2010 – the year of uncertainty
Global Trends
By MARTIN KHOR
The new year will be marked by uncertainty on whether the economic recovery will strengthen or slip, and if there will be a global understanding or anarchy on climate change.
THE new year has been ushered in with fireworks and parties in Malaysia and around the world. It certainly will be an interesting year ahead. How it will turn out is anybody’s guess.
“Interesting” and “uncertainty” are key words as 2010 gets down to business. The first and main uncertainty is in the world economy. The dreaded Depression predicted for last year fortunately did not materialise. The big question is whether the recovery that started in the second half of 2009 will continue and strengthen in 2010, or sputter out, bringing about a new downturn.
The optimists have an upper hand at the moment, because we are in the midst of a recovery. The stock markets are on an up-trend, GDP growth has turned positive in the last quarter in most countries, and property prices are even soaring in some countries like China.
But the pessimists, and they include such heavyweights as Joseph Stiglitz and George Soros, are persuasive in arguing that the crisis of 2008-9 was caused by structural flaws in the Western economies which remain uncorrected and the present recovery is simply due to their being put on artificial life support.
That life support comprises trillion-dollar bailouts of banks and companies, huge government injections of liquidity, very low interest rates and massive fiscal stimulus, or large increases in government spending financed by thumping budget deficits.
The underlying weaknesses (global trade imbalances, over-consumption in the United States, over-leveraging of financial institutions, laissez-faire in the financial sector) remain. And when conditions make it impossible to retain the life support systems, the patient may relapse into a life-threatening state.
The present recovery phase should thus be used to strengthen the immune system and restore health so that the life support can be withdrawn without harm. Instead, there seems to be a return to “business as usual”, with the disgraced financial institutions in the Western countries fighting, quite successfully, to be free to continue most of their former practices, albeit with a little more regulation.
The fact that Goldman Sachs, Wall Street’s biggest investment bank, could reap record profits, and that so many other banks could continue with billion-dollar bonuses for their executives, shows the limited extent to which the governments were in the end willing to instill the required discipline, even on firms that just several months ago received huge government bailouts paid for by the public.
Just a year ago, when the global economy was tethering on the edge, there was a lot of interest in major reforms to the global financial architecture, including strictly regulating the financial institutions and limiting the massive speculative cross-border flows of funds that have led to destructive cycles of booms and busts in developing countries, as capital would first enter in search of quick profits and then move out on the slightest sign of trouble.
Today, there is hardly the same level of interest in correcting the flaws. There is one certainty, however. The American consumers, who were given so much credit to over-spend on housing and consumer goodies, will no longer be able to provide the demand boost to global economic growth, as they are now asked to account for their debts.
Even if the US economy continues to recover, there will be less consumer spending, especially since unemployment is high and growing. The European and Japanese economies are also too weak to take up the slack.
Moreover at some time this year, the major economies are expected to put into effect their “exit strategy”, or withdrawal of the life support of fiscal spending and loose monetary policy.
Although China will continue its high growth (which may reach 9% to 10% according to recent estimates), this is not sufficient to fill in the gaping hole in global effective demand.
As 2010 progresses, the effects of this new reality will be felt in developing countries, especially in South-East Asia, that have depended so much on export-led growth.
Up to some months ago, the countries were contemplating the need to switch to new development strategies that are less dependent on exports to major developed countries. Because of the recovery, they are now waiting to see if they can stick to the same model that served them so well in the past.
It would be wise for them to formulate options for new growth strategies, in anticipation of another slowdown or even recession in the big countries.
The other big issue of 2009 was climate change. Unfortunately the much-anticipated Copenhagen climate conference ended in an anti-climax, without any new or firm understanding on how countries are to co-operate.
The new year will provide a chance for the countries to move beyond the blame game and pick up the negotiations again.
This much is clear. The challenge is not only to come up with a goal of cutting global emissions by 2050 but even more so to agree on each country’s allocation of emissions rights from now to that year.
The other challenge is to ensure that the developed countries live up to their pledge to fund the costs incurred by developing countries in shifting to a climate-friendly development path.
These are huge and complex issues, combining the science of what needs to be done physically with the economics of working out the economic pathways and costs of shifting to a less emissions-intensive development model, and the politics of distributing the burden of adjustment globally.
We might just conclude that the issues are too complex and highly charged for the world to reach an understanding, in which case there will be a fall from co-operation to anarchy, with each country looking after itself, and humanity will hurtle down the slippery slope to doom.
Or else a near miracle may happen, and 2010 could mark the beginning of genuine international partnership. It’s worth striving for. A lot is at stake.
Monday, January 4, 2010
Sunday, January 3, 2010
Rebuilding the world after the twin crises - Obsolete economic thought !
Rebuilding the world after the twin crises
By ANDREW SHENG
FIFTEEN months after the panic triggered by the failure of Lehman Brothers, we should begin the debate how to rebuild the world after the crisis. Several disturbing questions remain. Are we still in the crisis? Should we reform at all? What should we rebuild?
After all, the rescue efforts by the leading central banks have brought financial markets back to almost pre-2007 levels. Commercial banks have been rescued through massive guarantees and liquidity, and interest rates have been brought down to near zero.
There are some who think that 2010 will be a good year with revived growth. Others believe equally fervently that the real crisis has yet to come. Who is right?
Several things are now clearer. We were dealing in 2007/2009 with two simultaneous crises – one financial, the other about climate change. One brought about a shift in the economic power balance, with the G-20 calling the shots instead of the G-7. The other is being resolved through the Copenhagen Round of negotiations. Three fundamental differences define the two crises. The first is that the financial crisis was primarily dealt with at the national level, whereas the climate crisis was dealt with at the global level.
The second is that financial crisis had short-term effects that required immediate action, whereas the climate crisis had uncertain long-term effects, where people do not feel the immediate pain and had no cause to support reform.
