Every recession is different

29 04 2009

This is the message of Sean Collins’ excellent new essay, The ‘credit crunch’: another Great Depression?  where he looks at the difference between the slump in the 1930s and the recession today. As he quite rightly points out, every recession is different and therefore demands a different approach in terms of a resolution. Collins lists the following aspects of this recession which mark it out from the 30s: 

1) As the post-war boom ended, the major economies encountered significant problems of stagnant profitability in productive industries. These problems were not fundamentally addressed by the recessions of the 1970s, 1980s or the early 1990s, and remain to this day. Extreme examples of the holdover of unprofitable businesses are the American car manufacturers GM and Chrysler.

2) As the economy grows, so too will the credit and the financial sphere. However, a trend in the major economies is for this sphere to grow at a faster pace than the real economy. Especially noticeable since the 1987 stock market crash was the trend for stagnancy in production leading to surplus capital, which found outlets in an even more extensive expansion of credit and a greater development of (and reliance on) finance as an income-generating area. This development explains the stock market and housing bubbles, as well as the proliferation of financial instruments.

3) A turning point was the end of the Cold War in the late 1980s, which, among other things, lessened international tensions and weakened labour movements. In the global arena, we see greater export of capital and goods from the developed countries, and the expansion of production in emerging markets. A significant development is the opening up of new points of production in China and other parts of Asia.

4) The easing of tensions following the end of the Cold War also gave the market system much more room to manoeuvre, without the need for destructive, cleansing recessions. This allowed capitalism to survive without traditional boom-bust cycles, otherwise known as the ‘Great Moderation’ and ‘SAD’ (stable, anaemic, durable) period. Many have welcomed that recessions became milder and less frequent, but the downside was that growth was muted. Another self-imposed constraint in this period are ‘green’ measures that restrict expansion. 

5) The wide expansion of credit, including debt-fuelled consumption, was not sustainable. No one could anticipate when the limit of the credit system would be reached. But now we know: it was precipitated by the US sub-prime crisis, with domino effects across finance and into other sectors.

6) The problems in the productive sphere in the major economies continue today (and arguably more in the US and UK than in Germany and Japan). The ‘deleveraging’ effect from the credit crisis has not fully played out, and is likely to be destructive. In particular, the fallout from this severe asset-based recession will now curb both key drivers of previous 10 to 15 years of economic activity: bank lending/financial activity and consumer spending, leaving a question mark over future sources of growth.

Read this alongside Gavin Poynter’s analysis of the UK economy and you get a very compelling case for the specificities of the problems we face.

At The Battle for the Economy conference in London on May 16 (2009) we will be attempting to tackle some of the issues raised by Sean and Gavin. Lazy comparisons with the past are out, as are false hopes that the underlying problems will just go away.  Our politicians are ducking many of the central issues and at best they are offering us a future of austerity – it will be a great discussion so buy your tickets now.





After the recession, a New World Order?

27 04 2009
<I>Fixing Global Finance: How to Curb Financial Crises in the 21st Century </> by Martin Wolf

Fixing Global Finance: How to Curb Financial Crises in the 21st Century, by Martin Wolf

BOOK REVIEW
Fixing Global Finance: How to Curb Financial Crises in the 21st Century, by Martin Wolf (published by Yale University Press)

Following the ‘credit crunch’ and now the full-blown recession, the big story of the twenty-first century is likely to be the shift in the balance of power between the indebted West and the credited East.  There are some writers on the economy who seem to understand better than others that politics should be seen as concentrated economics. Martin Wolf, associate editor of the Financial Times, is one such writer.

His FT column is a must-read for anyone who wants to understand what is happening in the current economic crisis. His latest book is about the problems of the world financial system and the events that led up to the current debacle. In it, Wolf explains both the underlying causes of the recession while also exposing the complex and potentially dangerous political consequences that have arisen as a result.

The central point in the book is that China is now playing a role in the world economy that no country has ever done before. China is ‘both the largest exporter of capital (as the United Kingdom was in the late nineteenth century) and the fastest growing emerging giant (the role played by the United States at that time)’.

