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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]
- the failure of banks which constituted a very large component of
their host country's economies - such as in
Iceland
from 2008-2011 and in Cyprus in
early 2013
The development of an internationally oriented banking system in
Cyprus led to a crisis in 2013 when the EMU placed
a condition on funding bailout for its tax-haven banks by placing an
up-to-10% levy on the deposits in banks (after these had incurred large
losses through investment in Greek government bonds as part of EU rescue
arrangements for Greece [1]). This raised many complexities:
- the proposed levy eroded public confidence that bank deposits are
safe. Cyprus's banks held $90bn (5 times GDP) of which about $20bn was
the property of Russian mafia. The proposed levy angered Russia's
president. But the bigger problem was that eroded confidence in
deposit insurance - which was introduced at the time of the Great
Depression to prevent runs on banks. However it also allowed banks to
increase their leverage ration on assets from 4-5 in the 1920s to
about 30 in 2008. Now savers can not rely on banks not to go
bust, and can't rely on deposit insurance [1];
- while Germany might protest that it had not forced Cyprus's banks
to impose a levy on Russian (mafia) depositors, Russia could retaliate
by restricting gas supplies to Europe [1]
- After insisting that Europe's financial crisis was resolved,
challenges emerged from the Italian election and from crisis over levy
on Cyprus bank deposits - which has added further fuel to mood of
insurrection in southern Europe. Germany is seen to be rigid in
enforcing an austerity that is failing economically and leading to
worsening social conditions [1]
- banks have very little in reserve, and so always stand on the edge
of disaster. Deposits always depend on a solvent state that is willing
and able to step in. This is not possible in Cyprus because banking
was so large relative to its economy [1]
- the decision to impose levy on Cyprus banks was made in European
core - because of bail-out fatigue at home. This has violated
principle of deposit insurance, and thrown Portugal under a bus. The
principle of EMU solidarity has been shredded [1]
- events in Cyprus have called into question to status of tax havens
everywhere [1]
- the tax on bank deposits raises two serious issues - the risk of
social / political instability because of tax on small depositors, and
the risk that Europe's political system is seen to be failing [1]
- what has been done in Cyprus could be a precedent-setting decision
for future bail-outs in Europe [1]
- Cyprus had become one of the biggest money-laundering centres in
Europe. European politicians have been demanding a crackdown on
Russian money laundering as a condition of any eurozone rescue package
[1]
- the deposit tax in Cyprus will remind depositors that they have a
role to play in bank reconstructions [1]
- parliament of Cyprus rejected EU / IMF bailout offer for its banks
(which came at the cost of a once off levy) - and in doing so has left
itself with no option for repairing budget / bank problems [1]
- there has been a tension between financial stability and the
question of who pays when financial institutions incur losses.
Financial stability has been seen to require that depositors be
protected - even though equity / bond holders could lose when banks
failed. While it is argued that Cyprus is a special case, a precedent
has now been set - ie depositors are no longer protected). In US
authorities went to great lengths to rescue all depositors - except in
the case of Lehman Brothers - and this has serious side effects. After
Cyprus, whenever there is a problem in any peripheral European
economy, there will be a flight of deposits from the peripheral
country [1]
- until recently Cyprus was prosperous with tourism / shipping /
maritime activities as well as a significant international financial
sector. Deposits attracted were too large for local use, and so were
invested elsewhere. In 2012 Greek bailout engineered by EU imposed
50+% losses on foreign holders of Greek bonds - and this is a major
factor in the problems in Cyprus's banks [1]
- a last minute deal was done to resolve bank crisis with depositors
under 100,000 euro protected, and larger depositors potentially losing
30% of holdings [1]
- there are parallels between the 2008 failure of Lehman Brothers
and official responses to bank problems in Cyprus. The initial
solution proposed was viewed favourably across most of Europe as tax
avoiders who had received high interest rates for decades would be
punished. Cyprus was handled differently yo problems in Greece,
because in the latter allowing institutions to fail would have
adversely affected German banks (but in the former only Russia would
be significantly affected). Cyprus was like Lehman in that it was
considered small enough, and not systemically significant enough, to
be allowed to fail as an example to others. Chaos ensued after
Lehman's failure. It is too soon to tell the consequences of Cyprus.
The real test will come when a Spanish / Italian / Slovak / Hungarian
bank needs assistance [1]
- Cyprus's economy will suffer severely and for perhaps a decade
from bank problems. Investors will be more nervous, and bond market
sell-offs could result. Until now bank depositors in Europe had been
protected. The change could aversely affect other countries with large
foreign deposits. However it also provides clarity about new rules of
the game. The crisis will also see a shift in the way banks are funded
- with greater use of contingent convertible bonds [1]
- parallels have been suggested between Cyprus crisis and the 1931
failure of a small Austrian bank (Creditanstalt) that precipitated a
major financial panic. The transfer of losses to depositors was the
first time this has occurred since the IMF started surveys in 1970.
There is now likely to be flight of capital from weak banks in weak
countries (eg from Greece, Portugal, Ireland, Italy and Spain). It
will now also be harder for such banks to raise additional capital.
The crisis also undermines the credibility of ECB and EU in managing
the crisis while maintaining stability. It illustrates the increased
reluctance of countries such as Germany to support the weaker Eurozone
countries. The fundamental problem is that debt crises can't be dealt
with except by financial repression [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].
European share markets have improved since the sovereign debt
crisis began - but severe problems remain. Europe's problems don't lie
in 2008 credit crunch so much as in 1995 preparations for euro which led
to interest convergence across what had been very different economies.
This created a (private or public) credit bubble in peripheral
economies. Wages and prices on periphery started diverging from the core
- making periphery less competitive. This led to rising trade surplus in
core, and deficit in periphery. Europe's problems are uncorrected
balance of payments crisis - which hasn't been able to be corrected
through exchange rate movements (which would otherwise restore price
competitiveness and devalue debts). Under monetary union, creditor
nations demand cash from debtors, which the latter have to endure
self-defeating penury to provide. Debtors have to counter
misalignment with cuts to nominal wages and asset prices. Some see
progress from this as current account deficits are narrowing. Thus
Germany seems to have transformed Europe into mini-Germanys. Likewise
unit labour costs have converged with German core. However though some
deficit nations are doing better on exports, most of the rebalancing
reflects a collapse in internal demand on the periphery. And improved
unit costs is being translated into rising unemployment. Reductions in
labour costs have occurred mainly in the public sector - where this was
easiest. Internal devaluation to boost competitiveness, reduces taxes
and thus makes servicing existing debts harder. Raising taxes to plug
the deficit reduces competitiveness. If Germany accepted higher
inflation (eg by allowing ECB to buy asset backed securities in
periphery) it would become less competitive, while helping peripheral
economies. Germany also seems to be backtracking on creation of monetary
union. To work, internal devaluation has to be accompanied by debt
restructuring - ie by creditors accepting that their securities are
worth less (eg as occurred in Greece and Cyprus) [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)
In October 2013 it was argued that Europe was sliding into a
deflationary trap with debt ratios in several countries becoming
unsustainable and making a mockery of the EMU's debt crisis strategy.
Deflation may be benign in low debt countries, but is very serious in
those with high debt levels. When total debt exceeds 300% of GDP it
becomes lethal - and this is now the situation across most of Western
Europe. Heavily indebted states are being forced to regain competitiveness
by internal devaluations - which has the effect of increasing the risk of
deflation. Countries such as Italy and Spain face rapidly rising debt /
GDP rations despite draconian cuts. The alternative would be to allow
higher inflation in Germany and thereby resolve problems of
competitiveness differences within eurozone in a different way [1]
In late 2013 concerns about the risk of sovereign defaults also
extended to the US federal government (see below)
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
In late 2013 concern about the apparent inability of the US
political establishment to deal with the federal government's growing
debt levels heightened further. Following a partial 'shutdown' of government as a result
the refusal of the Republican dominated Congress to approve legislation
providing necessary funding approvals (because of concerns about health
reforms that had been labelled 'Obama-care'), there was further
disputation about approving the federal government's 'debt limit' which
was likely to be exceeded in mid October. If an increase was not
approved, there was a risk that (as a worst case) the US government
might default on some of its Treasury bonds - an outcome that
would have severe implications for the global financial system / economy
(because the credit rating of T-bonds might be down-graded, thereby
requiring many institutions who use these as highly secure capital to
sell - thereby driving up interest rates). This was significant
because:
- high debt levels in the US (including those of its federal and state
governments) have been partly a result of the financial imbalances that arose
because emerging economies have relied upon the US as the world's 'consumer
of last resort' to provide the demand to drive their growth (see
Why China had to buy US debt).
Many economies with poorly developed financial systems (especially Japan and
China) had long suppressed demand to maintain current account surpluses (and
thus avoid the need to borrow in international financial markets through
unsound financial institutions). Others most notably the US, thus had
to provide demand in excess of income if global growth was to be maintained
and be willing and able to continually increase their household / business /
government debt levels. Prior to the GFC, households had assumed much of
this burden (on the basis of rising property values supported by easy
monetary policies). Subsequently governments tended to absorb significant
costs (and rapidly rising debts to maintain confidence in financial
institutions)
- US analysts (both those who agree that the US's federal debt position
needs to be corrected, and those who do not, seem to under-estimate the
risks involved - because they consider the issue purely from a domestic
position (ie in terms of whether or not government spending is sustainable)
rather than in terms of the potential 'shock' that might come from global
financial instabilities;
US Federal Debt Position: Some Sources
US debt ceiling $US16.699 tr was reached in May. 2007 crisis created huge
gaps between income and spending. Economy was in recession, revenues fell - as
government tried to stabilize economy / financial sector. CBO says US debt is
73% of GDP - double that in 2007. Current Republican objections to raising
limited are frame in terms of supposed electorate rejection of Democrats
policies - and their concerns with Obamacare. Money could run out in October
2013 - creating problems and potential default. US can borrow at low interest
rates in international markets - and this helps keep consumer rates low. Default
could drive up cost of US borrowing - and create chaos in international markets.
[1] At
30/9/12 federal debt managed by BPD totalled $16.039tr - mainly from
borrowing fro operationsThis involved public holdings of $$11.27tr and
$4.789tr of intra-government debts. External borrowings reflect
cumulative cash deficits. Public debt includes holdings by
individuals, local governments, Federal reserve and foreign
governments. As of June 2012 48% of publicly held debt was held by
foreign governments. Foreign holdings increased from $983bn in 2001 to
$5311 bn in 2012. Intra-governmental debts mainly reflect debts owed
to trust funds such as Social Security and Medicare that have an
obligation to invest in Treasury securities. Intra-governmental debts
have much less significant budget impact (eg they do not require cash
payments) - though they do reflect a burden on taxpayers and future
obligations. Federal deficit in fiscal 2012 was $1089bn down from
$1297 in 2011. Public debt increased from 68% of GDP to 73%. Future
debts are expected to grow relation to GDP because of structural
imbalances driven by rising health care costs and demographics. Total
interest expenses have been declining - because average interest rates
have fallen. In 2009 and 2008 average interest rates paid were 0.3%
and 1.3%. Total interest expenses in 2012 were $432bn ($245bn being
public) - about 2.7%. Average interest rates on outstanding debts were
about 9% in 1990, 6.5% on 1995, 5% in 20004% in 2005, 2.5% in
2010 and 2% in 2012 [1]
US debt position has been improved in short term, but little has been
done about long term problems. Little has been done about drivers of
debt - and economic recovery has not been strong. Current budget can't
be sustained indefinitely. Higher interest rates / aging population /
rising health costs / more health subsidies are the problem. Unchanged
this implies that entitlement plus interest costs would double as
share of econoy - while everything else falls. Total spending could be
26% of GDP by 2038 compared with historical 20.5% average. Public held
debt could be 100% of GDP in 2038 9up from current 73%). [1]
Between 2009 and 2012 federal budget deficits were highest relative to
GDP since 1946. Public-held debt is 73% of GDP in 2013. If current
laws remain in place debts held by public would decline slightly - but
this is contrary to CBO expectation. Deficit has fallen to 4% of GDP
in 2013 - due to gradual recovery and policy changes. Under current
laws debts would fall to 68% of GDP by 2018 - then rise again due to
effect of interest costs. How long growth in debt could be maintained
is impossible to say. At some point investors would become concerned -
making borrowing more expensive. Higher debt costs would also reduce
private / productive investment; require tax rises; reduce government
flexibility; and raise risks of fiscal crisis. [1]
When subprime crisis started in 2007 the US cash rate was 5.25%. By
January 2009 it had fallen to near zero and remained at that level [1]
- the effect of the threatened 'default' seems likely to provide a major
impetus to reduce reliance by emerging economies on international financial
imbalances - and thus can be considered complementary to the US Federal
reserve's 'Currency War'. Whether this implies that the threatened default
is a 'game' intended to change the practices of those who have maintained
current account surpluses (and relied on US as 'consumer of last resort') is unknown.
