Well…what now?

Are we back to business as usual again as recession comes to an end with green shoots growing and reaching productive stage with every passing day? Was the collapse of capitalism, free-markets as it’s been mostly known by most so long is purely an isolated non-significant outlier for the near-to-medium future; or it rather highlights the beginning of a disruptive trend as a Black Swan event. That is, irrespective of the drastic measures taken or new regulations formed, irrespective of the green shoots of today, capitalism as perceived by the Wall Street must be ready for more Lehman-like incidents as disruptions increase.  Or even if such sudden collapse is avoided as we saw in 2008, the trend is set by demise of Lehman as a Black Swan event of considerable significance for the future – be it how financial markets operate, get regulated or the role of the symbolic Wall Street on main street and finally on the role of the US as an economic superpower.

The 1st anniversary of the demise of Lehman has seen considerable media debate lately. One thing is for sure. The perpetrators of the collapse, namely The Wall Street breed, irrespective of their knowing the implications of their actions that led to the collapse, have been helped globally by policy-makers and tax-payers to be back on their feet again, be it China (to safeguard its exports by saving the Wall Street) or the US. Wall Street has recovered, however similar signs are missing from many other indicators relevant for the main street from developed economies like the US, Japan or EU.

Question is why? Because economic recovery can only take place if markets recover. And unfortunately, amongst all that clutter, markets also got a new name of the like of The Wall Street all over the world.  Did we ever have a situation when (financial) markets rallied in recession times or vice-versa? Financial markets rather forecast the economic outlook.  Though the correctness of market sentiment can be questioned as Krugman pointed out, there is no denying that  market provides the best simple single overall indicator on a real time (momentary) basis. However as has been found, the momentary picture may not be something correct for the near term and thereby can not be extrapolated as a trend line, and therefore may itself be a outlier in a bell curve over the time. The participants in the market change, the available information change, the herd phenomena change leading to stampedes as it happened a year back or of another form earlier, and with that even the liquidity changes drastically.

We were not much concerned about sustainability of policy-led recovery (again how long is long is questionable as in the long run we all are dead as Keynes stated). The USA has always responded based on the need of the hour, often with a ‘fast-food’ mentality, irrespective of the quality of the food that temporarily satiates the hunger or its long term impact on health. The fire needed to be doused, and it has been doused successfully (unbelievably fast!), for the time being. And due credit is due to the fire-brigade, question remains whether that’s the right role for the Government or Federal Reserve for more than a year. True, it is a small part of the government role, as the bigger role is to set policies and regulations on how such fires can be prevented.

Unfortunately, the fact that the Wall Street has become symbolic of free market economy and they engage frequently in playing with fire with others ammunition and lives with the backing of government as the fire-brigade has been of secondary importance over the last one year.

The measure of recession is linked with the measure of GDP which in turn is linked with the performance of the (financial) markets.  Common people without a deep (formal) understanding on how GDP gets measured may often wonder how the GDP of the US can be more than that of China. One produces more but don’t have the purchasing power, other consumes more with increasing indebtedness (partly from the producer) but can’t produce competitively. Many of these points have been raised by Stiglitz  (and Sarkozy) as the (developed) world debates for the 1st time on the right measure for economic power.

The question therefore is: is the US the largest economic power by all relevant economic measures? There is no denying that it is the biggest consumer, but being the largest economic power and being the biggest consumer – are they effectively the same? Stephen Roach in The Next Asia pointed this out as  power of Asia grew, its dependence on the US also grew at even a faster rate following sort of a trend line so far. He found that although the Americans accounted for about 4.5 percent of the world’s population, their consumption spending totaled nearly $10 trillion in 2008. Comparatively China and India, which accounted for roughly 40 percent of the world’s population, consumed only about $2.5 trillion (but produced nearly $10 trillion of GDP (PPP) basis). More importantly, much of that consumption in the US was supported by the savings of the Chinese. Post Lehman, China has emerged as a net exporter of capital also, that too without the printing press. So whay is a poor per-capita consuming nation exporting capital when it also has the production machine of the world?

The role of China over last twenty years and more importantly in the last one year in driving global economic growth is significant, more so when one views the moderate to low inflation rate that prevailed in-spite of huge growth in money supply globally, led by the US Dollar. If there ever was a competition globally on the all-time best marketing case for a single product (or concept?), US $ will win that without any competition.  In-spite of some conspiracy schools or skirmishes lately, that position has remained in-tact even today. Question is, can the past be an indicator of the future here; or unprecedented developments of unexpected events of utmost significance can alter that much faster as Black Swan events typically do. Can the fall of Lehman be a related event linked with post 9/11 loose monetary policy and subsequent series of events (as new developments take place in Japan and in major European nations where the merit of the relationship with the US is increasingly getting questioned now) be of significant canonical milestones in rise and fall of power?

Most China-watchers would state that it may be another 15-40 years before China can be an equal (economic) superpower to the US. Point is – can events like Lehman shorten the cycle dramatically (unless China makes similar mistakes). The events of Lehman, recession, massive liquidity injection when the US government looked ill-placed to do so, 9/11, recent political changes in Japan, worsening relationship with the EU – all of these when examined as intersectional events than directional ones may strengthen the case of a faster rate of decline of the US (and its dollar and thereby further faster rise of China).

Lot of things had to change for a long time but they didn’t. Foremost on that list was the marketability and creditability of the US $. Free markets still can rule global economy, sans the Wall street types. That free market is not something minorly similar to the present day Wall Street or the quasi-view the US Government or Federal Reserve have about it. Free markets operate like nature where it takes self-correcting steps to rectify a problem (rise of China can be an example of free market economies).   It’s not driven by what the Chairman of the Federal Reserve says, and thereby dances according to the tunes of the Federal Reserve, it rather should be moving in tandem with natural laws. Otherwise there’s no point of studying economies as a subject where both science and arts matter, it purely becomes a subject where the beauty lies to the beholder. The more severe the problem is (unsustainable), the more severe the impact of those self-correcting mechanisms that nature (and markets) normally follow. No one can be sure about the exact timelines or the degree of severity due to the complexity of the natural system. However one can be certain that the natural repercussions are bound to happen.

Unlike global warming as the case with nature, where mankind has agreed on the problem and debating on the ways to cut Carbon foot-print; in case of financial markets – it’s always been the case of implementing a +ve feedback loop to rectify the problem momentarily that further strengthens the problems for a future date. No one has the guts to bell the cat called free market as perceived by the Wall Street, they rather feed it to keep it satiated. True, it’s the same with global warming; however there is growing agreement there about need of sustainable solutions and actions. The only thing that links strongly global warming and a recession is recession is good for the sustainability of the nature. Nature does not give credit, (the US) Government and Federal Reserve can create credit by marketing the concept called US $ all over the world out of thin air.

No wonder that the recession we witnessed lately was solely driven by lack of liquidity as there was nothing wrong with the growth machines (China, Japan, Germany and much of developing world), the fault lied with the dollar producing machines as it needed further capacity addition as prior excess capacity was wrongly played in the casino of the Wall Street. It was added quickly, and for the moment – the recession tends to come to an end. However what now, how long would China provide the greasing to the dollar-producing machine (and so would Japan and EU and OPEC) is a question of time.

True, the possibility that the hegemony of the dollar is nearing its end was raised since the 1970s, and most were proven wrong – time and again. However history shows Black Swan events do indeed occur and shape our world more than regular events. Lehman did fail. Unexpected things happen and impact the world much more going forward than the regular expected ones. More importantly, they happen faster than forecast.

Prof. Ranjit Goswami is with Indian Institute of Foreign Trade, Kolkata, India.

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