China, along with other dynamic exporting nations, such as Japan, built up massive external surpluses of money in the period after 1997. The surpluses were based on the export of manufactured goods to mainly Western countries. By 2006, says Wolf, ‘The total Asian surplus was $511billion ($239billion for China, $170billion for Japan, and $102billion for the rest of Asia). The surplus of the oil exporters was another $396billion… But the US deficit was $857billion.’

So the US deficit was the equivalent of the total surplus of Asia and the oil-exporting countries. As a result, ‘The United States has in turn, been absorbing about 70 per cent of the surplus savings in the rest of the world, with the difference accounted for, not by increased investments, but by higher consumption and a lower rate of savings.’

Wolf is highly critical of the US for consuming rather than investing the massive amounts of imported capital, which ended up inflating the housing bubble and presaged the credit crunch. He sees the problem as one of underconsumption within China and other developing countries. He attributes the running up of huge external surpluses by China and others as a policy response to the Asian crisis of 1997/1998 when currencies collapsed and there were devastating consequences for the economies of some East Asian countries. He argues that ‘The lesson learned by many emerging economies – both those directly affected by the crises and those who have been onlookers – is not to tolerate current account deficits’.

So he sees the growth of external surpluses as a policy decision by developing countries. Others have argued that it is not as straightforward as that (1). China in particular would struggle to reinvest its huge surpluses internally because of the general underdevelopment of huge parts of the country (although its huge internal fiscal stimulus this year is trying to address that problem).

Wolf discusses why China and others have put huge sums of money into the US when the rate of return is so low. Given the problems China has in developing its own economy, the question really should be: what was the alternative, other than keeping the money under the bed? The nightmare scenario now for the Chinese is that the US inflates its way out of its debt, thus reducing the value of Chinese capital in the US.

So while we can understand from the Chinese point of view how we have got to where we are, from the US point of view the problem is completely different. The US and other Western countries, like the UK, have run up massive debts because, as Wolf points out ‘The high income countries have become importers of savings since their savings rates have fallen below their investment rates’.

Quite simply, we in the US and the UK have taken the savings from developing countries and consumed them, leaving ourselves in massive debt. The key question that comes out of this is how this imbalance in the world economy can be righted. As Wolf says: ‘A large-scale flow of capital from poor countries to the world’s richest nations is perverse.’

One consequence of the recession is that the international flow of capital has collapsed. It seems unlikely that, once the recession is over, the flows of capital from East to West will return in the same way. A rebalancing of some sort will have to take place. The West is unlikely to be able to resume its consumption of the savings glut from the rest of the world, certainly to the extent that it has in recent years. Western countries will have to find other ways to finance growth and consumption while we can assume that developing countries will shift their surpluses more towards the development of internal markets.

The rebalancing of the world’s economies will also, of necessity, affect the way the world is managed politically. Currently all of the world’s financial and political global institutions reflect the relative economic weight of countries 40 or 50 years ago. This will have to change. This is where it becomes politically challenging. As Roger Alton has pointed out:

‘The financial and economic crash of 2008, the worst in over 75 years, is a major geopolitical setback for the United States and Europe. Over the medium term, Washington and European governments will have neither the resources nor the economic credibility to play the role in global affairs that they otherwise would have played. These weaknesses will eventually be repaired, but in the interim, they will accelerate trends that are shifting the world’s centre of gravity away from the United States.’ (2)

As a result, some countries will lose power and influence and others will gain. Whether and how this can be managed is going to be the story of the first part of the twenty-first. Managing this shift in the middle of a recession is a huge political task, to which Wolf offers no solution except to argue for a restructuring of the International Monetary Fund. Nevertheless, he has written a fine account of the economic issues underlying the political problems facing the world today.

This book review was published by www.spiked-online.com on 23 April 2009

(1) See Darling, it’s all about the global imbalances, by Stuart Simpson.

