By Michael Baxter 21 May 2010 [0 Comments | 644 views]
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Oh dear, it’s been another day of crisis.
If you have a nasty cold, and you take some miracle drug that masks the symptoms so you can go out and play in the sun, what happens when the effects of the drug wear off? Answer: you feel even worse. If you are in debt, and you borrow money to pay off your debt, what happens? Answer: you end up in even more debt. Back in September 2008, and then again in early 2009, it seemed as if capitalism itself was toppling. Some might say “good thing too,” but quite clearly the after effects of a banking collapse would have been misery. The great banking bailout that followed was hugely controversial, but probably meant we avoided an economic catastrophe on a scale that… well, you don’t want to go there. Suffice it to say that things would have been very nasty.
And now, 18 months on, it seems to be happening all over again. It would appear that the banking bailout was no more than a sticky plaster placed in haste over a gaping wound. And now the infection has spread. The symptoms were masked and now they have returned, if anything, worse than before. Media headlines have started talking about a return of the Great Depression.
So what is going on this time? Is it really that bad, and what’s the way out?
The prediction
Back in 2006 Ann Pettifor penned a book called “The Coming First World Debt Crisis”. The book’s main hypothesis was that up until that point we had only seen debt crises inflict the developing world, or even the undeveloped world. The author suggested that the developed world would be next, and the result would be a catastrophe on a scale we could barely conceive of. She reckoned the fundamental cause of the crisis that was about to develop, was what has commonly been referred to as ‘fiat money’, that’s this idea that the money supply is really determined by banks and their lending.
The author of this article read the book, but found himself getting annoyed by the conspiracy theory aspect of the fiat money debate. It seems the problem, according to the high priestess of the fiat money conspiracy, lies with banks, which supposedly are making money at the expense of everyone else, and relying on us borrowing more and more, and getting further and further into debt, to fund their massive profits.
Of course, four years on, it would appear the book was prescient indeed. Banks are certainly unpopular, and have been blamed for creating the economic crisis of our times. But we are not sure that the diagnosis of the problem is right.
There are so many predictions out there that the laws of statistics say some of these predictions will be right. But that does not make their authors some latter day Cassandra. Just because the prediction was right, it does not mean the theory behind the prediction was right. Astrologers amongst the Incas had predicted the end of their civilization. They were right. Does that prove astrology can foretell the future, or does it simply tell us something else? Perhaps the Incas were so convinced their astrologers were right, that when the Spanish arrived they made little effort to resist the conquest because they thought it would be pointless, and thus the prophecy became self-fulfilling.
The real point here is to beware of looking at all the theories predicting doom before the credit crisis happened, and of then heaping too much praise upon the authors.
The crisis
The latest reason for markets panicking is that they are fearing that governments are enacting austerity drives too quickly. Yes, that’s right. After spending an age telling us they were worried about fiscal debt, now markets are worried it is being reduced too fast. Of course, this panic comes on top of Germany’s ban on naked short-selling, which comes on top of the bourgeoning fears over Spain and Portugal, which come on top of the Greek economic tragedy, which comes on top of the banking crisis, which comes on top of the credit crunch, which comes on top of mortgage securitisation, which comes on top of the idea that house prices always go up.
This time it may be different
But before you dismiss ideas such as the banking bailout, and the EU bailout of Greece and Co., and say you can’t solve a debt crisis by lending more money, just remember there is a precedent for dealing with debt by borrowing more. During the 1930s, governments did what common sense said they should. They made cutbacks, and they encouraged thrift. And the depression got deeper. Then the Second World War came along and they had no choice but to borrow; the depression ended, and the global economy embarked on its best ever period of economic growth, which lasted right up to 1973. At the beginning of the UK’s golden period of economic growth, fiscal debt was 250 per cent of GDP. A quarter of a century later the average Brit was enjoying an income that was around twice the level at the beginning of the period.
You see, high government debt does not automatically mean low growth to follow.
Professors Reinhart and Rogoff have published a book called “This time it is different”. They have looked through the ages and found an incredibly high correlation between government debt and economic crisis. The title of their book is meant to be ironic. It never is different.
And yet the post Second World War experience shows this is not so. You can say most serious car crashes occur when the driver is going too fast. That does not mean that when cars are driven fast there is nearly always a serious car crash. Most people who go bust have previously got into big debt. This does not mean all people who get into big debt go bust.