The third is that the Copenhagen negotiations confirmed the shift in power to the population giants of China, India, Brazil and South Africa, which brokered the deal with the United States.
The age of juggernauts has arrived
There was certainly a lot of hot air and emotions coming out of Copenhagen, with the African chairman of the developing economy caucus claiming that the amount of money offered by the advanced economies for climate change is just enough to buy coffins.
Those who are dead do not have to worry about climate change, so all the emotion is about what to do with the living.
However messy and unsatisfactory an agreement, Copenhagen is still a major achievement. Globalisation will never be the same again, because there is at last some universal recognition, however fuzzy, that we must solve the threat to climate change. But there is a major divide between the West and the rest.
The trouble with climate change is that all of us are dealing with unknown unknowns. Although the majority of the scientists are convinced that climate change has already passed the tipping point of irreversible damage to the environment, some think that these predictions of doom are a conspiracy to tax the wealthy countries.
The climate crisis and the financial crisis are inter-related, because both stem from excessive consumption of natural resources. The financial side collapsed first, because the West’s excess leverage was not sustainable.
The climate change crisis has a much longer time horizon. It may take 20 to 30 years before the weather change and resource scarcity become visibly so bad that those affected will then support the need for change. By then, it may be too late.
Mankind is like a frog in the pot of water. When the temperature in the pot is raised very quickly, the frog feels the pain and will jump out very quickly to escape. This was what happened in this financial crisis when G-20 acted decisively in the face of an immediate threat of financial meltdown.
However, since climate change is incremental, the frog will not react if the temperature rises slowly, until the moment comes when the frog is boiled.
Rebuilding from the ashes
I was partially wrong last year when I suggested that global solutions would not be as achievable as regional and national reforms.
In 2009, however, there was greater consensus at the global and national levels than at the regional level, but as recovery gathered steam, global opinion has once again diverged. The blame game is now rearing its ugly head.
Instead of being praised for being the first to have a substantial fiscal stimulus to regenerate domestic and global economic growth, China is now being blamed for maintaining a peg with the US dollar that gives it competitive advantage.
Hence, there are two things that must be rebuilt if the world is to move ahead on a stable keel. The first is the global financial architecture, which will involve transparent rule changes and architectural adjustments that reflect the changing balance of economic power.
The second is the hidden rules that underlie serious differences of views on the crises and their solutions, namely, the differences in economic thought and philosophy between the East and West.
Obviously, rebuilding physical structures is easier than re-building mindsets, but one cannot change without the other.
The global financial architecture revamp
So far, the only area of global consensus is that the present global monetary structure is flawed and unsustainable. Of course the global financial crisis happened because of problems and mistakes at the national level. But national problems had global origins.
The Triffin Dilemma states that the central bank of the major reserve currency has to run a monetary policy that may be contradictory to its domestic needs. As the issuer of the reserve currency, the United States provided the world with ample liquidity but at the cost of running larger and larger current account deficits.
The role as world’s consumer of last resort enjoyed global support because the East and South producers and savers (including Germany and Japan) were willing to finance that deficit.
Unfortunately, in 2008, the United States over-extended its leverage in the financial sector, had a bubble deflation and now needs to rebuild its balance sheet by deleveraging and increasing domestic savings.
Since the United States is nearly one quarter of global gross domestic product (GDP), the cutback in consumption will slow global growth, thus giving time to the world to restore its imbalances from both the regional and ecological points of view.
Unfortunately, the G-3 rescue plan of doing “whatever it takes” to relieve pain used huge public sector deficits to assume losses of the private sector.
The solution replaced excessive financial sector leverage with large unsustainable public sector leverage, and instead of changing the incentives to deter excessive speculation that worsened the bubble, it rewarded speculators by providing zero cost funding through the central banks.
It replicated the Japanese solution of the 1990s with almost identical consequences of large carry-trades, creating volatile capital flows to emerging markets.
In essence, the world is now suffering a reverse Triffin Dilemma. What appears appropriate for the monetary policy of the reserve currency country is wrong monetary policy for the rest of the world.
I for one would not object to zero interest rate policy if this went towards subsidising the damage suffered by the US real sector, but instead, most of the benefits were captured by the financial sector that paid itself more in the form of huge bonuses.
Hence, combating the deflation in the bubble in the West seems to require a bubble in the East instead.
The unspoken assumption is that if the Eastern savers were to become large spenders to replace lost Western spending, the world would return to its high-growth path. This argument forgets that it was excessive expenditure that drove unsustainable resource depletion in the first place.
There are four flaws to this line of reasoning, namely, consumption bias, price distortion, tool ineffectiveness and institutional misalignment.
First, there is an unspoken inference that increased consumption by the emerging markets to correct their excessive savings is the correct solution to the global imbalance.
However, if every Chinese or Indian were to consume at the per capita consumption level of the average American, there would be no natural resources left.
Clearly, once the emerging markets increase their consumption, their lifestyle must change to a more ecologically sustainable form, involving more green and energy/resource saving technology that will take time to evolve.
Every economic and ecological historian remembers that excessive consumption was the underlying cause of the fall of civilizations, from the Mayans to the Romans.
Second, the switch to more ecologically sustainable lifestyle will not happen without changing the fundamental incentives, particularly price signals.
Most market economists would agree that the main defect of this fossil fuel-based global economy is the under-pricing of energy and water through politically-driven subsidies.
This under-pricing of non-replaceable natural resources is the main reason why the current mode of production is wasteful, inefficient and destructive.
The world could be much more ecologically sustainable and efficient if more resources were devoted to correcting distorted prices, taxation and subsidies, and improving public education towards acceptance of more green technologies and lifestyles.
All these could be achieved at national levels, with a modest amount of global or regional assistance or aid.
Third, many serious Western economists seem to think that the silver bullet to the global imbalance (and also for China’s own good) is revaluation of the nominal exchange rate and that every argument to the contrary is “misguided”.