(2) The Great Crash, 2008: A Geopolitical Setback for the West, Foreign Affairs, January/February 2009





The Battle for the Economy is on

24 04 2009

Battle for the Economy, Institute of Ideas

EVENT
Battle for the Economy
16 May 2009 (9.30 am-6.00 pm)
Googdenough College, London

On Wednesday we had a nothing budget from a politically exhausted and demoralised government.  There was a populist and financially meaningless tax rise for the rich but almost no recognition in any of the measures, or in the debate around the budget, of what we could be doing to tackle the deep seated problems of the UK economy.

This would not be so bad if there was an opposition with better ideas waiting in the wings. However the Tories have promised only one thing, to take a harder line on public spending than Labour has projected to do. In fact even this is not a real difference, for if Labour did win the next election against the odds it too would cut spending. The only reason Labour is not saying that now is to avoid alienating even further an already deeply discontented electorate.

Recently there have been efforts to suggest that the recession is coming to an end. It is certainly possible that the rate of decline is slowing . That does not mean that the recession is over, nor that there is any certainty of an early upturn. What is certain however is that the most important problems are still not being addressed. In the UK that includes the whole issue of excessive public spending.

In the coming year there will be a great deal of discussion about cutting  public sector spending. The public sector will account for around 48% of the UK economy by next year and there are no doubt parts of it which we could do without. The question of the role of the state in our society could do with a thorough examination, but it should not begin with what are the easiest parts to cut, but what kind of state we need and what role it should play.

It is issues like these which need to be subjected to the maximum public debate.  From the various discussions I have taken part in recently it is clear that many people have very strong views and opinions, some of them quite sensible, about what should be done. The dead nature of our political process means that there is very little opportunity for serious public discussion which can involve us all.

On May 16th (2009) The Battle for the Economy  conference, organised by the Institute of Ideas will begin to do just that. As you will see from both the speakers and the sessions, the Conference will directly address difficult issues led by speakers who are well informed about the background to the problems we face. I would urge you to buy your ticket now.





Sharing out the misery

22 04 2009

A recent study by Keep Britain Working has found that many workers have responded to the threat of job cuts by proposing that their own pay and benefits should be cut in order to save the jobs of others.  While I have no idea how sound the methodology of this survey is it does chime with anecdotal evidence.  How can we understand this apparently altruistic response, for which one struggles to think of a historical precedent?

There is a positive element of solidarity in not wanting to see your colleagues lose their jobs.  Perhaps there is even the fear that if you accept the redundancies of others then you may well be next.  However, whilst in previous recessions there has been a similar and quite strong tendency to fight for the defence of jobs, in the past people simultaneously fought to defend wages.  One need only go back to the UK Miners’ Strike in the early 80s to see that.  During this period, workers tended to focus on forcing employers to not make redundancies, cut pay or close businesses.  It would seem then that the virtual elimination of organised labour as an effective force in society today plays a significant role in fuelling a widespread mood of acceptance that cuts have to be made somewhere for us all to survive.

The prevailing popular reaction to the recession in the UK has been passive acceptance with underlying anger, where the anger has been directed mainly at bankers or foreign workers.  Very little active hostility or organised resistance has been directed at the government or at employers.  This recession is increasingly being seen as the product of greed in the City and perhaps also greed in general.  In light of that, we can see how the willingness to take cuts in living standards is the flip side of this diagnosis, in the sense that people now feel that a period of austerity is a necessary antidote to the age of greed.

The unwillingness of people to fight for what is in their best interests, which for many of us means the maintenance or improvement of living standards, shows how low our self-expectations have become.  Current discussion about the public sector and possible cuts in public spending will now take place within this milieu of virtuous and necessary austerity and prudence, in no small part influenced by our modern-day preoccupations with what is good for the environment. 

Perhaps it is time to focus our efforts elsewhere and create a different agenda which puts development and growth at the centre of our discussions on the recession, the economy and the future.  Let us put our time to better use and quit trying to work out how best to share out the misery.





