Friday, November 04, 2011

We have reached the point of perpetual economic crisis

Today’s G20 non-event in Cannes showed just how impotent the global political leadership is – China included – in fixing the European debt crisis. That Europe and the US are not engulfed in this mess as directly as Eurozone members is in part due to their independence from a currency perspective; and in part due to their swashbuckling (some would call it reckless) approach to dealing with the crisis through quantitative easing. The problem is the same for all western developed capitalist liberal democracies. They are all leveraged to the hilt.

At the end of the day, it comes down to resource distribution – raw materials, be that oil gold, copper, or other commodities. If you have those resources in sufficient supply, then you have a fundamental wealth that can support the economy. Labour as a resource long disappeared as a significant asset because it cost so much. Knowledge as a resource – intellectual property, patents, researchers, education – has not managed to fill the gap that Globalisation has created.

Since the end of the Second World War, financial instruments and derivatives of increasing complexity have evolved to take advantage of an increasingly interconnected economic environment all over the world. Governments have taken advantage of this to maintain growth, and therein prosperity, peace, and most importantly of all – power. Power is its own master. It protects itself, it serves itself. And those who seek it always serve it. When their usefulness to the prosperity of power is expended, they are cast aside.

Governments and societies first cultivated domestic economies through resource balancing in globally competitive environments. They were able to subsidise one industry where labour rates were uncompetitive with another where oversupply was commonplace – like mineral production or farming. Ultimately, however, this was unlikely to persist. Growing populations meant that farming was unlikely in the long run to provide oversupply and that food derivatives could continue to be exported profitably and competitively. Minerals and other natural resources ultimately run out. The knowledge economy, a phrase coined by Peter Drucker in 1992, became the panacea to cure those ills.

Wealth, and resource, is a zero sum game. There is only so much of it to go around. We cannot manufacture wealth from thin air. This, however, was what economists and economic engineers were able to do. They did this in a number of ways. First, they mortgaged the future, borrowing against future income, predicating their maths on future growth, and accepting effective slower increases in general wealth in return for a less volatile path. The basic presumption was that growth would inevitably continue in the long run, and if that was somehow compromised by events such as war, severe depression, or some other globally impacting event, then the “long run” would simply become longer. For the last 100 years, equities and all other financial instruments have performed positively – so long as you take a long enough view.

Armed with these financial instruments, successive governments increasingly leveraged their states. Some time in the early 2000’s, western liberal democracies reached their peak. They could be leveraged no more. The “long run” became finite. They were dependent on perpetual uninterrupted growth at the risk of significant crisis and default. When the subprime property crash hit the market in the US in 2008, the global financial system shuddered.

Quickly, the US began printing money. That effectively began to devalue US wealth in a global context, but allowed the illusion of domestic prosperity. Imported goods began to grow more and more expensive, but a reasonably broad domestic industrial base allowed native foodstuffs and other goods to supply domestic demand. Gas prices have kept on rising, which is the one real element of the US economy that it has less control of. Many would argue that this is at the heart of their middle eastern policy. Lehman brothers imploded as its exposure to the domestic economy – and in particular to the property market – was too great.

In the UK the effects were felt pretty immediately. The Eurozone economies began taking on water also as banks that were exposed to overpriced domestic property began to fail in Iceland (not in the Eurozone, but openly integrated with UK and Eurozone investments), then Ireland, then Greece. Sovereign credit was denied these countries as they scrambled to make some coherent structure of their sovereign accounts. It was an almost impossible task. On the one hand, fundamentally underperforming economies were structured (particularly in the public sector) to support much more prosperous ones, requiring painful readjustment. On the other, these economies were suddenly aware of massive debts that would have been eyewatering in the good times, if anyone had cared to look. With massively reduced growth prospects, and readjusted economy sizes in absolute terms, the debts are simply unsustainable on an individual country level.

All current efforts are geared towards stabilizing the ship. The volatility in the markets is bad for business, bad for growth. Getting back to manageable debt burdens and reasonably balanced national budgets is good, right? Well, no. That, essentially, brings us all back to 2007, still leveraged to the max, and waiting for a single shock to the system that will send us all reeling again. The efforts today will not build into the system any real change, as the political leadership doesn’t have the capacity or the will to effect that change. The cycles are too short; the impacts are too wide ranging and long term to be of consequence.

The debt, of course, is real. The wealth belongs to someone. That’s China, it’s the Middle East, it’s other resource rich countries. They have an interest in seeking adjustment, because business ceases entirely unless a reasonable structure can be found for overburdened sovereigns. But they have no interest in restructuring the entirety of the international credit system. That would – essentially – undermine the basis for their current wealth, and involve some kind of global redistribution of debt. And even then, there is no real answer to what system replaces it.

And so we find ourselves in perpetual crisis. Any need to increase leverage will be met with consternation by the markets. Any failure to deliver on basic growth numbers will be similarly frowned upon. Any “boom” will be characterized by transience and caution; any bust will be dramatic and painful.

Perpetual crisis will be socially unsustainable; but, folks, at least the air is free J

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