Unfortunately, two facts argue to the contrary. Given that China’s current GDP is US$4.8 trillion compared with the combined GDP of G-3 at US$37 trillion, a revaluation of the yuan by, say, 40%, would only increase China’s GDP by US$1.92 trillion or less than 5.2% of the G-3’s GDP.
Hence, to rely on China to replace the G-3 global engine in the short run is quantitatively unrealistic.
The other evidence to the contrary is the Japanese experience with the massive revaluation of the yen after the Plaza Accord in 1985, which had the opposite result of solving the global imbalance.
The Japan-US trade surplus did not disappear and Japan suffered a massive asset bubble that damaged its financial system and resulted in deflation for almost two decades. In other words, revaluing the exchange rate may be a cure worse than the problem itself, both for China and the world.
Fourth, the Bretton Wood institutions are neither geared nor prepared for the important roles of global public good providers that are required to restore global balance.
Quantitatively, their resources are now too small relative to global needs. The fact that their major resources depend on their capital base (which stems from the fact that they are controlled by the West) means that their combined financial resources are one-fourth of total official reserves of the surplus countries (US$4 trillion) and less than 0.5% of conventional global financial assets (US$214 trillion).
Quantitatively and qualitatively, the Bretton Wood institutions cannot act as central banks of last resort, nor undertake fiscal action to alleviate the effects of global imbalance or crises. These are still the domains of national authorities.
How to change this unsatisfactory global architecture is much more controversial and cannot be done overnight. It is one thing to complain about a single dominant power, but to build a global central bank, regulatory system and reform international financial institutions without global fiscal structure and with a G-20 of profoundly different views will be a daunting task.
My prediction is that there will be relatively little change, because there is no good unifying vision of what could be a viable alternative. To have a coherent architecture requires an architect. Sadly, we do not have anyone remotely like John Maynard Keynes to show us the way.
The crisis in economic thought
Our greatest obstacle to real reform is the failure of current economic thinking to predict and explain both crises in a consistent and coherent mode. Current economic theories are at best partial, explaining one crisis without taking into consideration the other.
Based on the historical delay in economic theory in predicting and explaining the Great Depression, we should not be surprised.
The Great Crash happened in 1929, but John Maynard Keynes’s General Theory was not published until 1936 to challenge the neo-classical orthodoxy. It took another decade before the General Theory was more widely accepted and adopted in using counter-cyclical fiscal tools.
Despite its failings in the 1930s, the neo-classical framework was revived in the 1970s through Milton Friedman and the Free Market School. Buttressed by the Efficient Market hypothesis and the wide adoption of financial models, the neo-classical orthodoxy proved very hard to dislodge, even today.
Rival theories of the European institutional school were basically ignored by the mainstream economists or begrudgingly incorporated at the fringes.
The neo-classical macro-economic theory was tautologically perfect, so long as its basic assumptions held. But the simplistic assumptions of perfect information, zero transaction costs and ceteris paribus (other things being equal) cannot hold because the market is dynamic and constantly evolving.
Other things cannot be equal. Central banks and monetary policies cannot be independent of the market. They are mutually inter-connected, interdependent and inter-active – a problem that even recent evolutions in game theory could not model effectively without very restrictive assumptions.
Clearly, we need much more complex non-linear explanations of human and market behaviour, including how different institutions react to imperfect information.
Without a more system-wide theory that embraces the crises of human interaction (financial crisis) and the human-natural interaction (climate change), we are reacting blindly. Partial solutions for one crisis may exacerbate the resolution of the other.
Hence, the real intellectual crisis today is one of obsolete economic thought, of departmental silos trying to cope with complex inter-related issues that are beyond the power of any single bureaucracy, and of fragmented nations dealing with global problems that affect all humanity.
To put it bluntly, our present economic theories cannot explain climate change adequately, just as Mayan priests found that more human sacrifices will not bring rain.
The twin crises are not just about man dealing with man’s follies but about man struggling with changing Mother Nature at the same time.
The dominant Western scientific logic of linear thinking has been operationally translated by traditional top-down bureaucracies into short-term “fixing the urgent rather than the important”, ignoring externalities that are difficult or cannot be measured, and sacrificing long-term benefits by dealing mostly with the immediate problem at hand.
Having consumed too much, the West is now blaming the East for saving too much, forgetting that the East’s savings come from producing for Western consumption at the expense of polluting their own environment and exploiting their cheap labour.
If the West did not consume, the East could not have had the income to generate their savings. Both sides gained but Mother Earth lost.
We ignored the externalities of ecological degradation because conventional economic theory and national statistics found them either difficult to measure or convenient to assume away.
Hence, the quick fix is not about asking the East to consume more to replace the decline in Western consumption, but to think a little more long-term on how to make human development more sustainable without destroying our environment.
We all need profound changes in economic thinking, including measures of “green” GDP that would enable us to measure more accurately the consequences of unsustainable consumption and production.
Parallel to building these new standards of sustainable growth will be the need to re-build our institutions.
The financial crisis was operationally an institutional crisis because the national and global institutional structures cannot cope with the externalities of financial institutions that operate globally, but are regulated and die nationally.
Rescuing these “too large to fail” dinosaurs are now beyond national resources. We need to appreciate that networked institutions are enmeshed into the global ecosystem and are not easy to remove surgically. Nor are their externalities easy to isolate or contain.
What is clear is that even though technology through scientific research and development has been able to defer the Malthusian doom, we must be realistic that as the world gets more and more inter-connected through telecommunications and modern transport, a more crowded world creates more and more disexternalities.
Hence, using lineal projections of growing prosperity in terms of conventional GDP cannot disguise the reality that there must be a change in the lifestyles of the majority of the world population in order to make our rise in standards of living more sustainable.
The clash of mindsets
An important consequence of the twin crises is that it has forced us to re-examine all options.