What’s wrong with a Green New Deal (Part 2)

20 04 2009

As you can see from the responses to my previous entry on this subject, the Green New Deal (GND) is a very controversial subject.  The amorphous character of the debate around it makes it very hard to pin down, yet governments and political parties are determined to sell it to us as a key component of the anti-recession packages.

As Ben Pile points out in his excellent article in the Register, there are countless reasons to question the investments being made in the creation of green jobs.  To take one example, the creation of 25,000 jobs in the Waste Management and Recovery & Recycling sectors will come at a cost of £1.2m per job since as is very often the case with the green sector it absorbs rather than creates wealth.  For this reason, I think it is highly doubtful that such investments will create meaningful jobs or use resources rationally.  So then is this really the best way of spending money if the main aim is to boost the economy?  I think not.

This is why a focus on economic growth as an objective of economic activity is far better than a focus on environmental outturns.  Again, as Ben Pile points out, even the limited success of recycling activity in the UK is due to demand from the dynamic Chinese economy for raw materials.

When demand is high and economies are growing, common sense tells us that the use of resources, whether raw materials or labour, will be more efficient and therefore more productive.  The market may not be the most imaginably efficient way of doing things necessarily, but it is more efficient than an economic agenda which is led by ideology; what the GND is becoming.





What’s wrong with a Green New Deal? (Part 1)

17 04 2009

The Conservatives have unveiled their plans for a Green New Deal for the UK (although they do not call it that).  It is fast becoming an item of common sense, from Obama downwards, that the twin problems of recession and global warming can be tackled by investing in green technology, thereby killing two birds with one stone.

This may on the surface seem an eminently sensible suggestion. There is a problem in that the climate change agenda is so politicised it is almost impossible to work out from the outside what the real facts are. But let us assume for the moment that climate change needs to be addressed.

The first problem with the Green New Deal (GND) is that it is a very amorphous concept. However, as the Tory proposals demonstrate, the GND almost always begin with a requirement to cut energy consumption. If one intention of the GND is to stimulate the economy out of recession, then cutting energy consumption is an odd way of doing this. As the authors of Energise have pointed out, a more rational approach to the issue of carbon emissions is to accelerate the development of better and cleaner energy sources rather than cutting consumption which can only have the effect of lowering living standards.

Indeed, China, the fastest growing economy in the world, has 16% of its electricity produced by renewables, compared with 4.5% in the UK. This is because China’s rapid growth has stimulated research, development into and implemetation of new sources of energy. In the West by contrast the whole issue of renewable enegy has become linked to an anti-growth agenda. The subtext of the current discussion on the GND in the West is that it is part of the new austerity.

Whether you accept all or some of the climate change agenda, the solution lies in innovation and growth, not consumption cutting and austerity.





Green shoots or reinflating the bubble?

15 04 2009

Green shoots

Obama is now seeing green shoots and the process of talking up the US economy has begun. This is a fairly transparent attempt to change the psychology of the recession from negative to positive, as in the worst is over. It is not possible to predict when the downturn will flatten out or when the economy will begin to grow again. What is possible is to predict  that if the main problems which underlie the recession are not addressed than any recovery will only presage the next crisis. The prospects for addressing these underlying problems do not look good.

While on holiday I met and had a long conversation with a Hedge Fund Manager. He  was quite the most pessimistic person about the economy that I have met, so far. He considers the entire UK economy to be a ‘dead man walking’. As a consequence he is busy converting his personal wealth into gold.

He introduced me to the phrase ‘mark to miff”.  Two weeks ago in the US the Financial Accounting Standards Board (FASB) bowed to pressure from the financial sector to abandon the ‘mark to market’ way of valuing financial assets. ‘Mark to market’ forces banks to revalue their assets every three months, which during the credit crunch has forced a continued downgrading of the value of banks.

My Hedge Fund Manager friend called this ‘mark to miff’. In other words a final abandoning of any pretence that the asset values of banks bear any relationship to the real world. The conclusion we should draw is that our leaders can see no further than trying to reinflate the asset price bubble which burst to create the current crisis.