It is very rare for Central Bankers to be optimistic about anything. They have so many factors to worry about, that it can almost be said they are paid to worry. The central theme of the Annual General Assembly of the Bank for International Settlements (BIS) - “a bank for central banks” –held in Basel, Switzerland, was nevertheless strangely optimistic. It said it was “time to step out of the shadow of the crisis”. Is the worst economic crisis since the Great Depression indeed drawing to a close, or is it indeed too soon for such optimism? In order to conduct such an analysis, it is necessary to step back and analyze how the major countries and economic blocks in the world are performing. In my opinion, a careful analysis will tend to show that there is an upswing, however weak, and that it is necessary to begin to trace a roadmap toward the future which includes at its chore, a path toward greater quality, more resilient growth. The purpose of this essay, thus, is twofold. On the one hand - in very general terms - I will carry out an analysis of the current global economic situation. On the other hand, I will try to suggest a possible roadmap of gradual reform we should implement and policies we should follow which will, I think, make growth in the following decades more prosperous, but also more sustainable than it was ever before.
Almost six excruciating years have elapsed since Lehman Brothers filed for bankruptcy in 2008, unleashing the worst of the global economic meltdown. A series of decisive and momentous policy decisions were implemented at the correct time, which albeit their very high cost, prevented the world from slipping unduly toward the abyss and into a crisis potentially worse than the Great Depression of the 1930s. Our world today is slowly creeping out of that deep recession which has already lasted for too long and hurt so many individuals. Though the upswing is, admittedly disappointingly weak, it appears to be occurring in different degrees throughout the world.
The U.S and Japan are performing particularly strongly. America’s economy is seeing a strong comeback in the second quarter of 2014, with 4% growth. All seems to indicate that the tapering of Quantitative Easing, begun a year ago in mid-2013 has been the correct policy, implemented at the correct moment and in the correct way. Japan, an economy in “suspended animation…for more than two decades” is kicking back to life under the three arrows of fiscal stimulus, monetary easing and structural reforms which form the keystone of abenomics.
The EU, however, is much more heterogeneous. Very broadly, it is divided along north/ south lines. Germany has always been a champion. Since the Maastricht Treaty in 1992, which first established the euro, it had been thought that Germany with its track record of sound and prudential macroeconomic management, would serve as a model among southern European countries. Instead, countries such as Greece only used the euro to take advantage of lower risk premiums, borrowing irresponsibly and creating a deficit which superseded anything contemplated in the Stability and Growth Pact. The result is a series of debt-ridden countries in the peripheries of Europe with very vulnerable economies and very little credibility in the markets.
The tide however, is turning even in the most hopeless of places. Greece is seeing its own economy, which shrunk by 25% during the crisis, begin to see weak growth in 2014 – likely to accelerate in 2015 – buoyed by tourism and by a €172 million euro-bailout of the economy which has been reinvested in recapitalizing the banking sector and an ambitious infrastructure projects.
Emerging Market (EMEs) economies have suffered from an end to superabundant liquidity in the world economy which coincided with tapering of Quantitative Easing (QE) by the Fed. In reflection, this is not particularly worrisome. In any case, the “vacuum cleaner” effect which is sucking money out of EMEs is just a counter effect to a similar but contrary effect, some years earlier, which pumped hot money in. EMEs were bloated by money which sooner or later was going to be repatriated. Now, simply EMEs, like advanced economies, are normalizing. This can actually be considered good news in the long run when we consider their proclivity towards inflation. Brazil, for example, has inflation nearing 7%. Argentina and Venezuela are much worse, but they are basket cases. Nevertheless, central banks throughout these countries with inflation targeting regimes are seeing inflation near the upper boundary permissible. In any case, the worse of the “great reversal” – a time of a turnabout of capital flows, when there was great stress placed on local currencies, bonds and equities - seems to be over.
The wiser of EMEs will recognize the need to strengthen fundamentals and begin to implement long-term, structural reforms, such as those implemented by Mexico which, amongst other things, saw an end to 75-year long monopoly on oil by state-owned PEMEX, creating a wholesale power market. Said reforms have helped buoy Mexico’s international credibility, securing reliable forms of external financing and attracting foreign investment. Although some of the causes of the crisis have been successfully solved or are being solved, it is urgent for national economies on the whole – advanced, emerging, underdeveloped - to think long-term and also strengthen their own fundamentals.
In this sense, deleveraging is urgent. According to statistics from the BIS, there is a debt-to-GDP ratio of 275% among advanced economies and 175% for EMEs. Said debt has been the punchbowl which has kept the party going, but monetary and fiscal stimulus are short term solutions. In the long run, there urgently needs to be structural reforms and implementation of supply-side shocks which increase productivity. The economy cannot remain floating on unsustainable levels of debt forever; the real economy that produces goods and services must make a comeback.
It is time to forget about the economic crisis and for individuals, corporations and policymakers to get back on track into economic growth. But we mustn’t only pursue growth for growth’s sake, as we recklessly did in the past. It is preferable to have lower levels of growth, but for that growth to be sustainable, inclusive and based on sound fundamentals. To these effects, the Bank for International Settlements suggests “three transitions” which must occur for long-run sustainable growth to occur: i) there must be a less debt ridden growth model; ii) there must normalization of monetary policy and; iii) we must move towards a more reliable financial system. I couldn’t agree more.
But I think there is more to be done. We must pursue a global growth model which is more homogenous and inclusive. Past growth, as Picketty has shown in his recent book, has benefited some but left many out. In the long term this growth is not beneficial for anybody; nor is it sustainable. An excellent example is Chile. It has a sound macroeconomic model, a well-regulated financial system, a successful fiscal and monetary policy. During the financial crisis, its developed derivatives market were extremely successful in hedging the Chilean economy from external shocks, and assuring that Chile was one of the EMEs to suffer least stress from the crisis, despite holding reserves much inferior to those of other Latin American countries. Nevertheless its growth model is very unequally distributed. Chile is now implementing a plan of structural reform to prop up education and ensure a better distribution of wealth in the future. Though, some details of the plan need perfecting, on the whole, I think that leveling socio-economic differences in one of the most unequal regions in the world is something that needs to be done. Growth can be achieved, but we must all benefit from it; not just the few.
Timidly, we are beginning to creep out of the abyss. However, the risks ahead are many. It is not time to be too optimistic. The international panorama is fraught with danger and instability. Hot spots are creeping up everywhere, from Venezuela to the Ukraine and thence on to the Middle East. In an over-leveraged world, it still seems that what we owe far outweighs what we own. This is true for us, and for our children. It is true not just of over-extended central bank balance sheets: it holds true of governments, corporations and individuals. This can be a depressing truth. However, there is some room for optimism. We are beginning to see the light at the end of the tunnel. As we do so, we have the unique opportunity of restructuring our broken-down economies to be more inclusive, sustainable and driven by true productivity, not by debt. If we manage this, we will have the satisfaction of leaving our heirs a better world than the one we were left with. It is essential, that we seize this momentous occasion and build on it.
1. Caruana, Jaime. “Stepping out of the shadow of the crisis: three transitions for the world economy”. Annual General Meeting of the Bank for International Settlements. Switzerland, Basel. 29 June 2014. Bank for International Settlements. Web. 29 June 2014.
2. “Abe’s Master Plan” The Economist. 18 May 2013. Web. 29 July 2014.