As global economic power ebbs from the West to the more solvent emerging economies of the East, conventional economic wisdom is being turned on its head.
In a research note published last month (“The End of the Post-war Era -- Sauve qui Peut”), Andrew Smithers, founder and chairman of investment consultancy Smithers & Co, argues the post-war economic era is now well and truly over. He also argues that, if the UK and US economies are to be returned to sustainable health, they must drop outmoded economic dogma and adopt economic policies different to those being imposed by the likes of US treasury secretary Tim Geithner and UK chancellor George Osborne (and their respective central bankers Ben Bernanke and Sir Mervyn King).
Smithers says the US and UK must seize the chance to draw a veil over the "bonus culture", which has been polluting our economy since the 1980s insofar as it has encouraged bankers to pursue short-term gains that often run contrary to the needs of the real economy and needs of society. Smithers said the bonus system "has produced a structural rather than a cyclical savings’ surplus in the business sector by depressing investment and boosting profit margins."
Smithers, who outlined the case against against executive share options in an earlier QFINANCE Viewpoint, warned that the global economy is entering a dangerous and unpredictable phase, while suggesting alternative policies to guide us out of the current mess.
He reminds us of the fundamental changes that have reshaped the global economy since the Second World War, to which many conventional economists often turn a blind eye. These include that the US has become much less isolationist, with international trade now accounting for 31% of its GDP as opposed to 7% in 1950. This has diluted its ability to reboot though domestic fiscal stimulus packages, since these are more likely to seep out into the rest of the world.
Smithers also reminds us that US economic clout is on the wane, with the US accounting for 17% of global today, down from 27% in 1950. The notion that US consumers can pull the global economy out of a hole is therefore looking more quixotic by the day. Smithers wrote:
"The post-war era is over. The world can no longer rely on the fiscal and monetary policy in the US, with help from Japan and the UK, to avoid or at least mitigate recessions".
Smithers also reminds us of how the West is being eclipsed by the East. Over the past 22 years emerging economies including Brazil, Russia, India and China have grown at the cracking average pace of 5% per year, while the developed nations have only managed average annual growth of 2%. Emerging economies today represent 62% of the world output, up from 24% in 1950. If these trajectories continue for the next two decades, the emerging economies (many of which have already 'emerged') would account for 75% of global output by 2032.
These fundamental macro shifts have undermined attempts by developed nations to prop up their economies via fiscal stimulus, says Smithers. Yet stimulus junkies like Professor Paul Krugman persist with their calls for further injections of debt-fuelled government spending. He said that a June 27 Financial Times op-ed by Krugman and Richard Layard illustrated the "the sterility of the current debate", adding that developed nations freedom of manoeuvre where further stimulus is concerned is much more limited than some have claimed.
Smithers said: "Those who should listen to the call for fiscal stimulus won’t, and those who would previously have been well disposed are constrained by their current massive deficits and have better policy options than those proposed in the [FT] article." He added:
"Today the constraints on policy make [further fiscal stimulus] unlikely. In Japan, the UK and the US stimuli are inhibited by the size of the deficits and in the rest of the world by a reluctance to accept the virtues of deficit financing, which is reinforced by the assumption that the past success of their policies did not depend on others’ fiscal stimuli."
The unavoidable fact that many non-Anglo Saxon countries, and especially the emerging economies, have an aversion to fiscal stimuli -- with some instead favoring exchange-rate manipulation -- has not helped, said Smithers. He believes that further quantitative easing, though likely, risks inflating asset price bubbles:
"US share prices are already well above fair value and quantitative easing is more likely to boost asset prices than the economy. The more asset prices rise, the greater they will subsequently fall and, if share and commercial property prices fall because the economy weakens, their fall will amplify the weakness."
This is where the "sauve qui peut" (“every man for himself”) mentality comes in. Smithers believes, partly out of economic amnesia and partly out of a failure to debate alternatives, many countries are now going to aggressively pursue narrow national interests, with disturbing parallels to the "beggar thy neighbour" policies adopted during the Great Depression of the 1930s. Smithers's alternative to this is altogether more sensible:
"The policies which we [at Smithers & Co] consider sensible are those of currency intervention, the reform of the bonus culture in the UK and the US, and tax reform in Japan. We fear, however, that they are unlikely to be introduced at least within the next twelve months, largely because these ideas are yet to receive the attention and public debate which is essential before changes in policy can usually be understood and agreed by politicians."
But can the World afford to wait that long?
Further reading on post-crisis economic solutions and how the emerging economies outpacing the developed world:
- The Final Decoupling is Going to be a Painful Wake-Up Call for the West by Bruce Stout
- Future Directions: The Global Economy After the Crash by Arun Motianey
- Fidelity is confident its MINTs won't suck by Ian Fraser
- Yen strength frustrates BoJ but future looks brighter for Japanese investments by Anthony Harrington
2012: The Year Ahead– Can emerging markets ride out the storm? by Ian Fraser and Anthony Harrington
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