global financial problem, then the rest
of the world’s options might be something along the lines suggested in
Getting out of the Economic Quicksand.
John Craig
PS: Some suggestions about
the need to understand the other implications of a possible ‘Asian century’ are
outlined in
An Asia-literate Approach to 'Asia'.
In August 2012 the president of the European
Commission suggested that Europe would seek to overcome problems
associated with financial imbalances within a 'firewall' created by
expansion of the European Stability mechanism
The eurozone is at a decisive juncture. Short term debt crisis has its roots in
structural problems. Europe is undergoing a correction of macroeconomic
imbalances that grew before financial shock of 2008. Europe's integrated
financial market had channelled savings from countries with sluggish domestic
demand to those with strong demand based on credit, and wages / prices were
increasing. This occurred both in US and EU. Europe has made progress over past
2 years in correcting these imbalances - and the situation in Ireland, Portugal
and Greece has improved. Talks continue regarding Greece and Spain. But
correcting imbalances remains a major problem. Some countries need to reduce
deficits, or increase surpluses - through boosting competitiveness. The European
Stability Mechanism has created a firewall inside which this can happen. This
will provide credit for countries that undertake lasting reforms. Europe will
build a genuine economic union to strengthen the existing financial union (eg by
creating a single supervisory mechanism for banks) (Rehn O. ' Delicate
balancing act to end continental drift, The Australian, 16/8/12)
Further observations about political aspects of the situation are in
Saving Democracy.
Limiting the 'Consumer of Last Resort'
[<]
In early August 2011, the US government finally accepted the need to
constrain the growth of US government debt. Soon thereafter the US
government lost its AAA credit rating because the adjustments to its
budgetary position were seen to be inadequate and the US political process
was not handling the challenge well.
This seemed likely to result
in serious consequences for the global economy because poorly developed
financial systems in major East Asian economies, and in emerging economies
elsewhere, had been protected from financial crises by limiting domestic
demand and reliance on current account surpluses largely at the expense of
the US, the world's 'consumer of last resort'.
Will ending the magic credit card bring the world economy
to its knees? (Email sent 2/8/11)
Peter Hartcher,
Sydney Morning Herald
Re:
The magic credit card brings US to its knees, Brisbane Times,
2/8/11
Your article
suggested that:
“The
US debt crisis marks the end, at least for some years to come, of American
exceptionalism - the idea that the normal rules of national conduct do not
apply. And because exceptionalism tempted the country into grave misjudgments,
this is a good thing.”
There is little doubt that apparent
strategic misjudgements by the US (such as those your article outlined) may have
been the result of overconfidence in its institutions and strength. However the
issue is more complex, and it by no means obvious that there are any
satisfactory alternatives.
For example the US’s
now-officially-recognized inability to continue increasing debts indefinitely
(which has been obvious for years) could prove to be a most ‘uncomfortable
thing’ for the world economy. Global economic growth has long relied on the US’s
role as ‘consumer of last resort’ and there are likely to be severe
repercussions from its inability to continue this role (including the likely
failure of the systems of socio-political-economy that have been the basis of
‘economic miracles’ in East Asia, and thus of Australia’s ‘China luck’).
Large segments of the world economy
(especially the emerging economies whose growth is now seen to be critically
important, because of weaknesses in developed economies, seem to depend on
current account surpluses to avoid the financial crises that would otherwise
afflict their poorly developed financial systems (eg see
Leadership
by Emerging Economies? and
Are East Asian Economic Models Sustainable?). The latter notes in
particular that neo-Confucian systems of socio-political-economy appear to
involve state-linked banking systems mobilizing national savings and directing
capital to state-linked enterprises with limited regard to profitability (an
arrangement that constitutes a novel form of industrial protectionism), while
domestic consumption is suppressed to the point that a current account surplus
results, so there is no need to expose banking systems with poor balance sheets
to a requirement to borrow in ‘capitalistic’ international financial markets.