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 help in
identifying the most dangerous financial products [1]
- without apparent recognition of the risks that large / persistent
financial imbalances generate ;
- proposals for a levy on bank deposits as part of
a bailout for banks in Cyprus cast doubts on the security of bank deposits
(especially in Europe) and thus of the extremely high leverage of assets that banks have relied upon;
- removing the expectations of government support were suggested as a
possible key to reducing the problems that high-risk strategies by banks
can create [1];
- efforts by the Basel Committee and the European Banking Authority to
ensure that banks adopt uniform procedures for assessing risks were seen
as likely to make the global financial system more pro-cyclical and
unstable [1];
- it was noted that reserve banks were being active in seeing to boost
economies, while political systems seemed to be stalemated - and that
there are risks with the reserve banks' efforts;
Meetings of BIS (which provides banking services to reserve banks and provides
clearing house for policy) held a recent free-flowing discussion - about which
nothing is reported. ECB looks like a hero for having come to rescue of Europe's
banks last year - which contrasts with faltering approach of Europe's political
leaders. US Fed's policy of buying government bonds has aided housing market
(and thus general economic) recovery - as well as recovery in risk markets. US
government is in gridlock, but Bernanke is getting things done. In Australia
government is trying to rein in budget deficits, while RBA helped start house
prices and retail sales rising. Japan's new government has installed fresh
management at Bank of Japan to get inflation up. This will encourage spending
and devalue government debts. It has also lowered yen value. Bank of Switzerland
is targeting exchange rates. Central banks in Asia (eg in Hong Kong) are also
engaged in direct regulatory intervention in the financial sector to control
credit flows while rates are down. There is concern that: (a) US intervention
could be merely creating an asset bubble; and (b) it will be hard to manage a
recovery. [ 1]
- it was suggested that many of the problems that had plagued financial
systems before 2007 remain in place - though there was no immediate risk
of another crisis [1];
- BRICS nations decided to establish a new development bank to finance
infrastructure and to create a $US100bn Contingency Reserve Arrangement to
tackle any financial crisis in the emerging economies [1].
However there was no agreement on how to give this practical effect [1]
Debt Denial: Stage 3 of the GFC... or
Worse?
[<]
- working draft
In 2009 the present writer had
speculated that the GFC was likely to be a three stage process,
involving:
- firstly the global financial system shocks that were
triggered by US sub-prime crisis - though they reflected far more profound
structural weaknesses in the international financial and economic order (eg
see GFC Causes);
- secondly a potential
for sovereign defaults that were increasingly
obvious in 2010; and
- thirdly 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 could no longer be papered
over.
However in early 2013, the expected third stage had not happened and there was growing optimism about global economic recovery.
Optimism
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).
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)
And reports started emerging of new technologies that had the potential
to initiate new industries. Also 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. The creation
of a North Atlantic free trade zone was suggested, and could provide a
major impetus to economic recovery.
However this seemed 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. Europe most notably remained mired in recession and
threats to the solvency of some governments and banks (eg in
Cyprus) were proving hard to resolve.
Moreover many observers expressed concern that improved real-economy
conditions might be more artificial than real, eg reference was being made
to:
- growing government debts and central bank balance sheets
potentially not ensuring sustainable growth;
- a lack of general agreement about the role of monetary
policy;
- the need to reverse 2 decades of trade, capital flow and
debt imbalances for sustainable growth;
- monetary policy's effect on underpinning asset values, and
difficulties with extricating from quantitative easing;
- the potential 'impossibility' of reversing monetisation of
government debts;
- a 'wall of money' resulting in flows to riskier assets -
recreating pre-GFC risks;
- official warnings of China's risks of a financial crisis
unless debt levels are brought under control;
- continuing developed-world debt crisis . Free money
creates bubbles, capital misallocation and excess leverage;
- peaking of real economic prospects. Emergency measures
have become a dangerous addiction;
- a possible rapid transition to higher interest rates
trapping those whose position seems secure at low rates;
- the financial sector becoming prosperous / bigger due to
rising debts / asset values - though cracks are emerging;
- reserve banks and sovereign wealth funds buying almost all
of the AAA rated bonds that are available;
- a likely end to a 32 year bull market in bonds [thus
interest rates would rise];
- likely massive losses on bonds as interest rates rise -
potentially putting financial system stability at risk;
- inadequacy of proposed recapitalization of European banks
relative to the scale of losses incurred;
- inadequate demand in global economy - with almost all
being debt driven;
- extreme credit excesses worldwide exceeding levels prior
to Lehman crisis;
- world facing the most extreme levels of excess liquidity /
money supply ever
- global debt levels have risen 40% since the GFC, while
global equity levels have fallen.
Pessimistic Observers
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)
Global 'currency war' could get worse if Europe becomes involved -
according to Brazilian finance minister who first used the term to refer
to describe currency devaluations by rich nations to bolster exports.
Reinvigorating economies with more investments was needed he suggested,
rather than seeking to weaken the euro to protect jobs. Brazil has
actively sought to devalue its currency and discourage speculative
capital imports - but argues that rich nations should not do this [1]
An attempt to defuse global tensions backfired, when it initially was
believed that G7 statements implied acceptance of Japan's efforts to
reinvigorate growth - even though the intent had been to warn Japan
about the devaluation of the yen that was likely to follow from Japan's
efforts to combat deflation [1]
While G20 tried to talk down the currency war risk, the risk remains
because there is no longer any agreement about the role of monetary
policy [1]
While the G20 agreed that there should be no currency war, the
reality is that one is underway - to devalue currencies and thus boost
demand via exports. This poses serious risks [1]
Trade, capital flow and debt imbalances
that have built up over the past 2 decades need to be reversed before
growth can become unsustainable - and the world needs to adjust. Key
indicators to watch in China are: growth - which must decline if demand
switches to domestic consumption; slower rate of debt growth;
financial scandals; off-balance sheet financing; inflation; and trade
data. Other key indicators are in Europe [1]
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]
Global economic recovery from 2008 crisis has long seemed likely to
be weak - because of rising debt / imbalances / inequality and policy
incrementalism. Governments are trying to deal with this with
hyperactive monetary policy and intermittent stimulus. In 2008 world
faced a deflationary output gap, because of rising supply and falling
demand (because of asset / credit bubbles). Governments attempted to
bridge this gap - with fiscal spending, tax cuts and income transfers -
financed by central banks at near zero interest. This worked for a
while, but then the demand impulse faded. Global coordination was
replaced by confusion / inaction. In 2013 US offers best recovery
prospects - though growth will be slow. Housing recovery will help, but
government debts will constrain. Japan is trying to boost growth - but
may not succeed. The euro-zone will remain mired in problems.
Emerging markets can play a useful role, because balance sheets are
flexible enough to support demand growth. But this can't be built on
investment, production and exports - because developed market
consumption is weak [1]
The amount of debt in the world is more than
all bank accounts - and the current financial situation facing Cyprus
must be next phase: confiscation. Central / bankers can no longer just
repackage debt - as they have been doing since early 1980s. The result
in 2007 was a huge debt mountain (eg $220tr debt (public / private /
unfunded contingent liabilities) compared with $14tr US GDP. Deals in
global derivatives now exceed $1 quadrillion - compared with global GDP
of $60tr. Since 2007 world's taxpayers have been unable to pay interest
/ repay capital - so repackaging has been attempted in the hope that
income would increase sufficiently. This didn't work - so Cyprus shows
the next stage (confiscation). [1]
[CPDS Comment: this writer appears to have a commercial interest in
advocating holding wealth in the form of the form of gold / silver]
There is concern associated with rock-bottom interest rates that when
rates recover there could be a repeat of conditions in 1994 which saw
large numbers of significant bankruptcies [1]
There has been a massive increase in the sale of 'junk bonds' (ie
high yielding securities) because monetary stimulus measures have forced
safe yielding investments down to very low yields and thus encouraged
even conservative investors to take on more risk. This lays the basis
for another financial crisis [1]
Concerns about economic outlook arise from: (a) Fed's encouragement
of risk - which has led to large take-up of junk bonds; (b) US
federal government is again encouraging banks to lend to riskier
borrowers - which was a factor in the GFC; and (c) it may be that
performance of US real economy is not up to that implied by stock market
gains [1]
Monetisation of government debts (in US, Europe, Japan) can never e
reversed. It must continue indefinitely as 'creditism' to encourage
spending in an environment where nobody wants to borrow [1]
The wall of money generated by reserve banks and economic recovery
will result in flows to the riskier assets seeking higher yields - thus
creating risks like those prior to the GFC ('Get ready to ride a wave of
money', Financial Review, 9/4/13)
One of China's top auditors has stopped approving local government
requests to increase their debt levels, and warns that China faces a
financial crisis bigger than that in the US and Europe unless debt levels
are brought under control [1]
Economic problems in Europe (especially in peripheral economies) are
as bad as in the Great depression. UK is on the point of recession -
and has had the greatest fall in GDP in 100 years. The IMF sees Europe
as facing potential stagnation like Japan's over past 2 decades. [1]
No one at a recent forum believed the world economy would rebound. 57%
thought that West's twightlight conditions could not be escaped. 20%
expect a full blown recession. Yet all are bullish on shares and
property because of the effects of QE [1]
The developed world remains mired in the 2008 debt crisis. Growth is
low, de-leveraging continues. Policy makers have responded with free
money - creating bubbles, capital misallocation and excess leverage. A
bubble in corporate bonds is inevitable. Companies are borrowing
heavily, and investors are not being compensated for the likely risk
of defaults. A new volatility cycle is likely in the US - because of
the large rise in credit. [1]
There has been a massive flow of credit
into emerging markets (BRICs) since the GFC - but the returns have
been poor. When the US Federal Reserve changes gear there is likely to
be a rally in the $US and a capital outflow from those countries that
will generate a financial crisis. This is most obvious in South Africa
- which risks becoming ungovernable. Brazil faces stagflation. The
BRICs miracle is mainly about China - but a massive run-up in credit
has been needed to sustain growth. China also is at the mercy of the
Fed - as it has pegged its exchange rate to $US - its currency will
rise against the rest of Asia when $US surges, compounding the effect
of 30% yen devaluation. China's $3.4tr foreign reserves will provide
no defence - as drawing on them would require conversion to yuan which
would drive up currency value - and undermine competitiveness. This is
happening just as China's trade surplus vanishes. The cycle of
emerging market exuberance is as old as capitalism. [1]
HSBC index for global economy has peaked. Countries that have not yet
locked in sustainable growth will be in trouble, and may experience
deflation. Eurozone is still mired in recession. World's gloomy
outlook seems disconnected from Fed's 'tapering' proposal. HSBC's
leading indicator has taken a long time to buckle given commodities
topped in September and trade topped in arch. The equity boom is built
on quicksand. Markets are betting that central banks will come to the
rescue again. Perhaps they will but only after demonstrating their
distaste for asset bubbles. Insiders are concerned that the longer QE
goes on the harder it will be to unwind. BIS has argued that emergency
stimulus has become a dangerous addiction. Unwinding QE could be
dangerous (and bring on events like 1937). But there are bubbles
everywhere. Companies are still borrowing cheap to buy back their own
stock - and some see this as responsible for half recent equity gains
. If there is another round of QE there must be a better way found to
inject the money - ie not just direct it to elites, but rather
directly making productive investments. Interest rates are near zero
across the developed world, and government debts are higher than in
2007. In 2007 BRICs were in the middle of a roaring boom, and China
responded to crisis with unrepeatable loan spree. BRICS now have
post-bubble hangovers, and China won't repeat what is now seen as a
major mistake. Europe is not retreating from austerity. Monetary
policy in Europe remains tight. Its M3 money supply has been flat.
