Wednesday, July 08, 2009

An Uncertain World

Have we reached the end of recession yet? The global business confidence is up, in the sense that it is not down, and though many people expect the state of affairs to be gloomy for at least another 12 months, there is this undying optimism that things can not go worse than this.

Indeed, there are some positive signs. Stock markets are up. Historically, stock markets recover about six months ahead of the real economy starts recovering. But then, one can not feel optimistic because stock markets are up, because stock markets are up because people are feeling optimistic.

There are other things too. The inventory levels are down. Primarily in the United States. The commodity prices are moving up. Some credit, though at a high interest rate, started flowing through the banking system. So, it seems modern governments could beat the recession down, somewhat midway, by resorting to Keynesian public spending schemes. All the economics education then did not go waste - we have almost tamed recession.

The point, of course, is that no one knows yet. Except for the feel-good pundits of the financial press, who of course have a vested interest in keeping people interested in the modern financial wonders. The inventories may be down, but so are jobs. The unemployment rates are highest in half-century. Interest rates are too high, despite the near-zero base rate in America and Britain. Most of the public spending, and public effort, have gone into propping up our economic system as it was - saving banks and companies which were too big to fail - and not enough has been done to correct the systemic problems that got us here in the first place. In the end, our economy-on-steroids has been transformed into economy-on-life-support, and as in such emergencies, we have learnt to accept that an absence of deterioration can be viewed as improvement.

That leads us to an uncertain world, where, despite the optimism, we would not know where we are heading. Here is a question that I do not the answer to: Was sub-prime lending was the problem, or was sub-prime lending was a symptom of a bigger problem? The conventional wisdom is of course that banks, through various non-banking channel which was not effectively regulated, lent lots of money to people who did not have the necessary credit-worthiness, and the house of cards unravelled when inflation drove interest rates up and they started defaulting on what they borrowed. But, here is my question - why did the lenders have to go sub-prime? The obvious answer is that there was not enough demand for credit in the 'prime', credit-worthy market to sustain the expansion that the shareholders of these financial institutions, us in turn, demanded. So, this was an amphitheatre of sorts where caution and decency had to be thrown away to sustain share prices, which was tied to various 'variable' components of pay of the bankers. The point is - the credit had to flow - from those who had more than they consume to those who consume more than they have. At some point, the connection snapped, and the whole system caved in.

The key point, however, is our dependence on sub-prime and its role in creating the 'longest period of continuous economic expansion in history' [poor Gordon Brown!]. The problem is that we have an inequal world, and as rich become richer, we shall discuss the possibility to moon tourism, agelessness and sprawling estates, but we shall also have abundant food and death in starvation at the same time, and research in plastic surgery and death in Malaria at the same point. The bigger problem is that the demand will remain sluggish, however much we try to build a middle class who will keep money going with their aspirational lifestyle. The people who has money to spend are too small, and the people who need money to spend are too large.

So far, we have hardly solved the problem. We threw money at institutions as they were, and kept them going. A new thinking about how the wealth gets distributed was needed, but was not forthcoming. The fact that markets are no more efficient than governments in creating sustained prosperity was illustrated, but we almost wished that this was not true. The faith in markets is indeed convenient in a way - it allows us to shrugg off our responsibility to behave, to be decent - and everyone wanted to go back to this familiar world.

And, that will lead us to an uncertain world. We are entering the phase now. This is one of those inflection points where our economic thinking will be challenged, and be transformed over a period of time. And, indeed, so will be our political systems. The nation state system that we have accepted as the highest and most sophisticated form of political organization is already coming under some pressure. As the economic linkages across the world becomes weaker in this recession, the unfeasibility of the nation states will become plain for everyone to see.

There are some real dangers around the corner too. The Great Depression brought Hitler to power, when the world was obsessed with the dangers of communism in Russia. So, we looked the other way while a monstrous regime took hold in a major country. History has this nasty habit of repeating itself, and as we search for Obama in the caves, a fascist dictatorship is slowly taking shape in Russia. The west has committed exactly the same set of mistakes that they did with pre-war Germany: showed little sensitivity to the suffering of the man on street, Bush (Chamberlin) looked into the eyes of Putin (Hitler) and had a feel of his soul, and Russia was allowed to carry on a sphere-of-influece thinking and lord over some of the vassal republics. And, then, suddenly, the West wakes up one day and remember their commitment to Georgia or Ukraine and promises them NATO membership, and disengage with Russia, a state with a failing economy, shrinking population and a huge nuclear arsenal!

China riots are also bad news, though we, and possibly no one, know how bad. The Chinese problem will continue to affect us in the days to come. The Chinese experiment of trying to create an economic powerhouse without political freedom can end up in only one place - a corporatist, fascist state of some form - which either crumbles from within or goes into war. Here, the comparison is not with Germany but with Pre-war Japan, whose economic development was driven by large, state-supported organizations, which had an overtly nationalistic outlook and wanted to finance the war to secure markets and energy sources [sound familiar?].

In summary, this is a time when the old system is crumbling beneath our feet. The centuries-old thinking about economics and politics are under seize. Of course, there is one thing we can be optimistic about - the power of human ideas. We are capable of inventing our way out of trouble, and I am sure the same will happen again. But, as in all the periods of history when our directions changed, the coming years will be uncertain, fraught with danger and will need us to be patient and imaginative.

But, in the end, we shall arrive at a better world. I am sure that is reward enough for our troubles.

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