Thursday, November 18, 2010

Asia Time Online - Daily News

THE POLITICS OF DEBT: Part 2
Pay up, or wiggle out
By Chan Akya

This article concludes a two-part report
PART 1: Debt and democracy

Vox populi, pox debitum

If I may be allowed to indulge in some small Latin, this article should start with a new pig Latin phrase that implies that the voice of the people (vox populi) is anathema to their ability to service national debt (pox debitum).

In Part 1, I wrote about the significant failings of popular movements to establish the primacy of longer-term prosperity over the expedience of near-term welfare, inevitably choosing expediency over efficiency.

The expectation that a people confronted with hardships would make every attempt to wiggle out of the situation rather than confront matters a bit more directly is the main reason for markets to panic on every occasion that a democracy encounters hardships.

Last week's graphs showed clearly the widening credit spreads of various Western democracies in this column. Over the weekend, fears of the European contagion spreading to the next possible victim, Ireland, were discernible in last week's startling decline in bond prices. The country's largest-selling newspaper, the Irish Independent, reported on Sunday as follows:
The Government has denied for the second time in 24 hours that it is in bailout talks with the EU, after the BBC reported yesterday that "preliminary talks" on financial support are taking place.

The BBC report made the unsubstantiated statement that recourse to the EU bailout fund was "no longer a matter of whether but when". But a spokesman for the Department of Finance was adamant last night: "There are no talks on an application for emergency funding from the European Union."
It then quotes a slew of economists who have a slightly different view and assessment of the Irish situation:
Nobel laureate Joseph Stiglitz said Ireland is in a "dismal" position and there is little chance that the Government's measures to reduce the budget and bail out banks will be a success.

"The austerity measures are weakening the economy, their approach to bank resolution is disappointing," Stiglitz, a Columbia University economics professor, said in an interview in Hong Kong today. "The prospect of success is very, very bleak" for the government's plan to resolve the problem, he said.
The newspaper then quotes Simon Johnson, a former chief economist at the International Monetary Fund (IMF) as saying the following:
"For the sake of the Irish people, it's time to go to the IMF. If you go in now and if you go in with your partners, you will get a good deal. You may not get such a good deal next week. It would have been a much better deal if they'd gone in February because Ireland wouldn't have had to go through all this discretionary tightening along the route."

While he agreed with the Governor of the Central Bank, Patrick Honohan, that the IMF might not change the policies already being implemented by the Government, he warned that this situation would not last.

"It's not untypical that countries wait too long and find themselves in more desperate straits. If you bring the IMF in this weekend, then Mr Honohan is exactly on target, but the longer you wait, the longer the politicians prevaricate, the worse it's going to be for everyone."
He is referring to the very democratic process of countries filing their national budgets. With the government looking at other austerity measures in the new budget to be unveiled early next month, speculation is rife that the political opposition will likely push for the bill being rejected in parliament, which would in turn automatically trigger elections.

The obvious implication of political fracture in Ireland and the possibility of the government going back on its austerity plans is the main reason for markets to fret.

All of which brings this article to a favorite question of mine that has been posed rather a lot recently to a bunch of my associates - "what is the most important lesson from Japan for the past 20 years?"

We're all Japanese now - redux
Last year, I wrote about the Japanese style of broad market intervention as the new standard for capitalists around the world (see "We're all Japanese now", Asia Times Online, September 5, 2009). Perhaps I was too subtle in that article because everything since then has only reiterated the simple truth that folks don't seem to have learnt the proper lesson from the Japanese malaise of the past 20 years.

Here is what Paul Krugman wrote in his blog as recently as October 28, 2010:
David Wessel has an article asking what Milton Friedman would say about quantitative easing, and concludes that he would have been in favor. But I was struck by Friedman's 1998 remarks about Japan, in which he basically said that increasing the monetary base would do the trick:

"The Bank of Japan can buy government bonds on the open market ... " he wrote in 1998. "Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand ... loans and open-market purchases. But whether they do so or not, the money supply will increase.... Higher money supply growth would have the same effect as always. After a year or so, the economywill expand more rapidly; output will grow, and after another delay, inflation will increase moderately."

Well, they did that: staring in 2000, the BOJ nearly doubled the monetary base over a period of three years.

And the money just sat there. Banks did not, in fact, expand loans. In fact, Japan's experience is a key element of the case against monetarism. Just printing notes does not work when you're in a liquidity trap.
All fair points, but slightly off topic because here is what Paul Krugman wrote in the New York Times last week in an article entitled "Doing it Again" (emphasis mine):
The case for a more expansionary policy by the Fed is overwhelming. Unemployment is disastrously high, while US inflation data over the past few years almost perfectly match the early stages of Japan's relentless slide into corrosive deflation.

Unfortunately, conventional monetary policy is no longer available ... So the Fed is shifting from its usual policy of buying only short-term debt, and is now buying long-term debt - a policy generally referred to as "quantitative easing."

... This time, much of the noise is coming from foreign governments, many of which are complaining vociferously that the Fed's actions have weakened the dollar ... the hypocrisy is so thick you could cut it with a knife.

As a practical matter, however, this foreign criticism doesn't matter much. The real damage is being done by our domestic inflationistas - the people who have spent every step of our march toward Japan-style deflation warning about runaway inflation just around the corner. They're doing it again - and they may already have succeeded in emasculating the Fed's new policy.
So there you have the nonsense of the Keynesians (to be differentiated from the actual articles of Keynes, but that's another story for another day) in two short articles. First Krugman suggests that monetarism is ineffective and then quietly contradicts himself with a suggestion that it would be the magic solution to America's problems if only it were allowed to work properly. That whole federal government deficit-expansion thing is called a failure, you see, because the rest of the economy didn't play ball.

Therein lies the core of the discussion of what the real lessons of Japan were in the first place. To cut to the chase, the answer is political not economic sclerosis.

The changing demographics of America broadly reflect the economic decline in as many words as the decline we see in the case of Japan for the past 20 years. An aging demographic requires stable income and for the sanctity of savings to be maintained. That is the reason the Japanese government bailed out the banks - not any great attachment to the businessmen themselves.

In turn, the rock-solid support of pensioners and those benefiting from fiscal expansion (eg the construction industry) ended up becoming the dominant political forces in Japan. Readers of my forum will note that this is precisely the line of argument that various forum members ended up with in discussing the apparent flip-flops of American polity in the most recent election.

This trajectory is well known and widely predicted; I wrote the "New Brahmins" (see Asia Times Online, March 29, 2008) highlighting this trend - and of course, this was hardly the first or only news outlet to express such opinions. Banks are central to populist reactions because a store of savings becomes doubly important to an ageing demographic; in the same way that it did to Japan and now the United States.

With one part of the policy constrained - ie a predilection to protect banks - comes the other side of the coin, namely the failure to stimulate balance sheet expansion due of course to stagnant asset prices and the lack of credit availability.

Low economic growth or stagnation is the easy result; it has the effect of slowly drawing the noose around the mountain of debt that is accumulated meanwhile. As the immediacy of debt repayment becomes more stringent, countries have a choice of either collectively tightening their belts or else choosing to resort to brinkmanship.

A better alternative is to allow banks to fail while protecting the interests of depositors. The resulting decline of asset prices combined with a meaningful adjustment of factor costs (wages, rents etc) allows the resumption of a fresh economic activity much faster.

Blanket protection of banks doesn't deliver this result, but clearly politicians feel constrained to do so in order to protect their voting base. That nexus between savings administration and popular perceptions is quickly emerging as the Achilles' heel of all democracies that find debt loads unbearable.

Vox populi, pox debitum indeed.

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