U.S. Treasury Secretary Henry Paulson stated on 27th July, the week in which stocks in the US saw its steepest fall in five years:
“Now I believe what we’re seeing is a strong global economy. This is the strongest global economy I’ve seen in 32 years. The growth rate in Europe has doubled. We’ve got growth throughout Asia. Japan is now growing, so I think this is being driven by strong growth outside of the U.S.“
Is something fundamentally different indeedÂ this time which forced a veteran like Paulson to state â€˜strongest global economy in 32 yearsâ€™ â€“ since 1975?
Forecast by IMF has again given almost 5% global economic growth rate for 2008. The traditional cycle of overheating so far didnâ€™t apply in China, and quarter after quarter its economy rather seemed to be accelerating, now reaching almost 12%. Asset prices all over the world, barring only gold and crude historically, did hit new highs with adjusted values of dollars with crude and oil historically.
And talks about economic imbalances â€“ US deficits to Chinaâ€™s forex reserves â€“ and their sustainability often get mentioned while examining the sustainability of present world economic growth.
However the other side of the story, with another news-article (couple of days back only, I donâ€™t remember the source now) narrated a story on how ordinary Japanese people are suffering with the example of a 54-year old lady contractual teacher, who barely survives with the free lunch she gets at school, worth otherwise 200 yen-a-day. That article further analyzed how Abe government became unpopular within years of coming to power. Superimpose this picture with the reality of Yen-Carry trade and 0.5% interest rate in Japan, after years of zero-interest rate; and some +ve economic activities in Japan lately.
And hundreds of similar stories like that of the Japanese teacher asked questions whether economic growth benefits all. Many stated a rising tide does not lift all boats; and Warren Buffet suggested that all boats are rising; but the yachts are rising faster.
And the question that comes from this other side of the story is, if indeed global economy is in its strongest as per the measure of the economists; is it getting translated verbatim in the living of the ordinary people of the world â€“ from US to Japan to China to India to everywhere?
So there remains essentially two questions (1) How long this growth would be sustainable and whether it indeed is different this time (true, a stupid notion), and (2) Whatever drives this growth; has it been good for the vast majority. If not; why so again?
Finding answer of 1st would help us explain 2nd question as well.
Back in June, taking cues from above facts, Moral of stocks up & housing down story appeared in BNN. Since then housing problem in the US has only worsened; and stocks, in-spite of their last week plunge; have decreased marginally. In the month of Mayâ€™07, Dow Jones Industry Average touched 13K figure for the first time.
Another fad of the business media in between was to report on unsustainably high valuation of Chinese stocks. â€˜Bubble in China? The answer is both â€˜yesâ€™ and â€˜noâ€™ covered those aspects, and since then China has also gone through some increased volatility; however no major downfall has been seen till now.
But none explain extensively the secret of this strongest global growth in 32 years. Have the economist (read Central Bankers) have suddenly found a magic potion on how to run the global economy better; or is it a mere accidental combination of factors that have fueled this so far â€˜high-growth-low-inflation-era-with-economic-imbalancesâ€™, both within countries and more so within societies?
Simple questions seldom get any simple answers â€“ these indeed are most profound. And probably no â€˜rightâ€™ answer exists to above questions.
However chances are, both the alternatives (central bankers getting it right with coincidental developments) are right. Yes, indeed central bankers have played a role with easy liquidity; and China did offer a conducive environment by converting liquidity to productive assets, thereby giving a helping hand in controlling global inflation.
However another transition is taking place in-between. The definition of capital itself has undergone vast changes with easy liquidity. Spurt in interest rate in few major economies didnâ€™t spoil the party of easy availability of liquidity (very lately, in-spite of liquidity being there, risk aversion caused by closure of hedge funds of Bear Sterns in subprime mortgage market has prompted less buyers of risky assets. However liquidity, without any doubt, still remains strong).
Capital so long meant resources â€“ human or natural or even monetary ones (fiat currency, post Bretton Woods period). However seldom did we see an era when a vast majority of the capital created in human history originated primarily from the fiat currency part.
Capital (or resources) has now come to a status that can be created as much as Central Bankers of major economies (by ensuring first adequate domestic supply of goods) wishes. However flow of those monetary resources must be controlled, to keep a tab on inflation. So Japan still manages low inflation with 0.5% interest rate and tremendous liquidity with money flowing out in the form of â€˜yen-carryâ€™ trade; China manages inflation with investment boom in-spite of tremendous inflows and now planning its investments outside China to ensure the huge cash reserves are utilized elsewhere; US, in-spite of being a borrower sees its investment bankers acquire physical/financial assets in lucrative overseas markets.
