The past was prologue. The present is panic. The future: a conundrum? Banks in every country, along with their industry counterparts, are queuing up for liquidity, capital, or guarantee assistance. ?If him, why not me?? Such ?me-too-ism? has triggered a cascade of knee-jerk reactions in governments around the world. The US has a bailout a day. The UK and EU follow a day later. The two giants of the future, India and China, are in on the act. The trend is snowballing downhill and we now have a recession.
Fiscal/monetary expansion in Sep-Oct 2008 was aimed at averting financial system collapse. In November, it was redirected at preventing global demand collapse. Extolling the lessons of 1929-39, when the global economy was rescued (paradoxically) by a world war, governments seem willing do anything; no matter how unacceptable in ?normal? times (what were those like?) to avert deep, prolonged recession, even a growth recession . Politically and socially, its consequences are unthinkable; especially for administrations (like India?s) at a critical juncture in their electoral cycles.
With gargantuan amounts of cash being pumped out, is there a risk of the world later drowning in a flood of worthless money created by well-intentioned public recession-fighters? Will such profligate largesse defer, or prevent from taking place, the adjustments needed to rectify chronic global imbalances in consumption, savings, investment, and borrowing? Policy-makers might regard such questions as misplaced, churlish, or premature. To them, any voice asking right now whether they know what they are doing or overdoing, is a foolish intrusion that will make this recession and financial crisis worse.
Keynes? solution of expanding countercyclical fiscal deficits to combat declines in output had a caveat; that, in boom times, governments must generate fiscal surpluses. Since 2000, most governments have been running large deficits in booms; not least in India. They now want to run even larger deficits to mitigate a bust. The logic seems to be that, since irresponsible government spending and borrowing created this mess in the first place, more reckless government spending and borrowing will get us out of it. Such reasoning may seem sensible to economists armed with theory. It is difficult to explicate to laymen armed only with common sense. That may be why economists are held in the regard they are. If experts think that unrestrained money-pumping will work out in the short and long term, they need to explain why. Perhaps we should be concerned that the experience of 1929-39 taught us what NOT to do in a recession; i.e. tighten the fisc and squeeze money supply. Unfortunately, it did not teach us WHAT to do, or be sure that what we are doing (i.e. the opposite of what was done before) is right. There is no play for this unprecedented scenario that has been rehearsed and worked out.
Looking to governments to solve the problem has dispensed with all concern about privatising profit and socialising cost. Diehard socialists and pompous purveyors of bizarre heterodoxy (suspicious of markets they cannot control directly) are gloating yet distraught. If we probe deep enough, looking to governments to solve the present crisis is not as odd as it seems. Our current predicament is rooted in: (a) prolonged, cavalier irresponsibility of governments?i.e. in irresponsible management of fiscal, monetary, trade, and external accounts (on the part of the US, UK and EU sans Germany), and (b) in self-serving, but globally damaging, exchange rate policies from 2000 to now on the part of China and, a lesser extent, India. The 2008 debacle is not, as populists would have it, rooted exclusively in financial system failure, with excess leverage and risk exacerbated by absurd compensation incentives that skewed the judgement and ethics of the financial community; though there was certainly plenty of that.
Winning the short-term battle of boosting demand and corporate cash flow now seems to be all that matters to former titans of finance and industry. Crisis-induced collapse of demand provides them with a timely excuse to obscure errors of vision, judgement, timing, strategy, and business-model failure. In making billions they believed they were omniscient, omnipotent, invincible, and infallible. Faced with losing billions they want society to bear the cost of their failures. That is the Faustian bargain of mutual assured destruction (MAD) that corporates, governments and consumers have made. So, the notion of taxpayer bailouts of banks and companies may be a tautological nonsense. In the final analysis, the taxpayer (or government on her behalf) is bailing out not banks and firms but herself?in her other avatars as consumer, borrower, depositor, businesswoman, employee, supplier, and producer.
What will be the costs of a victory in the short-term battle? What will happen when investment preferences shift from bank deposits and government bonds? How much will the US end up owing to the world? Can China and India change what they need to change? These are questions that no one is asking. The second part of this article deals with that.
The author is an economics and corporate finance expert. He chaired the high-powered committee on making Mumbai an international financial centre