Monday, September 28, 2009

Pandemic Economopathy

This is my analysis of the world's economic illness.

1. The diagnosis is global trade imbalances, and their consequences.

Globalisation has crashed. Elementary economic principles were ignored, because it was profitable and fashionable to do so.

2. Open borders, free trade, and similar economic nostrums can be sustained if and only if flows of goods and money are in balance over time. Similar standards of living, and of state welfare provision, energy prices, social structures and cultures - these are essential for such a balance among the nations in a free trade area. This forces industries and commerce to compete by increasing factors such as design, quality and efficiency, not by a race to the bottom in employment and other costs.

All these factors are present in the United States of America, still the world's largest and most successful free trade area. They are absent in a globalised economy; they are absent in the European Union, in which the strains of the global economy are replicated.

This principle of balance was simply ignored, if not denied.

3. Exchange rates between the currencies of a free trade zone must float freely, to offer a self-correcting mechanism against trade imbalances.

This principle was openly or covertly evaded by China and other important trading partners. The Euro inhibited self-correction in Europe.

4. The consequence of this economic folly is to divide the industrialised world into producer and consumer blocks, especially the USA and Britain as consumers, and China, Russia and petroleum exporters as producers.

Producer countries build up huge reserves of consumer currencies: industries in consumer countries wither and die; poverty eroding prosperity.

In some producer countries individuals now control wealth sufficient to perturb global markets in finance and goods: one man can move the world of finance to his advantage.

Producers' seek profitable investments for their new wealth; consumers' money must be recycled so trading can continue. These are the roots of the present crisis.

5. The producers' accumulated dollars, pounds and other currencies were deposited in American, British and European banks; the banks in turn had to generate returns for the tsunami of money flowing into the system. Housing and other assets were easy and popular choices.

Abundant money and cheap borrowing set the stage for a property boom, which moved towards frenzy as rising property prices fed back into demand.

6. In Britain and the USA banks were released from government regulation. Bankers are prudent, wise, honest and good; they can surely be trusted to govern themselves. So they argued; politicians listened and were convinced.

Our trust was betrayed. Abundant deposits, cheap to borrow, profitable to lend on - in these conditions bankers encouraged reckless short term behaviour, paid themselves fortunes, and devised clever 'instruments' to conceal the insecurity of many loans. Deliberate, criminal fraud was disguised, rewarded, celebrated. 'Toxic' debt was diffused into sound investments, poisoning trust in all.

Elementary rules of sound banking were declared obsolete. Bankers gambled with other peoples' money; the City of London is now a vast casino.

It needed a simple rise in interest rates to expose the rot in the system. The consequences of global banking collapse appalled governments, so unprecedented public wealth and credit has been committed to shore up the system. The long-term consequences of this panicky response cannot be evaluated with confidence. We can expect unemployment, taxation and inflation unto the second generation.

The Gods of the Copy-book Headings were mocked; they are back, jealous and vengeful.

Reckless bankers were a symptom, not the cause, of the global economic sickness.

7. New money was not being created; the process was inflationary only to asset values. Central bankers were not moved to raise interest rates - in Britain a new inflation index ensured house prices were removed from inflation evaluation. Most people felt more prosperous; politicians claimed credit for achieving non-inflationary growth, at last; bankers made easy fortunes, paid taxes, and spent their lavish bonuses.

Inflating asset values gave security for another boom in consumer borrowing. These loans supported continued purchasing from the producer nations, increasing their currency surpluses further, feeding even more purchasing power back into Western banks.

A system of obvious instability and unsustainability.

8. Why was this dangerous cycle not recognised and stabilised? Were world leaders and bankers stupid, short-sighted, or deceived by their own rhetoric? The few who spoke out were scorned. The dangers were obvious to people in my circle: how come those paid handsomely to manage these things failed so dismally?

As always, money talked. We'd never had it so good, why heed those crying 'woe'? Surely this time the world has changed, the old cautions and rules no longer apply. Prosperity is here to stay: the value of your house can only increase, release this new equity and enjoy your good fortune. Go with the flow.

And learned commentators agreed.

Pone merum et talus. Pereat qui crastina curat.

[Set down the wine and the dice. May he perish who cares for tomorrow.]

The motto of the New Labour years.

9. What can be done? Never get into this position is sound advice, but far too late. There is no salvation in trying to recreate the failed globalised system. The prevailing economic dogmas must be rethought, modified, in some respects reversed. Britain needs an election now; we need a government with an electoral mandate to think clearly and act rationally in the national long-term interest; free, for a while, of the shackles of electoral calculation.

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