Hazardous path out of crisis By Joergen Oerstroem Moeller
The global financial crisis lands an acute challenge on the table for
policymakers in Asia, as it is the only place in the world having room to
maneuver for active economic policies and is in possession of the world's
savings.
For some time, the question was open as to whether deregulation and
privatization - the policies of president Ronald Reagan and prime minister
Margaret Thatcher - were permanently shifting the paradigm of the global
economy, or were just another cyclical wave of political preferences. Now we
know. It was a cycle.
For the past 30 years the world has lived under the spell that the market gets
its right. This was the basis for economic and financial policies first in the
US, then Europe and after that most
other countries. Bastion after bastion of well-established and renowned
enterprises, many of them public utilities, were transferred from public
ownership (service to the population) to private ownership (where the priority
is profit). The philosophy was that profit would ensure efficiency and that
would guarantee the high-quality service the public looked for. The global
financial crisis demonstrates that if left alone, the market tends to get it
wrong - not right. When the assumption has been proved wrong, the policies
cannot and will not be kept in place unchanged.
More international regulation and control will certainly be included on
government agendas. That does not necessarily mean that deregulation and
privatization will be rolled back completely, but it does mean that more
deregulation and privatization is unlikely to take place and that some of the
privatized enterprises probably will be brought back under public ownership.
It is noteworthy that US mortgage guarantors Fannie Mae and Freddy Mac have
been nationalized - deprivatized, so to speak - and insurance giant AIG is in
reality undergoing a similar process. Forced by circumstances, a US
administration judged to be the least likely to nationalize and deprivatize has
ordered two of the most spectacular and far-reaching nationalizations of
financial institutions the world has seen. This lesson will not easily be
forgotten.
Second, a new wave of concentration of financial institutions is under way. The
Bank of America has bought Merrill Lynch and there will be other mergers and
acquisitions. The days where genuine competition ruled between the mayor
financial institutions are gone and will not come back.
The world will be left with a few mastodons so powerful and in possession of
enormous financial might that they soon will throw their weight around with
regard to economics and politics. We witness the gradual phasing out of
specialized financial institutions, crowded out by the mega institutions
without healthy competition and where wrong decisions may cause havoc because
of their size. Until recently we could hope that if a financial institution got
it wrong, the other ones might have got it right - not so anymore. Out of this
may not come a more robust system, but a more fragile one.
Third, deregulation and privatization gave birth to investment funds. Many
having enjoyed themselves during a spending spree buying public utilities one
after another, they now may face a rough time.
Many operated on the assumption that the valuation of the assets (bridges, toll
roads, airports and so forth) would continue to rise, allowing them to expand
by increasing borrowing using new loans to repay former loans. Now these assets
are starting to fall in value, with the inevitable consequence that it won't be
long before we read about such investment funds in difficulties.
They excelled in complicated and opaque financial operations selling and buying
among each other, sometimes between different subsidiaries inside the same
mother company, and often publishing obscure annual reports. Their owners were
sometimes pension funds, which did not want to undertake such risks under their
own name.
Fourth, it has so far primarily been the American and British financial systems
that have been in the firing line, with some Japanese banks also exposed. We
cannot be sure that the rest of Asia and the eurozone continue to be relatively
unharmed. It seems, however, a reasonable fair assumption that, if they are
drawn in, the repercussions will be smaller than for the US and the UK.
One wonders what the consequence of that will be for the future global
financial system. It is difficult to see the US regain its former position
after having demonstrated such incompetence. For years, observers have amused
themselves by pointing out that the eurozone was no match for London as a
financial center. Perhaps perceptions will change. Perhaps investors will start
to feel more at ease investing via more cautious, more conservative, and less
sophisticated but also less risky financial institutions in the eurozone, and
perhaps financial centers in Asia will start to emerge for real.
Fifth, the world needs a financial system ready to take calculated risks;
otherwise many investments will not be undertaken. The virtue of a good
financial system is that it knows how to weigh pros and cons and gets it right
most of the time. For the next years, the global financial system will tend to
be cautious and the risk for the global economy is that it may be too cautious,
always thinking of 2008 and fearing to repeat mistakes.
Human nature indicates and history shows this kind of behavior. After a period
of assuming unsustainable risks the world may move into a period with a
financial system that is too risk-aversive. Many developing countries and newly
industrialized countries will feel the pinch, and this may lead to lower global
growth.
The global authorities face a challenge to tell the financial system that even
if it is understandable in view of the 2008 crisis that they prefer to avoid
risks, continued global growth requires some risks and accordingly it should
not be too cautious. The balance must be found. The world may end up with a
financial system being extremely solid because it does not dare to lend, which
is why it is there. A strange outcome to a crisis started by reckless lending.
