The world economy is at the end of the beginning of the crisis, reads a sombre diagnosis in ‘Globalisation Fractures: How major nations’ interests are now in conflict’ by Charles Dumas (www.vivagroupindia.com).
The 25-year boom of 1948-73 burnt out in inflation, which had been making the boom increasingly unhealthy, starting from the late 1960s’ ‘guns and butter’ financing of the Vietnam war, he traces. “It took two oil-inflationary crises and nine years before the foundations of sound recovery had been laid. After the 25-year boom of 1982-2007, this time burning out in excessive debt, we are only three years – and the first crisis – into a comparably tough patch.”
Savings glut
Observing that the deflationary implications of the savings glut have not yet become fully obvious even to most economists, let alone key government authorities, the author frets that the behaviour patterns of major players – dependence on exports in China, Japan and Germany, and on government debt-led growth in the US and the UK – have hardly yet been modified.
He foresees, however, that the coming adjustment period will be worse for the savings-glut countries than the non-EMU (European Monetary Union) deficit countries, because the debt problems of the deficit countries are well understood. “This permits, and in time will ensure, action to reduce the dependence of growth on fresh borrowing. But the crucial role of excessive saving in provoking the extremity of the debt orgy is not much understood, and little acknowledged.”
Generating domestic consumption
The prediction, therefore, of Dumas is that we are a long way from action in savings-glut countries to generate domestic consumption (not wasteful investment) and reduce dependence on exports – which are bound to be curtailed now that the deficit countries have to reduce borrowing.
When it comes to stimulation of consumption, Japan perhaps would but can’t and Germany certainly could but won’t, he writes. (His take on India is that ‘spectacularly wasteful government deficits,’ with little resultant overseas deficit, have used up the savings rate.)
“China is groping for a solution, but it has created an economy where consumption is dependent and secondary, the primary sources of demand being exports and investment. Both are taken to the point of wasting resources, generating assets and reserves with negative returns.” Yet, in the author’s view, the key to making consumption an independent driver of the Chinese economy may be relaxation of government control over its citizens, something ‘conceptually impossible for China’s current rulers.’
US recovery
Compared to these obstacles, what Dumas sees as a relatively straightforward, though painful, option is to curb the consumption of the Anglo-Saxon world and, via a lower real exchange rate, its net imports.
The author’s forecast is that the US recovery could disappoint those expecting a simple, traditional, V-shaped rebound. He reasons that starting with government, US policy seems set to cut into growth, not enhance it. “The state and localities mostly have balanced-budget laws, and the recession damaged their balances seriously, mostly by collapsing tax revenues. State and local spending moved down in real terms in the second half of 2009, and overall government spending, strong in the middle quarters when the fiscal package was being implemented, fell at the end of the year.”
The result of downward pressure on wages and higher savings rate of the still-working baby-boomers can be a politically threatening rise in unemployment levels to nearly 10 per cent, cautions Dumas. On the other hand, he anticipates the shifting of balance of payments from deficit to equilibrium or even surplus, a satisfactory reduction in private-sector debt, and some lessening of dependence on the rest of the world for its economic well-being.
Yuan appreciation
China will unquestionably have to allow the yuan to rise, avers Dumas. Otherwise it will suffer major domestic trouble, he warns. “Without significant yuan appreciation soon, the rapidly accelerating wage-price inflationary spiral will enforce strong domestic monetary restraint, undermining domestic demand and asset prices. This dilemma is already acute and bound to sharpen further.”
China could also lose some US access for its chief mode of economic development, viz. exports, the author alerts. He makes a reference to the proposal gathering bipartisan support in the US, the idea of a surcharge on imports from China.
“China will no doubt react to this danger and reach a modus vivendi with the US. But yuan appreciation looks set to be little and late…”
Japan slide
A chapter on Japan rules out the possibility of economic revival through consumer spending in the next few years. The 1 per cent growth rate of the 1990s – regarded as such a feeble performance at the time – gave way to even worse in the cycle from end-2001 to end-2009, and the horizon shows no sign of improvement, the author states. “On the contrary, the recession could easily revive as a ‘double-dip’ in the next year or two and the downward spiral of the economy reassert itself, alongside the downward spiral of deflation.”
Among the many interesting numerical examples in the book is this one about how with a 1 per cent interest rate on government debt, but a 2 per cent real boost to that return via consumer price deflation, the real interest rate is 3 per cent; the catch, however, is that a pensioner would have to liquidate 2 per cent of his or her investment each year to get this full 3 per cent value in consumption. “This deters people from spending, as asset liquidation is generally supposed to go against the grain of a high-saving, cautious people.”
Europe’s losses
With Chinese exports strong and America importing less, the real losers are likely to be European businesses, in their share of both world exports and domestic markets, where Chinese inroads continue, says the author. He fears the possibility of a continued recession in Europe bordering on depression.
A grim scenario painted in the book is the probable splitting up of the euro zone, and the inconceivableness of the EMU (European Monetary Union) persisting in its present form. One logical outcome might be for Germany, France, Benelux and Austria to slough off Club Med, but such a clean break is unlikely, postulates Dumas.
The split, when it comes – probably not until one or two more crises have been endured – could easily involve Germany splitting from the euro zone, no doubt with the Netherlands and Austria, and perhaps Belgium, reads his analysis. “The euro zone would then dissolve, as there is no reason for France and the Club Med countries to stay together.”
Educative read.
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