Is this the end of the World?
Nostradamus, and the Mayan’s said it wouldn’t happen until the final quarter of 2012 but anyone following the news could be forgiven for thinking the Apocalypse is already upon us given the apparently increasing incidence of Global cataclysms.
Over the last 18 months the World has witnessed a host of natural disasters including: drought, famine, plagues, volcanoes, earthquakes, Tsunamis, floods and other extremes of weather.
We also seem to have increasingly frequent challenges of our own making, like: war, genocide, poverty, income inequality, declining standards of living, loss of access to justice, uncontrolled population growth or decline, demographic shifts, competition for scarce resources, rampant over-consumption, Globalisation undermining Sovereign Government, transnational migration of jobs, mass unemployment, increasing Sovereign debt burden, economic stagnation, market failure, weakening democracy, loss of confidence in politicians and Government, collapse in society, increasing civil unrest and disobedience...
It’s a depressing list but these are all recent or current events. Whether these are coincidental, unrelated events or not, the cumulative impact is devastating to our society - depleting resources, challenging capability, destabilising social progress and compromising the ability of States to govern themselves and manage their economies effectively. As resilient and resourceful as we are in adapting to our environment, the threads of western civilisation are beginning to fray. Just a few months ago we saw burning vehicles and buildings all around London with chilling effect as the fragility of our civilisation became shockingly evident and everyone witnessed how rapidly just a few people could disrupt normal life, and destabilise our society’s perception of security.
Understandably the news is currently full of the economic turmoil in Europe and its impact on the Global economy. The media has its beam squarely on the Euro zone, although the debt management activity in the US also has its attention. There is no respite for political leaders and the focus in the European Union, as elsewhere, is to identify how best the Euro zone can support the bankrupt economy of Greece, debt laden Italy, and other Euro-zone countries caught up in the developing crisis of confidence.
Just as striking is the story not getting any exposure at all – the raging drought and famine in Africa that is displacing and/or killing millions of people. We might all wonder what it says about the priorities in our society where reports of economic slow down occupy all of the news while heart wrenching human tragedy in Africa attracts no interest at all. As if to seal the point, a recent mainstream media news headline package was an impact piece about the increasing numbers of pets in the UK being sent to animal shelters because owners have lost their jobs and could no longer afford to keep them!
If World leaders are going to address the Global economic crisis they will need to look beyond the symptoms and resist the kinds of short term decisions that ultimately make things worse. In large part, the measures taken to resolve the banking crisis in 2008, in isolation of implementing other changes, have escalated to create the economic crisis in Europe and the US today.
What are the issues in Europe and how are these Globally relevant?
Apart from over-crowding in British animal shelters, the most pressing issues in Europe and the US relate to the challenge of how to reduce massive budget deficits without depressing the Global economy, to stem the crisis of confidence in Government’s ability to repay sovereign debt, to maintain liquidity in the banking systems in the face of debt default, to stimulate economic growth, increase employment and maintain an effective regulatory environment.
The scale of the problem is already unimaginable, and there is a growing sense of unease. Even after writing down half of its Sovereign debt, Greece still can’t shoulder the burden of its bond yield while progressively reducing its overall debt. The numbers are simply bigger than the failing Greek economy can support in any meaningful timescale, regardless of the practical implementation challenges. This realisation is pushing up bond yields to levels likely to force Greece out of the Euro, cause it to default on its debt and create financial stress to the European banks exposed to its bonds.
Italy, 3 times the size of Greece, Portugal and Spain combined, is also under pressure. Its Sovereign debt is an eye watering 120% of GDP, or 1.9 trillion Euros and if it’s bond market runs into trouble it is too big to save. With waning market sentiment, Italy’s bond yields recently broke the critical 7% threshold where annual interest payments are a staggering 350 billion Euros (approx. 40% GDP). The consequence of Italy defaulting on its Sovereign debt is unthinkable. French, German and UK banks collectively have about 400 billion Euros exposure to Italian bonds and failure would threaten their viability without intervention.
To illustrate the problem, Berlusconi planned to reduce Italy’s debt by about 68 billion Euros in the coming 12 months. Assuming it can meet its interest burden (which is in doubt), and the plan realises its target, ceteris paribus, at this rate of debt reduction it will take Italy more than a decade just to reduce its debt by 50%. That’s a long period of misery for Italian voters who are likely to get a chance to mark their polling cards in the next 12 months.
