At last, a brief article on the financial crisis that goes behind the facade to look at some of the deeper structural issues.
The author is Satyajit Das and the article (“Built to Fail “) was published in the latest Monthly. He sees the principle cause as excessive debt:
The most important lesson of the financial crisis may be that the current economic order was built to fail, for the global economy used debt and financial engineering to enhance growth, requiring ever more stimulus to maintain performance. The spike in debt globally caused a spike in growth rates. As much as $5 of debt was required to create $1 of growth. Approximately half the recorded of growth in the US over recent years was driven by borrowing against the rising value of houses (that is, mortgage-equity withdrawals). As the level of debt in the global economy decreases, attainable growth levels also decline.
This is now a fairly widely held view. More interesting, I think, is the beautifully simple fashion in which he goes on to consider the real-world impact:
The world economy used debt to accelerate consumption. Spending that would normally have taken place over many years was squeezed into a relatively short period because of the availability of cheap borrowings. Business over-invested, misreading demand and assuming that exaggerated growth would continue indefinitely, creating significant over-capacity in many sectors.
Until household balance sheets are restored, a significant portion of demand is quite simply gone and hence the capacity created to meet it is of questionable value. It’s a brute fact that can’t be easily papered over; it will take time, and considerable pain, to make the necessary adjustments. It’s also why all the frantic efforts to reflate, to get the credit machinery running again, to encourage consumption, may more often than not fail to gain purchase:
The current initiatives of governments and central banks are a hair-of-the-dog treatment. The problems they seek to address can be traced to the high levels of debt accumulated by banks, companies and consumers. In effect, this is now being replaced by government debt and, simultaneously, the debt-fueled consumption of companies and consumers is being replaced by debt-funded government expenditure. Yet adjustment in the level of debt and asset prices is part of the process through which the global economic system will re-establish itself. Like King Canute, central bankers and finance ministers cannot hold back the tide.
Nevertheless, they all feel they must try and already the severity of the crisis has created a “Whatever It Takes” attitude. This is (arguably) all very well if it works, but if it doesn’t it risks utter disaster. Not only economically, but in terms of social stability and trust in the political system.
We better hope they’re right.