March 18, 2008 | posted by Michael Baxter in UK economy, US economy, credit crunch |

The irony behind all this talk of doom is that, actually, the global economy has got more going for it now than has ever been seen before – that’s ever.

If the projections are to be believed, the period from 2004 to 2009 will quite possibly prove to be the most successful period for the global economy yet seen – we are in the midst of a golden age. Even if you ignore the likes of China and India and just look at the OECD then it would appear we are in the middle of a period of remarkable growth – the UK hasn’t had a recession since the early 90s, easily its best run of uninterrupted economic growth ever seen.

And while it could be argued that the global economy has been propelled forward by consumer borrowing in the US, UK and certain other countries, it could just as easily be argued that, actually, the real reason for the growth has been real changes in productivity.

The developed world has benefited from improving technology – improvements that were in part funded by the dotcom boom, while growth in China and India and other developing economies has been enabled simply because these countries have been importing ideas – they have imported the technological advances seen over the last few decades.  This growth was in part thanks to the Internet making information more transferable.

So the world today is more productive – the flip side to that is, of course, greater demand for scarce resources, such as oil and wheat, but just for today, set aside that argument. After all, the case to say we are entering a period of permanently  rising commodity prices is far from proven.

So, there are underlying reasons to be optimistic.

Here are two more points to consider. 

Point number one, on a global scale, there is no bubble in borrowing.   The borrowing in the Anglo Saxon world was funded by saving in other parts of the world.    Yesterday, writing in the Telegraph,  Ambrose Evans-Pritchard described how in June last year, no less than $6 trillion  of US long-term debt was owned by foreigners, including Japan with just shy of $1 trillion worth of debt and China holding $870bn of debt.

Just as we spend too much, others are saving too much.    But of late, there have been signs this is changing. During the January to February period, retail sales in China were up by no less than 20 per cent on the year before.  

The dollar is in freefall, ostensibly because of expected changes in the rate of interest.  But surely there are other factors at work too.

If the imbalance in the global economy is to be corrected, and spending rises in countries which have previously saved too much, and borrowing falls in indebted economies, then an inevitable symptom of that will be a drying up in the money markets, coupled with falls in the dollar – and presumably the pound.

It is possible that, actually the underlying cause of this crisis is that the global economy is gradually coming back into balance.  It was always going to be impossible for this to occur without pain – which is what we are witnessing at the moment – but in the longer-term this is a good thing.

The second point is this.     Periods of rapid technological change have often been followed, perversely by economic depression.    The 1930s and the UK in the 1870s are classic examples of this.    It seems likely both periods of gloom were caused because demand did not rise with supply.  

Actually, these depressions could have been avoided if, instead, the consumers and businesses of that time had been able to borrow from future income to spend in the present.   Back then, financial markets were just not sophisticated enough, while gold, which was the world’s currency, was too inflexible.    Global productivity increased, but the global supply of money was dependent on the supply of gold.  

In short,  today’s sophisticated financial markets, which have come under so much criticism, have provided the foundations for economic growth – who knows, without these sophisticated financial tools  – without CDOs, the world may have gone into a very deep recession some time ago.

But previous periods of economic woe have also frequently followed crashes in asset prices – this occurred in Japan in the 1990s and in the US in the 1930s.      A similar challenge exists today. There’s not much we can do about this, asset prices are already too high, and for as long as this is the case there will always be a danger of economic crisis.      Let’s hope, though, we learn our lesson, and in the future, less faith is placed in bricks and mortar.  

Perhaps, though, the real problem lies with over reliance on the rate of interest.   The US and UK need lower exchange rates so that the two countries can export their way out of crisis.     But these days, exchange rates only seem to fall if interest rates fall, yet falling interest rates encourage more debt.

That’s the real dilemma, and that’s why the Fed seems so impotent.     The rate of interest as a tool for controlling the economy is looking less and less effective.

After world War II, John Maynard Keynes and his American colleague Harry Dexter, defined the economic institutions that dominated the post war era – the IMF, the World Bank and Bretton Woods system of exchange. 

It is time for another such accord.     If the governments of the world’s major economies recognise the true forces at work here, and then do something about it, then what George Soros described as the worse financial crisis since World War II can be transformed into a unique opportunity  to provide prosperity to all.

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