Core inflation is low - approaching deflation. Real personal income in
US fell 5.8% in first quarter. After 5 years world is still struggling
to contain depression - with world savings rate of 25% and a chronic
shortage of demand. US has kept the world afloat by running savings
down to 2.7%. But this is not sustainable [1]
A rapid transition to higher interest rates could trap some whose
position seemed secure at lower rates . The World Bank warns that
countries with the greatest asset bubbles will be at the greatest
risk. Interest rates in BRICS could rise 2.7% as West unwinds
quantitative easing. Signs of problems are emerging in China - where
private debt (at 160% of GDP) is now highest of all BRICS. Turkey,
Brazil, Poland and India have all sought to block capital flight,
while Indonesia had to raise interest rates. The BRICS need to tackle
(for example) supply-side bottlenecks, poor regulation, corruption,
inadequate supply of electricity and education to return to pre-crisis
growth rates [1]
Since early 1980s the financial sector
has become very prosperous because of increased debt levels and rising
share markets. In US total debt levels rose over 50+ year periods to
pronounced peaks in 1933 and 2009 (ie up from about 100% of GDP in
1870 to about 300%, and then after a rapid fall from about 100% of GDP
in 1950 to about 370% of GDP - from which level a rapid decline again
seems to have started) - see
diagram. These booms and busts corresponded with increases in
Financial industry share of US economy from about 2% to a peak of 6%
in the mid 1930s and 8% at present. Rising debt levels permitted
the growing role of financial industries. The difference now is that
investment industry is more sophisticated. The financial industry had
an easy time in years leading up to 2007. Since then massive amounts
of central bank intervention underwrote market recovery - though
cracks are now appearing [1]
Financial asset prices are manipulated by reserve banks and the
sovereign wealth funds of a few emerging powers. They are buying
$1.8tr of AAA bonds yearly out of $2tr that are available. This is
unprecedented. Major reserve banks own $10tr in bonds - while China ,
the petro-powers and others own another $10tr - and the total is $25%
of global GDP. That is why Fed talk of Tapering and policy action in
China matters. Investors hope Fed will delay tapering - and he might
for another three months. Yet there are an increasing number of
reports which suggest that Fed now believes QE to be counterproductive
(eg a former board member argues that it is becoming harder for Fed to
extricate itself, as higher interest rates after QE could wipe out
Fed's own capital base, and make it impossible to support US
government budget with interest payments; Federal Advisory Council
suggests QE may be having serious side effects but not boosting
economy - eg pension funds are underwater on their liabilities; BIS
has openly criticised QE; Fed doves have changed their minds). Thus a
tough line by Fed is possible [1]
World may have seen the end of 32 year bull market in bonds. Changes
affecting monetary policy have changed the game. Risk on, risk off
trading is ending. The $US has strengthened on good news, rather than
this encouraging 'risk on' moves into emerging markets. Resource
currencies now reflect unwinding of resources boom. The markets are
now more likely to differentiate sensibly between markets. But the
eurozone still faces major problems. There are also uncertainties
about whether the Fed will taper - and concern that it may not be able
to taper. It is hard to see a happy ending [1]
BIS expressed concern about new bank crisis due to $trs in losses on
bonds as interest rates rise. A 3% rise on US Treasuries alone would
generate $1tr in losses. Financial system stability could be at risk.
One effect of tightening has been withdrawal of capital from emerging
markets. BIS argues that authorities must push ahead with monetary and
fiscal tightening - because easy money policy was doing more harm than
good and debt levels were becoming dangerous. However many others
argue that such tightening could have serious economic consequences [1].
The Eurozone Stability Mechanism is to provide $60bn to recapitalize
eurozone banks - but this seems irrelevant in relation to the $1-2.5tr
in losses that they have probably suffered as a result of a series of
crises. The preferred tactic has been to deny the problem and extend
its effect [1]
Economic growth will now be difficult because there is low demand in
the global economy - because most demand was debt driven [1]
Extreme credit excesses worldwide have reached / passed levels before
Lehman crisis - according to BIS. Hunt for yield have lured investors
into high risk instruments - just as Fed starts tapering. Previous
imbalances are still present - total public / private debts in
advanced economies are 30% higher than they were in 2007 - and there
are new problems of bubbles in emerging markets. Subordinated debt
(which leaves lenders exposed to bigger losses if things go wrong) has
increased 3 times (to $52bn) in Europe over past year and 10 times (to
$22bn) in US. Leveraged loans used by weakest borrowers in syndicated
loans has risen to 45% (10% above the 2007-08 level). Investors are
snapping up loans that offer little protection. Interbank credit to
emerging markets is at highest level ever. The value of bonds issued
offshore by companies in China, Brazil and other developing nations
exceeds that in rich countries - illustrating scale of debt build-up
in Asia, Latin America and middle East. The effect of Fed tapering is
unknown. BIS argues that 5 years since Lehman failed have been wasted,
as global system remains even more unbalanced - and is running out of
lifelines. The ultimate driver for world will be US interest rates -
and as this goes up there will be fall-outs for everyone. Abenomics
could go awry in Japan, while Europe is vulnerable to outside shocks.
The world is addicted to easy money. The is little ammunition left if
things go wrong again [1]
In October 2013 the IMF estimated that phasing out QE (or partial US
default as a result of failure to raise its debt ceiling) to lead to
$2.3tr market losses on bond portfolios worldwide if this lead
interest rates to rise 1%. Large elements of the world's financial
system were seen to be vulnerable to stresses as the extraordinary
post-crisis policies were wound back [1]
IMF's latest report suggests that World Economic Outlook is uncertain
but not disastrous. Growth in developed world has strengthened, while
china and emerging economies are weakening. The overall picture is of
tricky rebalancing of global growth, Risks include: eurozone progress
may not be sustained; disorderly tightening of US fiscal policy (or
even debt default); rising interest rates as QE is unwound (or
possible inflation). Excessively rapid fiscal austerity is creating
problems in Europe, UK and recently in US. This has forced reliance on
questionable monetary policies at a time when there is a private
savings glut. US recovery is helped by property recovery, increased
household wealth and easier credit. Japan is headed for fiscal
tightening. In Europe fiscal tightening - at a time when weak demand
constrains recovery. in longer term the pace of growth in developed
world and the path of fiscal stabilization are key issues. The former
is most important. Governments need coherent growth strategy. Failing
to use low interst rate opportunity for expanding investment is a
mistake. Emerging economies face a changed environment with higher
interest rates, lower commodity prices, stronger growth in rich
countries and weaker growth in China. The time of easy credit is over
- and the risks associated with hot money flows are being revealed.
India and China face structural slowdown. Both suffer important
imbalances - yet a modest rebalancing will not serious dampen their
longer term prospects. The position of emerging economies is more
robust than in the past [1]
A recent report from JP Morgan has argued that the world faces the
most extreme level of excess liquidity / money supply ever. The rise
which started in May 2012 goes far beyond rises from 1993-95 / 2001-06
/ 2008-10 all of which set off rapid asset price rises. Global money
supply has risen $3tr (to $66tr) in first nine months of 2013 - with
$2tr in emerging markets (probably China in particular). The surge in
money supply has set off an asset boom which is likely to be
vulnerable (because economies have not reached 'escape velocity' as
indicated by declining global trade volumes in August 2013) [1]
Credit boom in China has put the world in worse position than 2008.
Credit crisis arose then because there was too much credit - and there
is more now relative to economy than in 2008. IMF report shows that
percentage relative to GDP of advanced economies is now 30% above
2008. In China credit has increased by 50% of GDP over past 4.5 years
- the fastest increase in Asia. Many have suggested that rapid credit
growth is China's biggest risk. Problems also exist with household
debt in Asia. This has risen much faster than government debt. This
raises risk that minor economic crisis will be followed by money
printing - or of an inflationary spiral, Consumer and real estate
prices have escalated in Singapore and Hong Kong [1]
2014 will be year of strong $US - as the world's safe-haven currency.
US economy is also coming back to life - and may reach 'escape
velocity'. QE overcame effect of drastic fiscal tightening. Yields on
US 10 year bonds will exceed 3%. There are political uncertainties (eg
China's Air Defence Identification Zone). Japan's leader visited
Yasukuni Shrine - in a gesture aimed at China. China and Japan could
be on a war footing already. Defence stocks are rising. US steps back
from Middle East as the region is engulfed by Sunni-Shia conflicts -
that are like Europe's 30 years war. Gulf oil matters less because of
shale production. Ukraine's leaders have turned their backs on the EU.
Global savings rates will reach 25%. There is a chronic lack of
consumption. AS US Fed tightens a lot of the $4tr that has flowed to
emerging markets since 2009 will come back. The 'taper tantrum' of May
2013 illustrates what is likely to happen - according to IMF. Shadow
banking system of emerging economies is now the centre of global
stress. Emerging markets have $7tr of external debt - of which $2tr is
short term and must be rolled-over continuously. Europe will be hit by
rising interest rates - and by the fact that US is becoming
super-competitive (eg because of cheap energy) and so will be able to
meet its own consumption and thus not provide a stimulus to others.
Credit to firms is still contracting in peripheral Europe. Government
debt continues to rise despite austerity programs. However youth
unemployment rates around 50% will not be politically tolerated
indefinitely. Europe's macro policy failure will be clear by the end
of 2014. China faces a massive bubble. Credit has grown from
$9tr in 2008 to $24tr. The rate of loan growth (100% over the past 5
years) is without precedent. The central bank is struggling to deflate
this. China may seek to prevent hard landing by driving down the yuan
- which would lead to new Asian currency war. This would compound the
deflationary shock the world is likely to experience [1]
The IMF has warned that governments in many developed countries will
need to adopt 'financial repression' tactics like those that have been
required in developing countries to deal with high levels of
government debt - ie methods that divert citizens savings to the state
[1]
The Bank of International Settlements warned that global debt levels
had risen 40% to $100tr in the six years from mid-2007 to mid-2013
(and that most of the increase was government debt). However at the
same time the value of global equities (a measure of unencumbered
global wealth) had fallen $3.86tr to $53.8tr [1]
In recent years trade has played a major role in global economic
growth. But 3 years into a very weak recovery, slack demand from
consumers in Europe and US is depressing exports from developing world
[1]
US economy contracted in first quarter of 2014 and bond yields have
been falling (usually an indicator of economic slowdown) as a sign
that Fed tapering is biting. US monetary supply also indicates likely
slowdown [1]
Economic data in May 2014 has been driven by conflicting pressures.