These macroeconomically unbalanced economies have depended
on the willingness and ability of trading partners (mainly the US) to compensate
for their demand deficits by sustaining large current account deficits and
continually increasing debt levels (see
Structural Incompatibility Puts Global Growth at Risk, 2003). The associated
financial imbalances clearly played a role in encouraging the risky monetary
policies in the US that contributed to the global financial crisis (see
Impacting the Global Economy ) and thus also in the large debt levels that
governments in many countries incurred in rescuing their financial systems from
the effects of that crisis (see
The Asian Connection in the Public Debt Problems Facing Developed Economies).
There are, of course, other factors in the public debt problems now afflicting
many governments (eg limits to the democratic welfare state in the face of an
aging population).
However, many will not find the end of US exceptionalism to
be an unambiguously ‘good thing’ now that: (a) the limits to quantitative easing
in stimulating economic activity seem to have been reached; (b) the world’s
‘consumer of last resort’ (finally) faces pressure for frugality not only from
heavily indebted households but from governments; and (c) no country now seems
to be in a position to provide the demand required to support the financial
imbalances that emerging economies require.
Finally it is submitted that while problems
have emerged partly from over-confidence in the US’s own institutions and
strength, it is likely that problems have also been the product of a lack of
understanding of others’ cultures and institutions – see
Competing Civilizations and
The
Second Failure of Globalization, from 2001 – and in particular
Fatal Flaws (in relation to cultural constraints on introducing democratic
capitalism in the Middle East),
An Unrecognised Clash of Financial Systems (in relation to an
apparent pre-emptive challenge to democratic capitalism that seems to have been
under way for decades) and
Creating a New International 'Confucian' Social, Political and Economic Order
(in relation to the prospective emergence of an alternative to democratic
capitalism). The social science and humanities faculties of
Western universities seem to have been ‘asleep at the wheel’ for decades (see
A Case for Restoring Universities).
I would be
interested in your response to the above speculations.
John Craig
In late 2012 there was a great deal of global debate about the so-called
'fiscal cliff' in the US which reflected the need to bring US government debt
under control. However the international dimensions of this issue seemed to be
entirely overlooked.
A Plan to Both Reduce US Debt Levels and Sustain Growth - email sent 3/1/13
Stephen Barthlomeusz,
Business Spectator
Re:
Miles to go before markets can breathe, Business Spectator, 2/1/13
(also ‘No let-up in risk aversion until policymakers see path to stability’,
The Australian)
Your article correctly points
to the fact that the (so called) ‘fiscal cliff’ in the US is merely one
component in problems affecting the global economy, and that sustained recovery
is unlikely until policy-makers in the US and Europe have some clear path to
achieving longer-term stability. I should like to make a suggestion about what
that path might be.
My
interpretation of your article: The US
fiscal cliff is receiving a lot of attention, but this is only a distraction
from larger problems affecting the global economy. Despite short term solutions
being arranged to prevent immediate economic problems, US debt levels are
unsustainable – and there is a need for a long term plan to reduce these while
boosting growth. The US is still struggling with the consequences of the GFC,
and Europe is in worse shape. All that central banks have done with
unconventional monetary policies is to trigger a global currency war – in the
hope that this might stimulate growth and lessen risk aversion. This has been
good for equity markets, and ensured a flow of capital into $A assets. However
long-term use of easy money policies creates a risk of unpleasant consequences.
Without a real solution, institutions, companies and households will remain
cautious. Risk aversion won’t disappear until it becomes clear that
policy-makers in the US and Europe have pathways towards longer term stability.
As you are undoubtedly aware,
the ‘fiscal cliff’ in the US was an artificial device that was created to force
serious attention to be given to the US’s escalating public debts. And the
latter is not simply a domestic issue because the real problem arguably lies in
international financial imbalances (related to the developing world’s long
dependence on the US as the ‘consumer of last resort’ and structural demand
deficits in (mainly
East Asian and
emerging) economies that would face financial crisis if they incurred
current account deficits because of their poorly developed financial systems).
