Wednesday, 1 May 2013

Walking with the Dinosaurs

I spent last week at a finance conference in Asia, and what a revelation it was!  The contrast between the vibrant growth and optimism of Singapore and the depressed state of old world bankers was tangible.  It was like watching a Brontosaurus eat its last lunch.  In the distance I could hear the rumbling of another dinosaur.  Paul Krugman!

There is no doubt that Paul Krugman punches above his weight, a Nobel Laureate, Professor of Economics and International Affairs at the Woodrow Wilson School of Public and International Affairs at Princeton University, Centenary Professor at the London School of Economics blogger in chief at the NYT.  As he says in a recent blog post, he has had a good run over the last two weeks.  The unraveling of Reinhart’s and Rogoff’s research on the 90% tipping point for debt to GDP ratio was greeted with great glee by Keynesian economists. 
 Add to this, the growing sentiment in Europe for alternative measures to austerity and we have one happy economist.  It  maybe that the balance in the argument has changed, in 2009 - 2012 Keynesian’s  were on the run all over the world, but perhaps the game has changed and support will now grow for the Krugman’s view, that we need more not less government spending.
In a recent post he tells us -
So what could we do to reduce unemployment? The answer is, this is a time for above-normal government spending, to sustain the economy until the private sector is willing to spend again. The crucial point is that under current conditions, the government is not, repeat not, in competition with the private sector. Government spending doesn’t divert resources away from private uses; it puts unemployed resources to work. Government borrowing doesn’t crowd out private investment; it mobilizes funds that would otherwise go unused.

There are several problems with his argument and in common with Reinhart and Rogoff and like most other economist there is a gross simplification going on here.  Firstly, he focuses on solving a single negative symptom only – unemployment.  He brushes over the destruction of savings and future interest payments on government borrowings.  Secondly, the problem with this current crisis is that it has multiple dimensions, government indebtedness, deflationary pressure in the west, broken banks, shortage of liquidity, unemployment, and rapidly aging populations in the West (the growing cost of pensions, welfare and health).

The probable truth is that we are at an important tipping point for the West, our dominance over the world economic capital, natural resources and human talent is being challenged on all fronts.  Unfortunately we have been dealing with a severe cyclical downturn at a time when other more damaging macro issues are impacting our old world;  loss of global competitiveness  the burden of an aging populations on our public welfare and health institutions, rising pension costs and a broken and under-capitalised banking system. It’s these macro issues that we need to face up to and specifically the problem of competitiveness, it is this issue alone that threatens of prosperity in the West.  Addressing the problem of competitiveness will demand more ingenuity than some liberal tinkering with our government spending. 

This competitiveness issue is best observed through the lens of the Japanese economy.  Since the early 1990 Japan has been in a deflationary liquidity trap where people and business don’t believe conditions will ever return to ‘normal’.  Following a great asset bubble in the ‘80s asset prices have slowly declined, relative competitiveness has sunk and growth has disappeared. The one thing that has remained absolutely constant in the two decades of stagnation has been the low level of interest rates.  Easy or cheap money is like welfare it becomes an addictive drug for those to idle or incompetent to change their ways.  Had the Japanese faced up to their un-competitiveness (over valued assets and businesses) earlier there would have been more pain at the start but they would now be growing in new directions.

The toxic cocktail of low or negative interest rates and over spending governments has lulled us all in to a false sense of security and is the main reason why the old rich countries are taking so long to find some growth.  Like the victim in a date rape drugging, the West is barely conscious and waiting to be assaulted in the global economy by more energetic and nimble economies.  Having had our asset bubble in the years 2000-2008 the sad truth is that based on Japanese experience we may be facing another fifteen years of flat-lining living standards.  We need to make cash valuable again by raising interest rates, this will force tired and broken business into bankruptcy by it will release both valuable financial capital and energetic human capital so badly needed to compete on the global stage.  

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