An unstable global economic system that is being ignored

October 8, 2013

Today, the International Monetary Fund announced yet another a reduction in its global growth projections for 2014, with its estimate of U.S. growth also reduced (citing reduced government spending, but not the present U.S. government shutdown — or the heretofore unthinkable notion of the U.S. government defaulting on its obligations). Despite the seeming urgency of global economic slowdown, when world leaders attended their annual fall confabulation at the United Nations in New York last month, they focused on the diplomacy of physical security (Syria, Iran, etc.). Thus another year has passed in which global economic security issues were on no one’s reported agenda.

Policy makers continue to fail to appreciate that the most formidable economic challenge today lies in the area outside the borders of any one nation or region — and that multilateral action to address this challenge is arguably more important than efforts at increasingly less-effective internal stimulus.

Present-day economic imbalances — particularly those stemming from the rapid emergence of the post-socialist nations over the past 15 years, with their associated supply of excess labor, productive capacity and global capital, relative to demand — have hamstrung the economies of the advanced nations. Such economic dislocation can no longer be resolved by any one power, or even by two or three. Indeed, there is enormous risk today of unilateral or bilateral actions being viewed by players left out of such actions as economically threatening or even hostile, leading to economic countermeasures. The issue is compounded by the complexity of the relationships among and between developed nations on the one hand and emerging ones on the other. It is hard to imagine moving beyond a global economy that is just getting by, and therefore at material risk of new and deeper crisis, without a more open dialogue among the Group of 20 (G20) nations and proactive steps toward mutual accommodation.

Yet, since the central banks of the developed world have managed to more-or-less stabilize their economies — however tenuously — discussion of a global grand bargain focused on rebalancing international trade and finance has been all but absent. This is unfortunate, as it makes it unlikely that the advanced nations will be able to return to their potential growth trajectories for some time to come.

There is, nevertheless, enormous common interest if nations can find the right way to open a dialogue with one another. Both surplus and debtor nations have so far understood that it is to no one’s benefit to attempt to aggressively advance their singular interests at the expense of their trading partners. We’re all in this together, our interests are intertwined in a flat world, and we’re dealing with more economic interdependence than ever before. And thus far, at least, we have mostly avoided the “beggar thy neighbor” strategies that went awry in previous slumps, either out of wisdom or good fortune of their ineffectiveness. That said, we are a long way from a harmonious, cooperative global trading environment.

Three key multilateral issues need to be dealt with in order to achieve global economic stability:

The situation in the euro zone will continue to plague the global economy until it either self-stabilizes or a solution is found. I do not believe that it will self-stabilize (despite recent quiescence), so several proactive alternatives should be considered. A multilateral effort is going to require give-and-take across the board, and the European situation is at a stalemate. Other regions, I believe, would be willing to aid a European solution if it were part and parcel of moving the entire global economy forward. But no outside power is currently interested in assisting because the remedies that have been attempted to date have done little more than kick the can down the road.

On a similar note, regionally, China is at a crossroads in terms of its internal rebalancing from an oversaving and overinvesting nation (with a national savings rate — not to be confused with the personal savings rate — in 2011 equal to a whopping 51 percent of GDP) to one in which consumption plays a greater role. The same is true, to a lesser extent, of other developing nations.

Finally, part of any G20 grand bargain needs to include banking reform. At the beginning of the financial crisis, in 2007, Warren Buffett was widely quoted as observing, “It’s only when the tide goes out that you learn who’s been swimming naked.” As it turned out, the parade of nude bathers was quite long and included banks, investment banks, insurance companies, government-sponsored enterprises, and, in the case of the European periphery, entire countries.

Some were swept out to sea with the tide, but a sizable number have since obtained swimwear and are walking the boardwalk as though nothing ever happened. The fact is that many financial institutions today look pretty dismal under their cover-ups. Moreover, there is a substantial difference among regions of the developed world in terms of what constitutes a strong financial institution. Given the enormous interdependence of global financial institutions, having multiple standards means that the entire international financial system is as vulnerable as the weakest of those standards — which in the case of euro zone banks is very weak indeed.

The evidence of the global economy’s growth-stunting tendencies is abundant. For example, in my recent book The Age of Oversupply: Overcoming the Greatest Challenge to the Global Economy I refer to the “triple hoarding” of U.S. dollars in (i) the over $3.5 trillion held in foreign currency reserves; (ii) the nearly $2 trillion in excess domestic liquid assets held by nonfinancial U.S. corporations (together with perhaps another $3 trillion held in liquid form by U.S. business interests outside of the United States) and (iii) the trillions of dollars of uninvested household wealth, 75 percent of which is held by the top 10 percent of households. And I don’t blame any of the foregoing holders for not investing their money in new capacity (factories, equipment, offices, etc.) on a scale large enough to move the global needle. There is, after all, nothing very sensible for them to invest in, given the existing oversupply. Similar points can be raised with respect to the world’s secondary reserve currencies, the euro and the yen, but the numbers are of course far smaller.

This leaves the developed world with a dilemma. Either allow the pricing mechanism to clear the market of excess (which would mean wage, price, and asset deflation in the developed world, instead of the mere disinflation we have become familiar with) or find some other way of getting excess capital invested into their real economies to return to production potential.