Prior to the global financial crisis, US households carried most of the burden
of rapidly rising debt – on the basis of escalating asset values boosted by easy
money policies – but since sub-prime crisis burst the asset bubble much of the
burden in the US has shifted to the federal government. Imbalances have also
been a significant factor in the fiscal problems in Europe (see
Comment on the European Sovereign Debt Crisis).
As long as financial imbalances
remain in the too-hard basket (eg see
G20 in Washington: Waiting for Hell to Freeze Over?), it makes little
difference to the global economy whether the US government (say) moderates its
deficits, as (given the US’s large current account deficit) this would merely
shift the need to be willing and able to increase debt onto
already-heavily-indebted US households if total economic demand is not to
stagnate. And, as your article noted, neither households nor companies are
likely to be willing to carry this load until a clear path to long term
stability is apparent.
This
point is developed further in
Progress Towards Ending the Global Financial Crisis? The latter also
notes the inadequacy of counter-cyclical (fiscal and monetary) policies in
dealing with structural economic problems and includes
suggestions on: (a) options to overcome the constraints associated with
international financial imbalances; and (b) novel methods to boost growth (and
thus public revenues) in countries such as the US.
John Craig
Options to Resolve the Fiscal Cliff and Reduce Military Spending - email sent 7/1/13
Kevin Zeese,
Its Our Economy
Re:
Fiscal Cliff Over, Now the Attack on the People Begins, Global Research,
Jan 2, 2013,
Your article pointed to the failure of negotiations in relation
to the so-called ‘fiscal cliff’ to make any serious inroads into US military
spending (so that spending cuts are likely to adversely affect the general
community).
I should like to suggest that this could be changed by
demonstrating (to the US public / political system) that there are better
soft-power alternatives to military spending to reduce the threats associated
with groups who pose security risks. This is one of the options that could be
part of a broad approach to the world’s financial and economic challenges (see
Progress Towards Ending the Global Financial Crisis?).
The de-militarisation option (through a more serious effort to
deploy soft power) can be illustrated in relation to the security threat posed
by Islamist extremists. In particular:
- There were major limitations in the stated logic of the US-led
invasion of Iraq (see
Fatal Flaws). The 2002 US National Security Strategy seemed to be based on
the view that bringing ‘freedom’ to a country such as Iraq would result in major
political and economic gains, and thus eliminate the case for Islamist
revolutions in the Middle East (which indirectly led to attacks against Western
societies because they were seen to be supporting autocratic regimes in the
region). However this ‘logic’ overlooked the many cultural and institutional
preconditions that would have to be in place before ‘freedom’ (eg by displacing
Saddam Hussein’s autocratic regime) would be likely to bring those benefits. For
example, ‘freedom’ from an autocratic state is not sufficient if family /
communal constraints also seriously inhibit individual initiative, and democracy
can’t be effective without well-developed civil institutions; and
- There were soft-power options to greatly reduce the security risk
from Islamist extremists (without visiting Baghdad in force) by giving potential
supporters of Islamist extremists a chance to understand that the latter’s
ideology would make the situation in the Middle East even worse (see
Discouraging Pointless Extremism, 2002).
The military intervention option (which was advocated by the US
neo-cons) was accepted in the apparent complete absence of any serious proposals
in the US about alternative ways to dealing with what was a very real security
threat. The absence of an alternative was not the fault of defence analysts (or
their industrial / political connections) because their expertise is only in
military / security options. Rather the absence of an alternative largely
reflected the fact that students of the humanities and social sciences in
Western universities had been ‘asleep at the wheel’ and had not considered the
practical consequences of differences in cultural assumptions for a society’s
ability to achieve political stability and economic progress (see
Ignorance as a Source of Conflict).
Similarly there are soft-power options that, if successfully
deployed by those outside the military system, could make it obvious that there
is no need for high levels of US military spending in relation to the emerging
security threat associated with China’s increasing militarisation. What this
alternative might require is suggested in
A Better Australian Response to US Defence Proposals? (2012).