I am forced to conclude that the differences in approach are not one of Samuel Huntington’s “clash of civilisations”, but a more fundamental “short-term, partial and linear” mindset versus one that is more “long-term, system-wide and non-linear”.
The first one is easy to classify as current Western thinking, whereas the latter cannot be classified as distinctly Eastern, because there is no clearly articulated consensus amongst Eastern intellectuals whilst there is a growing strain of Western intellectuals moving in that direction.
In other words, we are caught between an unacceptable set of conventional follies that do not help us, and an intellectual wilderness without a “new Keynes” to guide us.
I am asking the emerging markets to start thinking seriously about how to change lifestyles in a manner that would be financially and ecologically sustainable.
Pragmatically, it is unlikely that there is a single person brilliant enough to think through the complex issues that we have before us.
The process of thinking through the implications of living in a smaller planet on a sustainable basis will have to be multi-disciplinary, with specialists from all fields, both physical science, ecology and even philosophy and behavioural science.
The issue of climate change is one that affects the future of all Mankind and not just any single nation. The debate in Copenhagen was unfortunate because it was framed as a blame game between the advanced countries and the rest.
The advanced countries are trying to stop the growing carbon emissions from the faster growing emerging markets without paying too much for it, whilst the emerging markets insist that since the advanced economies are responsible for most of the current status of carbon emission, they must bear the bulk of the burden.
The trouble with the climate change debate is that it is a tragedy of the commons on a global scale that cannot be resolved until we lower population growth and consumption levels to a more sustainable level.
It is a future disaster for which current economic thinking is not helpful. Like death, no one knows for sure when it will happen and perhaps no one wants to know. But we all have to deal with this, if not in our lifetime but for our children.
The world is clearly at the knife-edge of major changes that will require outstanding statesmanship between the West and the rest. When the world is crying out for heroic big decisions, global leaders are more likely to fudge the moment with good-sounding rhetoric but cautious small steps.
Experience will suggest that a muddled solution buys time for the community as a whole to digest what the options are. But the global clock is ticking.
Looking back at history, I now realise that turning points in history go through huge periods of turmoil, resolved either through war or profound intellectual conflict.
Thus, re-building a new intellectual framework to deal with the new environmental challenges will require first the creative destruction of the old economic orthodoxy.
China did not resolve the period of the Warring States till Confucianism won the clash of the Hundred Schools. The Renaissance in Europe resolved the separation between religion and the state that sowed the seeds of the scientific and industrial revolution.
So far, history has been written about how Man conquers Man, in which the conquest of the environment has been taken for granted.
Modern society has forgotten how Man emerged first amongst animals because he used knowledge to conquer Mother Nature. But the population of Man was small relative to the planet then. Human societies destroyed by the environment, such as the Khmer Civilization, the Mayan and the Easter Island cultures have been buried and ignored, because we all suffer from disaster myopia.
It is time that we begin once again a new intellectual revolution, about the application of science and technology to a sustainable living in a small planet.
If this cannot be done at the global level, then it must be done at the national and civil society levels. It is easy for Man to conquer other Men, but to conquer himself and his own greed, that is the most difficult task of all.
● Datuk Seri Panglima Andrew Sheng is adjunct professor at Tsinghua University, Beijing, and Universiti Malaya. He is a former chairman of the Hong Kong Securities and Futures Commission.
By ANDREW SHENG
FIFTEEN months after the panic triggered by the failure of Lehman Brothers, we should begin the debate how to rebuild the world after the crisis. Several disturbing questions remain. Are we still in the crisis? Should we reform at all? What should we rebuild?
After all, the rescue efforts by the leading central banks have brought financial markets back to almost pre-2007 levels. Commercial banks have been rescued through massive guarantees and liquidity, and interest rates have been brought down to near zero.
There are some who think that 2010 will be a good year with revived growth. Others believe equally fervently that the real crisis has yet to come. Who is right?
Several things are now clearer. We were dealing in 2007/2009 with two simultaneous crises – one financial, the other about climate change. One brought about a shift in the economic power balance, with the G-20 calling the shots instead of the G-7. The other is being resolved through the Copenhagen Round of negotiations. Three fundamental differences define the two crises. The first is that the financial crisis was primarily dealt with at the national level, whereas the climate crisis was dealt with at the global level.
The second is that financial crisis had short-term effects that required immediate action, whereas the climate crisis had uncertain long-term effects, where people do not feel the immediate pain and had no cause to support reform.
The third is that the Copenhagen negotiations confirmed the shift in power to the population giants of China, India, Brazil and South Africa, which brokered the deal with the United States.
The age of juggernauts has arrived
There was certainly a lot of hot air and emotions coming out of Copenhagen, with the African chairman of the developing economy caucus claiming that the amount of money offered by the advanced economies for climate change is just enough to buy coffins.
Those who are dead do not have to worry about climate change, so all the emotion is about what to do with the living.
However messy and unsatisfactory an agreement, Copenhagen is still a major achievement. Globalisation will never be the same again, because there is at last some universal recognition, however fuzzy, that we must solve the threat to climate change. But there is a major divide between the West and the rest.
The trouble with climate change is that all of us are dealing with unknown unknowns. Although the majority of the scientists are convinced that climate change has already passed the tipping point of irreversible damage to the environment, some think that these predictions of doom are a conspiracy to tax the wealthy countries.
The climate crisis and the financial crisis are inter-related, because both stem from excessive consumption of natural resources. The financial side collapsed first, because the West’s excess leverage was not sustainable.
The climate change crisis has a much longer time horizon. It may take 20 to 30 years before the weather change and resource scarcity become visibly so bad that those affected will then support the need for change. By then, it may be too late.
Mankind is like a frog in the pot of water. When the temperature in the pot is raised very quickly, the frog feels the pain and will jump out very quickly to escape. This was what happened in this financial crisis when G-20 acted decisively in the face of an immediate threat of financial meltdown.