Major economies are not doing well. US was supposed to be recovering -
but economy contracted (partly due to weather). Eurozone, China and
Japan are also soft. Germany is stagnant and Japanese-style moderate
deflation is a risk in in periphery . Japan's monetary stimulus
threatens to turn into a problem as wages stagnate while costs rise -
and fiscal structural aspects of 'Abenomics' are not in place. China's
growth has slowed - but inflation is very low. Advanced economies need
China (the world's largest creditor and trade surplus nation) to
resolve the imbalances in wages, costs and capital flows that underpin
the world's macroeconomic problems. Problems in China's real estate
sector and general slowness will further complicate matters. And an
economic reformist party has now won power in India - and this could
enable India to become a sustainable export-driven economy . All of
this indicates that the demand growth needed to reverse deflationary
pressures in advanced economies may be absent. The persistent debt
overhang in developed economies constrains consumer / government
spending [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 only on
conventional business / economic methods of analysis drawing upon 'real
economy' variables.
For example, the sources outlined above (and others) indicate that:
Corporate profits (to justify higher share market values) were
being driven by rising asset values;
declining consumer demand; an increased need for savings; and
dependence on exports were being accentuated by
population aging.
This phenomenon was apparent in Japan and peripheral European
countries, but was expected to have an increasing impact elsewhere in
future;
countries in East Asia with poor national balance sheets because
governments have used 'financial repression' to steer savings into
export-oriented production capacity / infrastructure and property 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;
some doubted the value of paper currencies - because of
monetisation.
Many countries seemed to be seeking to boost their gold reserves.
Germany sought return of its gold reserves from external repositories
(eg in US, France, UK) and was required to wait many years for this,
presumably because that gold had been leased to financial institutions
and used as the basis for a profitable 'paper gold' trade that
accounted for something like 100 times the trade in physical gold.
There has been a boom in the value of Bitcoins - an apparently-secure
electronic currency with a theoretically limited / known supply that
is independent of fiat currencies (ie those issued at the whim of
reserve banks) ;
However the problem was arguably more severe because it was hard to see
how a serious global demand deficiency could be avoided - because:
To achieve economic growth in this environment 'everyone' needed to rely
on either: (a) even more credit - which reserve banks had been seeking to
provide; or (b) increasing net exports . It was clearly impractical for
'everyone' to increase net exports, and this raised the risk of
1930s-style 'competitive devaluations' to seek greater export
competitiveness at others' expense. In fact concern was widely expressed 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. Quantitative easing had been
accepted as economically useful providing it was primarily aimed at stimulating the
domestic economy (ie to head off deflation and drive down unemployment) [1] In April 2013, an unexpected crash in the value of
gold (which had been becoming increasingly strategically
significant) suggested the possibility that a new dislocation
of the global financial system could be imminent (see
Interpreting the Canary in the Gold Mine).
This possibility was reinforced in April 2014 when the establishment of a
physically-settled gold futures market in Asia was seen to indicate that the
Western makers of paper-gold futures markets (whose physical gold holdings had
disappeared) might be bankrupted [1]
- though by that stage it was likely that significant institutions had
eliminated their exposure to losses from failure of 'paper gold' markets.
Interpreting the Canary in the Gold Mine suggested that: (a) these events needed to
be viewed in the context of a long term contest between
Western-style 'capitalism' (ie profit focused investment) and
(so-called) 'financial repression' by East Asian 'authoritarian
family-states'; and (b) the gold price collapse might presage:
-
rising interest rates facing heavily indebted
governments / institutions;
-
significant losses on 'paper gold' investments that might resurrect the credit freeze that unknown counterparty
risk generated after 2008; and
-
no viable method for counter-cyclical macroeconomic
management in the face of a severe financial crisis.
In mid 2013 there was increased speculation that quantitative easing was
of uncertain benefit because of its apparent contribution to asset bubbles.
However by that stage the build up of global debt levels (due to the
combined effect over several decades of international financial imbalances
and easy money policies) that there was a real risk of debt deflation and a
major crash that would be far worse than anything in recent decades.
Credit Bust First: 'Sixth Revolution' Later - email sent 18/6/13
Kris Sayce
Revolutionary Technology Investor
There is no doubt about the potential for emerging technologies
such as those suggested in your
Sixth Revolution to drive the growth of new industries (and thus provide
great investment opportunities).
However the credit bubble that has accompanied the Fifth
(Information) Revolution probably has to be eliminated first.
That a credit wipe-out is likely is suggested by the
diagram that appeared in
Truth or Dare Time for the Investment Industry (Gowdie V., Daily
Reckoning, 14/6/13). Though the escalation of debt / GDP ratios that this
diagram shows applies to the US, it is probably a fair reflection of the global
situation. It has, for example, recently been suggested that
China’s credit bubble is unprecedented in modern world history
The
Great Depression in the 1930s did not happen merely as a consequence of a
sharemarket crash in 1929 (or as a result of insufficient government spending,
or of a breakdown in international trade).
Debt deflation was also significant. The
collapse in the debt / GDP ratio after 1933 reflected the failure of large
numbers of ‘secure’ financial institutions (arguably triggered by the 1931
failure of an Austrian bank, Creditanstalt) which took down the credit
regime that had underpinned the global economy.
George Soros has plausibly argued (in The Alchemy of Finance)
that the provision of credit escalates the value of the assets for which credit
is provided (ie investing in something can have a self-fulfilling effect on the
value of that investment – due to a ‘crowd’ effect). However a point is
eventually reached, he argues, at which a credit-driven escalation in asset
values proves to be a ‘bubble’ and bursts. This seemed to happen in Japan after
1990.
Another point that seems significant about the ‘Total
Debt as % of GDP Graph’ is that it showed a rapid escalation in debt levels
in the 1980s, then a bit of hesitation before the escalation continued. A
severe recession was widely expected after a 1987 share-market crash had been
brought on by a rapid rise in interest rates on government bonds. But the US
Federal Reserve (under Alan Greenspan) then invented methods for preventing bond
and share market losses from affecting the real economy (which would have
compounded the financial market losses). The Fed achieved this by providing
large quantities of additional credit to financial institutions.
However this tactic (which others copied) led later to an even
stronger escalation of debt levels and asset values - because the expectation of
effective reserve bank intervention lowered the perceived risk associated with
investments, and thus increased the debts that were regarded as ‘safe’ for any
given level of income.
Another significant contributor to the escalation of debts has
arguably been long term international financial imbalances. Countries with
sustained current account deficits (eg US and Australia) have had to borrow for
decades to maintain growth, while others with current account surpluses (most
notably in East Asia) have poor balance sheets despite their large foreign
exchange reserves because of their poor financial systems.
The main source of these imbalances has been the non-capitalistic
financial systems that have prevailed in East Asia (see
Structural Incompatibility Puts Global Growth at Risk). Financial systems
that don’t take profitability seriously for
complex cultural reasons have had to maintain current account surpluses (by
suppressing consumption) to avoid having to borrow in international financial
markets. This
required their trading partners (mainly the US) to continue increasing their
household and government debt levels if global growth was not to stagnate.
This has probably been a significant factor in the growth of the US’s debt / GDP
ratio since the 1980s. Another source of international imbalances has been the
effect of the euro as a common currency amongst countries with radically
different economic capabilities. Germany developed surpluses, while peripheral
Europe became heavily indebted (see
Financial Imbalances and the European Sovereign Debt Crisis).
Now a credit peak seems to have been reached again, and
debt-deflation threatens. Reserve banks probably have little more ammunition
left to stop a credit collapse. Asset markets clearly respond mainly to
expectations about the future of quantitative easing, thus: (a) supporting fears
that QE is simply creating asset bubbles; and (b) leading to the perception that
QE needs to be phased out, because it is doing more harm than good.
I somewhat doubt that the technological opportunities that now
exist will now be able to drive sustained growth. If existing debt / GDP levels
can’t be at least maintained there will be an ongoing decline in the total
amount of credit (and thus in the availability of funds for consumption and
investment). The increasing interest rates that are accompanying warnings about
phasing out QE could well give rise to failures by a few supposedly ‘secure’
institutions (eg governments or major banks) which could trigger a
self-reinforcing world-wide collapse like that which followed the failure of
Creditanstalt in the 1930s. Presumably the reserve bank fraternity are trying to
figure out a way to stop this happening. But given the high debt / GDP ratios
that currently prevail they may well fail. Some sort of across the board
wipe-out of debt obligations seems to be required. But how this could be
achieved without crippling economies is hard to imagine. A debt wipe-out would
simultaneously: (a) eliminate creditor’s assets; and (b) remove the
underpinnings of bond, equity and real estate values.
A nasty recession would have occurred after 1987 if new monetary
policy techniques had not been invented in the hope that this would bring an end
to the centuries-old boom and bust business cycle. But the one that is now
possible could be much worse (perhaps even worse than the depression in the
1930s) – and be accompanied by wars in various parts of the world (eg in the
Middle East and
East Asia).
Only then, I suspect, is the Sixth Revolution likely to come to
fruition.
John Craig
In July 2013 the IMF warned of the consequences for the eurozone of
the ending of quantitative easing by the US Federal reserve. The onset
of a tightening cycle in US had already led to rising bond yields in
the eurozone. The resulting increase in borrowing costs could damage
demand and growth - unless European Central Bank takes countervailing
action. There is a high risk of stagnation on the periphery, and this
could lead to a debt-deflation spiral [1]
Stimulating demand through quantitative easing (ie
boosting access to more credit) to overcome demand constraints due to
high debt levels could lead to a severe financial crash followed by a prolonged and global 'balance sheet' recession and deflation.
Quantitative easing is a method for
counter-cyclical macroeconomic management that comes with risks, and
those risks are compounded by by international financial imbalances.
There is no obvious way of averting such a financial crisis. However
it is clear that financial system stresses can not be resolved without
finally addressing the challenge of international financial imbalances
which:
However, though some now understand that the financial
imbalances that have grown in recent decades have to be reversed
before growth can be sustainable [1,
2], most analysts (like the G20)
continue to put this in the 'too hard basket'.
And in October 2013, it was suggested that there was no need to
do anything in particular because imbalances were merely a
transitory phenomenon which would disappear as China (for example)
increased the role that domestic consumption played in its economy
- a suggestion that seemed overly optimistic.
A case for economic gloom amongst the pundits' optimism - email sent 1/10/13
Stephen Grenville
Lowy Institute
Re:
A case for economic optimism amongst the pundits’ gloom, Business
Spectator, 1/10/13
Your article critiqued some observers’ economic gloom
related to: (a) the possibility that technological progress may no longer create
major new economic opportunities; and (b) oversupply associated with easy credit
and heavy government spending to keep everyone employed – the latter being seen
to be the result of a ‘global savings glut’ and ‘international imbalances’ (with
China’s current account surplus seen as a major feature of this).
You then suggested that such concerns were overly
pessimistic as: (a) many observers doubt claims about limits to technological
progress; and (b) the ‘savings glut' is probably a transitional problem – noting
that China has recognised the need for rebalancing (and raising consumption to
more normal levels will automatically lower savings).
There seems to be no doubt that technology will create
highly productive new opportunities. However the structural ‘savings gluts’ and
consequent international financial imbalances that were essential components of
the
systems of socio-political-economy that allowed ‘economic miracles’ to be
achieved in East Asia (initially Japan and ultimately China) have played a major
role in generating global debt levels that make an economic crisis virtually
unavoidable despite the new (technological) opportunities that would otherwise
now permit sustainable recovery if the GFC had merely been a cyclical down-turn
(see
Credit Bust First: ‘Sixth Revolution’ Later).
When nationalistic financial institutions do not insist on
profitability from the loans they make to nationalistic enterprises (see
Evidence), it is essential that they avoid borrowing in international
profit-focused financial markets. Thus suppressing consumption (and thereby
generating domestic ‘savings gluts’ and international financial imbalances) has
been necessary to avoid domestic financial crises. However
the adverse effect that this has on the global economy (by requiring trading
partners to massively increase their debt levels if the global economy is not to
stagnate) is very serious – and has been going on for decades.