Sure, economic crises are often preceded by a fiscal debt crisis. But high fiscal debt does not always lead to crisis.
Bizarrely, the yield on UK, US and German ten-year bonds has fallen over the last week or two. Investors have been rushing to safety, pouring their money into the safest assets they can think of. And those assets are government bonds. Economics is like that that. It throws up strange results, and is not always common sense. Behaviour that is right for individuals can be wrong for an economy.
China joins the panic
Did you know that between January and February this year the Eurozone imported no less than 27.9bn euros worth of stuff from China. It was the region’s biggest import market. Yet exports came to just 12.6bn euros. For the EU 27, imports from China were 37.6bn euros. Exports were 15bn euros.
But that only masks the problem. A much more serious problem relates to the flow of trade within the EU, with German surpluses with the rest of the region meaning that by definition the rest of the EU has a massive deficit with Germany.
And just as the falling pound has been seen as good news by those who want to see the UK export its way forward, the falling euro is now being seen as good. Earlier this week, John Lipsky, the Deputy Director at the IMF told Bloomberg that: “The current level of the euro does not appear to pose problems.” He said: “The euro is rather close to what we would consider equilibrium value after an extended period at which it traded above that value.” Charles Wyplosz from the Graduate Institute of International and Development Studies in Geneva told the Chinese Xinhua news agency that the falling euro is a “godsend”.
In fact, while the deficit between Europe and China is way too big, there are signs that it is closing. Exports from the EU to China rose 47 per cent over the last year, whereas imports fell 2 per cent.
According to the FT, Asian exporters are becoming extremely anxious or ‘rattled’ over the plight of the euro. The pink ’un paraphrased Tom Albanese, Chief Executive of Rio Tinto, saying: “The European crisis is the greatest current risk to China’s growth.”
As you may know from several articles written here covering this point, China dealt with the crisis by boosting internal investment, possibly creating a new bubble and perhaps pushing up the global price of oil and other commodities. But she still enjoyed massive exports to the EU and US. China’s policies were short-sighted and are now rebounding on her. It may seem appealing to sell to, but not buy from, one’s main customers, but if this policy ultimately means your customers run out of money, then this policy can backfire. In business, all sides of a deal must gain.
At least the falling euro suggests Europe’s problems are seeing a partial fix, but the problem of trade flow within the EU is no closer to a solution. And Germany’s response to the Greek crisis shows she has no intention of doing her bit to boost demand within the EU.
Enter Venter and synthetic life
But maybe there is more to this crisis than just global imbalances.
The 1930s depression was odd, because back in 1929 most investors were extremely optimistic. And they had good reason. The previous half-century had seen unprecedented innovation. The problem in the 1930s was that the money supply contracted just at that point that innovation had created unprecedented potential. Industry could produce more for less labour input, and yet demand was falling.
It is like that today, too. In the US, productivity has been rising at an extraordinary pace.
And now we have Craig Venter. In the penultimate paragraph of the last article written in this column in 2009, it was said: “And by the way, watch genetic science over 2010, and prepare for announcements that will stun the world.”
Well, this morning, Craig Venter happened. The famous genetic scientist claims to have created a synthetic life form. Actually, he hasn’t done that at all. If you change some chips inside your computer, have you created a new computer or modified an existing one? Well, this analogy is fairly close to the ‘has Venter created synthetic life?’ debate.
But frankly, this debate is academic. What Venter is doing is truly stunning. It seems we are close to seeing synthetic life forms that can suck up waste and carbon dioxide, and create fuel. Algae may yet become the new oil. Cures for cancer and heart disease beckon. This may seem like hype, but it isn’t. What is going on in genetic science right now is probably the most significant scientific advance ever seen.
Of course there are doubters, just as there were doubters when Copernicus said the Earth went around the Sun, or Darwin said life had evolved. And there are dangers, too. If the credit crunch has taught us anything, it should be the importance of regulation, and just as bankers can get it wrong, so can scientists.
Are we victims of scientists?
But just as the period before the 1930s was one of extraordinary innovation, the period we are going through now is, too. But just like the 1930s, this creates the problem that demand may lag behind capacity. That was the problem in the 1930s, and it is the problem today.
And that brings us back to fiat money and the debt crisis. Debt is affordable if as a result of that debt we are able to produce more goods and services. And right now, the world’s ability to produce goods and services is without precedent. But to meet this new potential we need growing demand. Without this extra demand, we get deflation and depression.
