A ramble towards a conclusion

Spiegel Online is one of those rare media outlets that is intelligent, and also gives due space to explain the stories that are covered. I may not agree with their analysis, but it is certainly one of the more worthwhile sources. I was therefore interested to see their headline that asks whether the world is going bankrupt. I will quote from their conclusions:

It has become evident that debt-to-GDP ratios of 80, 90 or 100 percent will sooner or later cast doubt on a country's creditworthiness. Even supposed paragons of fiscal virtue such as Germany must be careful. The German debt ratio of 83 percent is too high, given the ageing population. Who is supposed to pay down that debt in the future?

I am not entirely convinced that the story supports their headline, but it is nevertheless interesting to see recognition that the current situation cannot continue. Perhaps even more startling is Edmund Conway in the Telegraph. Regular readers will remember that I was extremely critical of his stance on quantitative easing (money printing) by the Bank of England, but he seems to have completely reversed his previous support for this dangerous policy. In a surprising article, he traces the roots of today's crisis to the abandonment by Nixon of the gold standard. This is an example of his analysis:

Over the past 40 years, in the absence of a coherent international monetary system and under the veil of floating currencies, countries which would otherwise have been penalised for doing so were allowed to borrow enormous amounts (eg. The US and UK, or Greece). Other countries (eg. China or Germany) indulged them by lending enormous amounts. In the meantime, investors convinced themselves that the apparent economic growth fuelled by this debt was genuine rather than an artificial product of a binge.

The 2008 crisis represented the first recognition that those increases in asset prices and economic growth were chimerical. The recent relapse represents a recognition that the losses have merely been transferred on to sovereigns' balance sheets.

Even more interesting is the growing view that the $US is looking ever more fragile as the world's reserve currency. For example, the New York Times is taking a moderate position, where they posit that the $US has a long while to go yet as the reserve currency, but nevertheless see the writing on the wall:

Still, recent actions have clearly hurt the dollar more. And it is the bleeding from a thousand cuts, both inevitable and self-inflicted, that will eventually cost the dollar its dominance.

Even more interesting is commentary from Peter Hartcher of the Sydney Morning Herald. He commences his story with a comparison between US defence cuts and China's first aircraft carrier being completed. His story is rooted in the shift in power between East and West, and he sees the $US decline as a key element in the shift:

It's not just that the creeping shift of power from West to East has become a rush. We've known about that for years. There is something else going on, too. You can see it in the price of gold. An ounce of gold traded for about $300 a decade ago. This week it hit an all-time high of $US1800. Why?

Some investors have lost faith in the US dollar. It was the official global reserve currency for the first 25 years after the Second World War and the de facto reserve currency after that. Even the governments of the G-20 nations are actively discussing the idea of spreading the risk, creating a new reserve system comprising the currencies of multiple countries. This was unthinkable just a couple of years ago.

But while confidence in the US might be sinking, there is no corresponding rise in confidence in China. "You can see it in the price of gold," observes one of Australia's leading investors, Kerr Neilson, the head of Platinum Asset Management. "There is a system change under way."

Apparently, according to this commentator we have all known about the shift for years, but of course this is not true. Certainly when I was writing about the end of the $US as a reserve currency, and the great shift in wealth, when starting this blog, it was a radical position. It is now moving into the mainstream. Certainly the rise of China was widely discussed, but it was not posited that this would be at the cost of the fall of the West. China was supposed to rise up to meet the West; it was not supposed to happen that China would rise and the West would fall, only for both China and the West to meet somewhere in the middle. However, if you look at one of the key themes of this blog, the limits on resource growth and increases in the world labour force, it was the only possible outcome.

The DNA of the current panic is the recognition of the simple fact; the West is getting poorer right before our eyes. The allocation of limited resources in the world is shifting to the East, and that means that there is less to support the lifestyle of the West. Sure, commodity output is increasing, but just not enough for China (and the East more broadly) to rise up without seeing a fall in the West. I forget where read it, but a recent article discussed the shift of interest in US companies from serving the domestic market to an ever greater focus on the emerging markets. It has been going on for many years, but the article noted that this was a change in degree. Somewhat surprisingly, the Governor of the Bank of England has explicitly stated that the standard of living in the UK is in decline. All around us, we can see the shift in wealth, and it appears to be accelerating.

I put emphasis on the word appears. It has long been the contention of this blog that the shift has just been hidden with debt. For example, when (or rather if) governments adopt genuine austerity measures and stop borrowing from overseas, and consumer borrowing funded through overseas lending stops, the true level of real wealth will be revealed. Instead of thinking of this lending in abstract terms of money, I have always viewed it as the borrowing of resources and labour. It may be counted in money, but in reality it is always the lending of resource and labour. The complication in this system is that the resource is measured in units of money where the units might be changed to cheat the lenders. However, in all events, when the borrowing stops, there is going to be a change in the standard of living experienced by the borrowers.

It is becoming obvious that, faced with declining standards of living in the West, the solution to the problems is seen as defaulting on debt through currency devaluation, which a recent article in the Financial Times heralds as currency wars:

Yet with Tuesday’s announcement the Fed committed to easy money for the foreseeable future and signalled it was ready to loosen further. Thus the conditions are dangerously propitious for the currency wars to break out again.

A currency panic, with destabilising moves in exchange rates reinforcing collapsing asset markets, is one of the few problems from which the global economy has mercifully been spared throughout the global financial crisis. Even in the extraordinary movements of this week, there are few signs that leading currency markets have become disorderly. The falls in the dollar against the yen and Swiss franc have been accompanied by a rally rather than a sell-off in the prices of Treasuries, even at longer maturities. Investors appear to be responding to (justified) fears about the underlying strength of US growth rather than betting on market meltdown or sharing Standard & Poor’s views on US fiscal solvency.

