Now that growth is petering out in the developed world, inflation has become a difficult problem in emerging markets, the US government debt has been downgraded, European governments are forcing austerity down the throats of their people and comparisons with 2008 are being made, sceptical noises from a couple of years ago have acquired quite a prophetic ring. Instead of writing afresh views that have been said before, I’m taking the lazy way out and reproducing here the relevant excerpts from earlier columns.
Here’s one from December 2008, in a column with the nifty title “Kafka and the global financial system”: “Here’s where the game reaches its apogee of zaniness. What are policymakers doing to solve this problem created by this explosion of debt? Why, try their best to reopen the casino, urge US consumers to continue spending, flood the markets with money so that its cost comes down and people start borrowing again. Private debt is being replaced with public debt. They are desperately trying to pump air back into the bubble.”
What would be the result of the attempt to reflate the economy? A column in April 2010 with the heading “Shorter booms, more frequent downturns” approvingly quoted a report by the Economic Cycle Research Institute (ECRI) in the US: “Here’s its main thesis: ‘It is clear that the trend rate of growth during expansions has been falling for decades, with the 2001-07 expansion showing the lowest trend growth of all.’ They say that this trend is very likely to continue. Moreover, they also predict that volatility is going to increase, simply because the days of ‘The Great Moderation’, which saw low inflation and low interest rates, are behind us. This cocktail of higher cyclical volatility and lower growth during expansions, says ECRI, means just one thing: more frequent recessions. In other words, the expansion may be strong, but it isn’t likely to last long.” The column concludes: “The moral of the story is clear: Enjoy the cyclical rebound, but don’t expect the boom we had last time.” That was bang on target.
Here’s another rant against the partiality for band-aids and the avoidance of real reform, from a November 2009 column called “The real new normal and a paradigm shift”: “What has been the recent experience? Far from trying to usher in a new normal, governments and central banks have been trying their hardest to get back to the old one. If too much debt was at the centre of the crisis, their governments are busy taking on more of it. If too much leverage was what brought about the crash, leverage is being built up in new ways, such as the dollar carry trade. And there is precious little talk of putting a bit of sand in the wheels of speculation.”
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And in October 2009, when a sharp rebound had taken place, especially in emerging markets, this column had appreciated a report by Larry Cantor, head of research at Barclays Capital. Here it is: “The strength of the initial recovery surge should limit its duration, as typically occurs in V-shaped business cycles.” He says when investors come to believe that policy will be reversed, the sweet spot will end and the markets will find the going much tougher. That is exactly what happened.
But perhaps the most prescient, in the light of the US downgrade, was a column in March 2010 whose title said it all—“Risk has shifted to the developed world”. Here is its rather apocalyptic start: “The North Atlantic financial crisis has shown that the biggest risks to the global financial system lie not in the periphery, but in the heartland of capitalism.” And this is the telling comparison it made: “Greece, which was at the centre of the recent crisis in the European Union and which has a fiscal deficit of 12.7% of GDP (gross domestic product) and a public debt to GDP ratio of over 100%, has a rating of BBB+. Contrast Russia’s public debt of less than 10% of GDP and its rating of BBB. Or contrast India’s consolidated debt to GDP ratio of around 80% (with practically all the debt being domestic debt), its 8% GDP growth rate and its foreign exchange reserves of around $280 billion (around Rs12.76 trillion) and its sovereign rating of BBB-.” The column pointed out that John Lipsky, first deputy managing director of the International Monetary Fund, said that all the G-7 countries, except Germany and Canada, will have public debt to GDP ratios close to or exceeding 100% by 2014.
I have just pulled out, from earlier columns, some of the things that now seem right—I’m sure there have also been plenty of misses. The fact remains, though, that while in 2008 there was some hope that these policies would work, the market is far more sceptical now. That is not to say the market will not rebound from current levels. The recent Bank of America-Merrill Lynch survey shows there’s plenty of cash with fund managers, so a rebound is quite likely. But in the longer term, the world may have to get used to a long period of lower growth.
Illustration by Shyamal Banerjee/Mint
Manas Chakravarty looks at trends and issues in the financial markets. Comment at firstname.lastname@example.org