However, since climate change is incremental, the frog will not react if the temperature rises slowly, until the moment comes when the frog is boiled.
Rebuilding from the ashes
I was partially wrong last year when I suggested that global solutions would not be as achievable as regional and national reforms.
In 2009, however, there was greater consensus at the global and national levels than at the regional level, but as recovery gathered steam, global opinion has once again diverged. The blame game is now rearing its ugly head.
Instead of being praised for being the first to have a substantial fiscal stimulus to regenerate domestic and global economic growth, China is now being blamed for maintaining a peg with the US dollar that gives it competitive advantage.
Hence, there are two things that must be rebuilt if the world is to move ahead on a stable keel. The first is the global financial architecture, which will involve transparent rule changes and architectural adjustments that reflect the changing balance of economic power.
The second is the hidden rules that underlie serious differences of views on the crises and their solutions, namely, the differences in economic thought and philosophy between the East and West.
Obviously, rebuilding physical structures is easier than re-building mindsets, but one cannot change without the other.
The global financial architecture revamp
So far, the only area of global consensus is that the present global monetary structure is flawed and unsustainable. Of course the global financial crisis happened because of problems and mistakes at the national level. But national problems had global origins.
The Triffin Dilemma states that the central bank of the major reserve currency has to run a monetary policy that may be contradictory to its domestic needs. As the issuer of the reserve currency, the United States provided the world with ample liquidity but at the cost of running larger and larger current account deficits.
The role as world’s consumer of last resort enjoyed global support because the East and South producers and savers (including Germany and Japan) were willing to finance that deficit.
Unfortunately, in 2008, the United States over-extended its leverage in the financial sector, had a bubble deflation and now needs to rebuild its balance sheet by deleveraging and increasing domestic savings.
Since the United States is nearly one quarter of global gross domestic product (GDP), the cutback in consumption will slow global growth, thus giving time to the world to restore its imbalances from both the regional and ecological points of view.
Unfortunately, the G-3 rescue plan of doing “whatever it takes” to relieve pain used huge public sector deficits to assume losses of the private sector.
The solution replaced excessive financial sector leverage with large unsustainable public sector leverage, and instead of changing the incentives to deter excessive speculation that worsened the bubble, it rewarded speculators by providing zero cost funding through the central banks.
It replicated the Japanese solution of the 1990s with almost identical consequences of large carry-trades, creating volatile capital flows to emerging markets.
In essence, the world is now suffering a reverse Triffin Dilemma. What appears appropriate for the monetary policy of the reserve currency country is wrong monetary policy for the rest of the world.
I for one would not object to zero interest rate policy if this went towards subsidising the damage suffered by the US real sector, but instead, most of the benefits were captured by the financial sector that paid itself more in the form of huge bonuses.
Hence, combating the deflation in the bubble in the West seems to require a bubble in the East instead.
The unspoken assumption is that if the Eastern savers were to become large spenders to replace lost Western spending, the world would return to its high-growth path. This argument forgets that it was excessive expenditure that drove unsustainable resource depletion in the first place.
There are four flaws to this line of reasoning, namely, consumption bias, price distortion, tool ineffectiveness and institutional misalignment.
First, there is an unspoken inference that increased consumption by the emerging markets to correct their excessive savings is the correct solution to the global imbalance.
However, if every Chinese or Indian were to consume at the per capita consumption level of the average American, there would be no natural resources left.
Clearly, once the emerging markets increase their consumption, their lifestyle must change to a more ecologically sustainable form, involving more green and energy/resource saving technology that will take time to evolve.
Every economic and ecological historian remembers that excessive consumption was the underlying cause of the fall of civilizations, from the Mayans to the Romans.
Second, the switch to more ecologically sustainable lifestyle will not happen without changing the fundamental incentives, particularly price signals.
Most market economists would agree that the main defect of this fossil fuel-based global economy is the under-pricing of energy and water through politically-driven subsidies.
This under-pricing of non-replaceable natural resources is the main reason why the current mode of production is wasteful, inefficient and destructive.
The world could be much more ecologically sustainable and efficient if more resources were devoted to correcting distorted prices, taxation and subsidies, and improving public education towards acceptance of more green technologies and lifestyles.
All these could be achieved at national levels, with a modest amount of global or regional assistance or aid.
Third, many serious Western economists seem to think that the silver bullet to the global imbalance (and also for China’s own good) is revaluation of the nominal exchange rate and that every argument to the contrary is “misguided”.
Unfortunately, two facts argue to the contrary. Given that China’s current GDP is US$4.8 trillion compared with the combined GDP of G-3 at US$37 trillion, a revaluation of the yuan by, say, 40%, would only increase China’s GDP by US$1.92 trillion or less than 5.2% of the G-3’s GDP.
Hence, to rely on China to replace the G-3 global engine in the short run is quantitatively unrealistic.
The other evidence to the contrary is the Japanese experience with the massive revaluation of the yen after the Plaza Accord in 1985, which had the opposite result of solving the global imbalance.
The Japan-US trade surplus did not disappear and Japan suffered a massive asset bubble that damaged its financial system and resulted in deflation for almost two decades. In other words, revaluing the exchange rate may be a cure worse than the problem itself, both for China and the world.
Fourth, the Bretton Wood institutions are neither geared nor prepared for the important roles of global public good providers that are required to restore global balance.
Quantitatively, their resources are now too small relative to global needs. The fact that their major resources depend on their capital base (which stems from the fact that they are controlled by the West) means that their combined financial resources are one-fourth of total official reserves of the surplus countries (US$4 trillion) and less than 0.5% of conventional global financial assets (US$214 trillion).
Quantitatively and qualitatively, the Bretton Wood institutions cannot act as central banks of last resort, nor undertake fiscal action to alleviate the effects of global imbalance or crises. These are still the domains of national authorities.