The Greek and Italian Prime Ministers have both recently been replaced but any initial improvement in market confidence from this leadership change will be ephemeral and quickly dissipate as the problems of doing enough quickly are better understood. More fundamentally, convincing the Greek and Italian people to support decades of increased taxes and severe austerity measures will not pass smoothly. Resistance will be significant as resentment of deep-rooted economic inequalities and widespread frustration with the political class, boil over.
The European Sovereign debt crisis isn’t restricted to Greece and Italy. Prominent others include, Ireland, Portugal and Spain. Even France may need to support its banking system if market confidence continues to erode, or Italy defaults.
In this heady climate of frantic crisis resolution, maintaining liquidity, and engineering rapid budget deficit reduction that markets can have confidence in are foremost on the agenda of political and financial leaders sensitive to the fact that what needs to be done to save their economies will also be deeply divisive and damage their future political ambitions. Europe is battening down the hatches.
This sets the scene for the imminent global financial maelstrom about to be unleashed, should investors flee from risky Sovereign debt, bond yields escalate, contagion sweeps through the banking system, money circulation dries up, the global economy sinks into recession creating mass unemployment, and aggressive budget management elicits widespread social unrest in significant sections of the population with little to lose or look forward to in the foreseeable future.
Is there a reliable fix?
Some economists and financiers believe the liquidity issues can be addressed if the Central Banks print new money, as they did in 2008 with the onset of the banking crisis, and as the US Federal Reserve has been doing since - ‘Quantitative Easing’. Unfortunately printing new money doesn’t come without it’s own problems, as the Germans are all too aware. When Germany last printed money to stimulate its economy, the hyper-inflation created was so severe the economy collapsed creating the circumstances that gifted Adolf Hitler his political platform. It’s therefore unlikely Angela Merkel will be eager to support substantive quantitative easing to bail out Greece, or Italy, unless it is to negate a catastrophe for Germany itself.
Printing money may provide short-term relief to liquidity issues should bond yields increase, or should States have to support banks exposed to defaults, buy time for Governments to gain traction for their debt reduction plans, and perhaps help regain market confidence. In the longer term quantitative easing will cause other unwelcome problems. After all, if Governments can’t afford to service their debts today, the situation will only get worse as time goes by, yields go up and credit scores go down. Quantitative Easing certainly won’t solve the problem of how Europe and the US got into this trouble. Neither will it stop increasing amounts of the new money finding its way to the small number of powerful investors currently accumulating cash reserves – and thereby removing it from general circulation in the economy.
There is little good news on the horizon. Neither Greece nor Italy is likely to avoid depressing their economies while implementing austerity measures. Neither is likely to make sufficient progress in reducing sovereign debt to satisfy the markets, and neither will avoid widespread social unrest resulting from budget cuts. Sooner or later both will default and should that happen the impact will ripple throughout the Global financial system. There is no obvious new model for the Euro zone that everybody is agreed on and, as if those issues weren’t enough, there are additional underlying tensions that will hinder any debt reduction efforts beyond the immediate implementation challenges:-
· Firstly, although the Global population is set to increase to 9 billion by 2050, most of this growth is taking place in emerging economies. In contrast, excluding massive immigration, populations in Europe are in decline. Result - reducing consumption, reducing tax revenues and stagnating economic growth (GDP).
· Secondly, the populations of Europe are ageing due to increasing life expectancy and reduced birth rates. This creates long-term crisis for European economies. Result - fewer tax payers entering the workforce, declining tax revenues and increased public sector spending on social welfare and health care systems (or dramatically reduced benefits).
