ECONOMIC AFFAIRS: by Colin TeeseNews Weekly
Milestones to economic Armageddon
, October 29, 2011
The European Union is looking like an idea with a better past than a future.
We can all identify the disastrous mistake made by the EU bureaucracy in Brussels in devising the 1992 Maastricht Treaty which prescribed balanced budgets for member-states of the EU and thereafter tenaciously held to the mistaken belief (or hope?) that this could be enforced.
Maastricht was the foundation on which the currency union was built. Sadly, many of those member-states joining the currency union neither intended nor believed Maastricht to be binding.
But Maastricht and its contradictions are only part of the problem — perhaps, little more than a sideshow. The real problems are much more deep-seated and discomforting, and consequently more difficult to confront.
They are indeed, part of the wider problems of economic globalisation, as it is currently understood. The EU, along with most of the West, by embracing the ideology of deregulated free markets has been trying to give effect to policies which the unfettered global economy is incapable of managing.
Nobody denies that the trigger for financial meltdown which began in the US arose from irresponsible lending and borrowing practices facilitated and promoted by that country’s most prestigious banks. The fallout from this plunged the US into a serious and enduring economic slump.
Satyajit Das, an Indian-born Australian expert on hedge-fund banking and author of a new book Extreme Money: The Masters of the Universe and the Cult of Risk (available from News Weekly Books), makes this clear in an article he wrote in the business section of the Melbourne Age, entitled “The invoice is in: payment is overdue” (The Age, October 3, 2011).
Real unemployment in the US is around 15-20 per cent, within striking distance of the historic levels achieved during the 1930s Great Depression.
Those still employed are working fewer hours, and personal incomes on average are down 4 per cent. Housing statistics are down; house prices have fallen 35 per cent since the onset of the 2007 global financial crisis and are still falling.
The so-called PIIGS countries of Europe (Portugal, Italy, Ireland, Greece and Spain) face troubles which originated with similar misguided financial policies.
Global trade and currency wars could manifest themselves if, as seems likely, economies outside Europe follow the Japanese and Chinese example and hold down the external value of their currencies to make their exports more competitive.
Only a burst of big spending after the 2008 collapse by the so-called BRIC countries (Brazil, Russia, India and China) saved the world economy from total collapse — temporarily. But that can’t be done a second time.
Slower growth appears to be a fact of current world economic life. Consumption accounts for 60-70 per cent of the West’s GDP. That being so, the combined effect of unemployment, under-employment, government and private debt overhang is a formula for continued depressed growth.
But behind the financial meltdown and its aftermath in 2007-08 lies the deeper problem of the financial and trade structures associated with globalisation.
Not that anyone is yet facing up to these problems. Certainly not in Europe, though it is beginning to dawn on the Americans; and, if they can gather up courage, they are well placed to do something about it.
What’s urgently needed is to restore the manufacturing base and stem the flow of imports. Nobody is talking here about trade wars, more like correcting trade imbalances. But the effect has been the same. China is already complaining, and so will Germany and Japan, just to name a couple, if the idea takes hold.
Meanwhile, as if none of these possibilities existed, the governor of the Reserve Bank of Australia, Glenn Stevens, is preaching optimism — on the basis of forward expectations of our sales of minerals to China. How realistic is this? How likely is it that forward sales projections of iron ore and coal will be realised?
Chinese growth, based as it is, importantly, on European and US demand for its exports, is unlikely to continue growing at the pace the Reserve Bank envisages, even more so if the US follows through on its intended actions relating to international trade.
If China’s rapid growth peters out, China will no longer need or want the same volumes of our minerals. In these circumstances, there will be downward pressure on prices. Our major competitor, Brazil, is already holding down the value of its currency to retain an overall competitive advantage. We are not.
How much of a profit margin our producers need in order to meet intensified overseas price competition is unclear. However, we can be certain they will face this sort of pressure.
The first place to look for savings will be in wage levels and employment here in Australia. But there is only limited scope for savings here. Wages are not a big factor in minerals-extraction costs.
The question is: can our mining firms follow Brazil down on price — and, if they can, won’t this lead to an ongoing price war from which the only beneficiary will be China?
