If you listen to Timothy Geithner or President Obama, “rebalancing” global growth is their cure for the financial and economic crisis. It is, in fact, the only proposed “reform” to the financial sector. But what do they mean by it?
I am in crisis. My back is out of whack. I have lower back pain that would test the mental and physical endurance of a long distance runner and a nun combined.
My physiotherapist has urged me to "find balance in my life". I need to realign my back, strengthen my “core” muscles, and listen to my body. Finding inner harmony - spiritual, physical and psychological – she says - is the only way of resolving the crisis that is my back.
What I suffer from, in economics speak, is “structural”. It requires change that is deep rooted if I am ever going to realign and rebalance my back to get on with my life. And this got me thinking, about “rebalancing”. It seems to be the “it” word of the post-crisis world.
If you listen to Timothy Geithner, President Obama, Ben Bernanke, “rebalancing” global growth is their cure for the financial and economic crisis happening again. It is in fact the only proposed “reform” to the financial sector. So what do they mean by it?
Well the idea goes that countries such as China and Germany, which have a lot of savings and foreign reserves, should start getting their people to loosen up their purse strings a bit more, spend much more, and save less. By spending a bit more, the hope is that the Chinese will end up buying more foreign imports.
Meanwhile, countries such as the US and the UK, which have absolutely the opposite problem - they don’t really save but spend instead, and buy a lot of foreign goods, particularly from China - should learn to save and sell more of their own stuff to the Chinese. The hope is that by realigning itself, the world economy would have a greater balance between deficit and surplus countries.
This, I gather, is the Ying Yang model of economic harmony. Why didn’t they call it that? It would definitely have more appeal. I mean, if this crisis doesn’t make you re-embrace God, or at least all things spiritual, then what will?
Precious little reform
So will this “rebalancing” work? Will it stop another crisis from taking place? Well the answer to that depends on whether you think that the large deficits between the US and China were the root cause of the financial crisis? And in my mind, the answer to that is an absolute NO.
WE got into this mess due to the addiction that banks had with risk. It is their behaviour that needs to change. Or more aptly put, we need reforms that safeguard us and protect us from their gambling behaviour. We are adult enough to know by now that you can’t change anyone, but what you can do is to take steps that protect you from their excesses.
To date, there has been precious little reform of the banking system that would in any way curb banks appetite for risk taking.
In fact, the policies that we have applied to date, can only ENCOURAGE further gambles by the banks. How? Well we have given them an implicit gambling subsidy. Lehman’s collapse, and the ensuing credit freeze, has made banks realise that in the eyes of policymakers, that they are “ too important to fail”, what's become known as banks that are “ too big to fail”.
Moreover, this “bigness” has been enlarged due to a number of buyouts and mergers of banks, such as Bank of America swallowing up Merrill Lynch. So what were already over-bloated banks have now become obese behemoth institutions, “too big to fail” times 2!
This has meant that they now KNOW that they will always be bailed out by the poor sucker of a tax payer. This in turn can only encourage their risk taking behaviour. This is what is termed “moral hazard”. In blunt terms these banks have an implicit government guarantee that they will always be rescued, independent of their behaviour or the excessive risk they take. We are subsidising their gambling habit.
This means that all the talk presently about curbing pay, salaries and bonuses will come to naught, as it does nothing to the underlying incentive of what got into this mess - the risk taking behaviour of these banks.
Break it up
What needs to be done is the breaking up of these banks, as has been suggested this week by Mervyn King, the governor of the Bank of England. He has suggested that the utility or public face of the banks, the one that you and I use, that takes deposits and gives out loans - should be separated from the riskier investment-casino arm of the banks.
The hope is, as Stephen Lewis, chief economist with Monument Securities says:
“...that this would insulate the utility banks from the speculative arm of the banks. There would then be no grounds for any speculative institution to suppose that it was too important to fail.”
A great idea because then our credit system would not be held hostage by the more speculative-casino arm. If they choose to take risky gambles with their money, then they would have to shoulder the consequences of their actions, i.e. there would be no government bailout. After all that is what capitalism is meant to be about. You are meant to assume responsibility of your actions, and not pass the buck. Real capitalism should be founded on banks being too good to fail - not too big to fail.
Alas though, I fear that this proposed change will also come to naught as has been witnessed on both sides of the Atlantic. Why? The answer is simple: Banks are powerful. They have already spent $226 million lobbying everyone and anyone, so that the status quo remains.
This status quo is about them remaining the masters, and not the servants, of the economy. And that makes the present economic system we are living in- more out of whack than my back!
Next week: rebalancing the economy means coming to grips with some hard truths democracy, economics and class warfare