It seems very likely that that what you described as ‘attacks on
the people’ because of fiscal constraints can be avoided. But this requires that
those with the necessary skills and motivations get off their backsides to show
the public / political system that non-military / soft power options can be
effective in reducing security threats.
I would be interested in your response to my speculations.
John Craig
US Focus on the Asia Pacific
[<]
In November 2011, the US President announced an intention to shift the
US's national security focus to the Pacific, involving in particular:
- standing "for an international order in which the rights and
responsibilities of all nations and people are upheld. Where
international law and norms are enforced. Where commerce and freedom
of navigation are not impeded. Where emerging powers contribute to
regional security, and where disagreements are resolved peacefully"
and collaborating more (including militarily) with allies in the
region [1].
In particular emphasis was placed on expectations that China would
'play by the international rules' [1]
- strengthening efforts to free up trade in the Asia Pacific through
a Trans-Pacific Partnership Program [1].
The incompatibility between such US expectations and
East Asian practices clearly
lays the foundation for ongoing international tensions.
From 2011
disputes grew
between US and China about the apparently poor accounting practices of
Chinese companies with US operations (and the suspect auditing of the
Chinese operations of US companies) - and this (like the US Federal
Reserve's so-called 'Currency War') seems likely
to start getting at the root causes of those international financial
imbalances that have their origin in East Asia.
Creating an Effective International Financial System?
[<]
In June 2012, a former chairman of the US Federal Reserve, Paul
Volcker, suggested that the global economy would be unable to rely
indefinitely on high levels of consumption in the US, and on associated
financial imbalances. He put forward some suggestions about how a more
effective international financial / monetary system might be created in order
to reduce the risk of financial crises.
Financial systems can break down (eg Asia in the 1990s and
US / Europe a decade later). Without international consensus reform will be
difficult. Free markets can be constructive, but not with a deregulatory race to
the bottom. There is a need for a consistent approach to the imminent failure of
systemically-important institutions. The US has new approaches to bankruptcy -
but this will fail without similar provisions elsewhere or where other
jurisdictions undercut restrictions. There is also a need for reform of
international monetary system - as at present there does not seem to be a system
(ie there is no authority or official international currency). Such a system has
been made harder as markets / capital flows have become larger and more
capricious. The global economy and emerging markets have flourished with an
organised system. But international monetary disorder lay at the heart of crises
of 1990s and even more in 2008 - especially related to sustained / complementary
imbalances in the US and Asia. From 2000-2007 US had cumulative current account
deficit of $US5.5 tr, with offsetting increases in China and Japan. China ran
large trade surpluses, based on high savings rate and inward foreign investment.
By contrast the US had high consumption levels at the expense of savings, while
a housing bubble eventually burst. Any individual country may prefer to prolong
unsustainable imbalances - though this is likely to lead to financial crisis.
Floating exchange rates were expected to solve this problem, but many countries
find it impractical to let their currencies float. Thus there must be some sort
of surrender of sovereignty if an open world economy is to work. Ways to achieve
this include; (a) stronger surveillance by IMF; (b) direct recommendations by
IMF / G20 or others following mandatory consultations; (c) potential
disqualification from using IMF or other credit facilities; (d) interest or
other financial penalties such as a being considered in Europe. There could also
be agreement about appropriate 'equilibrium' exchange rates. An appropriate
reserve currency and adequate international liquidity is also needed. $US (and
other currencies) have play such a role, leading to complaints - but it is not
in US interest to accentuate its payments deficits at the expense of
internationally competitive economy with strong industry and restrained
consumption. And the rest of the world wants flexibility afforded by the
currency of the largest and most stable economy. A useful reserve currency must
have limited supply, but be sufficiently elastic to satisfy large /
unpredictable needs. (Volcker P., ' A
roadmap for global financial reform', Business Spectator, 7/6/12)
However, while this recognised that not all countries could
afford to have a market-based floating exchange rate (by implication countries such as
Japan and China), there was no obvious reference to, or necessary recognition
of:
In early 2013 a German member of the European Federal Parliament sought
suggestions about what are the most dangerous financial products - without
apparent recognition of the risks that large / persistent international
financial imbalances generate [1]
Debt Denial: Stage 3 of the GFC... or
Worse?