The present government has resisted any temptation to manipulate our exchange rate to improve the competitive position of manufacturers and farmers — such a move would be out of step with reigning ideology. From what we can gather, the Coalition is also similarly handcuffed.
How firmly will Australian politics hold its ideological nerve and adhere to free-market purism if currency devaluations by our competitors threaten our minerals export markets? A good question.
If, as Satyajit Das fears, the global economy drifts into trade and currency wars, what will be the position of our government — regardless of which party is in power? Will the decision be to hold out alone for free market economics, or will we follow the rest of the world by intervening to defend the interests of Australian businesses and people?
Much will depend on how strongly public opinion favours stronger border protection — for both goods and currency. At that moment, whichever party holds office will have to decide whether or not national interest trumps ideological purity.
The other uncomfortable possibility for Australia’s minerals export income prospects is that China seeks cheaper alternative sources — say, in Africa — where it might have greater direct influence on both prices and volumes.
These are the specific problems for Australia with its overwhelming dependence on minerals exports. Other Western economies, notably in the United States and Europe, are similarly troubled by problems which have their roots in ideology. All are struggling to reconcile the emerging problems arising from free-market fundamentalism and globalisation with their respective national interests.
Like it or not, the time has come to re-examine free-market fundamentalism, financial deregulation and free trade, which were initiated by the United States and bundled into a package called economic globalisation.
Following the collapse in 1973 of the postwar Bretton Woods system for promoting global economic stability, important economic and financial policy-makers and commentators in the US came to believe that it was time to ditch moderate interventionist capitalism.
They judged that an alternative approach — fundamentalist free-market economics, financial deregulation and free trade (later dubbed the Washington Consensus) — would better serve overall US interests.
The same individuals argued that shifting large elements of US manufacturing offshore would be more than matched by US gains in services trade and financial transactions, and would thereby would make all Americans better off. It was an idea that also took hold in varying degrees across the West.
Some theorists also put the view that the globalisation of economics would produce widespread gains to the world economy, enhancing both rich and poor countries alike. In particular, it would limit what they saw as the negative influence of national governments over economic life. Perhaps, as some suggested, it would signal the demise of the nation state.
Based on the raw growth figures, it seemed to be working. And certainly, it corresponded with the economic transformation of China. Much of this demonstrated growth was attributed, misguidedly, to the expansion of world trade arising from the trade liberalisation.
Growth based on cheap Chinese imports was fed by an upsurge in consumer spending. The fact — especially in the English speaking West — that all this was happening while real wages were actually falling, was overlooked. Generated by consumer and business borrowing, the growth spurt was unsustainable. Eventually, borrowings have to be paid back.
Neither were the increasing trade volumes sustainable. Inbuilt trade distortions were dividing the world into spending and saving economies. The spenders were importing cheap goods from the savers and going into debt in order to continue doing so. China and the other emerging exporters accumulated massive financial reserves and actually funded the debts of their Western customers.
All of this was built around the idea of floating exchange rates adjusting imports and exports to each other — a lynchpin in the globalisation exercise. A great idea in theory, except that not all countries were playing by the rules. The new exporters held down their exchange rates to keep their exports cheap while the importers let theirs “float” upwards, thereby making their exports less competitive.
Trade and money imbalances between savers and spenders destabilised the world economy. Put simply, much of the money used in international transactions, instead of being used to maintain trade flows, was being saved. China alone accumulated a large percentage of the world’s savings.
However, once the spenders have to start paying back their borrowings, the system can’t keep going on as before. A floating currency regime can’t work without the lubrication of an international currency or an enforceable commitment not to manipulate national currencies. The world has neither.
The alternative is for a single national economy to emerge strong enough to underwrite trade flows and bind the rest of the world to a system which makes currency manipulation impossible. Globalisation cannot deliver that.
The only time we had such a system was after the 1944 Bretton Woods agreement when the US successfully underwrote the international financial system with its own currency. Nations had confidence to hold reserves in US dollars because the US undertook to back its currency with gold.
The present mess cannot be fixed unless and until we get back to something like that again.
Colin Teese is a former deputy secretary of the Department of Trade.