One observers noted many years ago that Japan could not
repair its financial system in such a way as to avoid a need for favourable
financial imbalances (see
Why Japan can't deregulate its financial system) – and Japan’s position
became extremely exposed as a result (see
Japan's Predicament, 2009+).
China’s system is functionally similar to Japan’s (in that
investment decisions are based on consensus rather than profitability
calculations), and it seems extremely difficult to achieve the ‘rebalancing’
that China’s leaders have spoken about – because of the severe cultural
obstacles involved (for reasons suggested in
The Cultural Revolution needed in 'Asia' to Adapt to Western Financial Systems,
1998).
A Solution? - My
suspicion is that China’s intent could be to try to bypass the problem by
creating an internationally traded currency backed by the large gold reserves it
seems to be accumulating. If China ran current account deficits, there would be
a need to borrow in international financial markets – and China’s financial
institutions (with poor balance sheets) would typically be unable to do this
directly with safety. However China might be able to borrow against the value of
its gold reserves – especially if the value of those reserves were increased
dramatically by the transformation of the Yuan into an internationally-traded
gold-based currency. Needless to say the effect of this could be to create
another global financial crisis if the Western ‘bullion banks’ (ie those who
create a market in ‘paper gold’) have indeed created an unsupported ‘fractional
reserve banking’ arrangement for ‘paper gold’ as some observers have claimed
(see
Interpreting the Canary in the Gold Mine).
I suggest that there is a need to look much more closely at
how
East Asian systems of socio-political-economy actually work (and at the
difference between
the intellectual basis of those systems and that of
Western political economy) – rather than assume that such differences are
inconsequential.
John Craig
Resulting Interchange with Stephen Grenville -
email sent 1/10/13
Response from Stephen Grenville - 1/10/13
Thanks for your comments. I'm not sure that high savings is
a necessary part of the Confucian way. It certainly wasn't true of Singapore in
its high-growth catch-up phase in the 1960s, when it ran very large current
account deficits. I'm not even sure that it was true in Japan's high-growth
phase in the 1960s and 1970s, but I couldn't immediately check the data (perhaps
you can direct me to the evidence). Nor can I easily check Taiwan and Korea. But
it certainly wasn't true for a number of other fast growth countries, such as
Indonesia during the Soeharto era. Thus I'm less sure than you are that China is
stuck in a high CAS state. Time will tell.
Reply to Stephen Grenville - 1/10/13
Thanks for your comments – which I would greatly appreciate your permission to
reproduce on my website together with
A case for economic gloom amongst the pundits' optimism.
As I understand it, Confucius advice was to become rich through savings and
avoiding consumption. I can’t locate the original source that I had for this –
though
How the Wisdom of Confucius Can Lead You to Financial Success points in that
direction. And if one looks at the intellectual basis of East Asian
societies with an ancient Chinese cultural heritage, one finds that the use of
abstract concepts as the basis for rational decision making that have been the
basis of Western societies’ progress have had no role (see
Epistemology the Core Issue and
Competing Thought Cultures). Calculations of profitability by independent
decision makers have been the method used for economic coordination under
Western systems of political economy, but this has not been so in East Asia.
I am not certain what happened in Singapore in the 1960s, as I only got involved
in trying to understand what was going on in the late 1980s (see
background). My attempt to describe the consequences of differences in
financial systems is in
A Generally Unrecognised 'Financial War'? (which was not put together until
2001). The latter refers to: (a) evidence that profitability is not taken
seriously in either Japan or China; (b) another observers very explicit comments
on Japan’s financial system which corresponds precisely with my expectations;
(c) suggestions by a well-known Japan-watcher that Japan’s system had been
developed by its military in Manchuria in the 1930s and influenced China in the
late 1970s; (d) observations about Japan’s chronic trade surplus with the US
(and the US’s chronic trade deficit) which led to Plaza Accord in 1985 which was
expected to correct those imbalances – but did not do so because Japan’s
financial system directed capital to production but not to consumption; (e) the
effect of the Asian financial crisis in 1997 on countries with poorly developed
financial systems that did not maintain current account surpluses (such as
Indonesia), and the consequent subsequent efforts by many emerging economies to
arrange such surpluses.
I have not looked at the current account balance situation of East Asian
economies other than Japan and China. I have no resources other than my own
time, and I get involved in a large number of different issues. Singapore’s
situation is a bit unusual as it (like Hong Kong) started with a strong basis of
British institutions – though there is a clear neo-Confucian economic influence
(see
Competing and Collaborating Economically in South and East Asia). I don’t
know about Taiwan – but Korea quite clearly did not emphasise current account
surpluses before the Asian financial crisis – because it was badly affected at
that time.
I offer no guarantees that China won’t find a way to operate with a current
account deficit – merely that it would not do so by developing Western style
financial institutions that rely on profitability. Some indications of this are
in
Financial and Educational Reform in China: Headed in Opposite Directions? .
My earlier email suggested a possible way around this constraint that might
be being sought that would have adverse effects on the global (ie Western style)
economy.
However Japan does not seem to be moving towards acceptance of current account
surpluses and (a) until quite recently Japan (ie in the 1990s and for a few
years afterwards) was the world’s major source of credit – that was created at
low interest rates and diverted to other countries through Yen carry trades
which had the effect of boosting trading partners debt levels and demand for
Japan’s exports; and (b) Abenomics appeared to be an attempt to recreate similar
capital flows – though the actual consequences seem to have been quite different
(perhaps because others are seeking to counteract Japan’s efforts).
Response from Stephen Grenville - 2/10/13
Thanks. Sure, you're welcome to post it. In the first
sentence, my central point would be clearer if I had said 'high current account
surplus' rather than 'high savings'. I agree that these countries had high
saving during their fast-growth period but, sensibly, they also imported a lot
of investment goods.
Reply to Stephen Grenville - 2/10/13
Importing investment goods does not preclude a current account deficit – if
savings exceeded investment.
There is a need to look much more deeply at what is going on – especially at
cultural features that influence what is, and what can be, done. The issue is
whether there are cultural features involved in the methods that have been used
for economic development that require surpluses – which translate into a
significant macroeconomic obstacle to sustainable global growth (ie a
structural demand deficit).
Suggesting that there is no problem without seriously considering the cultural
dimension lacks credibility. Most analysts seem to assume that East Asia can be
understood in terms of Western models and concepts – but this is grossly
misleading for reasons suggested in
Babes in the Asian Woods;
Australia in the Claytons Century: The 'Asian' Century you have when you are not
having an Asian Century; and
Comments on Australia's Strategic Edge in 2030. The latter includes
suggestions on why understanding is difficult – but that difficulty does not
excuse failure to make an attempt to understand.
I have added your comments to my web-site.
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.
And the financial system reforms to create an environment for
sustainable growth are complicated by the need to simultaneously resolve
of other challenges facing the global community such as:
-
the emergence of new quasi 'world policemen' (eg France in North Africa), as
the US no
longer automatically assumes this role - partly due to fiscal constraints;
-
potentially explosive political
stresses (eg China's social inequality and corruption; the conspiracy
theories of the Occupy / Anonymous Movements and Islamist
extremists; North Korea's nuclear-armed ratbag government; tensions between China and its neighbours);
-
potential environmental emergencies (eg those related to Arctic methane,
biodiversity, food [
1
], water / soil, antibiotic resistant pathogens);
-
population aging - which cuts savings / constrains demand /
dramatically increases government costs relative to revenues - and
increases the dependence
of economic growth on net exports in a world in which almost all
countries need to rely on this.
While developed Western counties have significant problems, Japan, China and
the Islamic world
appear to be even worse affected;
-
potential US push for trading links with Europe at the expense
of Asia (as implied by President Obama's 2013 'state of the union' address)
Resurgent Protectionism?
[<]
In September 2013 it was reported that over the previous year there had
been a resurgence of protectionist measures which would impede global trade
- largely because of the credit difficulties that emerging markets face.
This poses a threat to economic recovery. Emerging markets now account for
50% of global output - but seem to be turning their backs on free trade.
Particular attention has been drawn to actions by Argentina, Brazil, India,
Indonesia, Russia and South Africa - with less concern now about China
[1]
In June 2014 it was suggested that: "In the immediate aftermath of the
2008 global financial crisis, policymakers’ success in preventing the Great
Recession from turning into Great Depression II held in check demands for
protectionist and inward-looking measures. But now the backlash against
globalization – and the freer movement of goods, services, capital, labor,
and technology that came with it – has arrived. " [1]
An Approaching Crisis?
[<]
In late 2013 there were increasing and accumulating signs of an approaching crisis - one
possible outcome of
which was that the 'second failure of
globalization' that this document has speculated about (ie a breakdown
of international political and economic order - equivalent to that at the end of the
19th century that preceded and arguably caused WWI) might become a reality.
At the same time there were signs of constructive business and policy
initiatives that could reduce these risks - though whether this could be
sufficient to overcome the 'drag' from accumulated bad debts, resource
constraints and
geopolitical tensions was anything but certain.
In February 2014 agreement was reached through the G20 that all members
would seek (before the end of that year) to identify actions that could be
taken to boost economic growth by 2%. However it was not at all clear that
the economic obstacles and geopolitical tensions which could disrupt such an
outcome were being recognised.
Economic Indicators
Economic indicators of the possibility of a catastrophic crisis include:
- constraints on global economic growth were
indicated by the
impossibility of continuing to increase the high debt levels that many (most?) governments had accumulated in an effort to
stimulate economic recovery from the effects of the GFC - and the apparent
dependence of economic growth on easy money policies (which had stimulated
the economy by allowing
government debts and household mortgages to rise to levels that were
unsustainable at normal interest rates) - see Debt Denial
(above). In relation to this it is noted that:
- the G20 (which was established to deal with the GFC) had proven
unable to come to grips with the cultural incompatibilities that
underpinned the international financial imbalances that made global
growth unsustainable because financial repression / high levels of savings in
countries with non-capitalistic economic systems translate into their
trading partners' escalating public and private debts - but only so long
as the latter are willing and able to put up with this (see
Structural Incompatibility that Puts Global Growth at Risk and G20 in
Washington: Waiting for Hell to Freeze Over);
- counter-cyclical (fiscal and monetary) policies which had been
deployed to respond to the GFC had (predictably) been unable to
create a sustainable solution in the face of those structural financial
imbalances (see
Counter-cyclical policy can't solve structural
problems, 2011). However, as noted below,
there seemed to be a risk that they were contributing to the very real
problem of inequality (which raised the risk of social and politic
stresses) in many developed economies;
- the private de-leveraging (ie reductions in total debt) that had
started as a result of the GFC in countries such as US, UK and Australia
has been reversed (ie private debt again started rising ) and this would
thus boost (rather than suppress) demand and thus strengthen growth [1].
However it is noted that the total increase of private debt between 1992
and 2009 was something like 161% of GDP, and the reduction in this
through subsequent de-leveraging before private debts again started
rising was only about 6% of GDP . The potential for private debt to lead
to a financial crisis remained much the same as it was prior to the GFC;
- a disconnect was seen between financial markets (which had boomed)
and real economies (which seemed to suffer many constraints);
Many assume that the GFC is history - but, while financial markets
have improved, the
real economy has been weak (with low growth, high and rising debt levels,
slow investment, overcapacity, high unemployment, low income growth and
negative real interest rates). GFC resulted from high debt levels, global
imbalances, excessive financialization of economies and an entitlement
society based on borrowing-driven consumption and unfunded social
entitlement
programs in developed countries. Despite talk of reform and recovery, the
root problems remain largely unaddressed. Total debt levels in most
countries have risen since 2007 - as high public borrowings have offset
business / household deleveraging. If unfunded liabilities (eg for pensions,
healthcare and aged care) are included indebtedness rises dramatically.
