Global growth is burning out and fading away
Commentary: Economic gains are limited, but investors don’t know it yet
new
March 11, 2013, 1:50 p.m. EDT
By Satyajit Das
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SYDNEY (MarketWatch) — Driven by massive monetary stimulus from the
world’s central banks, the performance of global financial markets,
especially stocks, have decoupled from the reality of a moribund world
economy.
Financiers assume that the strong rise in equity markets anticipates a
strong economic recovery. However, there are fundamental reasons why the
world may be entering a period of low- or no growth. If that is the
case, then the current optimism of financial markets may prove
premature.
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In historical terms, economic growth is a relatively recent phenomenon.
In a deliberately provocative 2012 National Bureau of Economic Research
paper entitled “Is U.S. Economic Growth Over? Faltering Innovation
Confronts The Six Headwinds,” economist Robert Gordon found that prior
to 1750 there was little or no economic growth (as measured by increases
in gross domestic product per capita).
It took approximately five centuries (from 1300 to 1800) for the
standard of living to double in terms of income per capita. Between 1800
and 1900, it doubled again. The 20th Century saw rapid improvements in
living standards, which increased by between five or six times. Living
standards doubled between 1929 and 1957 (28 years) and again between
1957 and 1988 (31 years). Read: Why China fears currency wars.
Other measures show similar trends. Between 1500 and 1820, economic
production increased by less than 2% per century. Between 1820 and 1900,
economic production roughly doubled. Between 1901 and 2000, economic
production increased by a factor of around four times.
Gordon controversially questions whether economic growth is a continuous
process that can persist forever. He argues that both growth and
improvements in living standards will slow significantly. For pure shock
value, he speculates that future yearly growth rates may be 0.2%, far
below even the modest 1.8% annualized growth between 1987 and 2007. Read: Moment of truth for Mario Draghi.
Low or no growth in fact may have positive effects, for example on the
environment or conservation of scarce resources. Still, the current
economic, political and social system is predicated on endless economic
expansion and related improvements in living standards.
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Over the last 30 years, a significant proportion of economic growth and
the wealth created relied on borrowed money and speculation. Since 2001,
borrowing against the rising value of houses contributed to around half
the recorded economic growth in the U.S.
Global trade is built on a financial model. Sellers of goods and
services, such as China, Japan and Germany, indirectly finance purchases
by lending foreign exchange reserves to countries including the U.S.
and the now deeply troubled “Club Med” economies of Southern Europe.
Debt allows society to borrow from the future. It accelerates
consumption, as debt is used to purchase something today against the
promise of paying back the money later. Spending that would have taken
place normally over years is squeezed into a relatively short period
because of the availability of cheap money. Business overinvests,
misreading demand and assuming the exaggerated growth will continue
indefinitely, increasing real asset prices and building significant
over-capacity.
Debt-driven consumption became the tool of generating economic growth.
But this process requires ever-increasing levels of debt. By 2008, $4 to
$5 of debt was required to create $1 of growth. China now needs $6 to
$8 of credit to generate $1 of growth, an increase from around $1 to $2 a
decade ago.
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The ability to maintain high rates of economic growth through additional
debt is now questionable. The need for governments as well the private
sector to reduce debt simultaneously reduces demand and locks the world
into a negative spiral of ever lower growth.
Extend and pretend
Growth was also based on policies that led to the unsustainable
degradation of the environment. It was based upon the uneconomic,
profligate use of mispriced non-renewable natural resources, such as oil
and water.
There are striking similarities between the problems of the financial
system, irreversible environmental damage and shortages of vital
resources like oil, food and water. In each area, society pushed
problems into the future. Short-term profits were pursued at the expense
of risks that were not evident immediately and emerged later.
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Another common theme in the parallel crises in finance, environment and
management of scarce resources is mis-pricing. In the period leading up
to the global financial crisis, risk, especially the ability of
individuals and firms to repay borrowings, was underpriced. The true
cost of polluting the environment or consuming certain resources has
also been discounted.
In all cases, there was significant privatization of gains, while losses
were socialized. Financiers entered into increasingly destructive
transactions, extracting large fees and leaving taxpayers to cover the
cost of economic damage.
In the early 20th century, German economist E.F. Schumacher observed
that human beings had begun living off capital: “Mankind has existed for
many thousands of years and has always lived off income. Only in the
last hundred years has man forcibly broken into nature’s larder and is
now emptying it out at breathtaking speed which increase from year to
year.” That observation is now just as true about the economic and
financial system as it is about the environment.
In his novel “Rabbit is Rich,” John Updike’s hero Harry Angstrom passed
judgement on the postwar generation: “Seems funny to say it, but I’m
glad I lived when I did. These kids coming up, they’ll be living on
table scraps. We had the meal.”
Losing the commanding heights
The current crisis calls into question the ability of governments to
maintain control of the most important and strategic elements of the
economy.
Government intervention can cushion some of the costs of the crisis but
cannot solve the fundamental problems. It is not self-evident that
growth can be conjured up policy
diktat
. If government deficit spending, low interest rates and policies to
supply unlimited amounts of cash to the financial system were universal
economic cures, then Japan’s economic problems would have been solved
many years ago. The lack of easy policy options means that the world
faces an unknown period of low, below-trend growth.
The simultaneous end of financially engineered growth, environmental
issues and the scarcity of essential resources threatens the end of an
unprecedented period of growth and expansion. But it was an
unsustainable world of Ponzi-like prosperity where the wealth was based
on either borrowing from or pushing problems into the future.
Arthur Miller wrote that “an era can be said to end when its basic
illusions are exhausted”. The central illusion of the Age of Capital —
unbounded economic growth — may be at that point.
Satyajit Das is a former banker and author of “Traders Guns & Money” and “Extreme Money.”
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