· Thirdly, offsetting declining population across Europe’s stagnating economy, China will add about 400 million new, relatively affluent consumers to its existing urban population of 500 million. India is forecast to add about 300 million new consumers to its urban population. The impact of these changes to Global trade is significant. Currently the world’s seven largest emerging economies (E7) are about 20% of the size of the seven largest economies (G7), in terms of market exchange rates (MER), and 75% of the size in terms of purchasing power parity (PPP). By 2050 the picture completely changes and the current E7 will be 25% larger than the G7 in terms of MER, and 75% larger in terms of PPP. G7 economies are already being marginalised and the impact will create a structural shift as commercial enterprise realigns its distribution model with the new centres of trade and where the business is actually getting done. Although there may be short to medium term relief with increased exports from Europe to the Far East, this will be temporary and the shift in the main centres of trade will result in wholesale migration of jobs, from west to east, resulting in extensive job loss in all sectors except those that must be distributed locally. Result - declining tax revenues from reductions in the workforce and from corporations migrating to more efficient tax jurisdictions, increasing social welfare costs putting pressure on budgets, increased balance of trade deficits
· Finally, dramatically reduced western economies will result in dramatically reduced financial markets and large corporations relocating to overseas bourses. Prada is a recent example, de-listing in Milan, shifting the hub of its trading activities and re-listing on the Hang Seng in Hong Kong. Result - severe impact on tax revenues for economies (like the UK) who are reliant on the financial service sector. David Cameron recently said that London (the City) was constantly under attack from overseas exchanges - trying to poach companies and the best City brains away from the UK.
Are politicians so fixed on the immediate economic crisis that they are ignoring the future outlook? The underlying issue in Europe is a reduced and ageing population that, regardless of the current economic issues, will cause stagnation and create serious pressure on public finances. Investors, said to be sitting on immense cash reserves, are unlikely to invest significant resources in the shrinking, stagnating economies of Europe in preference to the rapidly growing emerging markets where the gains are greater. Politicians can’t solve these economic problems without restructuring their economies and finding new ways to balance budgets against a back-drop of shifting commercial activity, reducing tax revenues and increasing need for social welfare support. Restructuring an economy takes a long time. Re-educating a significant welfare dependent section of society and altering its sense of entitlement is a traumatic process.
It’s hard to see how this will pan out. European corporations will hold their share of the global market but many will also refocus their business models, relocate their operations and relist on Asian bourses. In this scenario, one could imagine a radically different FTSE index as 30 years of gains are unwound, and all that that entails for the UK economy.
These scenarios are bleak and their social impact will be felt across Europe and North America for decades to come. Even American will have to stop printing money and get to grips with its debt, though the current state of leadership and consensus between parties, Senate and Congress is a barrier to progress.
The issues are complex and diverse but there is a growing sense of awareness, resentment and dissatisfaction evident in public displays of protest: among protesting students faced with increased tuition fees, public sector workers facing reduced pension entitlement and job loss, from low income families struggling to comprehend the paradox of how they can not afford to heat their homes while energy companies post £multi-billion quarterly profit reports, from the old and the infirm prevented from receiving adequate health care, from families whose discretionary income has been eroded through inflation and long term wage stagnation, from the vast majority of the population whose savings and capital has been eroded and replaced with personal debt, and who are worried that their equity based pension schemes won’t support them in later life, from an electorate that is disengaged from the democratic process and disillusioned with a political class unable or unwilling to hear their concerns and represent them properly.
The scene is set for widespread social unrest throughout Europe and the US. When large groups of people have a common cause they are difficult to ignore. When entire populations are impacted, a myriad of disparate dissatisfactions merge, populations mobilise, public order deteriorates and ‘systems of Government’ falter.
Politicians do need to address the immediate issues of maintaining confidence in the banking system and stimulating economic growth while managing debt. But they must also attend to the underlying structural, regulatory and social problems. This isn’t going to be easy. As austerity measures bite, the existing sense of inequality will intensify as people seek to apportion blame.
Unlike the 2% of people at the top of the socio-economic order, the rest of the population will suffer substantial economic loss and/or lose benefits they have long enjoyed. People will look to the State as a focal point for their pain. Anyone watching the public conduct of business in the UKs House of Commons is unlikely to be inspired. At times it’s hard to envisage how a group of public representatives could appear less representative of the public they are there to serve. Why are MPs puzzled by public apathy towards the democratic process, and/or antipathy towards the political class? Boards of Directors in large companies operate in complex, competitive, political environments but don’t exhibit such extremes of behaviour seen daily in the House of Commons. Perhaps one should not be surprised by the nature of televised broadcasts. Having watched numerous debates it’s hard to avoid feeling disappointed with the image presented by Parliamentarians. MPs should recognise that while their raucous behaviour may be a quaint eccentricity steeped in tradition and protocol, it no longer reflects the way things are done in the real world, or what the majority of people expect. This is more important now than it has been in the last 40 years. People can come to terms with the magnitude of challenges facing us all but they need to believe and have confidence that the nation’s leaderships is capable.