How to change this unsatisfactory global architecture is much more controversial and cannot be done overnight. It is one thing to complain about a single dominant power, but to build a global central bank, regulatory system and reform international financial institutions without global fiscal structure and with a G-20 of profoundly different views will be a daunting task.
My prediction is that there will be relatively little change, because there is no good unifying vision of what could be a viable alternative. To have a coherent architecture requires an architect. Sadly, we do not have anyone remotely like John Maynard Keynes to show us the way.
The crisis in economic thought
Our greatest obstacle to real reform is the failure of current economic thinking to predict and explain both crises in a consistent and coherent mode. Current economic theories are at best partial, explaining one crisis without taking into consideration the other.
Based on the historical delay in economic theory in predicting and explaining the Great Depression, we should not be surprised.
The Great Crash happened in 1929, but John Maynard Keynes’s General Theory was not published until 1936 to challenge the neo-classical orthodoxy. It took another decade before the General Theory was more widely accepted and adopted in using counter-cyclical fiscal tools.
Despite its failings in the 1930s, the neo-classical framework was revived in the 1970s through Milton Friedman and the Free Market School. Buttressed by the Efficient Market hypothesis and the wide adoption of financial models, the neo-classical orthodoxy proved very hard to dislodge, even today.
Rival theories of the European institutional school were basically ignored by the mainstream economists or begrudgingly incorporated at the fringes.
The neo-classical macro-economic theory was tautologically perfect, so long as its basic assumptions held. But the simplistic assumptions of perfect information, zero transaction costs and ceteris paribus (other things being equal) cannot hold because the market is dynamic and constantly evolving.
Other things cannot be equal. Central banks and monetary policies cannot be independent of the market. They are mutually inter-connected, interdependent and inter-active – a problem that even recent evolutions in game theory could not model effectively without very restrictive assumptions.
Clearly, we need much more complex non-linear explanations of human and market behaviour, including how different institutions react to imperfect information.
Without a more system-wide theory that embraces the crises of human interaction (financial crisis) and the human-natural interaction (climate change), we are reacting blindly. Partial solutions for one crisis may exacerbate the resolution of the other.
Hence, the real intellectual crisis today is one of obsolete economic thought, of departmental silos trying to cope with complex inter-related issues that are beyond the power of any single bureaucracy, and of fragmented nations dealing with global problems that affect all humanity.
To put it bluntly, our present economic theories cannot explain climate change adequately, just as Mayan priests found that more human sacrifices will not bring rain.
The twin crises are not just about man dealing with man’s follies but about man struggling with changing Mother Nature at the same time.
The dominant Western scientific logic of linear thinking has been operationally translated by traditional top-down bureaucracies into short-term “fixing the urgent rather than the important”, ignoring externalities that are difficult or cannot be measured, and sacrificing long-term benefits by dealing mostly with the immediate problem at hand.
Having consumed too much, the West is now blaming the East for saving too much, forgetting that the East’s savings come from producing for Western consumption at the expense of polluting their own environment and exploiting their cheap labour.
If the West did not consume, the East could not have had the income to generate their savings. Both sides gained but Mother Earth lost.
We ignored the externalities of ecological degradation because conventional economic theory and national statistics found them either difficult to measure or convenient to assume away.
Hence, the quick fix is not about asking the East to consume more to replace the decline in Western consumption, but to think a little more long-term on how to make human development more sustainable without destroying our environment.
We all need profound changes in economic thinking, including measures of “green” GDP that would enable us to measure more accurately the consequences of unsustainable consumption and production.
Parallel to building these new standards of sustainable growth will be the need to re-build our institutions.
The financial crisis was operationally an institutional crisis because the national and global institutional structures cannot cope with the externalities of financial institutions that operate globally, but are regulated and die nationally.
Rescuing these “too large to fail” dinosaurs are now beyond national resources. We need to appreciate that networked institutions are enmeshed into the global ecosystem and are not easy to remove surgically. Nor are their externalities easy to isolate or contain.
What is clear is that even though technology through scientific research and development has been able to defer the Malthusian doom, we must be realistic that as the world gets more and more inter-connected through telecommunications and modern transport, a more crowded world creates more and more disexternalities.
Hence, using lineal projections of growing prosperity in terms of conventional GDP cannot disguise the reality that there must be a change in the lifestyles of the majority of the world population in order to make our rise in standards of living more sustainable.
The clash of mindsets
An important consequence of the twin crises is that it has forced us to re-examine all options.
I am forced to conclude that the differences in approach are not one of Samuel Huntington’s “clash of civilisations”, but a more fundamental “short-term, partial and linear” mindset versus one that is more “long-term, system-wide and non-linear”.
The first one is easy to classify as current Western thinking, whereas the latter cannot be classified as distinctly Eastern, because there is no clearly articulated consensus amongst Eastern intellectuals whilst there is a growing strain of Western intellectuals moving in that direction.
In other words, we are caught between an unacceptable set of conventional follies that do not help us, and an intellectual wilderness without a “new Keynes” to guide us.
I am asking the emerging markets to start thinking seriously about how to change lifestyles in a manner that would be financially and ecologically sustainable.
Pragmatically, it is unlikely that there is a single person brilliant enough to think through the complex issues that we have before us.
The process of thinking through the implications of living in a smaller planet on a sustainable basis will have to be multi-disciplinary, with specialists from all fields, both physical science, ecology and even philosophy and behavioural science.
The issue of climate change is one that affects the future of all Mankind and not just any single nation. The debate in Copenhagen was unfortunate because it was framed as a blame game between the advanced countries and the rest.
The advanced countries are trying to stop the growing carbon emissions from the faster growing emerging markets without paying too much for it, whilst the emerging markets insist that since the advanced economies are responsible for most of the current status of carbon emission, they must bear the bulk of the burden.
The trouble with the climate change debate is that it is a tragedy of the commons on a global scale that cannot be resolved until we lower population growth and consumption levels to a more sustainable level.
