In the spring of 2015 I was flying back from a business trip to Korea and penned some thoughts in order to shake up the group think of my team at the British Chambers of Commerce. It is on this that this piece is based. Right now little has changed and it looks like there remains a risk of a global slowdown, if not recession.
Global debt remains a considerable multiple of global GDP. That is not sustainable without growth and productivity gains.
In cartoon style simplicity, we are in this position at root cause because of chronic loose money stemming from a lack of bank lending controls, including shadow banks (credit cards, credit companies, financial instruments, local authorities in China, etc.) and no break on trade deficits. This latter has its origins in the USA setting up the dollar as the global reserve currency without reference to “species” or a global currency (notwithstanding the best efforts of Keynes) and the abandonment of Bretton Woods by Nixon.
All this exacerbated recently (since the 1990’s) by Bank profligacy, supercharged by Clinton’s elimination of the separation of retail and investment banking (Glass Steagall) and more recently, the propping up expedients of QE and low interest rates.
Of course, the backdrop has been a state-controlled/corporate state economy in China, which we have tolerated and with which we have been complicit , with China acting like an “escalator”, selling goods at artificially low prices into the West during the 1990’s and 2000’s, grossly facilitated by companies like WalMart, who alone accounted for one third of US productivity growth in the late 1990’s, on the back of the efficiencies of importing everything and anything from China. (“Wal Mart, my source of cheap plastic s**t” tee shirts are on sale in Denver, Colorado).
This “escalator” was characterised by China selling cheap goods and making money, then lending this money back to the West, facilitated by Western banks through the international money markets, in order to buy more cheap goods. However, some of that cheap credit was siphoned off into the property markets and this, along with fancy, cheap, leveraged lending (Lehman style) helped fuel the catastrophic financial crash of 2007/2008. All underpinned of course by an artificially low renminbi currency valuation.
China has been “got” in the end as, inevitably and contrary to long held belief of the CBI and its representatives on the MPC, it could not go on for ever. Eventually the West has ran out of “dosh” and China can’t sell anything like as much as it did. It has to start buying its own stuff, or at least buying, but that requires a major re-positioning of its economic model and its birth rate and, in the interim, a form of crash. The only question is how big a crash. Incidentally, everything to do with China also applies to the mercantilist Germany within the EU context, but on a smaller scale. You can’t buck the fundamentals, but we have not yet seen the final outcome of the German-led and -fed Eurozone project.
We should fear that the gravitational effect of global debt may be too strong for the global economy now to achieve escape velocity and continue to float. The tide is going out, especially given that Central Banks have nowhere to go. Interest rates can’t go much lower and QE is and will just fuel the fundamental problem of cheap debt, especially as it doesn’t reach and stimulate the real economy in any meaningful way. Rather, it fuels asset bubbles and justifies moral hazard within the international banking and finance community, while encouraging ever more disparity between the haves and have-nots, with all the resentment that generates.
One set of things that could work in a crisis, but probably wouldn’t be applied until the crisis comes (which means probably too late) is as follows:
– Firstly, Keynesian public spending (it would be better if the world did it rather than one economy and it only works for a while) which means capital spending, a bigger state to soak up the unemployed, or war, the latter being the only public spending which is acceptable to sections of “capital”. Right now everybody is going the other way.
– The second remedy, which is unfortunate but could flow from public spending as currency values fall and money chases goods, is inflation, which would erode the debt.
– The third is managed default (private and public) , which would eliminate it. The US private sector did this to some extent after the financial crisis struck. It also may be that Haldane will be vindicated and we find Central Banks have, in addition, to cut rates to zero or below.
All this is ugly.
Long term, there needs to be control of credit, separation of investment and retail banking, criminal penalties for grossly or wilfully negligent bankers and a new mechanism for trade flow control – gold standard, global reserve currency, whatever you will, back to Bretton Woods, again back to Keynes.
Perhaps this is grossly pessimistic. It may be that China isn’t in a pickle and/or that the world’s Central Banks and authorities can paper over the cracks while China adjusts to internal growth and the US finds domestic growth and Germany continues successfully on its hegemony mission.