A new approach is needed to inspire confidence in the leadership of the country, and respect for the legitimate authority of Government. There needs to be a dramatic change of the culture within Parliament, to make it relevant to the electorate, effective and productive. People won’t tolerate financial hardship forced on them by a political class they neither respect or understand, and further feel alienated, having lost their voice and stake in the economy.
Is the structure and conduct in the House of Commons inappropriate? Are the skills of legislators consistent with those needed to manage the economy? Are Politicians best placed to solve Global economic problems?
Natural events are largely unpredictable. Economic events are predictable and engineered, whether by design or omission. Has the time come to recognise that the economy is so complex, dynamic and inter-dependent that its effective management is beyond the capacity of politicians whose training; experience, priorities and party-political agendas are inconsistent with the demands of global commerce? Should politics and Government be completely separate from the activities of managing the economy?
The developing economic crisis is a real and present danger. Politicians may not be best placed to resolve the problems, or manage the economy in the future, so how should this be done and is it even doable while avoiding boom and bust?
Perhaps the model of the free market capitalist model needs to be re-examined. Capitalism has enriched society at large and created a vibrant, increasingly affluent society. Ironically, the excesses of free market capitalism are also bad for the majority of people and, in the worst examples, create victims who are powerless to improve their lot. This is a dangerous development for society. If Government spending isn’t able to bridge the gap, and philanthropy is largely inadequate as a response, there is a risk that large sections of the population will be alienated. They will become radicalised and this will further reinforce the feeling of inequality. A new, fairer, model for capitalism may be required that addresses the issues across the spectrum of society.
Can the capitalist model be improved? Yes it can. But first there needs to be universal recognition of the long-term consequences of not doing so. A culture change is needed, along with an improved framework supporting principles of common good, social conscience and fairness, with effective regulation of the financial markets and business values - to curb excesses and the perception of greed, while avoiding conflicts of interest and political manipulation. Global leaders need to create a level playing field and recognise that exclusively representing national interests may not serve the common good, results in increasingly dramatic economic shocks, creates winners and losers and leading to social instability.
Apart from conspiracy theorists, the mainstream media is not telling this story in its broadest sense, except to address the most easily packaged elements. Why? Is the story too complicated to report factually? Or so big and alarming it is incredible?
A few American social commentators have had a go. Michael Moore for one. His documentary, Capitalism: a love story is a compelling outline of the drastic decline in various sectors of the US economy and its impact on ordinary working people. In the UK, Channel 4 recently aired: The Flaw, an attempt to explain in detail some of the causes for the financial crisis in 2008, again from a US perspective. While the issues in the US are interconnected with Europe, these programmes focus mainly on the plight of Americans following the banking crisis, and years preceding it.
What are the fundamental issues underlying or driving this crisis?
· Model of Government – the ability (and credibility) of politicians to balance the demands of a wide portfolio of activities, including: developing legislation and regulation, managing the economy, balancing the public sector budget and developing long term social policy. It may be that the impact of Globalisation is so demanding that governments can no longer maintain the inefficiency of party politics and need instead to engage in consensus and collaboration in coalition style politics.
· Economy – addressing how the economy is managed and by whom. Managing budgets effectively and matching tax revenues with public sector spending and borrowing, balancing the mix of services and manufacturing to maintain employment and the trade balance.
· Entitlement – after a hundred years of welfare support the sense of entitlement to welfare support, social security and health care has become unmanageable. So much so that Government is forced to spend and borrow more that it is able to collect in tax revenue. It’s hard to imagine any modern day commercial enterprise being able to survive with the kind of debt burden of developed economies and yet almost all of the G7 members have greater than 90% debt to GDP, some considerably more. In the past philanthropy has helped the plight of people in distress but this is an unreliable solution to a predictable problem. The situation is unsustainable and it is clear that something needs to change, both in terms of taxation, in terms of the sense of entitlement to welfare support, and the future approach to distributing public finance.
· Appropriate regulation - of business and the finance sectors to create a culture of fairness that can be widely recognised and appreciated by society while avoiding the worst excesses of economic power and inequality. Managing the tensions created by perceived inequality while also ensuring society provides adequate incentive and reward for those individuals who work hard, are successful, take personal risk and invest their capital.
I suspect we'll find out as time goes by.