Emerging markets (eg China) have increased debt levels substantially since
crisis in an effort to boost growth. Global imbalances have decreased but
only modestly - as a reflection of reduced economic activity in
developed economies. Large exporters (eg Germany, Japan and China)
remain committed to exports, large current account surpluses. Currencies
are increasingly manipulated to maintain export competitiveness. The
banking sector has increase significantly in developed economies. Too
big to fail banks have become larger. Trading volumes are much greater
than needed to support goods and services trade. Profits on financial
trade still exceeds that in the real economy. Government / central bank
policies of low interest rates and abundant liquidity have exacerbated
this problem. Complex links within financial system that transmitted
shocks in GFC remain - while new ones (such as CCP for derivatives have
been added. Links between 'too big to fail banks' and nations have risen
- as governments sought cheap funding from central banks. Reform of
entitlements is politically difficult. The problem has been ignored, and
made to appear to go away through low interest credit to fund government
spending. Aggressive lending practices (equivalent to pre-GFC CDOs) have
risen. Policy settings have been like those prior to GFC. It
is proving difficult to end expansionary monetary policy. In future it
seems likely that: growth will be slow; deflation will be a risk;
sovereign debt problems will remain; emerging markets will experience
greater problems; inadequacies of available policies will become more
evident; economic problems will have social (eg social inequality /
unemployment) and political (discontent, extremism) impacts.
International distrust, 'beggar my neighbour' policies and rising
nationalism are likely [ 1]
- the Bank of International Settlements (BIS - the reserve bank to
reserve banks) warned in mid-2014 of the risks associated with ultra-low
interest rates and the failure to deal with financial imbalances;
BIS warns that persistent 'easing bias'
by reserve banks has lulled governments into
a false sense of security. Ultra-low interest rates and a failure to
lean against persistent financial imbalances could make global economy
permanently unstable. Reducing interest rates during downturns while
not later increasing them results in accumulation of excessive debt -
which make it hard to then increase rates without damaging economy (ie
creates a 'debt trap'). Another financial crisis could lead to retreat
into protectionism and end current open global order. [1]
BIS warned of the need to end super-loose monetary policy in
2013. It has done so again in 2014 in stronger terms. In the meantime
asset values have boomed. In 2013 BIS warned of dangerous imbalances
in the financial system. In 2014 it suggested that the problems that
led to GFC remain unresolved. Market buoyancy seems disconnected from
underlying economic conditions. US Federal Reserve began tapering
money printing 6 months ago - but has not increased interest rates.
The slow pace of policy normalization after 2003 contributed to GFC.
Keeping interest rates low for long periods lulls governments into
false sense of security. It may be hard to arrange a smooth exist from
low rates. Markets may move first if reserve banks are seen to be too
slow. BIS sees a need to look at 15-20 year financial cycle - not just
at business cycle of about 8 years. Apart from setting markets up for
a big bust, persistent low interest rates are increasing income
inequality. When asset prices rise, the rich get richer. But real
wages are flat of declining, while governments cut back on welfare to
reduce budget deficits [1]
The world economy is seen to be just as vulnerable in 2014 to a
financial crisis as it was in 2007 according to BIS - because
investors were ignoring the risk of increasing interest rates as they
search for yield. The problem has been compounded by debt ratios that
are now much higher and emerging markets are been drawn into the line
of fire. Debt ratios in developed economies have risen 20% to 275% of
GDP. 40% of loans are to sub-investment grade borrowers (higher than
in 2004) while creditors have fewer protections. China, Brazil, Turkey
(and other emerging markets) have had private credit booms - partly as
a spill-over from QE in the west. Debt ratios there have risen to 175%
of GDP - with average interest rates of 1% pa for 5 years - an
extremely-low rate that could suddenly reverse [1]
- as a consequence of easy money policies many institutions and
individuals have apparently incurred debt levels that they could be
unable to service if / when interest rates return to more normal levels (eg see note
below on governments). A crisis could be
triggered if:
- easy money policies were to stimulate a significant
increase in real economic activity (rather than mainly just boosting
asset values). An inflationary surge would seem very likely - as the
'velocity of money' would increase. To prevent an inflationary spiral,
the ready availability of cheap credit would need to be rapidly ended and
interest rates rapidly increased;
- there were significant increases in wage rates. Signs of such a
breakout (because of a decline in the available workforce, rather than
because of any increase in economic activity) were being seen in the US
in mid 2014 [1];
- speculative excesses were seen to be to only effect of easy money
policies - about which concerns were emerging in the US in mid 2014;.
In the US consumers and companies are reducing spending,
technology leaders are not innovating and increasing regulation
poses risks. Wall Street and the owners of capital are seen to be
booming while Main Street and the workers struggle. Speculative
excesses could cause the Fed to tighten. The stimulus from low
interest rates has been unable to overcome de-leveraging, regulation
and a lack of innovation. Despite this Wall Street booms. Though
employment has grown, consumer confidence is weak. The 1% GDP fall
in first quarter of 2014 is likely to be revised down even further.
Nominal GDP has risen only 19% in five years - well below the 45%
that arises in normal recoveries. Meanwhile the stock market booms.
The longer this imbalance continues the greater the risk that it
will be necessary to curb speculation before real recovery occurs. [1]
- it was possible (though not certain) that government debt levels in
various major economies may have become so high (as a result of
counter-cyclical fiscal and monetary policies) that it may now be
impossible to avoid a worse global financial crisis than that which
started in 2008.
During GFC the world's money supply has increased rapidly as a result of QE by
reserve banks. A major effect of QE has been to allow governments to
borrow cheaply and expand their debt levels while (except in a few cases)
containing their debt service costs to within available revenue. Creating credit
in this way has led to economically destructive inflation at many times in
history. However this has not happened because the
escalation of money supply has been counterbalanced by an offsetting decline in
the velocity of money (ie the number of times that money supply turns over
annually has fallen because business and households have been reluctant to spend
the money that has been created). In a recovery situation, the velocity of
money could also recover and require a rapid reversal of QE if a high rate of
inflation is to be avoided. However rapidly phasing out QE would have the effect
of raising interest rates - and thus making government debt levels impossible to
service in many major economies (as these currently depend on ultra-low interest rates). US national debt
(for example) has been suggested to perhaps reach $20tr by 2020. If more normal
(eg 5%)
interest rates prevailed, debt service would consume 40% of US federal
revenues. Thus in some sense government debts are giving rise to a 'too big to be allowed to
fail' scenario which parallels that major banks created for policy-makers after 2008. However preventing government fiscal collapse by
maintaining QE in a recovery environment would presumably lead to massive
inflation [ 1]
- simultaneous monetary tightening by the US and China raised the risk
of a deflationary trap for many of the world's economies as liquidity
drained away (according to the IMF) [1]
China appears to be serious about ending its credit bubble (rather than
deferring this) - even though it has acted to bail out a number of
failing trusts. This will have adverse implications for emerging
economies and commodities' producers. It may be hard to achieve slow
deflation - and a hard landing is possible. China's credit expansion had
been unprecedented - and seeking to reverse this could lead to a crisis.
China also has significant offshore credit exposure. Global coordination
does not exist. Some exposed economies are tightening into economic
downturns to protect their currencies. The US Fed is tapering out of
concern for asset bubbles. The ECB has been paralysed by German
constitutional court decision - which prevented Bundesbank participating
in QE. [ 1]
- there is an increasing view that cheap money policies have been
economically distorting - and many examples to support this. What has
been done has been unprecedented in history. How it will end is
uncertain - but it is almost certain to end badly [1]
- it has been suggested that quantitative easing through reducing
interest rates may itself be causing
deflation and that an alternative involving increasing the quantity of
money may be better. However the issues are arguably more complex for
reasons suggested below;
- the creation of peer-to-peer 'virtual currencies' such as Bitcoin has been
suggested to potentially make it impossible for reserve banks (and thus
monetary policy) to operate
effectively - a possibility that though anything but certain, seems to
require closer examination because of its geo-political implications
Is Bitcoin a Threat? - email sent 18/3/14
Mike Ward
Money Map Press and
Michael Robinson
Money Morning
Re:
Edison’s revenge on the dollar, 13/4/14
Your video-article suggested that
Bitcoin (as a peer-to-peer virtual currency backed by a scarce electronic
‘commodity’) will undermine the ability of Reserve Banks to issue fiat
currencies, and that this creates profit opportunities. I would like to suggest
for your consideration that, if Bitcoin (and its imitators whose numbers are
reportedly escalating) survives, the long-term effect could be to undermine,
rather than promote, economic freedom. Thus the phenomenon needs much broader
evaluation – and the following suggests some aspects that perhaps need
attention.
There are undoubtedly problems with the way currencies are
managed at present (eg as reflected in the apparent need for reserve banks to
‘print’ of paper money to provide credit to governments and liquidity to the
banking system). However there is a need to consider why this practice has
arisen – because this is central to the environment into which virtual
‘currencies’ such as Bitcoin would be introduced, and which they would
potentially affect.
Firstly easy money policies by reserve banks reflect the
breakdown of assumptions (that were popularised by Keynes in the 1930s) that
economic booms and busts could be prevented by counter-cyclical government
spending.
Explanation:
Counter-cyclical public spending to balance business cycles was recognised to be
inadequate in the 1970s. For example, governments could seldom get the timing
right and their ‘counter-cyclical’ actions often proved pro-cyclical (ie
attempts to increase spending to counter a ‘bust’ often resulted in large extra
public spending during the next ‘boom’). When a potential ‘bust’ threatened the
US as a result of the 1987 share market crash, the US Federal Reserve tried a
new method for counter-cyclical economic management. Increasing the liquidity
available to the banking system prevented the financial market ‘crash’ from
affecting the real economy – and thus speeded recovery. The continued use of
this method allowed an unprecedented two decades of global economic growth that
was not interrupted by major reversals (ie the business cycle was stabilized to
some extent and booms and busts in the real economy were minimized). However it
also led ultimately to increasing risk of financial instabilities – because, for
example, investors decided that they did not have to take as much account of
risk as they had previously done, and this encouraged asset bubbles.
Secondly the bursting of particularly vulnerable asset bubbles in
2007-08 led to a major shortfall in ordinary financial institutions’ ability to
provide the credit that the global economy required (because financial
institutions’ balance sheets had been seriously damaged
and it would be
impossible in the long term to continue funding demand through large
international financial deficits). The disciplined
creation of credit through reserve banks provided a means to avoid a dramatic
real-economy recession / depression. It also created the risk of future
financial instabilities by allowing the risks associated with investment to
continue to be discounted.
These and other concerns have arguably made it necessary to
develop alternative methods for counter-cyclical economic management (see
New Methods for Macroeconomic Management?, 2007).
Moreover there has perhaps been a ‘clash of civilizations’
dimension that needs to be considered in relation to the loose monetary policies
by reserve banks that have prevailed in recent years (eg
see Competing Civilizations).
Explanation:
It appears that there has been a generally-unrecognised contest (a virtual
‘ war’ for control of the international financial system) between liberal
Western-style institutions (ie economies based on profit-motivated independent
initiative) and East Asia neo-Confucian alternatives (ie economies, initially
Japan’s, where state-linked enterprises are funded by state-linked banks on the
basis of consensus by authoritarian intellectual elites rather than calculations
of investment profitability). Where (for
cultural reasons) profitability is not taken seriously (see
Evidence) economic growth can potentially be very rapid given elite guidance
using neo-Confucian methods (see
Understanding East Asia's Neo-Confucian Systems of Socio-political-economy,
2009). However such arrangements require financial repression / savings gluts to
ensure that current account surpluses eliminate the need to borrow in
international profit-seeking financial markets. Thus structural demand deficits
exist that threaten global economic growth (see
Structural Incompatibility Puts Global Growth at Risk, 2003). However the
pre global-financial-crisis (GFC) era was characterised by loose monetary policy
especially in Japan (to feed the so-call “Yen carry trade’) and in the US (where
Federal Reserve officials often referred to the need to counter the risk of
deflation – presumably in Japan). This permitted demand well in excess of supply
- especially in the US - because asset values boomed. Thus global growth could
be sustained despite the demand deficits that were needed by major East Asian
economies and emerging economies with poorly-developed financial systems (see
Impacting the Global Economy, 2009). In the post GFC era the situation has
become even more complex because large international
financial deficits could not indefinitely be relied upon to finance US
domestic demand and the consequent need for quantitative easing by the Federal
Reserve also led to the emergence of what have been seen as
‘currency wars’. For example, the Federal Reserve’s quantitative easing program
can be viewed as a possible (also undeclared) counter-offensive – involving
doing-unto-others as others had long done to the US – ie providing cheap credit
encouraged carry-trades and incautious investment (which could create a risk of
asset-bubbles) elsewhere (see
Currency War?).
