It’s been a few years since I’ve written here, so I thought I’d start by going back and reading some of my old posts.
The following paragraph jumped out from something I wrote in 2005.
U.S. real-estate slowdown will have global consequences: Interest rates, U.S. bond prices, U.S. consumer confidence, dollar exchange rates (and hence the offshoring business), combined with the huge (and increasing) U.S. trade deficit are all pieces of a fragile domino game. This game could easily turn ugly if the U.S. real estate market accelerates its slowdown, or even worse, turns out to be a bubble. Bad news in the U.S. housing market could trigger a global recession.
(From Predictions for 2006 from an Indian perspective on VentureWoods, emphasis added)
This seems all remarkably prescient and oracle-y now, and I almost made a suitably massive upgrade to my ego. But like recent Sensex rallies my ego quickly came crashing down when I read some of my other predictions – e.g. Yahoo will start catching up with Google (Hope is eternal, and I might yet come back to gloat).
But lets get back to more important things:
There seems to be a tendency amongst many to regard a recession as a finite event, associated with a numerical reduction in GDP or stock market values. Business writers seem to compare a recession with a winter, where you hunker down (“cash is king”) and hibernate on minimal life support – after all, spring is just around the corner.
That might be a useful survival strategy, but it misses the bigger point – recessions (and especially this one) are discontinuities with totally unpredictable consequences (gosh I sound like a Nassim Taleb fanboy). To continue my useful but terribly flawed nature analogy, recessions are not like winters, but more like the Ice age that made the dinosaurs extinct. Like the Ice Age, this recession has already essentially destroyed the US Investment Bank business model.
What other changes will this Ice Age bring? I see a few possibilities:
1. Currency changes – The hegemony of the US financial industry (and the financial industry in general) is over. As I write this, the G-20 is meeting to discuss what could very well be the birth of Bretton-Woods II. A covert agreement to safely achieve a massive devaluation of the US Dollar is not out of the question (what will the Rupee do ?). Nor is it impossible to envision the emergence of an alternate reserve currency (or more likely a basket).
2. Consumer changes – We have lived, learned and grown up in a world where the world (now mostly China) manufactures and the US consumes. That world has changed. The US consumer is now on life support. She might live for a long while more, but that vitality and voracious appetite is unlikely to return. For the sake of my mental well-being I prefer to not imagine the consequences of this to the Chinese economy.
3. Fiscal policy changes – The ghost of Keynes is stirring – World governments will unleash the mother of all fiscal (deficit) spending rather than allow deflation to take hold. This sort of worldwide government stimulus is unprecedented, and its implications (or even its effectiveness) are unknown at this point. Will all the stimulus go into productive areas of the economy or will it be gambled away ?
4. Political landscape changes – The current bonhomie between nations and “global co-operation to solve the crisis” is very fragile and based on mutual fear. The Doha talks fiasco shows that developing nations are no pushovers now. There is a real chance that this “united in fear” sentiment could morph into a very ugly blame game. The parallels of the current situation to the Nixon Shock (when the French demanded gold from the US in return for dollars) are eerie and very scary.
So my question to the readership of this blog is this – does anyone see these changes too ? And more importantly, what other seismic shifts do you see occurring in our economic and business landscape ?
- 4 ways this recession is changing our world forever - November 15, 2008
- Why do Indian outsourcing majors not pursue open source ? - January 13, 2006
- Writing for the attention starved world - January 11, 2006
You could also argue that the current situation is periodic. If you see the past 100 years of trend in the US economy. Every republican leaves the country in deficit and every democrat in surplus. Republicans spend more, do more wars. I am not being prejudiced. There is a perfectly good reason in terms of economics to do wars.
This crisis however is far bigger because of this particular republican administration. They were plain stupid and made too many mistakes. They spent far too much, far more than what they are supposed to.
Well, the only change that I see happening with this recession is a change in attitude. This change was long overdue.
The financial and resulting economic mess in the US has its advantages – for those countries that can step up to the plate to serve as attractive investment opportunities for the surplus wealth available in the world.
This will involve doing a lot of what the US has done well for years – attracting talent, money and a safe physical environment for businesses to operate in – and avoiding the blunders they made.
If done successfully – the global monies that chase low yielding paper – can certainly power growth here and earn higher returns as well.
From infrastructure to education to health care – we can attract capital – that can transform this country.
The multiplier effect of the telecom investments (money as well as technology) that have come in over the past decade is a clear example of the benefits that accrue if policies and business environments favour investments.
That could be a silver lining to the dark clouds in the global skies.
This could truly be a unique opportunity – we cannot afford not to raise our sails when the winds, however slow, start blowing.
Policy makers, bureaucrats, industry and financial institutions – all will need to work in sync to make this happen.
Regards
Thanks Sumedh.
Lowering taxes during a recession is the biggest fraud perpetrated on people. Recession would mean automatically lower income that is entitled to lower rates of tax even otherwise. It’s just a sleight of hand (and not economic stimulus) than honest policy intention to leave higher disposable income/retained earnings. That’s exactly why fiscal measures fail during a depression – when the taxable base is weak, how can they meet revenue targets?
The US got out of recession after WWII by default since Europe (including USSR) was impoverished and Japan was nuked. US was the only power left. That’s when the American extortion game started on the whole world economy and dollar replaced gold standard. That explains your point 2 as well.
When government spending is deficit driven, it distorts money supply(M3), fuels inflation and asset price bubbles as it had up until september 2007. Rest of it is history that is getting made now.
Thanks.
@Krish
Great points. Just a couple of thoughts:
1. Government spending is a net economic stimulus if its accompanied with lower taxes. Most fiscal and monetary measures failed in the depression due to high taxes. It actually took WWII to get the US out of the depression, not the “New Deal”.
2. If government spending is deficit/printing driven, the government is essentially competing with businesses for loans (not good).
3. Yes, when you put it that way, there doesn’t seem to be an escape from the “Chinese saving, Americans spend” vicious cycle. At this point the Chinese are probably more dependent on the US than vice versa. Any move to shift Chinese reserves away from dollars might heavily reduce the value of the rest of their reserves.
I like your conjecture, a bit over simplified though… And here’s how I see them –
Debunking leverage and the U.S. I-banking model is easy. What isn’t is finding an alternative liquidity creation mechanism. Blame excessive leverage by all means, but recognize that markets can’t afford to disregard leverage itself as it fuels much needed liquidity. Assets that are illiquid, lose value.
I’d rather look to the history to repeat, not for fantasies to come true. In the great depression (the closest metaphor for the current times) there was flight world wide INTO the US dollar. Not out of it!
Consumption patterns in the US? Check out post great depression economic revival again. It may change in the near term but so long as China saves, America can spend. The Chinese don’t trust their own economy so much as to leave their huge surpluses in their own backyard.
Government spending? Yes and is welcome. At other times they stop at just collecting taxes. That’s their payback:-)
Change in political landscapes? Oh boy, all are equally disposed here. Nobody has a clue how to resolve the crisis. They’ve been so far cutting interest rates and when it didn’t work, they cut more. Hank Paulson has already buried his congress approved original bailout plan (to use the bailout funds to buy up toxic assets) and is now thinking of a new plan to use that to recapitalize financial institutions. Meanwhile Obama wants to resurrect Detroit. So all are on same page, perfect chaos. Aren’t they?
Other seismic shifts? Dawn of a new kind of optimism – with the realization that things can’t get any worse 🙂