Yet, although it is hard to imagine that the world’s leading economies are having much good fortune, their governments are riding their luck as far as currencies are concerned. If there is a re-emergence of serious political tension over exchange rates – perhaps a flight out of the euro pushing the dollar higher – the global economic order still does not have a credible means of co-ordinating currency management.

As this article recognises, the game is out in the open. It is also a rather apt way of describing the situation. Was it Bismark who said something about war being diplomacy by other means? In this case, what we are seeing is war by other means. It cannot end well. More to the point, it does nothing to address the real problem, which is access to resources. The only real solution to the overall problem is expansion of resource availability overall, and I am not sure what the solution to this might be. There are some bright spots, such as the emergence of technology to access shale gas. This might allow for greater supplies of one of the key inputs into the world economy, which is energy.

However, on the other side of the equation, there is still a pool of labour that is not fully integrated into the world economy, but is nevertheless entering into the world economy. The entry of this labour will be resource intensive, continuing the trend of the last 10-20 years, with the necessity of building resource hungry infrastructure. And then there is the nature of this new labour. It is comprised of individuals who have very little, whose resource use is just somewhere above that required for survival of themselves and their families. Any improvement to their resource makes a huge difference to their lives, and they will grab any opportunity to raise themselves up. Visit the countryside in China or India, and you will see what I mean. And who can blame them for wanting a better life?

And then there is the West. We have the infrastructure. We have opportunities and systems that have allowed us to have lifestyles that this emerging labour could only dream about. However, it was not enough for us. We wanted more, and more and more. We voted in governments that told us that we could have more and who borrowed in our names, and we borrowed to support our lifestyles, all the time thinking that it was our 'right' to enjoy our huge share of the world's resources. Well, it is time for the West to wake up, and accept that the game has changed. What excuse was there for countries with fully developed infrastructure to borrow money, or why did so many individuals borrow so much when their wages might allow for a reasonably good life? It was borrowed because we wanted to consume more than we can produce. We came to a point where we thought that we deserved to enjoy such a high standard of living as a right.

We have done so much in the recent past to support our idea of wealth as a right. The trouble is that it is not a right that is exclusive to us. The peasant on a Chinese or Indian farm is perfectly entitled to compete with a worker in the West for a greater share of resource. People talk of sweat shops, and unfair competition resultant from poor wages. However, as I once expressed in a previous post, I would not want to be the person that turns a young Chinese girl back to her village, when she seeks a better life in the city. Standing on the road to the village, and telling her that she is going to be exploited for working for so little will not convince her not to leave. For her, it is a better life than that which she has now. She deserves the better opportunity.

So we come to the underlying problem. How can we insist that we should have the disproportionate share of resources as our right? What is it that makes us somehow so different? On what basis do we found our belief that we will always be so much more wealthy? I have yet to see any argument that can explain this.

The situation is now one in which the world has already changed. We are just seeing the consequences, but we are failing to adapt. We must change to meet our new circumstances. That means that we can no longer take for granted that we will have all that we had before. That means that we must think hard on what we think are the priorities for where we allocate our diminishing resource. For example, is it health care, or is it education? How can we make our systems work with less resource, and what are our priorities within each area?

What we now see is that the attempts to solve the so-called financial crisis were simply delaying mechanisms. It was never a financial crisis, but an economic crisis. All around us we can see the chaos as the fundamental change in the world economy forces itself firmly back into view. Sure, the central bankers and policymakers squeezed the problems from view for a while. But still the economic crisis forces itself back into view. However much we may not like it, we are all variants of Greece. But when we are confronted with reality, who is there left to bail us out? In a recent Economist article, the discussion was one of how France, if it extends itself much further on bailing out others, will teeter towards its own crisis. It is the absurdity that the massively indebted are saving the even more massively indebted. Their credit is, for the moment, just a bit better than the bailee....

This is a somewhat rambling approach to a post. It was not my intention to go down this particular route, but it seems that, wherever I look at in the news, the footprints lead me back to the same place. This post is a reflection that the surface symptoms all lead to the same underlying causation. If we look at the surface, we can not deal with the problem, or rather we can not confront the problem. The comments and quotes that started the post are starting to reflect the explanation of the economic crisis that emerged when I started this blog. The trouble is that the shifting understanding of the commentators, the move towards the position of this blog, have not gone far enough yet. They are starting to 'get it', but they still have not confronted the hard reality of the new shape of the world economy. They still do not fully accept the hyper-competition of the new world economy. It is brutal, but there is no way to avoid confronting it.

Note: I had a comment on my last post in which a regular reader accused me of taking an ideological position for tracing the roots of the crisis back to the final impacts of communism/socialism. If my fundamental premise that the economic crisis is a result of the shock entry of so much labour into the world economy is accepted, this is not an ideological position. The governments in countries like India and China rejected the global capitalist economy, and developed systems in which most of their labour force were utilised in a way that was barely above subsistence. When they abandoned this path, and sought to connect their labour into the capitalist world economy, the flood of new labour can only be explained as being resultant from the previous policy.

Sure, there are very significant problems in the way that the capitalist system met the change that this entry caused, but that does not take away the fact that the problem started somewhere. Perhaps a more appropriate point would have been to comment on my use of 'capitalist' as a broad brush characterisation, as there are elements of different economies that might suggest that this term is being misapplied. However, for the sake of ease, it seems a good shorthand for the contrast between, for example, the Chinese system pre-Deng reforms and the system joined post-Deng reform. Also, socialist for India might be described as misnomer. However, post-Independence India followed the lead of the Soviet Union in economic policy, albeit with Indian characteristics (to adapt an expression used for communism in China).

I was a little disappointed with the tone of the comment. However, as the comment came from a longstanding follower of the blog, I nevertheless thought I would respond.