Sunday, June 27, 2010

Sunday Essay - Europe, China and the GFC

I am constantly surprised at how little I know. I was reminded of this because, with the G20 meeting underway in Canada, I did a quick tour of various economists' blogs. I am simply not as up to date as I should be!

Earlier in June in Economic clouds gather, I expressed a somewhat pessimistic view on the economic outlook. Storm clouds have continued to gather, with the current G20 meeting split down the middle on the need for fiscal consolidation vs continued expansionary activities. I was reminded of the 1970s when something of the same split occurred. Then, as now, one issue was the willingness of Germany to undertake economic expansion. German memories of the hyper-inflation after the First World War still run deep.

I presently lack the detailed understanding of the numbers to make really sensible comments. However, I would point to a few things that I think to be of importance.

The first is the continued debt overhang associated not so much with Government borrowings, but with total borrowings in the period leading up to the GFC. I am not sure of the real level of impairment in balance sheets, but it is probably substantial.

Here, I think, we need to make a distinction between firms in general, the finance sector and Government.

At least in Australia, ordinary company balance sheets have been significantly improved. In the absence of a total economic crash, there is not a general corporate debt problem. Firms have the capacity to increase debt to fund expansion. With the exception of China, I think that the same process has been happening elsewhere.

Where the impairment continues to be substantial is in the now interlocked finance-government sectors. As best I can understand it, the real problem with Greece from a global perspective lies not in the size of the Greek economy or even Greek debt in an absolute sense, but in the potential flow-on effects to a banking sector within Europe already weakened by the GFC. I am sure that I am putting this very simplistically, but I am trying to keep it simple for my own sake.

There is a lot of discussion at present about the possible end of the Euro and the damage done to the EU by the Greek crisis. The first is possible, the second certain. But what does all this mean in the type of time horizons we are talking about, say the next two years?

My best guess is that Europe will muddle through. However, this will come at the cost of very low economic growth.

In considering this, I think it helpful to remember that Europe already faced long term structural problems at the time the GFC hit from a combination of demographic change with domestic economic inflexibilities in areas such as the labour market. Current problems compound these difficulties. The practical effect of the GFC may be to force Europe to deal with some of its structural problems now rather than later.

Given this, what about the US? Again, I don't really know! Looking at a two year time horizon and taking account of US economic imbalances, my best guess would be very slow economic growth.

All this may sound very depressing, but I wonder about this. Keeping my simplistic Jim hat on, world resources at any point in time are limited. I am not talking in an environmental sense here, just an economics one.

If China, India etc are to grow faster than the world average, then they have to attract additional resources. Given constraints on absolute growth, faster growth in one area implies slower growth in another. Looking at things this way makes me wonder whether global policies designed to accelerate growth in all countries could ever achieve their desired effects at a time of fundamental economic change. Its a bit like all companies in a sector setting growth targets greater in aggregate than the sector's possible growth; it can't be done!  

What does this mean for Australia? I think that it means that we will see continued demand for our minerals underpinning growth, but without the type of absurd windfall prices that some have come to expect.

What do you think? Does all this make sense? What am I missing?


Winton Bates said...

I think your views about the G20 do make sense, Jim.

I suppose the theory is that if you have concerted action at a global level then fiscal stimulus might do more good because you would then have less leakages. But that means more government debt and expectations of higher taxes, so further fiscal stimulus will probably do more harm than good.

Perhaps there are other things they will be talking about. Monetary policy is important but that is set at a national level. Some central banks seem to be a lot better than others at maintaining stable (i.e. low but positive) inflation expectations.

They could talk about fiscal consolidation and long run growth i.e. the effects of instutions and policies on long run growth rates. But that also is national policy.

They could talk about banking regulation. I suppose that has international implications but I doubt whether the experts even know what they are talking about in that area at this stage. The lessons of the financial crisis need to be properly digested before additional regulation is imposed.

It might be interesting to read the communique that comes out of the conference. Then again, it will probably just be a carefully crafted load of nonsense.

Anonymous said...


It is obvious I am not an economist, so my comments should only be read, at best, as those of a frustrated layman.

I think the Eurozone sowed the seeds of its demise back when they built cheese mountains, and filled wine and milk lakes, and engineered all those other unsupportable inefficient voter-friendly artefacts.

I don’t think it matters much how much any nation borrows until the time comes to pay it back or roll it over. Britain seems better placed than most in this, but pay it back she will have to, someday. And let’s all look the other way as the US stumbles by on its way from Vietnam to Afghanistan. More on that later.

It amazes me that my local shire authority (in charge of roads, garbage and sewerage) can be brought undone by the US sub prime mess. It depresses me that I chose to become a (the largest) foundation shareholder in a new local Bendigo Bank branch (local communities helping each other), only to see them then cohabit with Adelaide – who are/were one of the most significant “players” in the futures and derivatives markets in Australia. I didn’t get to vote on that. And “players” is the appropriate word.

And it frightens me that the world’s biggest arsenal is owned by the world’s biggest debtor, and that military conflict is and has always been an efficacious (I did not say efficient) way of galvanising/propping up an economy. Saturday’s Good Weekend included an article on Afghanistan; in just one province we are spending $4 Bn each year against an enemy spending “$200,000 – maximum”.

It’s probably exaggerated; with so many zeros, there is bound to be a few misplaced.
Apologies - nothing to do with economics. Or is it?


Anonymous said...


Now that I have ranted (again) I would like to support Mr Bates' comment re banking regulation.

Specifically a regulated division between old fashioned banking operations and other financial services. It must surely increase stability and confidence if the buccaneers play with their own money, while we little people are left in peace to pay off our mortgages, and our credit cards, and earn our miserly x% on what we have left to save.

And what is wrong with an extra % or 2 of GST if that's what it takes nationally to get us back to fiscal conservatism/rectitude?


Jim Belshaw said...

I always like your rants, KVD.

Winton, I thought that coordinated stimulus was a good idea, too. I still do. One problem is the combination of fiscal action with that required to deal with the the banks created its own conseqnuent problems.

It will be interesting to see the communique.

KVD, your comment on councils and the Bendigo bank struck a real chord. That annoys me too. It's interesting.

I have long argued that the emphasis in management and public policy on particular themes, the words used, actually masks the converse; the need for better people management coincided with process re-engineering and downsizing; the emphasis on brands coincided with the greatest period of brand destruction; and the emphasis on risk and risk management led into a range of disasters including the GFC.

I think that I agree re separation of activities and on the GST.

Anonymous said...


Not to extend this discussion (because I would wander off-topic again) but I do find your second last para ("I have long argued..") most intriguing.

Not cause-effect connections I would have made. But then again, you used the term 'coincided' - which is not necessarily the same thing - is it?

Anyway, thanks for "rant space"; I do try not to abuse the privilege.


Jim Belshaw said...

Hi KVD. The coincidence is an odd one. I think that the connections are there, although they are not always clear nor is the overlap perfect

I will try to spell this out at some point.