Markets Insight
September 11, 2013 9:05 am
Post-crisis policies promise chronic stagnation
Public and private debt in major economies has risen, not fallen
It is a measure of our overly financial times that people can recall the day Lehman collapsed as a previous generation remembers the moment when an American president was assassinated in Dallas.
Surprisingly, little has changed. Unsurprisingly, activity has not equated to achievement. Since 2007, total public and private debt in major economies has increased not decreased, with higher public borrowing offsetting debt reductions by businesses and households. Debt levels have also risen in emerging countries from before the crisis.
Modest reductions in global imbalances in trade and capital flows are the result of lower growth, rather than reform. Germany, Japan and China remain reluctant to alter an economic model reliant on exports and large current account surpluses.
The financial sector exists to support the real economy. Financial instruments, such as shares, bonds and their derivatives, are claims on real businesses. But over time, trading in the claims themselves has become more rewarding, leading to a disproportionate increase in the level of financial rather than real business activity.
The financial sector needs to be pared back to its utility function: making payments, matching savers and borrowers, and providing simple risk management tools.
Instead of fundamental reform, policy makers are introducing complex capital, liquidity and trading controls of dubious efficacy that invite regulatory arbitrage.
Too-big-to-fail banks have become larger. Initiatives such as the central counterparty for derivatives have introduced complex interconnections and new systemic risks. Reform of entitlements has also proved difficult.
The real solution always required reducing debt, reversing imbalances, decreasing financialisation and modifying behaviours. In the short run, such measures would have led to a significant economic contraction and lower living standards. In the long term, they would have rid the system of unsustainable excesses, creating the foundation for a sustainable recovery.
But rather than deal with the fundamental issues, policy makers preferred the path of expediency, substituting public spending, financed by government debt or central banks, to boost demand. Strong growth and increased inflation would correct the problems.
Developed nations sought to export problems to emerging markets. Currency devaluation was used to increase the competitiveness of developed economies. It was also used to reduce the value of sovereign debt, in which emerging nations had invested their savings and foreign reserves.
Available fiscal and monetary policy tools are inadequate. Echoing Viennese critic Karl Krause’s observation about psychiatry being the disease that masquerades as the cure, low rates, mispricing of risk and excessive debt levels, which contributed to the crisis, are now considered the ‘solution’.
Fearing electoral defeat and unwilling to challenge lobby groups, risk averse leaders and politicised policy makers have eschewed essential changes. Instead, they have resorted to financial repression to channel savings and funds to finance the public sector, lower borrowing costs and liquidate debt.
Measures include increasing existing taxes and imposing new taxes, including on financial transactions. Policy makers target low nominal and negative real rates of interest. Governments exert control over the use of savings, directing it into government securities. Capital controls may be used to control outflows of funds.
In a number of countries, the government has seized pension fund assets to finance government activities. Increased government intervention in the economy, including direct state ownership, can be expected.
These policies will engineer a chronic stagnation, requiring continuous intervention to prevent rapid deterioration.
At the start of the crisis, the choice was always pain now or prolonged agony later. In Ernest Hemingway’s novel The Sun Also Rises, a character describes the path to bankruptcy – gradually, then suddenly. It is an accurate description of the present economic and financial trajectory.
Satyajit Das is a former banker and author of Extreme Money and Traders Guns & Money
The collapse of Lehman Brothers and the ensuing financial seizure was symptomatic of high debt levels, global imbalances, excessive financialisation and unfinanced social entitlements, which underpinned an economic model reliant on credit-driven consumption.
Modest reductions in global imbalances in trade and capital flows are the result of lower growth, rather than reform. Germany, Japan and China remain reluctant to alter an economic model reliant on exports and large current account surpluses.
The financial sector exists to support the real economy. Financial instruments, such as shares, bonds and their derivatives, are claims on real businesses. But over time, trading in the claims themselves has become more rewarding, leading to a disproportionate increase in the level of financial rather than real business activity.
The financial sector needs to be pared back to its utility function: making payments, matching savers and borrowers, and providing simple risk management tools.
Instead of fundamental reform, policy makers are introducing complex capital, liquidity and trading controls of dubious efficacy that invite regulatory arbitrage.
Too-big-to-fail banks have become larger. Initiatives such as the central counterparty for derivatives have introduced complex interconnections and new systemic risks. Reform of entitlements has also proved difficult.
The real solution always required reducing debt, reversing imbalances, decreasing financialisation and modifying behaviours. In the short run, such measures would have led to a significant economic contraction and lower living standards. In the long term, they would have rid the system of unsustainable excesses, creating the foundation for a sustainable recovery.
But rather than deal with the fundamental issues, policy makers preferred the path of expediency, substituting public spending, financed by government debt or central banks, to boost demand. Strong growth and increased inflation would correct the problems.
Developed nations sought to export problems to emerging markets. Currency devaluation was used to increase the competitiveness of developed economies. It was also used to reduce the value of sovereign debt, in which emerging nations had invested their savings and foreign reserves.
A conspicuous lack of success – moribund growth, low inflation, persistent financial system weakness and now increasing stresses in emerging markets – has not deterred policy makers from persisting with the same policies. They have taken Irish author Samuel Beckett’s advice: “Ever tried. Ever failed. No matter. Try Again. Fail again. Fail better.”
Fearing electoral defeat and unwilling to challenge lobby groups, risk averse leaders and politicised policy makers have eschewed essential changes. Instead, they have resorted to financial repression to channel savings and funds to finance the public sector, lower borrowing costs and liquidate debt.
Measures include increasing existing taxes and imposing new taxes, including on financial transactions. Policy makers target low nominal and negative real rates of interest. Governments exert control over the use of savings, directing it into government securities. Capital controls may be used to control outflows of funds.
In a number of countries, the government has seized pension fund assets to finance government activities. Increased government intervention in the economy, including direct state ownership, can be expected.
These policies will engineer a chronic stagnation, requiring continuous intervention to prevent rapid deterioration.
At the start of the crisis, the choice was always pain now or prolonged agony later. In Ernest Hemingway’s novel The Sun Also Rises, a character describes the path to bankruptcy – gradually, then suddenly. It is an accurate description of the present economic and financial trajectory.
Satyajit Das is a former banker and author of Extreme Money and Traders Guns & Money
Copyright The Financial Times Limited 2013.
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