In this environment the creation of peer-to-peer virtual
currencies could have geo-political implications – as (if they survive) they
could threaten the ability of Reserve Banks to stabilize banking systems and
provide a measure of macroeconomic management. Thus governments will
(presumably) need to consider those issues – and other factors such as those
mentioned below:
- Without effective reserve banks there would be no back-up to
banks. Such a back-up is vital, because banks typically borrow short but lend
long, and are thus potentially exposed at times to runs because of short term
financial-system instabilities even if their long term prospects may be sound;
- The effect that independently-created / invisible virtual
currencies would potentially have on allowing financial transactions to be
hidden and taxes to be avoided is another reason that governments will have to
consider the implications of Bitcoin and its imitators. Bitcoin has also
reportedly been the
subject of concern that it has been used for illegal activities;
- Large numbers of virtual so-called ‘crypto-currencies’ are
reportedly being developed to mimic Bitcoin (see Volkering S., ‘The
Crypoconomy: Goodbye banks, Hello the future of money’, Money Morning,
17/3/14). If ‘crypto-currencies’ survive, this would not only dramatically
increase their potential destabilizing financial / economic impact, but also put
their survival at risk – because: (a) all such ‘crypto-currencies’ would
presumably have the same potential value in the long term; and (b) as long as
that value exceeded zero other individuals / groups would be motivated to make
their fortune by creating a new ‘crypto-currency’ (as many now seem to be
doing). Imitators' ability to create an infinite number of
essentially identical and thus equally valuable crypto-currencies at low
cost presumably implies that their price would trend towards zero;
- Though it is unlikely it is possible that the
mysteriously-sourced idea of ‘crypto-currencies’ could have been planted as
a ‘currency war’ counter-counter-offensive. If Bitcoin and the like were to
survive and make it impossible for reserve banks to stabilize financial
institutions (and thus to stabilize the financial system and economies)
liberal capitalistic Western-style systems of political economy would be
disadvantaged relative to their East Asian competitors (as the latter rely
on economic coordination largely through state-linked elite social relationships
rather than through a search for profitability by independent enterprises). A
reliable financial system is the ‘nervous system’ of Western economies, but is
much less significant in East Asia. Making suggestions that enemies find
appealing and act on without understanding possible negative consequences is a
conventional ‘Art of War’ tactic. Also Western
observers need to be aware of the need to
Look at the Forest
not Just at the Trees (ie at the big
picture, not just at specific 'things') in order to adequately understand
the implications of 'things' that might emerge from East Asia;
- There have arguably been reasons for several years to constrain
the ‘virtual’ economy (ie the possibility of making profits through transactions
that have no ‘real economy’ benefits of which the Bitcoin is a recent example) -
see
Restricting the Role of Financial Services;
At the very least some sort of regulatory arrangement (presumably
global in scope and perhaps under the Bank of International Settlements or the
International Monetary Fund) would need to be created to govern virtual markets
for ‘crypto-currencies’ like Bitcoin. Regulations would presumably need to
include: (a) licencing the creation and operation of ‘crypto-currencies’; and
(b) requirements for peer to peer ‘crypto-currency’ transactions to generate
traceable records that would be accessible to authorities (to reduce the
potential for of tax evasion and criminal activities).
I would be interested in your response to my speculations.
John Craig
- the legacy of the GFC was a major constraint on global economy in the OECD's
view. Growth was slow, unemployment high, inequalities were growing, public
trust in institutions established over the past 100 years was low, investment
and job growth were weak [1];
- very serious problems with inequality had
emerged in many developed economies over the past few decades. Though
there were many factors involved reliance on easy money policies to
sustain overall economic growth seemed to be a significant cause of those rising
inequalities (see Who is Failing the
Low and Middle Classes?);
- questions have been asked about the future viability of pre-GFC
economic growth rates in advanced economies such as the US - because of
constraints related to: (a) demographic changes (which imply that a
smaller population percentage is working); (b) the high cost of education;
(c) high consumer / government debt levels; (d) costly environmental
regulations; (e) the effect of globalization - which reduces incomes of
those exposed to competition from low wage economies; and (f) inequality -
the benefits of growth flowing much more to high income earners than to
those on lower incomes who are also traditionally the main consumers [1]
[CPDS Comment: Options to improve those prospects are suggested, in
an Australian context, in A Case for
Innovative Economic Leadership]
- A great deal of attention was often paid to the level of (government /
total) debt that particular countries had (eg by citing debt / GDP ratios)
as an indicator of their risk of financial crises. For example there was
concern that
debts in relatively small peripheral European economies seemed
unsustainable and serious US federal government debt
problem seemed likely in several years if action to reduce deficits
was not taken. However what was arguably really important was the quality
of debt. Where borrowings have not been invested productively, they are
much more likely to lead to a financial crisis than where disciplined
financial practices are the norm;
- Significant risks apparently faced various emerging economies, such as
the so-call Fragile Five (India, Indonesia, South Africa, Turkey and
Brazil).
In relation to emerging economies it was suggested that:
- financial exposure in countries with poorly developed financial
systems resulted from quantitative easing programs by the US Federal
Reserve and others (which some had seen as elements in a
Currency War);
- A string of emerging market economies (Turkey, Argentina, Brazil) were forced to tighten monetary policy to halt capita flight - and this
raised the risk of a viscous cycle as debt problems mount. Emerging
markets make up half global economy. They had not undertaken necessary
reforms over previous years - but instead relied on China's growth and
ample global liquidity [1];
- the IMF argued that banks and businesses in emerging economies
undertook massive expansion of borrowing from international markets - and
were faced with serious disruption as interest rates increase in the
West. This implied that large foreign exchange reserves and borrowing in
their own currencies had not insulated such countries from problems [1];
- the possibility of a 'market rout' was perceived in emerging economies
(and
global contagion from this). Argentina's currency collapsed, and there was concern
for Brazil. The IMF suggested that prospective tapering in US had caused
global liquidity to dry up - causing problems for emerging economies.
Countries that had benefited from the commodities super-cycle and the
credit boom would need to implement structural reforms urgently [1];
- OECD warns that deepening slowdown in emerging economies is holding
back global economy and poses financial system risks to Spain, UK and
other European countries with large bank exposure to emerging economies.
The US's 'tapering' of QE has only just begun - and capital flight from
emerging economies could intensify. Spain is particularly exposed (Spain's
bank exposure to emerging economies is 35% of GDP) while US is not (3% of
GDP). OECD wants phase out of QE to be slow and ECB / Bank of Japan to
increase stimulus. Emerging markets' now account for 50% of global
economy. Leading indicator for them peaked in 2011 and has declined since.
Tightening monetary policy to defend currencies has recently made the
situation worse. European banks are also increasingly constrained by ECB
stress tests - at a time when private sector lending is contracting and
small firms in southern Europe face a credit crunch [1]
- major East Asian economies such as in Japan (see Japan's
Predicament) and China (see
China's Predicament) seemed to face imminent financial crises because of
the massive expansion of credit to sustain growth and their lax accounting
standards (ie to the fact that return on, or even return of, capital was
not seen to be important);
- in July 2014 concerns about the viability of one of Portugal's major
banks (and about the fact that Portugals debt burden (eg private sector
debts are 250% of GDP) will probably require defaults) cast doubt on
Europe's leverage problems more generally [1]
- in July 2014 it seemed that the US Fed was moving much more rapidly
towards higher interest rates than previously expected - because
unemployment had fallen to its 6% target and inflation was increasing -
thus raising the risk of over-shooting on inflation unless easy money
policies were wound back. This could cuase problems for many countries
that have 'gorged' on the $3.5tr that the Fed had provided to the world
economy through its bond purchase program. Problems can be expected in
the 'fragile five' (India, Indonesia, South Africa, Turkey and Brazil).
Large amounts of hot money had gone into emerging markets - and will
probably come out quickly. Monetary easing in West had forced emerging
economies to choose between higher exchange rates and asset bubbles -
and most had chosen the latter. Debt to GDP ratios have gone to 175% of
GDP (and in China it is 220%). Many doubt that China can extricate
itself. There are a lot of countries facing the middle-income trap -
having exhaustion low-hanging fruit of catch-up growth yet have not put
market reforms in place. Brazil South Africa and Russia have been headed
for recession. All will now face secular rise in interest rates. The
BRICS, mini-BRICS and much of global finance have taken out a short
position against the $US. The Fed has now issued a margin call [1].
In this context there seemed to be an urgent need for the G20 to finally
face up to the problems associated with structural incompatibilities in the international financial
system -
but perhaps little prospect that this would be achieved.
Making the G20 Useful at Last - email sent 26/11/13
Senator the Hon Arthur Sinodinos, AO
Assistant Treasurer
Re:
G20 policy on private investment key for infrastructure, The Australian,
26/11/13
Your article started by suggesting that:
“Australia will take over the presidency of
the G20 next week and, with it, the opportunity to advance an important policy
agenda for the world's most economically powerful countries. Top of this agenda
will be the promotion of investment, especially for infrastructure”.
I should like to suggest for your consideration that a
focus on increasing (especially private) investment in infrastructure would be a
waste of the opportunity that Australia has in having the presidency of the G20.
My reason for suggesting this can be illustrated by the sub-heading that
appeared with your article:
“Society is the poorer when capital is not allocated to maximize its value”
The biggest problem that the world’s financial systems face
(which it is the G20’s role to address) has nothing to do with private
investment in infrastructure, but rather involves the allocation of capital with
little interest in maximizing its value by major East Asian states (eg Japan and
China – see
evidence). That problem:
- Arises from the neo-Confucian methods that have been used to
achieve ‘economic miracles’ in East Asia (see
Understanding East Asia's Neo-Confucian Systems of Socio-political-economy,
2009);
- Played a major role in generating the international financial
imbalances that required the loose monetary policies in the US that ultimately
led to the GFC (eg see Impacting
the Global Economy). Where capital is allocated by state-linked banks to
state-linked enterprises with a goal of maximizing market share rather than
economic value added, it is essential to suppress demand to maintain a current
account surplus (and thus avoid having to borrow in international profit-seeking
financial markets). Global economic activity can only be sustained if trading
partners are willing and able to maintain large current account deficits and
ever increasing debt levels;
- Has been the main issue that the G20 should have dealt with from
the start, but has been neglected because of the difficult cultural issues
involved – see
G20: Avoiding key Issues (2008);
G20: Peace for our Time'? (2009);
Too Hard for the G20?
(2010);
G20 in Korea: Unreal Optimism? (2010); and
G20 in Washington: Waiting for Hell to Freeze Over? (2011); and
- Seems now to be on the point of generating a crisis – because of:
(a) the high debt levels in developed economies that constrains their ability to
provide the excess demand that countries reliant on current account surpluses
require; and (b) the huge levels of bad debts that apparently threaten economic
and political meltdowns in countries such as Japan and China (see
An Approaching Crisis?).
Thus the key reason for suggesting that a focus on private
infrastructure investment would be the waste of an opportunity is that there is
a much higher priority issue (and an imminent crisis) that arguably needs
attention by the G20.
