Bring on Plan C to save the global econ­omy

The Pak Banker - - OPINION - Martin Wolf

THE world econ­omy is slow­ing, both struc­turally and cycli­cally. How might pol­icy re­spond? With des­per­ate im­pro­vi­sa­tions, no doubt. Neg­a­tive in­ter­est rates have al­ready moved from the un­think­able to re­al­ity. The next step is likely to in­clude fis­cal ex­pan­sion. In­deed, this is what the OECD, long an en­thu­si­ast for fis­cal aus­ter­ity, rec­om­mends in its "In­terim Eco­nomic Out­look". But that is un­likely to be the end. With fis­cal ex­pan­sion might go di­rect mon­e­tary sup­port, in­clud­ing the most rad­i­cal pol­icy of all: the "he­li­copter drops" of money rec­om­mended by the late Mil­ton Fried­man.

More re­cently, this is the pol­icy fore­seen by Ray Dalio, founder of Bridgewater, a hedge fund. The world econ­omy is not just slow­ing, he ar­gues, but "mon­e­tary pol­icy 1" - lower in­ter­est rates - and "mon­e­tary pol­icy 2" - quan­ti­ta­tive eas­ing - are largely ex­hausted. Thus, he says, the world will need a "mon­e­tary pol­icy 3" di­rectly tar­geted at en­cour­ag­ing spend­ing. That we might need such a pol­icy is also the rec­om­men­da­tion of Adair Turner, for­mer chair­man of the Fi­nan­cial Ser­vices Au­thor­ity, in his book "Be­tween Debt and the Devil".

Why might the world be driven to such ex­pe­di­ents? The short an­swer is that the global econ­omy is slow­ing durably. The OECD now fore­casts growth of global out­put in 2016 "to be no higher than in 2015, it­self the slow­est pace in the past five years".

Be­hind this is a sim­ple re­al­ity: the global sav­ings glut - the ten­dency for de­sired sav­ings to rise more than de­sired in­vest­ment - is grow- ing and so the "chronic de­mand de­fi­ciency syn­drome" is wors­en­ing.

This stage of de­mand weak­ness must be seen in its his­tor­i­cal con­text. The long-term real in­ter­est rate on safe se­cu­ri­ties has been de­clin­ing for at least two decades. It has been near zero since the fi­nan­cial cri­sis of 2007-09.

Be­fore then, an un­sus­tain­able western credit boom off­set the weak­ness of de­mand. Af­ter­wards, fis­cal deficits, zero in­ter­est rates and ex­pan­sions of cen­tral bank bal­ance-sheets sta­bilised de­mand in the west, while a credit ex­pan­sion funded mas­sive in­vest­ment in China. Loose western mon­e­tary poli­cies and loose Chi­nese credit poli­cies also drove the post-cri­sis com­mod­ity boom, though China's ex­cep­tional growth was the most im­por­tant sin­gle fac­tor. The end of th­ese credit booms is an im­por­tant cause of to­day's weak de­mand. But de­mand is also weak rel­a­tive to a slow­ing growth of sup­ply.

At the world level, growth of labour sup­ply and labour pro­duc­tiv­ity have fallen sharply since the middle of the last decade. Lower growth of po­ten­tial out­put it­self weak­ens de­mand, be­cause it low­ers in­vest­ment, al­ways a cru­cial driver of spend­ing in a cap­i­tal­ist econ­omy.

It is this back­ground - slow­ing growth of sup­ply, ris­ing im­bal­ances be­tween de­sired sav­ings and in­vest­ment, the end of un­sus­tain­able credit booms and, not least, a legacy of huge debt over­hangs and weak­ened fi­nan­cial sys­tems - that ex­plains the cur­rent predica­ment. It ex­plains, too, why economies that can­not gen­er­ate ad­e­quate de­mand at home are com­pelled to­wards beg­gar-my-neigh­bour, ex­port-led growth via weak­en­ing ex­change rates. Ja­pan and the Eu­ro­zone are in that club. So, too, are the emerg­ing economies with col­lapsed ex­change rates.

China is re­sist­ing, but for how long? A weaker ren­minbi seems al­most in­evitable, what­ever the au­thor­i­ties say. No sim­ple so­lu­tions for the global eco­nomic im­bal­ances of to­day ex­ist, only pal­lia­tives. The cur­rent favourite flavour in mon­e­tary pol­icy is neg­a­tive in­ter­est rates.

Dalio ar­gues that: "While neg­a­tive in­ter­est rates will make cash a bit less at­trac­tive (but not much), it won't drive savers to buy the sort of as­sets that will fi­nance spend­ing." I agree. I can­not imag­ine that busi­nesses will rush to in­vest as a re­sult. The same is true of con­ven­tional quan­ti­ta­tive eas­ing. The big­gest ef­fect of th­ese poli­cies is likely to be via ex­change rates. In ef­fect, other coun­tries will be seek­ing ex­port-led growth vis-a-vis over-bor­rowed US con­sumers. That is bound to blow up.

One al­ter­na­tive then is fis­cal pol­icy. The OECD ar­gues, per­sua­sively, that co­or­di­nated ex­pan­sion of pub­lic in­vest­ment, com­bined with ap­pro­pri­ate struc­tural re­forms, could ex­pand out­put and even lower the ra­tio of pub­lic debt to gross do­mes­tic prod­uct.

This is par­tic­u­larly plau­si­ble nowa­days, be­cause the ma­jor gov­ern­ments are able to bor­row at zero or even neg­a­tive real in­ter­est rates, long term. The aus­ter­ity ob­ses­sion, even when bor­row­ing costs are so low, is lu­natic.

If the fis­cal au­thor­i­ties are un­will­ing to be­have so sen­si­bly - and the signs, alas, are that they are not - cen­tral banks are the only play­ers. They could be given the power to send money, ideally in elec­tronic form, to ev­ery adult ci­ti­zen.

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