Michael Cembalest of JPMorgan booked a trip to Manitoba during the Thanksgiving break to speak with an authority on energy matters in the university there. His efforts produced a concise nine-page note for us. One of his key messages was this:
“…almost the entire future increase in oil supplies projected by the EIA (Energy Information Administration) is based on unconventional supplies (tar sands, deep-sea drilling, enhanced oil recovery, oil shale, etc.), with the word ‘unconventional’ being shorthand for ‘more expensive’…. In the long run, as we outline return expectations for the future, uncertainties related to energy availability are yet another reason why price-to-earnings multiples may remain well below their historic averages. A break in the chain of unfulfilled promises from breakthrough technologies will be needed to alter this view.”
Michael Feroli of JPMorgan wrote that the share of US national income going to labour as opposed to capital has hit an all-time low. Further, the labour market used to behave anti-cyclically. That is, in economic downturns, the share of income going to labour used to rise and vice-versa. It is now pro-cyclical. The decline in the labour income share and the change in its counter-cyclical pattern both commenced in the 1980s.
Photo by Bloomberg.
It was in the 1980s that the Reagan-Thatcher conservative counter-revolution started. Economic liberalization and deregulation were applied thoughtlessly to the financial sector as well. As finance began its domination, most of the established patterns of economic cycles began to go awry. Whether or not Mrs Thatcher intended to celebrate instability as much as she wanted to celebrate inequality, the former was and had become a permanent uninvited guest in the world economy—the legacy of financial liberalization that accompanied globalization and economic deregulation.
One of the key strengths of capitalism was its underlying principle that those who took risks had to accept the consequences that come out of it—namely, to scoop up the rewards and to accept the losses. Starting with the bailout of Chrysler Corp. in the 1980s, followed by periodic rate cuts whenever the economy appeared to be losing momentum, bailouts became the norm in the US. This happened alongside the growing encroachment of the financial sector into national and international economies. The US, given its stature, set the rules of the game, and other nations—particularly in the West and in East Asia (that was one of the reasons for their crisis in 1997-98)—had to follow them, either reluctantly or willingly.
It is this financial sector that has again been bailed out by the European policymakers. In their latest balanced budget accord, private sector loss-bearing has been diluted considerably. It is almost a non-starter. Many academic types are now piling up pressure on the European Central Bank (ECB) to lend money to the governments in distress. The fact that loose central bank policies in 2002-2004 set the stage for the 2007-08 crisis does not bother them. The fact that China is struggling to contain the effects of its credit boom is of little relevance to them. The fond belief that more money would solve the problems created by money is so transparently illogical and suicidal that the failure to grasp it is inexplicable.
Further, they overlook the contradiction in their recommendations. If there is genuine fiscal union and commitment to a balanced budget and if the private sector is not going to be burdened with losses (they will only be rewarded with gains), what is the need for ECB to finance their borrowing requirements? If ECB does, it is going to be used only to repay the loans taken from banks for which taxpayers in these countries would pay with austerity. Bank chiefs, now with their balance sheets repaired and restored, can continue to pay themselves bonuses for the deft management of their personal career risk.
It would also add more fuel to the inflationary fire that is still smouldering due to the fact that the era of cheap resources is over. Developing countries are directly in the line of that inflationary fire. India and China are particularly vulnerable to resurgence in inflation in 2012. Capital inflows will cause developing economy currencies to appreciate again. Some will signal the end of their patience and launch their own countermeasures. Think trade protection, capital controls and renminbi devaluation. When the US, the UK, Europe, Switzerland and Japan are playing the only game in town, it is hard to expect China not to join them even if it is uninvited.
That many of us seem to think the printing of euros by ECB will solve the European problem reflects our discomfort with and reluctance to face the truth. Asset-price inflation is both familiar and personally comforting, no matter how many unpleasant side effects it causes. The logic of self-preservation is more powerful than economic wisdom.
It would be fitting if the year ahead puts an end to several undesirable trends that began in the 1980s and if, in the process, it lit a bonfire to the vanities that stalk financial skyscrapers, academic hallways and policy portals.
V. Anantha Nageswaran is a senior economist with Asianomics. These are his personal views. Comments are welcome at firstname.lastname@example.org
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