INSIGHTS: WE’RE FACING A VERY DIFFERENT ECONOMIC GLOBAL CRISIS
By Guest Columnist Desmond Lachman:
Resident Fellow at American Enterprise Institute. He is a former Managing Director and Chief Emerging Market Strategist at Saloman Smith Barney and Deputy Director in the International Monetary Fund’s Policy Development and Review Department. Reprinted with permission.
Leo Tolstoy famously wrote that “Happy families are all alike; every unhappy family is unhappy in its own way.” It would appear that the same might be said of different global economic crises. For instance, the 2008 global economic crisis differed fundamentally from that of 1998. Now it would seem that the global economic crisis that is presently brewing in 2016 has its own special characteristics. That will almost certainly make this crisis very different, though possibly no less severe, from both those in 1998 and 2008.
For all of today’s vulnerabilities in the world economy, unlike in 2008, they are not centered in the United States. In particular, the main threat to today’s global economy is not a major bubble in the U.S. housing market, nor is it one of very high leverage and the excessive use of derivatives in the U.S. financial sector. Indeed, if anything, the U.S. economy is one of the few sources of strength in today’s very troubled global economy.
Similarly for all of today’s weaknesses in the emerging market economies, unlike in the 1998 crisis, fixed exchange rates of the sort that prevailed throughout Asia and Latin America in 1998 are not one of them. For the most part, having learned from the 1998 crisis of the dangers of overly rigid exchange rate policies and of currency crisis contagion, practically all of the major emerging market economies have moved to very much more flexible exchange rate policies. They are also generally now going into the brewing economic crisis with much lower public debt levels and more balanced public finances than before.
One of the major distinctions between the global economy today from 1998 and 2008 is that its center of gravity has shifted dramatically away from the world’s industrialized economies to the emerging market economies. As a result of many years of very rapid growth in the emerging markets and of sclerotic performance in the industrialized economies, China has now become the world’s second largest economy, while the emerging market economies, including China, now account for over 40 percent of the world economy. This makes developments in those countries today much more important for the global economy than was the case in either 1998 or 2008.
Yet another fundamental distinction between today’s global economy and those of 1998 and 2008 is that the world’s central banks are now running out of room for policy maneuver. Unlike in 1998 and 2008, when at the outset of the economic crisis, interest rates in the world’s major economies were far from the zero-bound interest rate, today we find that they have been stuck at that rate for many years. Similarly, we now find that the world’s major central banks have already gone well down the road of unorthodox monetary policies with apparently diminishing returns. This has to raise basic questions as to how effective might those central banks be in moderating a renewed global economic downturn through additional monetary policy action.
Perhaps the most fundamental distinction between today’s global economy and those of 1998 and 2008 are the many more sources of vulnerability today than in the previous crises. Sadly, unlike in both 1998 and 2008, when the global economic crisis emanated from a confined geographical area, today’s crisis has the potential of being driven by events not only in China and the emerging market economies but also by events in the European economic periphery, the United Kingdom and Japan.
The multiplicity of serious trouble spots in today’s global economy might be underlined by considering three major fault lines. First, China, which earlier was the main engine of global economic growth, is now undergoing a major transition away from its earlier investment and export-led model that is almost certain to result in a major slowing in that economy. This is all the more so the case considering that it is occurring at a time when the country is experiencing a major outflow of capital as Chinese residents lose confidence in their economy. That has the potential to cause China to further depreciate its currency, which could very well result in a global currency war.
Second, the major emerging market economies like Brazil, Russia and South Africa are being hit by a major commodity bust that shows little sign of ending anytime soon. This has to be of systemic concern not simply because of the increased relative importance of these countries to the global economy, but rather because the corporate sectors of these economies could soon start defaulting on the major debt mountains that they have built up during the boom years.
Third, economic and political developments in Europe suggest that any slowing in the global economy could reignite the European sovereign debt crisis. Economies in the European economic periphery are still drowning in debt. Meanwhile, they have generally now elected governments that are opposed to the budget austerity and structural economic reform that might have held out the prospect that those countries might eventually grow their way out of their debt problems. To compound matters, the European banks are holding an excessive amount of troubled sovereign debt, while it does not help that fears about a “Brexit” ahead of a likely referendum on this question in June 2016 will heighten European economic uncertainty.
All the evidence cited above would strongly suggest that the global economic crisis of 2016 will not resemble either 1998 or 2008. However, that is not to say that it will be any less painful or deep given the multiplicity of vulnerabilities. That would especially seem to be the case should global policymakers continue to underestimate the likely severity of the forthcoming global economic crisis.
