A race to the bottom4 min read . Updated: 08 Dec 2008, 10:41 PM IST
A race to the bottom
A race to the bottom
India on Sunday was the latest to cut interest rates. In Asia-Pacific, we saw the Bank of Thailand cut rates by 100 basis points to 2.75% and the Reserve Bank of New Zealand drop rates to 5%. Both of them promise more. Riksbank in Sweden cut rates by 1.75% while the Bank of England brought its base rate down to 2% from 3%. The European Central Bank cut rates by 75 basis points down to 2.5%. It is dizzying stuff, literally.
Interest rates are not just about maintaining growth around trend and inflation below tolerance levels. They equilibrate savings and investment. Low interest rates in chronic savings-short countries risk perpetuating that imbalance. Bad investment choices will be made. They were made in the US and they have been made in China, too, where interest rates, in real terms, were too low for too long. We are seeing more of the same now. Intellectual bankruptcy has outpaced the rise in financial bankruptcy.
We are reminded of an observation by the German chancellor a week ago. “Excessively cheap money in the US was a driver of today’s crisis," Angela Merkel told the German parliament. “I am deeply concerned about whether we are now reinforcing this trend through measures being adopted in the US and elsewhere and whether we could find ourselves in five years facing the exact same crisis."
Further, it is not even sure that these measures can stem the deleveraging that is both inevitable and necessary at some level. Adequate debate on the policy balance to be struck between allowing forces of creative destruction to play their part and unleashing the ameliorative powers of the government has not taken place.
Indeed, sometimes recessions are good cleansers. Those who can bear its pain must do so with necessary adjustments in lifestyle, while the state finds ways to support only those who feel its pain the most and who need support in coping with it.
Instead, the response of policymakers has been to avoid recessions as though they are plagues to be resisted at all costs, instead of harnessing their cleansing powers. Academic opinion in the US, too, has pushed this line on policymakers without debate. For a country that has a zero savings rate, the obsession with the post-Thanksgiving sales turnover as a sign of economic strength is a reflection of misplaced priorities. The attempt is to restore growth as soon as possible while numerous studies have shown that there is very little correlation, let alone causation, between growth and happiness.
The slowdown has distracted critics of the global financial architecture that has developed over the last two decades and provided policymakers an excuse to look dynamic and decisive, while deflecting attention from the errors that were responsible for bringing the world economy and financial markets to their present state.
In the past, academics, particularly from the US, denounced the gold standard for its policy straitjacket that precipitated bank failures in Europe and huge unemployment in the 1930s. Yet, without the policy-fetters-imposed gold standard, global fiat money printers have managed to create a banking and financial crisis.
Further, we do not know how in the world of climate change and vanishing hydrocarbon reserves rapid growth can be sustainable. Even a cursory reading of the International Energy Agency’s World Energy Outlook 2008 is a must for all of us. IEA, by no stretch of imagination, is in the camp of “peak oil" theorists. Yet, they are quite bemused about how the world appetite and habit for hydrocarbons can be met given emerging supply constraints and environmental considerations. In a way, the current slowdown is a welcome break from the oil price of $140 per barrel. Yet, policymakers are acting as though they cannot wait to have it back.
In the meantime, as the recent employment data suggests, the US is deeply entrenched in the economic malaise now. Every day, the US stock market has meaningful action in the last hour or two of trading, aided and abetted by leaks, innuendoes and unspecified government action with the support of friendly media outlets. One is at a loss to understand if these were the right lessons to learn from the crisis.
Yes, the Great Depression was bad. But housing and mortgage finance boom and bust followed by a fragile recovery laced with sharp inflation acceleration to be followed by a more painful and prolonged slump seems like a worse outcome to embrace to avoid the bad depression.
Central bankers and policymakers are in a race to the bottom—literally. In their attempts to get us out of there, it remains to be seen if they will leave us there, forever. Gold makes eminent sense, logic and is a wise investment choice in these times.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at email@example.com