Thursday 12 March 2009
Time to get the Keynesian animal spirits moving again
One of the most frightening things about the world financial and economic crisis (apart from the very fact that it has now become a global affair) is the awful lack of certainty about what caused it and what can be done about it. Just how did things collapse so badly, and with such alarming rapidity, compared to previous economic downturns - and can they be fixed?
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Time to get the Keynesian animal spirits moving again
By ANTHONY ROWLEY
12 March 2009
One of the most frightening things about the world financial and economic crisis (apart from the very fact that it has now become a global affair) is the awful lack of certainty about what caused it and what can be done about it. Just how did things collapse so badly, and with such alarming rapidity, compared to previous economic downturns - and can they be fixed?
Perhaps the most revealing number to emerge so far in a wealth of depressing data on the crisis was one that appeared this week in an Asian Development Bank (ADB) report. This suggested that the world has lost about US$50 trillion of portfolio wealth - equivalent to a year of global gross domestic product (GDP) - as a result of the financial-market crash. This is a truly colossal amount of money and it represents the value lost in the collapse of stock and bond markets and in bank assets around the world since the end of 2007, when the crisis began to take firm hold. Some will argue that this was only ‘paper wealth’, but this of course misses the point.
Stock-market gains represent real wealth in the hands of individuals who can spend income and savings, as well as borrow money, against the collateral of these market gains. Likewise, these gains represent real wealth in the hands of business corporations that are prepared to invest on the basis of such gains, and of banks whose capital is strengthened by stock gains.
In this sense a stock market is like a nuclear reactor at the heart of a modern economy. Once activity gets going in the core of the market, it quickly generates a reaction that spreads to other parts of the economy and generates heat. Unfortunately, if the reactor overheats and shuts down, the chain reaction of events that follow creates a freeze-up in the economy.
Can this lost portfolio wealth be replaced by official stimulus actions, such as those that the world’s major economies are scrambling to take now? The ADB report, titled Global Financial Turmoil and Emerging Economies, estimates the total size of stimulus packages announced so far at around US$2.2 trillion, with by far the largest part being in the United States and China.
Clearly, this can do no more than scratch the surface when it comes to compensating for what the ADB report calls the ‘astounding’ loss of wealth on global stocks and bonds and in bank assets. Even if central banks print money fast enough to allow fiscal stimulus to grow on a scale that would have horrified even British economist John Maynard Keynes, the official money machine cannot re-create the market monster.
Just what a monster was created in the five years running up to the time when crisis struck is obvious from yet another reference in the ADB report (which was prepared for the bank by the Centennial Group Latin America).
This shows that the ratio of financial assets to world GDP increased by a half between 2003 and 2008 to an astonishing 490 per cent. Even this does not include financial derivatives, which are of a complexity that defies easy analysis, the report acknowledged. Nor does it include the vast gains in property prices that occurred around the world until last year (except insofar as this is covered by the increase in bank assets).
Asia took a large part of the hit (nearly US$10 trillion of the US$50 trillion loss in global asset values), according to the ADB report. Of the US$9.63 trillion of lost wealth in Asia, no less than 81 per cent was accounted for by the crash in Asian stock markets, with the rest being in banks assets and bond markets. This does not include Japan, however, and if Japan were added in then Asia’s total share of the US$50 trillion global wealth loss would obviously be very much greater than 20 per cent, given that Japan is still the second largest economy in the world and that the Tokyo stock market is still the second largest of any single country after that of the US.
So, apart from suffering a massive trade shock - by virtue of being the world’s most open region in this sense - Asia has been hit also by a massive implosion of internal wealth, in addition to suffering (along with other developing regions of the world) a slump in capital inflows. No wonder this region as a whole is hurting so badly.
What are the policy lessons to be learned from all this? One, of course, is - don’t make the same mistake again and allow such speculative bubbles to develop in the first place. Much attention is being given to this idea now, in the sense of tightening regulations, asking central banks to target asset inflation and so on. Another lesson might be to focus more attention on stock markets where official stimulus is concerned. Certainly, the global banking system needs fixing in order to get funds flowing again through the system. But ‘animal spirits’ (as Keynes said) need to be revived before people will spend, borrow or invest again, and stock markets are key to reviving them.
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