It is a future disaster for which current economic thinking is not helpful. Like death, no one knows for sure when it will happen and perhaps no one wants to know. But we all have to deal with this, if not in our lifetime but for our children.
The world is clearly at the knife-edge of major changes that will require outstanding statesmanship between the West and the rest. When the world is crying out for heroic big decisions, global leaders are more likely to fudge the moment with good-sounding rhetoric but cautious small steps.
Experience will suggest that a muddled solution buys time for the community as a whole to digest what the options are. But the global clock is ticking.
Looking back at history, I now realise that turning points in history go through huge periods of turmoil, resolved either through war or profound intellectual conflict.
Thus, re-building a new intellectual framework to deal with the new environmental challenges will require first the creative destruction of the old economic orthodoxy.
China did not resolve the period of the Warring States till Confucianism won the clash of the Hundred Schools. The Renaissance in Europe resolved the separation between religion and the state that sowed the seeds of the scientific and industrial revolution.
So far, history has been written about how Man conquers Man, in which the conquest of the environment has been taken for granted.
Modern society has forgotten how Man emerged first amongst animals because he used knowledge to conquer Mother Nature. But the population of Man was small relative to the planet then. Human societies destroyed by the environment, such as the Khmer Civilization, the Mayan and the Easter Island cultures have been buried and ignored, because we all suffer from disaster myopia.
It is time that we begin once again a new intellectual revolution, about the application of science and technology to a sustainable living in a small planet.
If this cannot be done at the global level, then it must be done at the national and civil society levels. It is easy for Man to conquer other Men, but to conquer himself and his own greed, that is the most difficult task of all.
● Datuk Seri Panglima Andrew Sheng is adjunct professor at Tsinghua University, Beijing, and Universiti Malaya. He is a former chairman of the Hong Kong Securities and Futures Commission.
Saturday, January 2, 2010
Interest rates: The only way is up
Interest rates: The only way is up
By CECILIA KOK
IT has been a year of “free money”. Well, almost, especially so in developed countries such as the United States and Japan, where interest rates have sunk to near zero levels over the past one year.
In most other countries, including Malaysia, interest rates are nowhere near zero, but they have been hovering at their historical lows. So, in general, money in these countries has been generally “cheaper” than ever as well.
Now, let’s think of interest rates as the price of money and liquidity as the lifeblood of the economy.
From the time governments worldwide began slashing interest rates towards the end of 2008 and early 2009, they have essentially opened the tap for cheap money to flood the economy. They call it a loose monetary policy, and the strategy is to encourage businesses to borrow more to boost investments and households to save less and consume more to help bring life back to an economy seen then to be at risk of sliding down into an unprecedented, deep and prolonged recession.
To a certain extent, the strategy of a loose monetary policy has worked pretty well for most economies. But of course, the strategy wouldn’t have worked as effectively if not for the massive government spending on public projects and various other incentive programmes to stimulate their economies.
Rising stakes
But the stakes are rising, as the global economy gradually returns to a growth path.
For one, the low interest rates are seen to be fuelling the emergence of new asset bubbles, particularly in Asian economies such as China, Hong Kong, South Korea and Singapore, where property and equity prices have surged beyond what their fundamentals would justify.
There is also money chasing commodities, such as gold and crude oil, as investors seek to invest in assets that promise higher returns. And that has resulted in the prices of major commodities rising sharply.
The other concern pertains to the rise of inflationary pressure. The general price level of goods and services could accelerate as total demand in an economy continues to grow with the improving economy or as the rise of commodity and raw material prices continue to push up costs.
While the consensus view is that inflation is still a subdued risk for most economies at this stage, the next few months can present a different story. Already, the United Nations Food and Agriculture Organisation warned that global food prices had bounced back to a 14-month high last November. This could be just one of the signs of rising inflation risk.
The risk of inflation cannot be left unchecked, as it could result in the value of money being significantly eroded, and hence, the purchasing power of consumers diminished. So, amid the rising risk of new asset bubbles and inflation in a more stabilised and improved economy this year, the next sensible move expected of policymakers is to turn off the tap of super-cheap money by raising interest rates before their economies get overheated with other problems.
So far, Australia has been leading the world in raising interest rates. Since October last year, the country’s central bank has raised its benchmark interest rates three times by 25 basis points each to the present level of 3.75%. Local economists are now saying that the next meeting of policymakers at the Reserve Bank of Australia in February could result in a fourth consecutive rise in interest rates.
Most policymakers in other countries, including Malaysia, are still assessing the appropriate time to raise rates by weighing the risks of tightening too soon with remaining loose for too long.
Malaysia’s Monetary Policy Committee (MPC) at Bank Negara will meet at the end of this month to determine the level of the country’s benchmark interest rate, that is, the overnight policy rate (OPR), for the next two months. No change in the OPR is expected out this first meeting of the year.
In general, the MPC meets six times each year to decide on the direction of the OPR based on its outlook of the local economy and inflation expectations for the country. It is noteworthy that while one of the key priorities of the central bank is to ensure general price stability, policymakers do not actually have a targeted rate of inflation to determine the movement of the country’s key interest rates, unlike some other leading economies such as Britain, which has an inflation target of 2%.
The reason for this is that Bank Negara wants to be flexible in terms of providing ample support for economic activities in the country to expand.
One thing is clear at this moment – the pace of Malaysia’s economic recovery is already gaining momentum. Key economic indicators such as industrial output and trade have been showing consistent improvements over the past few months, and the country’s economy is seen to have broken out of recession in the fourth quarter of last year.
(For the first quarter of last year, Malaysia’s gross domestic product, or GDP, contracted 6.9%. The subsequent two quarters also saw a contraction respectively of 3.9% and 1.2%.)
But gauging the risks of rising inflation causing price instability is tougher as various factors come into play. Economists are cautious over the rising pressure of commodity prices as well as the Government’s restructuring of its subsidy schemes this year as part of its economic transformation plans.