[<]
In early 2013, there was growing optimism about global economic recovery.
However this is likely to be misplaced because nothing had been done to resolve
fundamental problems in the global financial system (eg
those that give rise
to large financial imbalances) and 'recovery' was being expected in an environment
characterised by 'Ponzi-like'
financial systems.
Elaboration - preliminary notes only
In early 2013 there was clear optimism about economic recovery being
reflected in rising stock markets, in an environment in which
quantitative easing by reserve banks (ie 'debt denial' by monetising the
debts of governments and systemically-important corporations) was widespread (eg in US, Europe
and Japan).
And a case could be made that monetisation of government debts could be
a necessary / viable strategy.
Some are sure that Western economies suffer a surfeit of money; economic
orthodoxy suggests that forcing private spending up is needed for
recovery; and everyone agrees that monetary financing of government is
lethal. All these views are wrong. It is only the quantity of money that
matters - and these have stagnated since crisis started. Broad money in
US in 2012 was 17% below trend. Deposits do not create loans, loans
create deposits - and since the crisis started loans have stagnated.
Banks don't expand lending in accord with their reserves - so
hyperinflation is not unavoidable. Expanding bank reserves encourages
low interest rates (and thus makes business investment more likely,
while increasing asset values and thus making consumer spending more
likely - though this might have unintended consequences (eg by
threatening the health of financial institutions / financial markets /
central banks and making government imprudent) that imply limits to what
central banks can do. However there are alternatives - such as breaking
the link between creation of money and growth of private debt (ie by
offering state guarantees on all bank deposits). It is not necessary to
go that far, but it makes the point that monetary easing can validly
boost spending on public infrastructure. This has the twin advantage of
fiscal stimulus and monetary expansion - without necessarily risking
hyper-inflation. Japan could have solved its problem by going to
outright monetary financing 20 years ago. a helicopter response to a
financial crisis has to be recognised as a possible option (Wolf M., 'The
Case for Deploying the Helicopter', Financial Times, 14/2/13)
Though Europe remained mired in recession, US housing prices
(whose collapse had been a trigger for the GFC) were recovering,
attracting investment and (potentially) boosting household wealth /
consumption - and shale-gas developments raised the
medium-term prospects of reversing the long term constraint of expensive
oil imports on US domestic demand / economic growth. China resumed the
infrastructure-investment-led methods that had maintained growth
following the start of the GFC in 2008.
However many observers were concerned that these improved prospects might be
artificial than real.
Global outlook is everywhere seen to be brighter. Leaders say their
policies are now working - but central banks continue to grow their
balance sheets - thus 'kicking the can down the road' while keeping hope
alive. Australia's treasurer says things are fine. But what if the green
shoots don't blossom, and central bankers tactics prove to be a giant Ponzi scheme. When governments / central banks in response to crises (eg
that in Greece) there are consequences. There is now a very tight
correlation between US stockmarket and FED's balance sheet (much tighter
than in the past). Corporate earnings are not rising - rather stocks are
rising because the ration between price and earnings is growing. This
may be leading to misallocation of scarce capital. And governments spend
without concern for fiscal prudence. Despite the fiscal cliff
negotiations the US is heading into much deeper debt, and has a $US 7 tr
deficit now (based on US Generally Accepted Accounting Principles)
rather than its nominal $US 1.1 tr. The West now has reached a
situation in which total private and public debt plus unfunded
liabilities can never be repaid by an aging demographic. One day even
debt servicing will be impossible, and the great international Ponzi
scheme will end. . (Newman M., 'Lifting
lid on a Ponzi scheme', The Australian, 23/1/13)
US Federal
Reserve officials are worried about extricating US from quantitative
easing. A paper pointed to the risk of Fed's capital base being wiped
out as interest rates rise (and bond values collapse). The Fed has
average bond maturity of 11 years - with implies much larger losses when