ON THE ECONOMY: THE HEALING
By John Dunham:
Managing Partner, John Dunham & Associates
I got something in motion, something you can’t see. It requires devotion, from those who truly believe. This is something you can’t touch, this is something you feel. For some people it’s too much. For some people it heals. Gary Clark Jr. ended his concert last week at Nashville’s Ryman Auditorium with this 2015 song from his album The Story of Sonny Boy Slim. The lyrics are poignant and kind of reflect the current national political environment where insurgent presidential candidates are getting a lot of devotion from those who truly believe.
The reason behind this is actually very simple. For the past 16 years, through both Republican and Democrat administrations, the American economy has floundered. Sure there were some periods of growth, but these were almost completely created by debt financed spending – first on houses that nobody wanted, and then on government programs that nobody wanted. The aftermath of nearly two decades of economic stagnation is an angry electorate, and a large portion of the population experiencing financial difficulty and difficulty finding gainful employment.
The sad part of all of this is that it never had to happen. In fact, the American economy is amazingly resilient, diversified, and sound, with one of the best systems of laws in the world, some of the best workers, and a level of flexibility that most other countries can only envy. The problem is that this dynamic economy has been hampered by years and years of poor fiscal, monetary and regulatory policy.
We were fortunate to have worked with Steve Forbes in scoring the tax system that he and co-writer Elizabeth Ames presented in their recent book Reviving America. In the book, Mr. Forbes notes that repealing Obamacare, replacing the tax code and reforming the Federal Reserve will do much to restore prosperity in America. I have to agree with him; however, I do take a somewhat different approach to the issues facing the country.
Growth in America has been hampered by an out of control regulatory system that both Congress and the State Legislatures have allowed to take over the country. When the Founders wrote the Constitution they intended elected (or in the case of the US Senate – appointed) legislatures to write the laws and the rules governing social interaction between Americans. And this was how things worked until the past 40 or so years. Now, rather than actually debating rules and policies, Congress and many state legislatures have delegated these duties to unelected bureaucracies with acronymic names like FDA, EPA, OSHA, BLM. These agencies exist for no other purpose than to promulgate rules, and this is exactly what they have done. Across America, rules, regulations, requirements, licenses and price controls (think minimum wage) have sucked the life out of the private sector. Rather than spend their resources and manpower building better widgets, most businesses today spend more time worrying about what they are doing wrong than what they should be doing.
The thumb of regulation (not just Obamacare) has made it less profitable to invest in new plant, new equipment, and new ideas, but rather to invest in old assets. Firms make more money borrowing from the future to buy back shares, or to invest in financial instruments. Without new and vibrant enterprises, from corner delis to giant aluminum smelters, America will continue to stagnate.
This stagnation is not helped by a corporate tax system that discourages investment – particularly investment in the United States. While it is true that the top corporate tax rate of 39 percent is rarely an actual tax rate, the average corporate tax rate in America is still about 23 percent. This means that 23 percent of every dollar made by a firm, goes to the Federal government. States tack another 5-10 percent on top of this. Mr. Forbes proposes a simplified 17 percent flat tax, and our analysis shows that this will generate a lot of new investment and economic growth; however, the elimination of the corporate tax altogether would be a much more powerful mechanism to achieve this. A fair and impartial flat tax on all income (including dividend income from corporate profits) would truly help to revive the American economy in a major way, particularly by encouraging foreign investment into American business.
Finally, the third factor, reforming monetary policy, is incredibly important. But I think this is a larger problem than most. Monetary policy in America is designed to encourage the accumulation of debt. I learned back in economics school that debt was a call on future work (while savings was a way to store current work for the future). Over the past 10 years not only has the government more than doubled the national debt, but it has nationalized huge amounts of private debt through Federal Reserve balance sheet transactions. All of this debt reflects future earnings that have already been spent – and almost none of it went into productive investments. Literally an entire year of economic activity is now needed to pay back just the Federal portion of America’s debt burden.
This worshiping of debt comes from the echo chamber of the orthodox economists and finance people that literally run the government economic system today, with little in the way of discussion of even consideration that they may not be right. Unfortunately that kind of thinking is how the country got into this mess and continuing to do the same thing will not get it out.
No wonder that people would rather vote for a geriatric socialist or a real estate developer for President than an established politician. It does not take rocket science to see that bad economic policies are leading to a lot of pain, and that the orthodox solution of digging the hole just a little deeper is going to just make things worse.
But maybe, just maybe, something is in motion, something we can’t see and maybe the political classes will finally start policies that can lead to a healing of the American economy.
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