It effectively means:
- Ensure adequate domestic supply of goods (for China or Japan) or a strong currency (for US to keep costs of import low) to manage inflation. Lately though dollar has weakened a bit; the weakness is not of any significance compared what fundamentals suggest.
- Once major economies and its Central Bankers achieve above, keep on creating resources through fiat channel. Print as much money as you can; but ensure much of that money is invested overseas in countries with weaker currencies. The world essentially does not mean the G-8; and much part of the world still remains starved of all the three categories of resources (human, natural or fiat currency. Natural resources, even if they exist, remain undeveloped).
- Thereby major economies ensure that it owns up real resources (natural ones) in those underdeveloped parts of the world through artificially created ones; and by manipulating forex rates. Chinaâ€™s acquisition of assets in Africa is a glaring example; and so are US investment bakers backing real estate sectors in India.
- So China invests heavily in Africa (no major economy with fiat strength there or with a strong currency); Japan does it all over, and US does it in China, India and to all over within its allies. The assets they acquire eventually come from either the poor governments; or the â€˜have notsâ€™ of those underdeveloped countries/societies. So the â€˜havesâ€™ acquire physical assets against fiat assets.
Effectively by this â€˜magic potionâ€™ formula of easy liquidity; central bankers of major economies can ensure their country owns up more and more assets all over the world. Asset â€˜Aâ€™ in the US and Japan costs much more than same asset in India or China; and it even costs less in most of Africa. So similar natural resources, true with different geopolitical risks, get valued differently when measured with â€˜artificially created resourcesâ€™ in money markets.
The 2nd thing is, barring China, nowhere does firms report losses as they used to do historically. Auto-sector in US does face some troubles, but those are not from operations alone but more to do with employee welfares. Outputs of firms are already priced quite high; global demand also remains robust as increasingly the large section of â€˜have nothingsâ€™ slowly converts to â€˜have notsâ€™ and to some extent to the â€˜haveâ€™ section. So as long as firm output prices donâ€™t come down substantially; firms even at present level of prices would make enough profits, with expanded capacities as well. And therefore inflation would be controlled; as China has done to the world.
Demand was always there; enough supply was not. As of now, creation of supply has not yet overtaken that demand to ensure that firms face pricing pressure; which in turn can cause firms to make losses; as business cycles usually meant historically.
So an expanding monetary policy where Central Bankers create resources or capital works well for all. The only victim, if any is nature as more the artificial assets we create with money supply; more is the demand generated and supply created (because pricing supports supply assuring profitability) from natural resources; and more is the pollution, Green House Gas emissions.
Nature never allowed any to consume today fruits of tomorrow. But when central bankers create resources with fiat money and still be able to contain inflation because existing price levels and demand justify that; we allow nature to suffer faster.
Much of the borrowings would never get repaid ever â€“ be it by government or by firms. However no one is certain of the consequences when we borrow from nature beyond what nature can provide us in a sustainable manner; and ten we donâ€™t even pay back. Government can run with perpetual debt; nature canâ€™t.
The cost we pay to the nature for unsustainable borrowings may be much more catastrophic than the interest rate we pay on debts.
With still 3 billion people belonging to different categories of â€˜have notsâ€™ and therefore demand being there, firm profitability being higher and therefore encouraging more supply, liquidity being high to drive investments; the only real dampener, barring geopolitical risks that can topple this strongest growth cycle can only come from nature.
And itâ€™s already happening.
And that partly explains why yachts are rising faster than boats in this economic growth cycle where we borrow more and more from nature to drive the strongest growth in 32-years. When central bankers can drive economic growth with easy printing of fiat money; the process logically continues with anyone with little ability to borrow by writing future checks.
People who could not borrow; people who consumed tomorrowâ€™s fruit tomorrow and not today; mostly remained left behind from this economic growth. And they again get affected first and the most as Climate change hurts â€˜have notsâ€™.
Ranjit Goswami is a research scholar with the Indian Institute of Technology (IIT), Kharagpur, India; and is the author of the book â€œWondering Man, Money & Go(l)dâ€™â€œ.