Thus far the signal that Bank Negara has been sending out is that the current monetary policy stance is appropriate for the country, as it still believes the risk of inflation this year is modest. And while policymakers have not hinted at any rate change as yet, most private economists hold the view that the OPR is most likely to be maintained at 2% only until the middle of the year before the rate rise sets in in the latter part of the year.
Exactly when and at what rate, that’s anyone’s guess. But when the inevitable happens, the cost of obtaining credit will no longer be that cheap, although the incentive to save money in private banks will improve. For instance, mortgage and hire-purchase rates would rise, and so would savings rates as the fixed deposit rates.
And the uptrend of interest rates could also slow the rise of equity prices – which could be a good thing to prevent equity prices from overshooting beyond their fundamentals.
Certainly, the change in interest rates has a broader implication on the economy as a whole, but as in any case, if any change is necessary, a gradual one is vital to prevent any shock from happening.
By CECILIA KOK
IT has been a year of “free money”. Well, almost, especially so in developed countries such as the United States and Japan, where interest rates have sunk to near zero levels over the past one year.
In most other countries, including Malaysia, interest rates are nowhere near zero, but they have been hovering at their historical lows. So, in general, money in these countries has been generally “cheaper” than ever as well.
Now, let’s think of interest rates as the price of money and liquidity as the lifeblood of the economy.
From the time governments worldwide began slashing interest rates towards the end of 2008 and early 2009, they have essentially opened the tap for cheap money to flood the economy. They call it a loose monetary policy, and the strategy is to encourage businesses to borrow more to boost investments and households to save less and consume more to help bring life back to an economy seen then to be at risk of sliding down into an unprecedented, deep and prolonged recession.
To a certain extent, the strategy of a loose monetary policy has worked pretty well for most economies. But of course, the strategy wouldn’t have worked as effectively if not for the massive government spending on public projects and various other incentive programmes to stimulate their economies.
Rising stakes
But the stakes are rising, as the global economy gradually returns to a growth path.
For one, the low interest rates are seen to be fuelling the emergence of new asset bubbles, particularly in Asian economies such as China, Hong Kong, South Korea and Singapore, where property and equity prices have surged beyond what their fundamentals would justify.
There is also money chasing commodities, such as gold and crude oil, as investors seek to invest in assets that promise higher returns. And that has resulted in the prices of major commodities rising sharply.
The other concern pertains to the rise of inflationary pressure. The general price level of goods and services could accelerate as total demand in an economy continues to grow with the improving economy or as the rise of commodity and raw material prices continue to push up costs.
While the consensus view is that inflation is still a subdued risk for most economies at this stage, the next few months can present a different story. Already, the United Nations Food and Agriculture Organisation warned that global food prices had bounced back to a 14-month high last November. This could be just one of the signs of rising inflation risk.
The risk of inflation cannot be left unchecked, as it could result in the value of money being significantly eroded, and hence, the purchasing power of consumers diminished. So, amid the rising risk of new asset bubbles and inflation in a more stabilised and improved economy this year, the next sensible move expected of policymakers is to turn off the tap of super-cheap money by raising interest rates before their economies get overheated with other problems.
So far, Australia has been leading the world in raising interest rates. Since October last year, the country’s central bank has raised its benchmark interest rates three times by 25 basis points each to the present level of 3.75%. Local economists are now saying that the next meeting of policymakers at the Reserve Bank of Australia in February could result in a fourth consecutive rise in interest rates.
Most policymakers in other countries, including Malaysia, are still assessing the appropriate time to raise rates by weighing the risks of tightening too soon with remaining loose for too long.
Malaysia’s Monetary Policy Committee (MPC) at Bank Negara will meet at the end of this month to determine the level of the country’s benchmark interest rate, that is, the overnight policy rate (OPR), for the next two months. No change in the OPR is expected out this first meeting of the year.
In general, the MPC meets six times each year to decide on the direction of the OPR based on its outlook of the local economy and inflation expectations for the country. It is noteworthy that while one of the key priorities of the central bank is to ensure general price stability, policymakers do not actually have a targeted rate of inflation to determine the movement of the country’s key interest rates, unlike some other leading economies such as Britain, which has an inflation target of 2%.
The reason for this is that Bank Negara wants to be flexible in terms of providing ample support for economic activities in the country to expand.
One thing is clear at this moment – the pace of Malaysia’s economic recovery is already gaining momentum. Key economic indicators such as industrial output and trade have been showing consistent improvements over the past few months, and the country’s economy is seen to have broken out of recession in the fourth quarter of last year.
(For the first quarter of last year, Malaysia’s gross domestic product, or GDP, contracted 6.9%. The subsequent two quarters also saw a contraction respectively of 3.9% and 1.2%.)
But gauging the risks of rising inflation causing price instability is tougher as various factors come into play. Economists are cautious over the rising pressure of commodity prices as well as the Government’s restructuring of its subsidy schemes this year as part of its economic transformation plans.
Thus far the signal that Bank Negara has been sending out is that the current monetary policy stance is appropriate for the country, as it still believes the risk of inflation this year is modest. And while policymakers have not hinted at any rate change as yet, most private economists hold the view that the OPR is most likely to be maintained at 2% only until the middle of the year before the rate rise sets in in the latter part of the year.
Exactly when and at what rate, that’s anyone’s guess. But when the inevitable happens, the cost of obtaining credit will no longer be that cheap, although the incentive to save money in private banks will improve. For instance, mortgage and hire-purchase rates would rise, and so would savings rates as the fixed deposit rates.
And the uptrend of interest rates could also slow the rise of equity prices – which could be a good thing to prevent equity prices from overshooting beyond their fundamentals.
Certainly, the change in interest rates has a broader implication on the economy as a whole, but as in any case, if any change is necessary, a gradual one is vital to prevent any shock from happening.
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