GLOBAL FINANCIAL CRISIS: by Colin TeeseNews Weekly
Have we reached the end of the beginning?
, July 10, 2010
There is an unjustified optimism about where the world now stands, at least in relation to the financial crisis that came close to destroying the global economy from the middle of 2007.
It is widely held that the worst is over and we are now on the path to recovery. By "recovery", most seem to expect that things will gradually right themselves and we will get back to "normal" - "normal" being the way the West was before the crisis hit. Nothing, so the belief goes, needs to change.
The reality is different. We are far from being near the end of the crisis. More likely, we are at the end of the beginning.
Stage Two is upon us. Much of this is recognised in more enlightened circles, though nothing is being done to fix the problem, perhaps because nobody really knows what can or should be done - certainly within the framework of current economic orthodoxy.
What we observe happening in the European Union certainly supports this view. In all probability, the EU's debt problems are a microcosm of what prevails in most of the Western capitalist nations.
Things are moving really fast. As recently as six or eight weeks ago, this writer would have dismissed out of hand the likelihood of the EU's currency union collapsing. Now that is a real possibility.
This is all the more so now that it appears that yet another EU economy - Hungary - is facing problems similar to those of the so-called PIIGS countries (Portugal, Italy, Ireland, Greece and Spain). In addition, one of France's oldest financial institutions, Société Générale, is reported to be in trouble with its derivatives. Is it any wonder, therefore, that the Euro has fallen close to the level it held at the time of its launch in 1999?
Suppose, for purposes of discussion, that the currency union breaks up, what might we expect to follow? Can the member-states go back to using their former currencies? If so, how would they establish the relative values of each others' currencies? And what kind of disruption would that cause to already distressed financial markets, not to mention the flow of trade back and forth across EU borders? Trade within this customs union - although the EU pretends it is international trade - is its economic backbone, and, in particular, is absolutely essential to the prosperity of the EU's two biggest economies - France and Germany.
There seems to be no immediately obvious answers to these quite baffling questions, but it is nevertheless useful to try to understand how Western economies, from a position of such strength 30 years ago, got into such a mess.
As we all know, the West as an economic and political grouping was effectively created out of the Bretton Woods agreement (July 1944) under the leadership of the United States towards the end of World War II. As a result of that agreement, the overwhelmingly powerful US became de facto
leader of the West and effectively underwrote its trade and payments system. Once European rebuilding had reached the point of re-establishing fully working economies - about 10 or so years after the war - a new economic model had been created.
It proved to be an enormously successful experiment in international co-operation - perhaps the first ever - and delivered to its participants unprecedented and enduring prosperity.
The West's new capitalist economic model was motored primarily by consumer demand. That had been made possible by the fact that, as a result of the war and its aftermath, there had been a big shift in the distribution of national incomes away from profits and towards wages. Not only were workers better paid than ever before, but full employment was the fundamental goal enshrined in the aims of the UN's International Labor Organisation (ILO).
Reliable, well-paid jobs resulted in more widely distributed prosperity than ever before, and stimulated an ever-growing capacity and desire to consume. In such circumstances, consumer spending drove economic growth faster than had ever before been possible.
Faster growth based on high wages and full employment became the economic norm of Western countries. Inflation was left to look after itself - and, curiously, it did, for a while. Perhaps this was because there was a tacit acceptance of the need for higher levels of taxation than had prevailed pre-war. That, and a battery of regulatory and interventionist measures, seemed to keep the whole thing humming along for the next 20 or so years.
The US Johnson Administration's financing of the Great Society program and the unpopular Vietnam War by printing money, rather than by higher taxation, began the process of undoing a flourishing economic mechanism. Soaring inflation, generated in the US, rapidly infected all the Western economies tied into the Bretton Woods system by fixed exchange rates.
Mounting pressure for reduced tax imposts on individuals and businesses, as part of a rightward philosophical shift in the US, further fuelled the inflationary fires, exacerbated by the surging world oil prices of the 1970s.
A combination of these issues resulted in the US losing both the capacity and the will to underwrite the Bretton Woods system. This coupled with a commitment to lower taxation and its accompanying philosophical drive in the direction of free market economics resulted in a fundamental shift away from the regulatory arrangements that had made possible high wages and full employment.
The new emphasis was on cheaper imported consumer goods through lower trade barriers and downward pressure on wages. And, in response to the movement offshore by manufacturers in search of lower wage manufacturing, the better-paid jobs went with them.
However, none of this could alter the fact that the West's domestic economies were still dependent on consumer spending for their continued growth. Yet, how could this go on if wages were not keeping up? And we now know they were not, because, in the 20 years after 1980, US real wages (i.e., adjusted for inflation) hardly rose at all.
Reversing the trend of the previous 20 years, the new mix of deregulation, free market economics and low taxation saw a redistribution of national incomes away from wages and towards profits in most Western economies.
In the face of all this, how could consumer spending continue to drive the economy? The answer lies in cheap imports from low-wage countries, especially China, and, no less important, a much enhanced availability of consumer access to credit.
Taking the US as the lead example, consumers borrowed, with little regard to repayment consequences, to keep feeding their spending habits. Many were spending way beyond their means.
The whole exercise ground to a halt in mid-2007 when banks in the US and Europe, throwing risk-assessment measures out of the window, over-lent and effectively landed themselves into near bankruptcy.
Most of the well over-stretched "Atlantic" nations' banks froze as the consequences of their over-generous lending policies struck home, and they ceased lending. Governments, in order to avert total economic collapse, had to, in effect, recapitalise them or risk a catastrophe.
Even so, economic output and employment in most of the West slumped. Again, governments stepped in with so-called stimulus packages to keep their economies ticking over. Perhaps these band-aid measures helped in many cases; but the underlying problem of households over-burdened with debt (and the consequences flowing from it) is yet to be confronted.
If we are to see an eventual end to the crisis, the debt problems of governments and households must be dealt with. The question is how.
There are three possibilities.
Some say that nations must cut back on spending and cut wages. But in a consumer-driven economy, this can only mean less consumption and a decline in national income. National income growth and business prosperity would be immediate causalities. Quite possibly, the world economy could be tipped into deflation. The path back would be long and painful.
Ask the Japanese about their deflation over the last 20 years. Once it gets a grip, it reinforces the tendency not to spend. Holding onto money actually increases its worth.
The second proposition is to keep up total spending until recovery is self-sustaining. We have no idea how long this might take. What we do know is that it will load more debt onto already over-indebted economies.
Moreover, Scottish-born Harvard historian Niall Ferguson reminds us that only one nation in history has managed to repay a debt the size of that now confronting the United States - that was Britain after the Napoleonic wars. And, as Ferguson makes clear, that was possible only in special circumstances that no longer apply (reported in News Weekly
, June 26, 2010).
The third possibility is that the indebted nations should default on at least part of the debt. Even if this could be envisaged, it is certainly possible that such an outcome would threaten the stability of the world financial system.
When we are confronted with these disturbing alternatives, it becomes blindingly clear that we are indeed only at the end of the beginning of a crisis dissimilar from any the world has previously faced.
Further, resort to any of the available orthodox solutions - aside from the option of partial mass default - may not help us much.
For the moment, governments cannot even admit to considering such an alternative, but, ultimately, if Niall Ferguson is right, we might, ironically, be forced to recall British Prime Minister Thatcher's trademark phrase in a totally different context: "There is no alternative" (TINA).
It may turn out that there is no alternative, except picking up on the debt default option to some extent.Colin Teese is a former deputy secretary of the Department of Trade.