The present crisis is due to one single factor and nothing else: high and
persistent imbalances in the US building up over decades and culminating in
explosive growth of these during the past eight years. The US government's
liabilities and long-term commitment stands at almost US$50 trillion - four
times total annual production. The total federal debt is more than $10
trillion. Next year, the budget deficit will probably surpass $500 billion. The
balance of payments has been in deficit for years.
Total demand can surpass production for some years - as it has - but not
indefinitely. The longer it lasts, the more painful the alignment will be. It
has become a global crisis because the US was and still is the largest and most
powerful economy, with one-quarter of global production. Consequently, a
solution must be a global one defining the burden-sharing between the US and
the rest of the world.
Restoring balance for the US economy requires lower demand or increased
production and/or a combination of both. Demand can be reined in by restrictive
economic policies, but that will deepen the recession. Stimulating policies can
be applied to combat recession through an upswing, but will aggravate the
imbalances. The policy implication is that US fiscal and monetary policies
cannot be applied effectively.
Years of irresponsible policies have removed any room of maneuver. It is good
to hear plans of expansionary economic policies, but where does the money come
from? More borrowing, and if so from whom? Private households already
dissaving, a business sector facing alarming falls in profit, a maimed
financial sector? The rest of the world is already up to the hilt with Treasury
bonds, it definitely does not want to accumulate more of these.
That leaves us with two not very attractive policies: depreciation of the US
dollar and/or protectionism.
They can do at least some of the job by reducing real incomes, thus cutting
total demand and enhancing competitiveness and thus stimulating production
through exports. It looks fine, but it isn't.
What the US gains the rest of the world loses. These policies redress US
imbalances by shifting them to other countries. Only if other countries are
willing to accept this will such policies work. And they can only be expected
to do so if the US is ready to enter into some kind of arrangement ensuring
that their burden is accompanied by a comparable effort by the US.
Irrespective of which policies are set in motion, the result is a transfer of
purchasing power from America to other countries and a lower real income for
the US - a lower share of global gross domestic product (GDP). The US can
scream or squirm or whatever it likes, this is going to happen.
Here follows a sketch about how to manage adjustment and minimize the negative
repercussions:
First, the US undertakes to reduce oil consumption, in particular in the
transport sector. For an incoming administration, the opportunity arises to
introduce a new energy policy. The political question is whether the American
people, having resisted such measures for years, are now finally ready.
Second, a commitment by everybody to refrain from protectionist steps, thus
guaranteeing continued free trade and international investment banning any
attempts to solve one's own problems by shifting them to other countries. There
is talk about relaunching the Doha-round, and that would be wonderful, but let
us have both feet on the ground and not jump for the moon however desirable it
looks.
Third, policymakers announce guidelines for a US dollar depreciation, signaling
that a falling US dollar is the preferred option and thus removing the risk
that such a policy triggers speculation. Major economic powers must align
domestic monetary policies in particular interest rate changes so as not to
open windows for speculators to exploit any differences.
Fourth, measures to stimulate domestic demand in countries having room to
maneuver to do to uphold global demand. The recently announced Chinese stimulus
package amounting to $586 billion and composed of three elements - loose
monetary policy, tax reductions and investments - is a step in the right
direction.
Fifth, a US commitment to follow economic policies in conformity with
guidelines normally laid down by the International Monetary Fund (IMF) for
countries needing assistance to sort out economic imbalances. The
interpretation is limits for deficits on the public budget and the balance of
payments.
Sixth, the top 10 or 20 global economic powers (not G-10, but the 10 countries
with the largest share of global GDP) agree to coordinate economic policies to
better synchronize the global business cycle.
Seventh, a keen awareness of the risk to the global economy of countries that
may not be able to weather the crisis sliding into political anarchy and
economic chaos, thus joining the list of failed states.
This is where the world really needs preemptive and preventive policies. The
normal blueprint imposing restrictive economic policies will not do in these
circumstances; something more imaginative is needed to keep the economy going.
The IMF should step in, but the IMF does not possess money itself. It borrows
from member countries to lend to other member countries. Only if creditors find
it attractive or necessary will they place the necessary funds at the disposal
of the IMF, and global leaders must create an atmosphere in which they are
ready to do so.
These seven steps look like a tall order, and other methods to rebalance the US
economy without too much harm for the rest of the world may be available - but
they are not easy to spot.
Joergen Oerstroem Moeller is Visiting Senior Research Fellow, Institute
of Southeast Asian Studies, Singapore and Adjunct Professor Singapore
Management University & Copenhagen Business School.
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