Published with the kind permission of the author
The crisis in the global economy is a subject that engages many and affects most of mankind. Like all such issues we find little clarity but a lot of fire and brimstone. Few have tried to seek feasible solutions. Even fewer are qualified, experienced and with a usefully cosmic view of the world we live in to propose a way out. The global economy expanded at a frenetic pace of over 3.5% annually till it arrived at the precipice in 2008. Since then we are seeking to find new pathways to get over it. And clearly we are struggling.
In 2016 the World GDP totaled about $77.83 trillion. In 1960 the WGDP was $6.85 trillion (1990). The WGDP was just $1.1 trillion in 1900 and took half a century to grow fourfold to $4.01 trillion and grew ten fold in the next fifty to $41 trillion (1990). The big leaps began after 1971 when US President Richard Nixon unilaterally delinked the US dollar from the international gold standard and opened the dollar floodgates. This and the US opening to China forged a great economic and financial system that accelerated world GDP growths to new levels. This was the dawn of globalization.
But since 2008 we are increasingly a world where trust is in deficit. Countries don't trust each other. People don't trust their governments. Government’s don’t trust their regulators. Regulators don't trust the banks and the financial community. But above all governments don't trust the people will support them to do the right things. But as Mervyn King the former Bank of England governor (2003-2013) recently wrote: “Trust is the ingredient that makes a market economy work. It is central to the role of money and banks, and the institutions that manage our economy.” How do we find trust again often seems to be the main issue of our time.
Raghuram Rajan once wrote: “Politicians know that structural reforms – to increase competition, foster innovation, and drive institutional change – are the way to tackle structural impediments to growth. But they know that, while the pain from reform is immediate, gains are typically delayed and their beneficiaries uncertain.” As a prime minister said at the height of the euro crisis: “We all know what to do; we just don't know how to get re-elected after we’ve done it!”
Now lets see how the global system actually works. The emerging countries produce goods and services at the lowest costs for consumption in the USA, which in turn pays them in dollars, which they in turn deposit in US banks. Give or take a little. Since money cannot sit still, this money in US banks is then lent to Americans, who today have the highest per capita indebtedness in the world, to splurge on houses, cars, HD TV’s, computers and play stations, which they can often ill-afford. The cumulative debt of US households is now $11.4 trillion. Credit card debt alone of each US household is over $15000. There are 160 million credit cards in the US. Quite clearly the USA’s finances, public and personal, are out of control.
But as the saying goes: “when America sneezes, the world catches a cold!” With good reason too. The USA accounts for a quarter of the global economy and the world keeps two thirds of its reserves in US dollars. But what happens when the US catches a cold?
The irony is that this is well understood, but like the people who kept investing with Bernard Madoff, countries like China, Russia, Japan, Kuwait, India and others keep investing in US securities at interest rates mostly between 1-2%. Thus, in effect the rest of the world was plying the USA with cheap credit, encouraging it to splurge even more. Unfortunately there was and is no global regulator to caution the US on its profligacy or force it to mend its ways. There is also no global regulator who can ensure that countries like China balance their trade. Thus, it is US profligacy and Chinese surpluses parked in US banks that are the biggest cause of this dysfunction. Many have described this relationship as akin to that of a drug addict and a drug peddler. The drug addict is now in rehab and it’s the peddler who is suffering from withdrawal!
At the Breton Woods Conference of July 1944 that took place under the fast receding shadow of WWII, Lord Keynes had in mind an elaborate scheme that called for the establishment of an international reserve currency. But this had to be shelved in the face of American obduracy. Keynes' proposals would have established a world reserve currency called "Bancor" to be administered by a international Central Bank. This Central Bank would have been vested with the responsibility of creating money and with the authority to take actions on a much larger scale. In case of balance of payments imbalances, Keynes recommended that countries with payment surpluses should increase their imports from the deficit countries and thereby create foreign trade equilibrium.
But since the 1971 dollar–gold delinking, the USA has emerged has a great credit factory. It has been the world’s biggest deficit country for several decades and with increasing deficits with most countries. But the world largely trusted the US dollar and the US Federal Bank presses just kept printing them for the rest to hold for the dollar is the world’s preferred reserve currency. This trust is now eroding and this is now at the core of the world’s greatest financial problem.
Earlier this year, Raghuram Rajan wrote: Arguably, what I have in mind will eventually require a new international agreement along the lines of Bretton Woods, and some reinterpretation of the mandates of internationally influential central banks. Setting the rules will take time. But the international community has a choice. We can pretend all is well with the global monetary non-system and hope that nothing goes spectacularly wrong. Or we can start building a system fit for the integrated world of the twenty-first century.”
Democracy, national sovereignty and economic integration find themselves incompatible. People choose according to their immediate needs and lights, and are mostly swayed by manufactured perceptions. The people’s faith in the market to generate prosperity is severely corroded. Is it a failure of individuals, institutions or ideas? Or all three? Eminent people like Mervyn King plaintively seek “an intellectual revolution”. But such revolutions only follow a cataclysmic crisis. We had one in 2008 and the next one is also certain. But when?
Then there are other new realities. The post Cold War era has seen the economic and political rise of a host of nations, Brazil, China and India being foremost among them. Each one of these nations is now a major economic player with bigger GDP’s than many in the G-7. The economic balance of power is shifting towards Asia. Jim O’Neill, the Goldman Sachs economist who was first to coin the acronym BRICS, now predicts: “It's likely that the combined GDP of the four big BRIC nations will exceed that of the G-7 by 2020.” Since the USA and Europe do not see it as being in their interest to reform the system, it devolves upon these world growth engines to bring more order into the world system.
Like Communism the ideology of the Washington Consensus has also been proved to be a failure. We need to forge a new system, but it will have to be done by more than just the G-7. Another Bretton Woods of the high priests of economics and finance of a much-changed world is needed to fashion a more robust global system.