Why the world economy is crashing and why India should benefit from it
Tuesday, 25 August 2015|
Hardik Bhawsar
The crash-bang-thud heard from stock and currency markets the world over in recent days, including its massive echo in India’s Sensex, which tumbled 1,624 points on Monday, is further proof that the snake oil sold as remedy for a sputtering world economy after 2008 isn’t working.
After the sub-prime crisis in the US and the steep fall in markets following the Lehman Brothers bust, the world has tried to solve the problem by throwing more and more money at the problem – money printed and lent out at near zero interest rates almost all over the developed world.
The US, after seven years of grappling with the problem, is still making only intermittent noises about raising interest rates; if the markets continue to crash and the global economy slows down, it may yet chicken out; Europe is keeping near zero rates in the hope growth will revive even as Greece is trashing about for survival; Japan kept the money-printing presses working overtime for more than a decade, but has, under Shinzo Abe, gone back to the same trick of monetary expansion; China, with its export engine struggling, has been extremely unsuccessful in shifting its emphasis to domestic consumption-led growth.
Why isn’t the medicine working? And why are the markets crashing today? The answer is complex, but the following are the prime reasons for this failure by the world to cure itself after Lehman.
First, the purpose of making money cheap was to ensure the credit markets do not choke up and prevent a recovery. But in the absence of a more fundamental re-balancing of real economy incentives and the return of covert mercantilism among countries, it is the financial markets that fed themselves on zero-cost money. Put another way, the cheap money was used by companies and financial institutions not to lend to companies creating jobs, but to make money from money – which means financial investments like stocks and bonds.
More financial wealth has been created over the last seven years than probably in the previous seven – and this when the world isn’t growing too strongly. The Dow Jones Industrial Average hit a new all-time high of 18,312 this May, up from the November 2008 low of less than 7,450.
When there is so much money to be made from money, who in his right mind will put up factories and roads in the hope that they will yield a positive return? The sharp fall in the Dow over the last two sessions by nearly 1,600 points suggests that the smart money is trying to lock in its profits before it evaporates. In the process it is causing prices to over-correct. The same thing is happening with Indian stocks.
Second, while keeping money cheap after Lehman was the right short-term response, the obvious mistake western governments made was to let monetary policy do all the hard work, and letting fiscal policy hibernate. If you want to revive growth, you need people to invest and consume, not speculate. When the private sector was unwilling to invest and people in excessive personal debts were trying to bring leverage levels down, the logical thing for the US to do was to invest in infrastructure – which is what India is trying to do now – in order to correct what is called a balance-sheet recession.
By first world standards, US infrastructure sucks, and a half trillion dollars spent there would have done more to revive growth than spending the same in rescuing banks and no-hopers.
This is where doctrinaire approaches to what government should do or not do does not help. When economic confidence wanes, the only entity that can act is the government, which technically can spend even without having the money. The Right may not like it, and the Left will crow, but that isn’t the point. When nothing works, the government has to work.
The US government left the Fed to do the heavy lifting instead of chipping in with public investment boosters. The Tea Partyists and the Paul Krugmans and Occupy Wall Streeters got into a Left-Right argument which didn’t help.
After the sub-prime crisis in the US and the steep fall in markets following the Lehman Brothers bust, the world has tried to solve the problem by throwing more and more money at the problem – money printed and lent out at near zero interest rates almost all over the developed world.
The US, after seven years of grappling with the problem, is still making only intermittent noises about raising interest rates; if the markets continue to crash and the global economy slows down, it may yet chicken out; Europe is keeping near zero rates in the hope growth will revive even as Greece is trashing about for survival; Japan kept the money-printing presses working overtime for more than a decade, but has, under Shinzo Abe, gone back to the same trick of monetary expansion; China, with its export engine struggling, has been extremely unsuccessful in shifting its emphasis to domestic consumption-led growth.
Why isn’t the medicine working? And why are the markets crashing today? The answer is complex, but the following are the prime reasons for this failure by the world to cure itself after Lehman.
First, the purpose of making money cheap was to ensure the credit markets do not choke up and prevent a recovery. But in the absence of a more fundamental re-balancing of real economy incentives and the return of covert mercantilism among countries, it is the financial markets that fed themselves on zero-cost money. Put another way, the cheap money was used by companies and financial institutions not to lend to companies creating jobs, but to make money from money – which means financial investments like stocks and bonds.
More financial wealth has been created over the last seven years than probably in the previous seven – and this when the world isn’t growing too strongly. The Dow Jones Industrial Average hit a new all-time high of 18,312 this May, up from the November 2008 low of less than 7,450.
When there is so much money to be made from money, who in his right mind will put up factories and roads in the hope that they will yield a positive return? The sharp fall in the Dow over the last two sessions by nearly 1,600 points suggests that the smart money is trying to lock in its profits before it evaporates. In the process it is causing prices to over-correct. The same thing is happening with Indian stocks.
Second, while keeping money cheap after Lehman was the right short-term response, the obvious mistake western governments made was to let monetary policy do all the hard work, and letting fiscal policy hibernate. If you want to revive growth, you need people to invest and consume, not speculate. When the private sector was unwilling to invest and people in excessive personal debts were trying to bring leverage levels down, the logical thing for the US to do was to invest in infrastructure – which is what India is trying to do now – in order to correct what is called a balance-sheet recession.
By first world standards, US infrastructure sucks, and a half trillion dollars spent there would have done more to revive growth than spending the same in rescuing banks and no-hopers.
This is where doctrinaire approaches to what government should do or not do does not help. When economic confidence wanes, the only entity that can act is the government, which technically can spend even without having the money. The Right may not like it, and the Left will crow, but that isn’t the point. When nothing works, the government has to work.
The US government left the Fed to do the heavy lifting instead of chipping in with public investment boosters. The Tea Partyists and the Paul Krugmans and Occupy Wall Streeters got into a Left-Right argument which didn’t help.
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