interest rates rise than for shorter maturities. Sovereign risk for US
is very real. qe in Europe also involves monetisation of the debts of
weak governments. Fed may be trapped - because 'bond vigilantes' could
devalue bonds - and force up interest rates. Gold would need to go to
$10,000 per ounce to cover fed's obligations. The US economy has not
reached escape velocity - and shrank in 4th quarter of 2012. QE recently
(in US / Europe / Asia) have boosted asset markets - but not improved
real economy - and arguably can't while East-West trade imbalances
remain. Belt-tightening in countries with public debts over 80-90% of
GDP is painful - unless offset by loose money. Tight money sets of
down-ward spiral. US may start to experience this as gross public debt
is approaching 107% of GDP. With domestic stimulus exhausted the only
option may be to seek stimulus from foreigners - and this could result
in trade conflicts [1]
In 1931 Keynes
suggested that bureaucratic tinkering (to attempt to deal with financial
crisis) had created a huge muddle / problem because it involved
tinkering with poorly understood systems. William White (formerly chief
economist with BIS) suggested central banks efforts to boost economies
were an unprecedented experiment which could be sowing the seeds of a
greater financial crisis. Other economists express diverse views [1]
Stock market
surge conceals problems in US economy, and regulators in trying to help
are fuelling a bull market. Corporate earnings are up, and household
income is down. Companies are using new technologies and outsourcing to
boost profitability. But reserve bank efforts to boost credit by buying
mortgages is boosting stockmarket - by forcing savers into equities.
Congress is seeking to constrain government spending, which will
increase unemployment. China faces the same income disparities as the US
and fears revolution - and so is tied to uneconomic infrastructure
investment [1]
Monetary policy in US and Europe are underpinning the value of assets.
This process must either be continued indefinitely or will have a very
poor outcome when the asset bubble bursts. (Sender H., 'Feds free
lunch will come to an untidy end', Financial Review, 4/3/13)
While there is a perception that money is flowing from bonds into
equities as part of a 'great rotation', the reality seems to be that it
is flowing from cash into both as savers prefer to get something rather
than nothing in a QE environment (Shapiro J. 'Bond markets at tipping
point', Financial Review, 6/3/13)
While share markets are surging, fundamental economic changes in US
economy are disturbing. Corporate profits are at record level of GDP, at
the expense of employees (because of the effect of new technologies and
outsourcing). Also quantitative easing by Federal Reserve primarily just
boost stock markets. Low interest rates (primarily a response to China)
force savers into equities. In China income inequalities also increase,
and raises fear of revolution. China ploughs money into unproductive
investment to keep its economy going - but this has a ring of
artificiality [1]
In Japan there is a massive divergence between stock market gains and
real economy decline. China is experiencing difficulties. US is holding
up. Europe remains a black hole. World Bank officials are concerned that
global economy may not reach 'escape velocity' and be held back by debt
overhang and chronic lack of demand [1]
In some respects the situation seemed like a return to 2007 in terms of
the vulnerability of financial systems to potential crises - a
vulnerability that was not necessarily obvious to those who focused on
conventional business / economic methods of analysis drawing upon 'real
economy' variables. For example:
countries in East Asia with poor national balance sheets because
governments had used 'financial repression' to steer savings into
export-oriented production capacity with little regard to
profitability were reliant on accumulated-but-now-probably-eroding
foreign exchange reserves to protect against 'sovereign risk' (see
Interchange Regarding China's Financial Challenges and
Japan's Predicament) - a
phenomenon that seemed to be generally unrecognised;
There was a lack of demand for credit from consumers. Encouraging
investment may result in over-capacity if households' willingness to
spend remains weak. Serious industrial over-capacity plagues China;
Corporate profits (to justify higher share market values) were
being driven by rising asset values;
There was a large build up of total credit . Credit was growing faster
than economic production - and this was likely to be having a role in
maintaining / boosting asset values;
some doubted the value of paper currencies - because of
monetisation.
