Lessons From the Tiger

This article first appeared in the June 2009 edition of Business Plus and is reproduced here with their kind permission.

If it looks like a duck, walks like a duck etc, you know the rest. In 2009, we are now clearly in a Depression, with major variations from the Great Depression admittedly, but clearly a fully-fledged member of that genus, with discredited financial experts and disgraced bankers providing the occasional quack.

Not all experts are quacks. A new book by economic adviser Con Power points to the lessons of the fairly recent past, 1979-1993, when the Irish economy addressed some of the issue is it now again faces and steadily pulled itself up to the point where the Celtic Tiger became a real possibility.

In global terms we can say the current Depression is like an ever – expanding table with four legs. The first leg – low interest rates – arose out of the desire to avoid the serious recession that threatened us all (and we’ve forgotten about) after 9/11, 2001. With low interest rates and inflation slightly higher, money seemed free to many – an incentive to borrow and a disincentive to save. The second leg – was the encouragement of home ownership regardless of ability to meet loan/mortgage repayments. This was done through legislation in the US, and elsewhere, and only a few “killjoys” complained. Regulation was minimal or non-existent on much of this new borrowing. This made a property bubble inevitable and created an increased demand for debt.

The third leg – the financial sector’s activities – the creation of ever expanding leverage together with loan instruments and financial derivatives (which few fully understood until it was too late) to meet the demand for increased property sales and to maximise the profitability of companies in the sector- led to a massive credit bubble. The fourth and last leg was the huge growth in quantity and eventually price of commodities, raw materials, and general exports, leading to a worldwide export bubble.

The “dog that did not bark” at this ever expanding table was inflation (as inflation draws government action and could have ” pricked” the bubbles in time), and here China here stepped up to the plate. By exporting low-priced goods and accepting billions of US dollars in return, China enabled the US and the rest of the world to party well into daylight hours. The American deficit on current account and its “consumption binge” and absence of savings was “matched” by a Chinese surplus on current account. The Chinese government forced its citizens to save with Chinese banks, and they reinvested the export proceeds in US government securities, including Fannie Mae and Freddie Mac, the property lenders who were seeding the hurricane of “sub prime mortgages”. The circle was complete. The bubble had to burst eventually – and the table duly collapsed on us all.

From today’s perspective what happened globally between 2002 and 2008 looks predictable, but a strong brew of wishful thinking, ideology, government inaction and pure greed got in the way of appropriate countermeasures. Based on the length of time individuals and corporations will spend deleveraging and recovering “lost” pension investments, we should expect that until 2015, the world economy will be affected by an enormous hangover, following the first decades party. Then when the excessive borrowing and binging has been sweated out of the system, we can be sure that the new point of “equilibrium ” will be very different to the old one.

Con Power’s new book Metamorphosis points to political leadership, industrial partnership, education and competitiveness as pillars on which past economic growth was built. He devotes too much space to the detail of the workings of the Confederation of Irish Industry, now part of IBEC, to make this an easy or currently relevant read. He offers little guidance about our immediate problems, beyond the emphasis on partnership and competitiveness, where we really have to reinvent the wheel, again and again ,as Germany has done. Curiously EU Commissioner Charlie McCreevy shows how little he has learned by citing ‘light touch regulation” as a positive in a preface to this book.

On the world stage governments will have to regulate effectively, including setting new rules to constrain leverage, while accepting that controlling bubbles is part of the regulators job. Governments have to accept that measures like those taken in 2002 to avoid recession cannot be left in place distorting markets until all sense of reality is lost. The debate, just starting, on home ownership needs to be widespread both internationally and in Ireland, with the personal and national implications fully considered.

Countries which reform deep and well will come out of the necessary adjustment period faster than anyone else. With the new Obama administration, and unusually positive demographics, the US is likely to lead the field. The EU is likely to be much slower, not helped by negative demographics and its declining (relatively) “geostrategic footprint ” in world terms. Ireland will likely be very slow to recover, despite positive demographics, with the timing of our recovery fully dependent on how quickly we deal with our competitiveness problems. This is an issue that Power’s book covers quite well.

See also: Richard’s extensive article “The 2009 World Depression – An International Analysis”.

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