Friday, 13 March 2009


13th March 2009

The Malta Independent - Friday Wisdom

In last week’s article I said that “the minister, and government generally, are exhibiting a whiff of undue optimism, based more on hope rather than reasonable expectations, that our economy can get through this international financial turmoil and consequential recession, with mere superficial damage”.

When I read it I said to myself that I made an under-statement. It is more than a whiff. It breaks your nose.

Let no one have any doubts. This international recession is not like anything we have been through before in our lifetime. This is not just a deeper cyclical recession. This is a global banking crisis and before the banking crisis gets fixed, the economy cannot recover. On the contrary, starved of credit it will continue to spiral downwards.

I happen to belong to the school of thought that believes that only mass nationalisation of banking systems in countries that suffered the credit crunch, the US and UK in particular but not exclusively, can restore the banking system to anything like normality. Only nationalisation can offer the possibility to clean up the banks from their toxic assets, re-sanitise them with strong capital and render them capable of being re-privatised to start sending a normal flow of credit through the financial plumbing system of the world. Only nationalisation can deliver a strong and clean banking system with the necessary speed before the recession turns into an ugly depression.

I am not suggesting that governments should become bankers deciding the allocation of credit, although frankly it is difficult to do a worse job than investment bankers did these last three years. Governments should stick to the business of governing and privatisation should be a top priority for nationalised banks. But it is governments’ duty to clean up the banks with speed and determination and it is their duty to regulate banks to ensure that they operate in a manner which does not endanger the whole system. No bank should be considered too big to fail and if a bank ever gets too big to fail, governments have to penalise such bank with high taxation to ensure that the taxpayer is compensated for offering an implicit guarantee against failure.

Cleaning up the banks, however, is only the start of what needs to be done to get ourselves out of the economic woes which have engulfed us once consumers’ and investors’ confidence were blown away to pieces with the collapse of Lehman Brothers last September.

The ultimate cause of these economic woes was the structural imbalances that were allowed to accumulate in the global payments and trade system. The ultimate cause was that America has over consumed and China has over saved. America’s over-consumption has enabled many Chinese to get out of poverty but this could only work as long as China was willing to lend their surpluses at cheap rates to the Americans so that they can spend it all over again on Chinese goods manufactured by people who were pulled of rural poverty into urban jobs in China’s new cities. That could not go on forever. The poor cannot finance the rich forever! And now that it has collapsed, health can only be restored in a sustainable manner if there is a reversal of past excesses.

We need a global deal whereby the Chinese start consuming and Americans start to save. China has to spend its accumulated surpluses and in so doing become a net importer to stimulate the economies of the West without the latter having to resort to more consumption and more debt. If excessive debt has actually gummed up the US financial system, more debt cannot possibly produce a lasting solution.

China needs to be persuaded that it is in its own interest to stimulate consumption in order to keep its own economy growing at the double digit rates they were used to and that Chinese authorities themselves consider necessary to maintain social order and sustain the process of economic enrichment. They can no longer depend on the US consumer to stimulate such growth. They have to stimulate their internal consumption by building a social network to persuade Chinese workers that they can safely reduce their savings and spend more on their current wellbeing. China domestic consumption can only be spurred if they abandon their policy to peg their exchange rate to the US dollar and so let their currency appreciate to external value that reflects their efficiency gains. It is in their interest to do so if they are to switch from being net exporters to net importers.

This will not be without consequences on the US side. Without the Chinese readily financing their deficits, the US will have to finance their own by promoting less consumption and more saving. So US economic recovery can no longer depend on consumer demand and has to switch to export demand which is the other side of the coin of the shift in China from export-led growth to domestic-led growth. For this purpose we have to see a sharp reversal of the strength of the US dollar seen since the financial turmoil began.

If you want a marker of whether there is progress being registered in resolving this crisis, the value of the US dollar is a good marker. If the US dollar keeps strengthening it means that things are getting more serious. If things stop getting more serious we will see the US dollar weakening, eroding the strength it has artificially accumulated these last six months, giving a chance for the US economic engine to shift from consumption mode to productive mode.

It is good that we are going to have a G20 meeting in London next month where the major economic players can discuss, agree and hopefully implement a coordinated response to get us out of this crisis. But the force of the numbers shows that the core of such a strategy has to be based on Chimerica i.e. China and America. Unless these two economic giants somehow agree to a coordinated approach which basically unwinds the excesses they worked out between themselves in the past, it does not matter what the others do. Japan, Europe and other invitees for the G20 meeting do not have the force of numbers to work their way out of this mess, if China and America do not lead this effort in the coordinated way indicated.

So tiny Malta is at the mercy of the global players and there is pretty little we can do to repel the consequences of an international recession, other than show a deep sense of solidarity to ensure that the adjustment pain does not fall only on those that get directly affected and to undertake sensible investments, in the physical and human capital, to ensure we are ready to maximise our potential as soon as the recession reverses.

It is for this reason that I maintain government is being capriciously optimistic in expecting we can get out of this recession with mere superficial damage. There are no easy solutions but it is definitely not a solution to play down the economic troubles about to hit our shores. The crisis offers opportunities to be exploited for the long term but this does not diminish the adverse impact in the short term.

We should be thankful that our deep-rooted culture of thrift has protected us from the immediate consequences of the international credit crunch and has kept our banking system working in a perfectly normal manner. I write off street complaints that local banks are unduly tightening their lending standards as appropriate measures to cool down the over-supply in the property market which would have been necessary even if there were no international credit crunch.

We should be thankful that our public accounts, unlike the experience of other major countries and trading partners, have not been put under pressure by crisis demands to recapitalise the banking system.

But nothing suggests that we will be spared the consequences of a deepening international recession consequential to the credit crunch. It is only a matter of time lags. Credit crunch consequences are felt instantaneously, international recession consequences are felt with a time lag varying between six and 12 months. The absence of credit crunch consequences should not give us any false sense of security that the consequences of the international recession can be escaped. They cannot and we will know it soon enough as spring turns into summer, unless Chimerica raise up to their responsibilities to save the world.

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