While I spent nearly a week in Mumbai “fiddling” over grass-roots entrepreneurialism in India, financial markets began to simmer and then “burnt”. That the problem boiled over should really not have come as a surprise because there were no easy solutions. That is the problem with policymakers, investors and the public.
We think there are magic wands not yet waved and all that policymakers have to do is to pick up one and wave it. Governments too have done precious little to disabuse investors and the public of that notion. In fact, the €720 billion aid package that the European Union has cobbled together is a reinforcement of the belief that there is a bailout for every trouble.
Today, everyone latches on to the obvious lacunae in a currency union— there is no exchange rate tool left for sovereigns to ostensibly depreciate their way out of trouble. But that was known when they all signed up for the single currency project. In return, they got their sovereign yields down to the level of German debt. Corporate cost of capital fell too. What did most countries do with it? They produced real estate investment and bubbles. There was no attempt made to plan for the eventual onset of ageing, slower trend growth and the fiscal burden of having to service a generous pension and welfare system.
In a democracy, it would be difficult for any leader—let alone Angela Merkel —to convince her voters that they should throw good money after bad money, especially when Greek politicians and the public were more focused on blaming Germans for failing to come to their rescue than on owning up to the situation and taking charge of it.
When I asked my fixed-income analyst-colleague last week before setting off for Mumbai on a personal visit if he would endorse buying Greek sovereign bonds on a speculative basis, he shook his head vigorously. He said that back in 1998, when the South Korean president announced that his country was in crisis, he literally rolled up his sleeves and exhorted his countrymen and women to get down to work. They did. They gave up their jewels and personal savings for the government to bail out its banks (who else?) and the economy. He said that he saw none of that in Greece and hence he felt no urge to recommend Greek bonds to me.
My colleague would be rather pleased to know that he is in very distinguished company. Writing in VoxEU, Barry Eichengreen spells out four things that Europeans have to do. The first in the list is that Greece should be encouraged to reach a social consensus on reforms and restructuring. The second is that Portugal and Spain must do more to convince markets that they are not Greece. Third, the European Central Bank must support their (Portugal and Spain) bond markets. Fourth, Germans need to support European growth by spending more.
There is not much to quarrel with this quartet of recommendations. Had Greece done this instead of admitting to successively higher budget deficit estimates, the problem would not have exploded into an existential crisis for the euro zone. To blame the Germans for their reluctance to stump up cash without any strings attached to it or to blame the European Central Bank for not announcing an unconditional purchase of sovereign debt of the countries in the line of fire is to betray the mindset that still prevails in the financial world that liquidity and easy money would solve all problems.
The great moderation of economic cycles was an outcome of serendipitous factors that happened at the same time. Commodity prices were in a downward trend, the power of labour unions diminished, inflation rates declined and so did interest rates. It was not so much central banks and financial innovation that delivered two fortunate decades for the West in the 1980s and 1990s.
As these conditions exhausted themselves due to many other developments (the rise of economic growth/aggregate demand in the developing world, just to name one), economic policymakers and the financial industry not only failed to read the tea leaves correctly but are sticking to a vain attempt to restore their halcyon growth days through low interest rates. They got the crisis and yet they are at it, again.
To be fair to them, they deliver what they think we would accept. In democracies, voters get the government they deserve. In modern-day, low-interest rate and high leverage-aided capitalism, investors and the public earn what they deserve. We have lowered our pain threshold in a world of instant gratification and hence policymakers are afraid to administer pain. The result is going to be lower growth, higher inflation, rising interest rate trend and more frequent boom-bust cycles.
What do smart investors do in these times? They have to learn to think of three months as the long-term horizon. Further, they should take note of the performance of the yellow metal last week.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org