We had asked in the first part of this article whether there?s a risk in the world drowning in a flood of money created by well-intentioned recession-fighters; also, whether necessary adjustments are being ignored. Keynes? countercyclical strategy was being misinterpreted, we had argued, because no one is mentioning the caveat about budget surpluses in boom times. In this part of the article we point out the consequences of this strategy.
The possibility that victory in the short-term battle of reviving cashflow might result in losing the long-term war of financial responsibility and equilibrium, seems not to matter. To comfort the public that they will do everything in their power to avert prolonged recession, governments are acting in ways that we may not realise the consequences of. The US? serial bailouts have enlarged its fiscal deficit by over 10% of US-GDP. We have not seen the end of them. Adding the UK and EU you get another 8-10% of their GDP. Add others and you have incremental fiscal deficits and incremental net public borrowing piling up to over $5 trillion in the next 1-2 years. This will all need to be borrowed from central banks (risking future inflation) or capital markets where savings are overstretched.
A dramatic shift in risk preference now favours bank deposits and government bonds. But, what happens when that preference shifts to other investments, as it eventually must? Will the shift of all incremental savings into US/EU government debt create stickiness for the eventual recovery of equity markets thereafter? By then the US will owe the rest of the world $7-8 trillion. What does it mean when the only large reserve currency issuer is the world?s largest debtor, sucking in capital from countries that need it more for their own development? Should the world?s reserve currency issuer and largest debtor remain exempt from multilateral control, surveillance and guidance when it continues to risk endangering the health and balance of the global economy and financial system?
Likewise, the new liquidity facilities announced by the Fed amount to over $7.5 trillion; of which $4 trillion have been used. Those of the EU and other developed countries amount to $6 trillion. India and China account for yet another $800 billion. These bloated deficits and liquidity emissions are not trivial. They will have significant future side-effects. Will they succeed in staving off a long and deep recession? We do not know. Will they create post-recession complications that thwart sensible recovery? That likelihood may be higher than it appears now.
After these humongous deficits and liquidity emissions, what strategies will be deployed to bring deficits and money supply back under control; to generate fiscal surpluses and contract liquidity to avoid intractable post-recession inflation? If serious dislocation is to be avoided, and a soft re-entry to normalcy for the world is to be orchestrated, how long will that take? What will it mean for relative growth trajectories in the US, EU, Japan, China, India and other developing countries? What will it imply in terms of achieving essential adjustments: such as the US consuming and borrowing much less, reducing its debt to the world, while saving and investing much more? Will it lead to Europe finally acknowledging the unaffordability, unsustainability, uncompetitiveness, and counter-productivity of its basic economic model: i.e. that of an ever enlarging and intrusive welfare state, increasingly dependent on high-tax but inefficient government intervention to solve every personal/social problem and providing cradle-to-grave insurance, against every contingency? Or will some element of personal responsibility for healthcare, education, and managing personal risk be re-introduced?
Will China be convinced to consume/import more, while exporting, saving and investing less, for global balance to be restored? Will India take the steps necessary to consume, save and invest more, by reducing its fiscal deficit through public asset sales? Will it liberalise its financial system while relieving government of its ownership? Will it transform its labour and land laws/markets? Will it simplify and reform its absurd FDI, FII, NRI capital control regimes to achieve greater efficiency and productivity? Can India and China stave off protectionism by the US and EU by demanding an open global trading regime, while continuing to manage exchange rates (thus preventing adjustment from occurring automatically in global markets) and leaving their capital accounts partially closed? Are open current accounts compatible or congruous with conveniently perforated capital accounts indefinitely?
Such questions may be premature. But are they churlish? The answers may be elusive. So, should these questions not be posed? Indulging in my usual perversity let me ask again: does anyone have a post-recession exit strategy for correcting the fiscal/monetary imbalances we are temporarily but intemperately exacerbating to fight recession? Or have we become so myopic that we are unable to look beyond the next month? If so, the generation just entering the labour market should be seriously afraid about the inter-generational tax and other burdens they are about to inherit involuntarily.
(concluded)
The author is an economics and corporate finance expert. He chaired the high-powered committee on making Mumbai an international financial centre