Many countries seeking gold - China says that $US dominates to keep gold
down??
Moreover government debts were now unsustainably high in many places
(partly as a consequence of responding to the GFC).
There is likely to be a global deficiency in demand - because almost
everyone suffers from significant debt problems - a corollary of the
high levels of credit. Outcome could be global balance sheet recession /
deflation.
Can't keep increasing government debts indefinitely - cost of credit
rises, then assets (bonds / equities) fall
Austerity programs in Europe were: (a) generating social stresses that
may make them unsustainable; and (b) contributing to ongoing recession.
It was not clear that Europe's debt crisis is being resolved. There
was concern about monetary easing - namely that it might constitute a
form of 'currency war' to drive down exchange rates so as to boost
trade competitiveness. In particular there was concern that Japan might seek to directly
interfere in currency
markets by buying foreign bonds to weaken the yen. This would go beyond
quantitative easing that is accepted providing it is aimed at stimulating the
domestic economy (ie to head off deflation and drive down unemployment) [1]
None of these financial system stresses can be resolved without
dealing with the challenge of international financial imbalances
which:
In 2009 the present writer had
speculated that the GFC was likely to be a three stage process.
The first seemed to be the global financial system shocks that was
triggered by US sub-prime crisis - though it reflected far more profound
structural weaknesses in the international financial and economic order (eg
see GFC Causes). The second involved the potential
for sovereign defaults that was increasingly
obvious in 2010. The third could involve either the breakdown of the global
financial system altogether or the
failure of
East Asian economic models - related: (a) their internal weaknesses; and
(b) the stresses that they impose on the global financial system creating an
environment in which their internal weaknesses can no longer be papered
over.
To create an environment in which economic growth can be sustainable
there is arguably a need to:
In the unstable environment that will exist in the meantime countries
would arguably reduce their risks by seeking: political stability; a future oriented economy; and sound balance sheets
for households, businesses and governments.
Financial system reforms to be achieved in an environment in which there are numerous other
challenges facing the global community such as:
-
the emergence of new 'world policemen' (eg France in North Africa), as US no
longer assumes this role - partly due to fiscal constraints;
-
potentially explosive political
stress (China's social inequality and corruption; Occupy Movement; Islamist
extremists; North Korea; tensions between China and its neighbours);
-
potential environmental emergency (eg methane,
biodiversity, food [
1
], water / soil, pathogens);
-
population aging - which cuts savings / constrains demand /
dramatically increases government costs relative to revenues.
While developed Western counties have significant problems, Japan, China and Islamic world
appear to be even worse affected;
-
potential US push for trading links with Europe at the expense
of Asia (as implied by Obama's 'state of the union' address)
The Future?
[<]
A process to build agreement and facilitate complementary domestic initiatives
that the present writer suggested in the context of the need for effective global
responses to the underlying problems related to the 'war against terror' might
(with modifications) be relevant if there were to be a serious international
commitment to addressing the true complexity of the GFC (see
Proposal for A New 'Manhattan'
Project for Global Peace, Prosperity and Security, 2001).
Moreover in parallel with the narrow financial-system reforms initially arranged
through, and the macroeconomic policies subsequently discussed by, the G20,
it might be desirable to assemble some sort of 'coalition of the willing' to
address the more fundamental problems.
However, as experience suggests that such initiatives are unlikely, the GFC
probably marks the end of an era in many respects. For example:
-
the role that the US has sought to play in world affairs since WWII (ie
in promoting and defending Western-style democratic capitalism as the dominant
system of political economy) will be even less financially feasible than it
had been becoming because of large past budget deficits and spending backlogs
- and (as noted
above
) the US seems to be moving
away from its former willingness to allow its markets to be used to accelerate
development elsewhere;
-
efforts to develop effective global institutions appear likely to end
in failure.