If it doesn’t work, the implications of a mega crash in a globalised, terrorist-ridden, nuclear-proliferated world, are incalculable. Certainly a backlash against the establishment, against the greed of global capital and its CEO henchmen, against bankers and financiers, against the capitalist system, we will undoubtedly reap the whirlwind. There will be international tensions, protectionism, inflation (everyone’s money/wealth value will at least halve to reflect the excess of credit over GDP), shares will crash, property prices will crash, leveraged companies will go bust, pension funds will collapse, taxes will rise and gold will spike. In an Armageddon scenario, even gold will be worthless and we had better start hoarding canned food.
Given what is at stake, we should expect that Central Banks, international institutions and governments will be alive to the risks, even if they are trying to put a brave poker face on right now. But what can they do if they are wedded to shrinking the state and fiscal prudence?
The very best answer is out of the hands of them all. It is technological innovation an increase in global productivity, leading to a ‘Great Leap Forward’, or a series of smaller jumps, stimulating global growth.
It is also the growth of India and Mexico and Indonesia and other emerging economies, sufficient to take up the slack from China.
What can they do to help fill the gap and stimulate these possibilities?
– Reduce interest rates further, but the downside is that this will fuel more cheap borrowing, assuming it flows through to borrowing costs. The upside is that it will keep the plates spinning, for now.
– Produce more QE, but this is promoting the problem of debt and building an even greater problem for the future. Hope is not a strategy. In any event there is no evidence that QE flowed to the real economy.
– Stimulate public spending of the best kind. Capital spending, funded by private money as well as taxes, but this will increase government debt, at least in the short term.
– Encourage both economic liberalisation and political change in India and the emerging markets, through investments linked to liberalisation. Trade support rather than aid support, might be a good start.
– Promote productivity growth in the private and public sector, through making available and incentivising business investment and by the outsourcing of government services. But this requires access to finance, appropriate skills (long term education reform and short term access to skilled labour) and a break on the dead hand of indiscriminate, cheap labour arising from migration.
– Most of all they need to make sure that the innovators in national economies, who are the entrepreneurs and small businesses, have across the board access to working capital and to long term patient risk capital, both equity and, most crucially, loan capital, as appropriate to the individual business and that they don’t try to pick winners but instead the winners pick themselves. On a parochial, UK level, this must include an adjustment to inward investment to stop these innovators and technologies being lost to the economy and to encourage “re-shoring” (and where “off-shoring” takes place, outward investment in ownership and control), in order to gain the economic innovation and productivity that will be the only true saviour of growth and deliverer of debt reduction worldwide.
Whatever happens at a global level, here in the UK there are three possible and not mutually exclusive resolutions to enable Britain to prosper in a globalised world:
1) Adopt measures to stimulate productivity growth and above all create the essential economic environment to promote entrepreneurialism and innovation. Support R&D and ensure the IP benefits the UK economy. Incentivise investment through tax incentives. The repatriation of the net contribution provides the capital for this and the many real economic benefits of Brexit are unilaterally available to the government including free trade and tariff reduction. Brexit provides an opportunity for Britain to become the best place in the world to do business and the government should make it its business to make sure this happens and signal the direction of travel early (Q1 2018).
2) Promote global trade and economic liberalisation in India and the emerging markets. In the meantime, keep the plates spinning, as it will take three to five years if it is to work. Post-Brexit Britain has a huge opportunity to manage its relationship with the rest of the world and promote an open, trading relationship, while avoiding selling off the family silver through inappropriate FDI. We can also manage our currency value as do so many others. Perhaps our unsustainable, negative current account balance can be reversed.
3) Adopt fiscally-led, economic stimulus measures through infrastructure and development spending; rail, road, airport, housing, fibre. In other words, provide the infrastructure for business to do business, in particular, world class digital and wireless. Post-Brexit and free of the state aid straitjacket, we now have the flexibility to deliver, rather than merely talk about this.
In the final analysis, if the global institutions fail, there is a risk the world will hit the reset button. Fortunately Britain is an island and has a history, values and behaviours which suggest resilience. As long as we maintain control of our own affairs, retain our values and behaviours, our sense of social equity and fair play, and our nuclear weapons (which is the saving grace for small nations), we will be in a good place to survive and prosper in all circumstances.
Most ills have a cure. We must make sure the cure is not worse than the disease and if there is no cure for the global disease, we must maintain control of our own affairs while reaching out to the globe, the two are not mutually exclusive.
In the meantime I am partying on the basis that if you spend it you can’t lose it and shrouds have no pockets!
July 15th, 2017: Brexit Central