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Winnipeg Free Press - PRINT EDITION

Stimulus packages are just a shuffling of the debt

By: Satyajit Das

2/07/2009 1:00 AM | Comments: 0

THE current crisis is financial, economic, social and increasingly ideological. There have been undoubtedly egregious market failures, management excesses and errors in the lead-up to the Global Financial Crisis (GFC). But the key lessons of the crisis may be subtler than first evident.

All brands of politics and economics have been informed by assumptions about the sustainability of high levels of economic growth. The ability of governments and central banks to control and "fine tune" the economy with a judicial mixture of monetary and fiscal policy became an article of accepted faith.

The key lessons of the GFC may be that the current economic order is "built to fail."

The ability to sustain high rates of economic growth, decreed by governments and central bankers, is questionable. The aggressive increase in debt globally resulted in a sharp increase in sustainable growth rates. Four dollars to $5 of debt was required to create $1 of growth. Approximately half the recorded growth in the United States over recent years was driven by borrowing against the rising value of houses (mortgage equity withdrawals). As the level of debt in the global economy decreases, attainable growth levels also decline.

The world used debt to accelerate its consumption. Spending that would have taken place normally over a period of many years was squeezed into a relatively short period because of the availability of cheap borrowings. Business over-invested, misreading demand and assuming that the exaggerated growth would continue indefinitely, creating significant over-capacity in many sectors.

Growth in global trade and capital flows was also "built to fail." It was built on a financing model where sellers of goods and services indirectly financed the purchase.

As the risk of trade and financial protectionism emerges, globalization of trade and capital flows is reversing.

Slowing exports, lower growth and loss of jobs are encouraging trade protectionism. Several countries have implemented trade barriers (import tariffs and export subsidies).

The fiscal packages in many countries are "economic nationalist," encouraging spending on domestically produced goods and supporting national champions and local industries. Financial protectionism has also emerged. Governments are supporting domestic banks and increasingly "directing" lending to domestic firms and households.

National and international "committees to save the world" have implemented a bewildering and ever-changing array of measures to try to stave off economic collapse. Current initiatives resemble the "hair of the dog that bit you" cure where ingestion of alcohol is the treatment for a hangover. The current problems can be traced to high levels of debt accumulated by banks, consumers and companies. In effect, this debt is now being replaced by government debt. Simultaneously, the debt-fuelled consumption of consumers and companies is being replaced by debt-funded government expenditure.

Debtors still have too much debt and are not able to service it. Until the debt is written down and restructured, growth may not resume.

Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006, FT-Prentice Hall), and a consultant to Jory Capital of Winnipeg.

Republished from the Winnipeg Free Press print edition July 2, 2009 B6

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