8 June 2011

Would economies be more stable, people’s living standards higher, if Central Bankers didn’t intervene?

Recession is louring. It’s a pity those on watch are asleep.
The world economy, losing momentum gradually during the preceding twelve months, lost it precipitately in the early summer. In part, the process was involuntary; in part, engineered. The chronology of the business cycle was such that activity would have slowed in any event. But its impact was powerfully reinforced by a drift towards monetary austerity.

Instead, they feather bed the public sector, and raise interest rates!
In India and China, central banks had tightened credit to curb excess demand; in Australia and Brazil, they’d done so to contain inflation; in Europe, the ECB’s interest rate hike was an act of defiant bravado—Trichet, preferring to scuttle the fleet rather than abandon the euro.

Even in the States, the Fed seemed to be wavering.
Previously, Bernanke had claimed he’d pursue accommodative policies for as long as economics activity stayed inadequate. Suddenly, though, in the face of weakish labour market numbers, he too was changing tack. The talk was no longer of whether “quantitative easing” would be unwound, but of when it would be.

Housing will be hard pressed.
Unsurprisingly, sentiment crashed. Housing proved to be particularly susceptible. Valuations had been fragile when unemployment was falling and credit expansive. They’d likely be hammered when these factors were reversed.

Those that suffered last time will suffer again this time. And some others as well!
Spain and Ireland were most vulnerable; the US, the UK and Australia not much better placed. China and India would have also to be monitored carefully. If, as in the thirties, protectionism became fashionable, the latter would take a beating. Like Argentina, in the earlier period, they’d suffer, not prosper, as a result of their competitiveness!

Politicians will be changed.
Predictably, incumbent politicians have been blamed. In 2007 and 2008, when the financial crisis began, they’d pretended they knew what to do. Today, when it’s obvious they didn’t, they’re having to pay the price. Tweddledum is routinely preferred to Tweddledee.

Perhaps policies as well.
Will that change economics policies? Probably. It’ll justify gradually lower public spending, for instance. It’ll be acknowledged that transferring resources from the relatively efficient private sector to the relatively inefficient public doesn’t boost overall activity, but does reduce living standards.

Those relating to commercial banks, for instance.
Similarly, it’ll be appreciated that bailing out the commercial banks in 2008 was a huge error. Those who made the decision to do so, primarily central bankers, are likely to have to fall on their swords. Those who approved it, incumbent politicians and dozy academics, will have to apologise, promising not to be so silly in the future.

Stock prices may be resilient.
Ironically, some would say perversely, the securities markets may hold up quite well in the difficult period that lies ahead. The prospective setback in activity will stifle economies’ inflationary tendencies, and that’ll allow nominal interest rates (though not real ones) to be cut again. Coupled with lower public borrowing, that’ll transform the outlook for Treasuries markets. Most (the no-hopers in the EZ only excepted) will be rallying within a few months.

Bonds initially; ordinaries subsequently.
Meanwhile, corporate profit margins are likely to exceed investors’ expectations. Recession will have a particularly significant effect on labour costs. Dividends and earnings won’t be buoyant, but sufficiently good, given the lower bond yields, to justify current valuations!

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