Don’t panic… yet
How pleasing to return from holiday to discover that the chumps who manage our savings have finally woken up. But the pleasure in seeing US and European stock markets at a slightly less loopy level is marred by the extremity of the money men’s mood swing. Many of the people who recently shrugged off the problems of Asia as a disinflationary non-crisis now seem convinced that global deflation is imminent.
The excuse for all this gloom is fear of the so-called negative wealth effect-a presumed reluctance, especially on the part of Americans, to spend money when their stock market investments are shrinking in value. Yet Americans who returned from holiday this September were looking at a Dow Jones Industrial Average that was still 12 per cent higher than in December 1996 when Federal Reserve chairman Alan Greenspan complained about “irrational exuberance” in the stock market.
Having shrugged off this earlier caution the professional money men are now in a funk over Greenspan’s stunningly uncontroversial observation that the US cannot “remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress.”
What has been clear since early this year is that the global economic prospect has been deteriorating as a result of incipient deflation in Japan and in the emerging markets. But the US economy is still growing strongly, while continental Europe is now well into a respectable economic recovery. To suggest that the whole world is running into a 1930s-style problem of deficient demand-the problem with which Keynes wrestled in his General Theory- is thus premature. At present only Japan with its excess savings and deficient demand lends itself to traditional Keynesian solutions.
If there are grounds for worry they lie not in the modest stock market slide but in the unbalanced nature of US economic growth. With household savings down to an astonishingly low 0.6 per cent of disposable income in the second quarter of this year, and with the US budget set to remain in surplus, it is hard to foresee what will drive the US economy as the millennium approaches. On anything but a short-term view, the rate of personal saving can only go up.
In a world that is excessively dependent on the US market-Europe runs a trade surplus with the rest of the globe-that is an uncomfortable predicament. All the more so, given that the US balance of payments has sprung a huge and growing leak on the current account. If we throw in a financial meltdown, with a really serious negative wealth effect, then the deflationary talk begins, alas, to make some sense.
Capitalism without capitalists
One of the great merits of the much criticised continental European approach to capitalism is that it is not directly vulnerable to such negative wealth effects. For this the continentals have Bismarck to thank. Part of the genius of Bismarckian social insurance was that it pre-empted the role of ownership. Pay-as-you-go state pensions help to create a capitalism without the rentier.
Anglo-Saxon financiers pour scorn on a system which leaves capital markets under-developed. And we now know that this humane form of capitalism without capitalists becomes hard to sustain when welfare spending takes a very high share of gross domestic product. But to suggest that the impending switch from pay-as-you-go to funded pensions is a great step forward for the continentals is a grotesque over-simplification (see Malcolm Crawford, “Reforming Pensions” page 56). One certain consequence will be greater financial instability as more Europeans are exposed to what Ronald Reagan called the magic of the market.
Is Mahathir right?
In the light of the wild and massive fluctuations in capital flows in Asia, it is surely logical to ask how the power of the state can be harnessed to stabilise currencies and financial markets. After all, the case for capital account liberalisation is nothing like as strong as the one for free trade in goods and services. Yet when Malaysia’s Mahathir Mohamad reintroduced capital controls there was almost total disapproval from the developed world. This deviation from the free market is deemed dangerous and likely to herald a move to trade protectionism.
This is odd, because the last thing the Asians are likely to demand in their present crisis is a more protectionist trade environment. It is the Americans we should be more worried about on that score. And the idea that this free market in currencies is working well is questionable.
The recent volatility in the emerging markets partly reflects the growth of proprietary trading by banks and of bank-financed speculation by hedge funds. Such punting is fuelled by implicit government guarantees: because large banks are deemed too big to fail, their appetite for risk is inadequately constrained. So the market is distorted. There is an obvious case for toughening the Basle capital adequacy regime to damp down these destabilising forms of speculation that reinforce the inclination of markets to over-shoot. But such is the current respect for markets that it will probably not happen.
Why the world is so indulgent towards bankers is doubly hard to fathom in the light of the annual survey, produced by the London-based Centre for the Study of Financial Innovation, known as Banking Banana Skins. In this rare confessional exercise, bankers and regulators reveal their innermost fears about the banking system. The report summarises their views thus: “The biggest worry of all was management of risk-what many regard as bankers’ core competency. Problems were seen in inadequate controls, failure to understand the dynamics of a fast moving business and, in the worst cases, in incompetence and greed.”