Another reason for not focusing on mobilizing funds for
infrastructure investment is that Australia’s current machinery for the planning
and development of infrastructure is dysfunctional (eg see
Infrastructure Constraints on Australia's Economy, 2005 and
Infrastructure Magic?, 2008). Fixing the institutional mess is much more
likely to result in the ‘allocation of capital to maximize its value’ than
encouraging private investors to direct funds into a dysfunctional system.
John Craig
Trade is not Enough for Economic Progress - email sent 20/1/14
Richard Goyder (Wesfarmers) and Harold McGraw (McGraw Hill)
Re:
Davos offers rare opportunity to push for economic progress,
The Australian, 20/1/14
Your article argued that trade
liberalization should be the top priority agenda item for the coming G20 summit
in Australia.
I would like to suggest for your
consideration that dealing with financial system distortions should be an even
higher priority – as they can make a liberal trading regime unsustainable.
This point is developed from one
perspective in
Making the G20 Useful at Last. Until
serious attention is paid to the demand deficits / current account surpluses
that some significant economies have had to have in order to avoid a financial
crisis (eg those with non-capitalistic financial systems such as Japan and
China, as well as emerging economies with poorly-developed financial systems),
it will be impossible to sustain growth under a liberal trading order as: (a)
the resulting international financial imbalances require their trading partners
to be willing and able to tolerate ever-rising debt levels; and (b) financial
crises will remain an ongoing risk almost everywhere. Moreover the
non-capitalistic financial systems create what amounts to a novel form of
protectionism that needs to be considered in relation to the rules of
international trade (see
Resist Protectionism: A Call That is Decades Too Late,
2010).
However problems have also developed in
capitalistic (ie profit-oriented) financial systems as their complexity has
escalated, and this also needs attention (perhaps as suggested in
Restricting the Role of Financial Services?) before a future
liberal trading regime can be sustainable.
John Craig
Structural Obstacles to Global Economic Recovery Need Attention - email sent 5/6/14
Ambrose Evan’s Prichard
Telegraph
Re:
The nagging fear that QE itself may be causing deflation, The Telegraph,
4/6/14
Your article raised the possibility that
low interest rate policies may not be able to prevent: (a) the global economy
sliding towards deflation; and (b) economic globalization failing in the face of
a new era of protectionism. It also suggested an alternative approach to
monetary policy stimulus (ie boosting the quantity of money rather than
restricting interest rates). However global economic recovery will arguably be
impossible until attention is paid to the savings gluts and demand deficits that
have been critical to the non-capitalistic financial systems that have been
components of the ‘economic miracles’ achieved in recent decades in East Asia.
My
interpretation of your article: The whole
world is headed for zero interest rates - because of the risk of deflation in
countries with burst credit bubbles and a global savings rate that has risen to
25% - starving the world of demand. ECB is headed for negative interest rates to
lower the euro and pass the risk of deflation to someone else. China is
proposing 'targeted monetary easing' and seeking ways to deflate its property
boom - which is not easy because government revenues and economic activity
depend heavily on this. Beijing's land value is about the same percentage of US
GDP as Tokyo's was at the peak of its 1990 bubble. China is facing deflation in
supply chain and a workforce that is now declining by 3m pa (similar to trends
that started Japan's deflation). Difficulties in shaking off 'lowflation'
malaise are partly the result of a glut of factories worldwide. However it is
also suggested that low rates and QE may cause deflation - because buying
government bonds lowers the 'liquidity premium' which in turn pulls down
inflation. India's central bank suggests that QE is a 'beggar my neighbour'
devaluation policy. Western QE causes a flood of money to emerging markets
(seeking yield) which creates destructive booms - and post-bubble hangovers.
Emerging economies thus need to tighten policy, restrict demand and build up
foreign reserves as a safety buffer. This perpetuates the global savings glut
that has starved the world of demand - and may be the main cause of the long
slump. BIS argues that the world is suffering from addiction to stimulus.
Refusing to let the business cycle run its course and purge debts is corrosive.
The global economy can be in a deceptively stable disequilibrium. There are
signs that globalization could be in retreat - and be followed by an era of
financial and trade protectionism. Japan tried aggressive monetary policies in
the 1990s - yet deflation ground on. In US / UK QE has had a potent effect -
preventing double-dip recessions as austerity bites (in contrast to Europe).
However recent US contraction is a warning sign of possible problems. The
problem may be that Western central banks have focused only on interest rates -
and not on quantity of money changes. Targeting quantity of money increases
(with interest rates finding their own level) might have been better. The ECB
could be making the same mistake - by only adjusting interest rates
Monetary policy is an unsatisfactory tool for
counter-cyclical economic management because its effect, though potentially
significant, is too complex to be properly understood or targeted. Monetary
policy primarily affects asset values (rather than economic demand) and thus can
contribute to asset bubbles and busts. And its effect can be transmitted
internationally by carry trades, with potentially disruptive consequences (see
Booms and Busts: Unsatisfactory Tools for Macroeconomic Management, 2007).
It also (perhaps) contributes to the income inequality that is now causing
international controversy (see
Who Is Failing the Lower and Middle Classes?).
However finding an alternative method for macroeconomic
management is not policy-makers’ biggest challenge.
Global economic growth can’t be sustained in the face of
persistent and structural international financial imbalances. Increases in
economic demand (whether due to market conditions or stimulus measures) are not
limited in their effect to a particular country. They will also have spill-over
effects on the global economy and, if trading partners persistently suppress
demand so as to generate current account surpluses, then counties that do not
deliberately restrict demand must increase their public and private debts to the
point that demand eventually has to be stifled there as well. Financial and
trade protectionism thus becomes unavoidable and economic globalization must
collapse.
There is no possibility of overcoming the world’s current
tendency towards a savings / supply glut and a demand deficit until attention is
paid to cultural factors that have led to significant international financial
imbalances for reasons suggested in
Structural Incompatibility Puts Global Growth at Risk (2003) and
Understanding East Asia's Neo-Confucian Systems of Socio-political-economy
(2009). Globally unsustainable imbalances have been domestically vital to
protect the non-capitalistic financial systems (ie those
not seriously concerned with return on capital) that have been a central
part of East Asian economic ‘miracles’.
The G20 was set up to address problems in the international
financial system that gave rise to the post 2007-08 global financial crisis.
However it has repeatedly failed to get to grips with the cultural
incompatibilities that are arguably at the core of the problem it is supposed to
be solving (eg see
G20 in Washington: Waiting for Hell to Freeze Over?, 2011).
John Craig
There also seemed to be no consideration of real possibility that
constraints on obtaining the resources required to maintain traditional patterns of
economic growth seemed to: (a) potentially lead to an inflationary surge, and economic disruption, like that in
the 1970s; and (b) require urgent innovation if that risk were to be
avoided. For example:
- global production of conventional oil seemed to have peaked around
2006 (see General Notes
on Peak Oil), and while increased production was being achieved
through 'fracking' technologies to access shale oil the rapid decline
rates associated with these methods implied that such oil production was
not only environmentally controversial but: (a) was proving unprofitable;
and (b) would require very high oil prices and ready availability of cheap
credit [1].
The latter requirement seemed incompatible with: (a) the
apparent need to end the easy money policies
(as the latter had distorted resource allocation and created potential
asset bubbles); and (b) the likely need to rapidly bring quantitative
easing to an end if inflation starts to accelerate. There is no doubt that
innovation in this arena is proceeding - but whether this can be
sufficient is anything but clear;
- a plausible (though not yet debated) case was developed that there was
a risk of 'peak mining' in about 2017 (whose effect on product costs would be similar to
'peak oil') because it was increasingly necessary to exploit very large
low quality mineral deposits through the use of highly energy intensive
methods [1].
- significant risks of wars over access to water, land and food were
seen to be possible because of rapidly escalating food demands unless
agricultural intensification (ie getting more food from available land and
water) is successful [1]
It should be noted that:
- options to dramatically improve efficiency in the extraction and use of
resources were also suggested [1];
- the development of renewable energy technologies (especially solar
energy) is proceeding rapidly - and this could turn the $5.4 tr invested in
fossil fuel exploration and unconventional oil production over past 6 years
into areas of financial loss - because their production costs are so high [1]
;
- grid-scale battery technology that could inexpensively store solar and
wind energy is being developed [1]
Geopolitical Indicators
There were at the same time indicators of potential threats to the global
political and economic order that went beyond those associated with
financial and economic systems. For example:
- there have been signs of a China-focused attempt (eg through the development of
'bureaucratic-style' consensus amongst leaders of the BRICS countries and
in numerous other ways) to
create an international neo-Confucian political order administered from
China which
would complement the Japanese-led
'financial war' of
recent decades in challenging the liberal international order based on democratic capitalist
principles that had been established after WWII and been championed by the
United States, (see
Creating a New International
'Confucian' Financial and Political Order?). The existence and
implications of such a renewed authoritarian challenge to a liberal
international order are unfortunately unlikely to be apparent
to most Western observers because of the complex
cultural issues involved - eg because the means of gaining
authoritarian power are likely to be
initially subtle. Such understanding is vital because
it may be the major non-capitalist economies in East Asia (ie Japan and
China) face financial and political crises unless the liberal democratic
capitalist post-WWII international order can be disrupted (see
The Need);
- security risks seemed to be increasing as indicated by:
- the war rumblings in North Asia that could transform into real conflicts in
that region (see
Fasten Seat Belts - Rough Weather Ahead);
- the relationship between apparent attempts to create a new
international neo-Confucian order in competition with the post-WWII
democratic-capitalist international order and military tensions in the region (see
Comments on Australia's Strategic Edge in 2030);
- the serious and uncontained regional conflicts that appear
to be emerging in the Middle East that seem to result from disagreements
about what sort of system of political economy would enable Muslim-dominated
nations to overcome the relative backwardness that they have experienced
in recent centuries (see
The Muslim World Seems to be
Headed for Chaos);
- a manifestation of the incipient Sunni-Shia sectarian civil war in
Iraq in mid 2014 (ie an attempt by Islamist extremists to create an
Islamic State) was seen as potentially disrupting global oil supplies and
pushing oil prices to levels that would be economically disruptive [1]
- warning from security analysts in SE Asia that terrorism from
extremists trained in the Middle East is likely to escalate worldwide [1]
- the large number of
ongoing conflicts in Africa ;
- efforts to undermine the security intelligence foundations of Western
defence arrangements that seemed to be emerging (see Smarter
Authoritarians). The latter includes reference to the
possible motivation of such effects, and the methods that might
have been used to encourage worldwide political questioning of the
intelligence gathering efforts that had their origins in the Cold War and
subsequent perceived terrorism risks from Islamist extremists (potentially
involving WMD). The possibility of a diversity of
complementary 'attacks'
coordinated from North Asia was one possible (though by no means certain) 'Art of War' interpretation
of North Korea's apparently crazy threats of nuclear attacks on the US;
and
- political instability in the Ukraine (related to debts that made
government unsustainable and uncertainty about whether the Ukraine should
have a liberal-European or authoritarian-Russia style political regime).
This led to: (a) Russian military involvement (which some compared with
Hitler's 1938 invasion of the Sudetenland in 1938 while Russia declared
pro-European factions in the Ukraine to be like 'Nazis'); (b) potential
Western sanctions against Russia; and (c) Russian threats of
counter-measures -such as confiscating Western investments in Russia and
abandoning the use of $US) which could have significant costs for others.
The US's case for sanctions against Russia (on the basis of Russia's
invasion of another country) was weakened by the fact that the US itself
had a history of intervening militarily in other countries in order to
correct perceived political dysfunctions. The decision by Russia's
president in May 2014 to back away from intervention in the Ukraine might
reflect the influence of a quite different emergent power bloc (eg see
Creating a New International
'Confucian' Economic and Political Order?);
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 international cultural,
social, political and economic situation(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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