Can the markets fix it? The past few weeks – and from a British perspective the past few days – have been a dispiriting period, with evidence of rising inflation and slower growth prospects just about everywhere you look. The balance between these two varies from country to country, with most developed countries more concerned about the slowdown and most of the developing world more worried about inflation, but the problems are universal.
Yet we know from past experience that markets are immensely powerful creatures and that they will in their disorganised way eventually correct global imbalances, albeit at a cost. They are, for example, correcting the imbalance in supply and demand in the oil market because oil at $130 a barrel will force conservation and eventually stimulate supply. But they cause a lot of collateral damage on the way and the aim of public policy should be to try to stop markets having to move to such extreme positions by, for example in the oil market, encouraging conservation at an earlier stage.
The policy has, however, to be global. You can attribute part of the global housing boom and bust to excessively low interest rates in the US, but part of the more general problem of huge global imbalances was the desire of Asian countries to build up large savings both nationally and individually. The world is going through a big adjustment now, with much slower growth, maybe recession, in the US but so far most of the pressure has been on the markets to fix it, rather than on policy changes that might make their task easier.
We will come to policy in a moment; first, just look at the adjustment that is happening now. Start with the UK: yesterday we had the Bank of England agents' reports on the economy. The Bank's people talk to businesses around the country to try to get an early feeling for commercial conditions, before what might show up in the statistics. One picture that is emerging is the contrast between the buoyancy of export demand and the flat demand at home. This is just what "ought" to be happening. Sterling has fallen by around 15 per cent against the euro and the eurozone is our largest export market. The adjustment has begun.
Another forward-looking indicator came out yesterday, the Ifo Index of German business expectations. This surprised people by being quite strong. True, German companies are much more positive about the current situation than they are about the future but overall levels of confidence are very high by recent standards, certainly much higher than you would find in their counterparts in Italy. Why? Part of the answer, at least, is that German companies have been very successful at grinding down their costs. Germany has had about seven years when there was hardly any rise in living standards: wages were held down, products driven up-market and production was shifted to lower-cost eastern Europe. Result: the world's biggest goods exporter was forced by market pressures to adjust and has become super-competitive again.
Mind you, Italy faced similar pressures but failed to make the adjustment and, accordingly, faces very slow growth, maybe recession. So the reaction to market signals matters crucially too.
What about commodity prices? We will leave oil aside for the moment but, energy apart, most commodity prices do seem at last to be reaching some sort of plateau. Moody's reckons that the commodity bubble is gradually ending, with the price of precious metals flat now for some weeks and the price of many soft commodities, including most forms of food, no longer rising. The chart shows the Chicago Board of Trade price of maize and rice and, as you can see, there seems to be some sort of falling back at last. This does not mean that the price of rice around the world is falling because these markets are segmented along national lines, with all sorts of subsidies, taxes and export/import barriers.
As for oil, well, markets do overshoot. Already the price is high enough to force a decline in the consumption of petrol in the US, the first since the early 1980s. There has also been a fall in US oil imports, reversing a long-term upward trend. I suspect much the same will be happening across Europe and in the UK too, and the fact that we here have a particular problem with diesel prices will force change too. (We may have another riot about fuel prices – but that is another matter.)
Finally, if you want evidence of change, look at what has been happening to the US current account. Despite the huge rise in energy prices – and the US imports about half its oil – the US deficit has started to correct itself. It is not a huge swing yet but you have to start somewhere and turning round something so fundamental as that is an enormous task. The super-competitive dollar is evidently low enough to start doing the job.
So the markets will eventually make the adjustments but they have no mind – they simply respond to the pressures they have to mediate – so they will do it in a rough way. The aim of policy should be to reduce the pressure on them, to help them, so-to-speak, to do their job better.
It will be several years before the world's monetary authorities get to grips with the reasons for their own failures during this cycle but importantly people are beginning to think about what needs to be done to try to minimise the amplitude of the boom/bust cycle. For example, banking regulation will be changed, with maybe some adjustment in capital requirements for different stages of the cycle. It would be tricky because there would have to be international agreement both on what had to be done and the calibration of the cycle. But it is worth thinking about.
I expect, too, that after the next UK general election there will be changes in our own fiscal rules. It would be impossible to take fiscal policy out of the political arena, in the way that monetary policy has been hived off. But it would certainly be sensible to take the analysis of the cycle out of ministerial control. The idea of having fiscal rules was a very good one; the execution of the policy has shown up the need for some independent voice in their application.
Finally, two forward-looking bits of global analysis emerged yesterday, one from the Bank Credit Analyst group in Montreal, the other from the Commission on Growth and Development, a group of economists and policymakers led by the Nobel Laureate Michael Spence.
The BCA paper looks at the way Asian economic policy contributed to the present downswing: "For a period, the cheap currency policy was an effective tool to fight deflation emanating from the financial meltdown. Over time, however, it has begun to outlive its usefulness. Now, the cheap currency policy has become a key culprit behind rising inflation." It follows that gradually there will have to be revaluations of the Asian currencies on the lines now happening in China, which seems to be moving towards holding the yuan against a basket of currencies.
Much the same theme em-erges from the Growth Report. It looks much more widely, covering everything from global warming to the shift to the cities, but one particular matter is the shift in policies needed and the pressures that have resulted from the Asian boom this cycle. As it notes: "Fast, sustained growth is not a miracle – it is possible for developing countries, as long as their leaders are committed to achieving it and take advantage of the opportunities provided by the global economy." Quite right, too.Reuse content