Existing weakness in the UN
, will
probably be compounded by
an inability to reach
agreement about any international system for economic and financial regulation
, because of the lack of agreement on (or even acknowledgement of) the radical
culturally-based differences in perceptions about the nature of such a system;
-
virtual nationalization of (or at least extensive government influence
over) many banks in the US and Europe appears likely, and this would tend
to result in an inward looking, and rather than international, global financial
system [
1
];
-
countries such as US and Australia will need a concerted effort to boost
the supply side of their economies in order to shift from high consuming capital
importers to being high savings capital exporters. Methods to overcome their
declining productivity performance have long been available (eg see
Defects in Economic Tactics, Strategy and Outcomes
,
and
A Case for Innovative Economic
Leadership
). The long delays in starting to consider these requirements
(while priority is given to trying to restore economic growth on a pre-GFC
basis) will clearly make this challenge more difficult;
-
export-dependent economic strategies will be much less viable, and it
will be difficult to unwind these without a retreat into protectionism;
-
past strategies that led to the rise of Asia thus won't be sustainable,
because export-oriented industrialization has been foundational. Development
based on domestic demand, which would require financial institutions that
took profitability seriously, would encounter severe political and cultural
obstacles (eg see
Are East Asian
Economic Models Sustainable?
). Whether socially-coordinated economic systems
(eg Japan's 'non-capitalist market economy' or China's 'crony capitalism')
can be successful as the basis for an entirely different kind of economic
regime in which the role of capital / money played a minor role is currently
unclear - though it does appear that such an arrangement is being attempted
(see
Creating a New
International 'Confucian' Economic Order?
);
-
'Europe' also appears likely to suffer setbacks because of both demographic
and economic decline which are long entrenched [
1]
- democratic governments may also be under pressure because of difficulties
in meeting community expectations. Broadly representative democracy emerged
following the industrial revolution in the UK arguably as a means for
better sharing the wealth
generate from the use of capital in mass production
. This has progressively
ceased to be available since the 1960s in the face of NIC competition in mature
technology capital intensive industries - but was replaced by high value-added
knowledge industries - especially those linked to financial services which
are likely to be much less productive in future.
- there appear to be no obvious techniques for future macroeconomic management,
as counter-cyclical public spending proved defective in the 1970s (ie it was
difficult to get the timing right so initiatives tended to amplify, rather
than smooth, business cycles) and
monetary policy
was effective in the short term because it generated asset bubbles that were
dangerous in the longer term.
The future may be one in which political and economic power will be available
for the taking, and there will be many contenders perhaps using methods of which
Western societies have little experience or understanding (eg see
China as the Future
of the World?,
Creating
a New 'Confucian' Economic World? and
Don't Forget Japan).
One observer appears to see such a world as like a return to the Middle Ages.
Imagine a world with expanded Chinese and India power; expanded Islamic
influence; a European crisis of legitimacy; sovereign city states; and private
mercenary armies / religious radicals / humanitarian bodies playing by their
own rules. This seems increasingly likely, and was also true at height of
Middle Ages. 21st century might resemble 12th century, not just with many
nations but with many other forms of power. World was genuinely western
and eastern simultaneously 1000 years ago. In medieval times there was a
global trading system - like today, and transcontinental ventures were arranged.
Globalization is now doing the same - diffusing power away from the west
(and also away from states to cities / companies / religious groups / NGOs
/ super-empowered individuals). Diplomacy now is amongst those with power,
rather than legitimacy. Some see contrary trend (ie return of state power)
in post GFC world. But the crumbling of most of post-colonial world into
failed states is more revealing. Many states are shifting to hybrid public-private
systems of governance. States have simply become filters trying to manage
flows of people / money / goods. In medieval world, loyalty was to whoever
delivered the goods - not to states. World now looks to companies rather
than states to deliver. Middle Ages had no America. But if Europe now plays
the part of declining Holy Roman Empire, America could play the role of
Byzantium which faced both east and west, and survived for many centuries
while slowly declining. (Khanna P.
Future shock? Welcome to the new middle ages' , 28/12/10
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