Repairing all of the problems addressed here comprise an ambitious agenda, to say the least. It will require an overhaul of the global economic and financial system of no lesser scope than that of the 1944 Bretton Woods Agreement, which established a new such order for the post–World War Two era, or the de facto Bretton Woods II understanding that has prevailed since the United States terminated the dollar’s gold convertibility in 1971 and most major world currencies became free-floating.

Some may argue that the problems are too complex to be resolved and the best we can do is to wait them out. If we were able to do that, policy makers would be saved from having to make some very tough decisions. But economic, political, and social pressures arising during this age of oversupply are not likely to grant us that luxury. It is long past time to sit down and lay out a new economic playing field that is conducive to more evenly shared growth.

PHOTO: People walk outside the International Monetary Fund headquarters at the start of the annual IMF-World Bank fall meetings in Washington, October 8, 2013. REUTERS/Jonathan Ernst

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see

“I do not believe that [The situation in the euro zone] will self-stabilize…”. I’m with you there.

“Given the enormous interdependence of global financial institutions, having multiple standards means that the entire international financial system is as vulnerable as the weakest of those standards — which in the case of euro zone banks is very weak indeed.” Well, duh?

You suggest a choice in the developed world between “…wage, price, and asset deflation…or find some other way of getting excess capital invested into their real economies to return to production potential…economic, political, and social pressures arising during this age of oversupply are not likely to grant us that luxury.” You ignore the elephant in the room!

In America the personal computer has transformed how we do things. The need for untold millions of “good jobs” such as draftsmen, girls Friday, secretaries, administrative assistants, clerks of every sort (inventory, warehouse, bookkeeping), lower-level management and coordinators is gone. Not offshored,, just gone. Forever!

Laboratories are ever more automated as our knowledge leaps forward ever faster with fewer and fewer people. 3-D printing threatens to replace much of our existing “cottage industries” supplying domestic auto makers and aircraft manufacturers with component parts. As cheap natural gas replaces coal generating our electricity, the environmental gain nationwide is offset by enough lost jobs to threaten the economic viability of large areas of multiple states.

The educational system everywhere must be ripped out by the roots because it is failing to prepare young Americans to fill society’s needs. Today it is our socio-economic underclass and the size and expense of government and government programs at every level that are growing. We’re on the wrong road, so going faster and faster ahead is really, really stupid.

The world no longer needs philosophical generalists no one will hire. We need a system that can produce workers completely prepared for productive employment with the ability and means to retrain them if and when demand changes.

It will serve no purpose for all nations to form a navel-gazing circle to dream up an illusion of some “new economic playing field” that offers everyone a trophy in the game of life. For the predictable future the American economy, however anemic, will be the “engine of world prosperity”.

For better or worse, we own the ride. The rest must buy tickets and reach for brass rings as they can.

Posted by OneOfTheSheep | Report as abusive

This economist, along with all economists, pundits and politicians – keep ignoring the 10,000 Kilogram elephant in the room…DEBT and the resulting huge derivative bubble which someday is going to crash. They ignore the fact that none of the big multinational banks are actually stable. They’re still very much over-leveraged, in other words – BROKE!

All that debt caused by a gigantic market of worthless bundled mortgage securities and other derivatives was never washed away. Other than a few fall guys like Lehman, none of these big banks were forced into receivership. Instead, auditing criteria were changed to maintain an illusion of fake wealth. It’s been swept under the rug by central banks purchasing it with money printed out of thin air, deflating currencies, primarily in the US and Europe.

The proof of this lies in the global 500 – 700 trillion dollar derivative bubble. Why such a big range? Because nobody actually knows how large it is as different sources use different metrics to calculate it. The latest estimates place it at 710 trillion dollars. That is not even possible as this would be near ten times the entire global GDP. Yet, it exists. Why? Because those derivatives have no real value. They’re marked to some unicorn universe standard instead of being marked to market prices.

Why? Fear! Everyone knows that big elephant bursting will cause immediate and severe pain, but instead of attempting a controlled draw-down, it is simply ignored. And how do governments hide this? They lie! They publish mythical numbers which make it appear as if “slow” growth is occurring when the reality is negative growth, and it has been for years now. The truth lies in prices of consumables – fuel and food, which have been steadily rising and are no longer counted in inflation indices. If you insert food and fuel price inflation into the equation when calculating GDP, there is NO growth in GDP!

Sooner or later, it will all come crashing down, resulting in a global depression which will make past depressions look like a Sunday picnic. The only solution will be to wash away the derivative bubble with mutual debt reduction across the board. All the newly minted millionaires and billionaires whose wealth was created over the last two decades by worthless paper instruments, hence creating the largest wealth gap disparity the world has ever seen – will be wiped out. The huge banks will need to be broken up, with depositors and bondholders paid first, and shareholders getting NOTHING as there will be nothing left.

Laws will need to be passed which permanently separate savings banking from investment banking (Ex: Glass-Steagal), set limits on leverage for investment banks, and force derivatives to be marked-to-market and only be traded over-the-counter.

Until all that debt is washed away and imaginary instruments banished, Western economies will continue to stagnate, problems ignored will get worse, and major depression will set in.

Posted by DaveIL | Report as abusive