The Group of 20 (G-20) meeting of finance ministers, in preparation for the G-20 summit to be held on 2 April was held over the weekend. They promised fiscal stimulus and yet signalled their focus on sustainability. They promised conventional and unconventional monetary policy easing until recovery arrived and yet were determined not to harm price stability. In short, the communiqué released at the end of the meeting promised the world that G-20 finance ministers, short of walking on water, would do everything else to restore global growth. So far, so good.
What was missing was the commitment to change the approach to financial industry and financial markets that are at the heart of asset price bubbles and busts. That is the commitment to target asset prices either directly or indirectly via targeting credit growth rather than focus on consumer price inflation. As George Cooper framed it so well in his book Origins of Financial Crises, standard consumer goods and services inflation need not be targeted at all, given rational human response to rising prices of goods and services. They are mostly self-regulating. Investors behave differently when it comes to asset prices. They buy more of the asset whose price is rising and sell more of that whose price is falling. That is inherently destabilizing. That requires a focus on the underlying fuel—liquidity, easy money and credit— which drives such behaviour.
Prof. Michael Pettis told me in Beijing last month that, in his book Volatility Machine, he has documented how all the previous six episodes of globalization were derailed by liquidity crises. Therefore, the all-important questions of whether policymakers are alive to the dangers of excess liquidity and are cognizant of its manifestation in many forms remain unanswered. Sometimes, it could be asset price bubbles, sometimes it could be asset price bubbles fuelled by credit growth, sometimes it could be carry-trade or low risk-premium (relative to history) on risky assets, sometimes it could be low volatility.
There has to be a smorgasbord of indicators for the policymakers to track and a willingness to tackle those excesses at the incipient signs at a nascent stage of such excesses. The willingness to re-examine the reliance on asset prices to support growth, employment, incomes, etc., was missing. That is disappointing, for it confirms that in dealing with this crisis, policymakers are comfortable using the same medicine that caused the disease in the first place.
Further, what was missing was the recognition that specialization of nations in either manufacturing or services to the near-total exclusion of the other has not worked. Yes, we know about the theory of comparative advantage on which international merchandise trade is based. I am not sure that the automatic extension of it to specialization in manufacturing and services is theoretically well founded. In any case, the empirical evidence of the last eight years is that the theoretical foundation, if it existed, was weak, at best and flawed, at worst.
Emphasizing services and outsourcing manufacturing condemns a nation to perpetual deficit in merchandise trade and the borrowings made to finance that push and expand the overall current account balance, too, into the red. That, over time, builds up into an unsustainable imbalance. Similarly, countries specializing in manufacturing initially do that due to their natural cost advantages. Over time, as rising incomes and wages erode these advantages, they resort to manipulation of exchange rates and other input costs to maintain export competitiveness. That distorts prices and resource allocation in the economy while resulting in accumulation of foreign exchange reserves beyond reasonable limits.
Despite the cyclical collapse in the US merchandise trade deficit, these imbalances have not been rectified. Presumably, they were not discussed in the G-20 meeting. It is impossible to rectify them without the global currencies undergoing major realignment.
With household spending contracting (without a larger than usual seasonal adjustment factor, February retail sales would have contracted 1.5%, according to Merrill’s Rosenberg) and with the sectors that created jobs in the six years up to 2007 in contraction mode, there is no sustainable growth in the US without exports spurred by a substantially weaker dollar. The longer it takes this outcome to arrive, the more violent it is likely to be when it does. On the other side, China is unable to either swallow (add more) or spit out (diversify) the reserves it has without hurting itself. The result has been stalemate. It means that the market would do it for China one day.
For investors, it means holding their cash in a diversified basket of currencies with only a minority allocation for the two major currencies—the euro and the US dollar. For the umpteenth time, Bare Talk stresses the case for gold in preparation for this eventuality. It is good to have fire insurance. The insurance is a small consolation if the fire accident strikes. If the accident does not happen and the premium is expensed, investors should be happy. That should be their attitude to gold.
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