Wednesday, August 8, 2012

Can Global Growth Be Saved?

Yesterday, I noted that every region in the world is being hit by a growth slowdown.  The BRIC model of growth is producing diminishing returns, Europe is mired in what I believe to be their version of the US Constitutional Crisis and the US is dealing with the after-effects of a debt-deflation, economy wide credit bust.  Today, I want to address what can be done about this -- if anything.  Let me answer this by addressing the US' problems, followed by Asia's and than Europe's.

The US issues are actually fairly easy to deal with.  Standard macro states that in the event of a credit bubble burst, counter-cyclical federal spending is in order.  This will not be a new thought to readers of this blog, but it does need repeating as the "leaders" in Washington (and I use that term very liberally) are mired in their own stupidity.  The US has several advantages right now: ultra-low government bond rates, a high level of blue collar unemployment and a massively out-of-date and dilapidated infrastructure.  As one example of the latter, the Washington Post recently ran a story called, "Aging Power Grid on Overload As US Demands More Electricity," which noted:

The United States doesn’t yet face the critical shortage of power that has left more than 600 million people in India without electricity this week

But the U.S. grid is aging and stretched to capacity. More often the victim of decrepitude than the forces of nature, it is beginning to falter. Experts fear failures that caused blackouts in New York, Boston and San Diego may become more common as the voracious demand for power continues to grow. They say it will take a multibillion-dollar investment to avoid them.

“I like to think of our grid much like a water system, and basically all of our pipes are at full pressure now,” said Otto J. Lynch, vice president of Wisconsin-based Power Line Systems, “and if one of our pipes bursts and we have to shut off that line, that just increases the pressure on our remaining pipes until another one bursts, and next thing you know, we’re in a catastrophic run and we have to shut the whole water system down.”

As I've noted on more than one occasion, the American Society of Civil Engineers has given the US infrastructure a grade of "D."  You also might want to watch a program called, The Crumbling of America, which ran on the History Channel, which highlights the infrastructure problems we face.

Right now the US can borrow at record low rates (the markets are, in fact, basically asking as to take their money), rebuild its infrastructure, hire a ton of unemployed manufacturing and construction workers and rekindle demand.  We can also rehire a large number of teachers, police officers and other public servants who provide services we all extol but are seldom willing to pay for.

The Asian problem can initially be dealt with through a round of interest rate cuts.  Consider the following levels of benchmark rates from around the region:

As the blog Money Illusions has noted in the past, the Australian central bank has been far more prone to lower rates in anticipation of coming problems, rather than waiting for the economy to falter and then act.  I believe both China and South Korea also fall into that category -- banks that will and have demonstrated a proclivity to proactively manage and direct monetary policy to "lean against the wind."  None of these economies are in terrible shape: China's latest Y/O/Y percentage change in GDP growth was 7.6%, Australia's was 4.3%, Taiwan's was -.16% and South Korea's was 2.4%.  However, all are slowing and need an additional push which lower interest rates should help to accomplish.

The above problems are actually pretty easy to deal with -- at least for those of us writing on a blog.  In practical matters, they are harder to implement because the powers that be are typically pretty useless.  Now we move to the more intractable problems.

Two BRIC countries -- India and Russia -- face pretty daunting political problems that may be impossible to overcome.  India's political system is mired in a level of gridlock and graft, as noted by the Economist:

But India's slowdown is due mainly to problems at home and has been looming for a while. The state is borrowing too much, crowding out private firms and keeping inflation high. It has not passed a big reform for years. Graft, confusion and red tape have infuriated domestic businesses and harmed investment. A high-handed view of foreign investors has made a big current-account deficit harder to finance, and the rupee has plunged.

Russia has a different problem.  As recently noted by Barry Ritholtz over at the Big Picture Blog, (I'm paraphrasing here), there is no population in the world that has been more screwed over than the Russians, first by the Czars, than the communists and finally the mob.  Russia was lucky in the fact that they had oil, which helped them to grow with the other BRICs.  But needed reforms in the area of property rights and corruption have not been forthcoming.  The country has grown since the recession, but at far slower rates (between 3.8% and 5) than their BRIC brethren.  Until they pass and implement meaningful reform, they may fall back to their previous status as a country that really should do better, but can't.

China and Brazil are in an interesting situation.  Both have seen tremendous growth over the last 10-20 years.  But that growth is now petering out.  Part of the reason for the slowdown is the overall global slowdown: China supplies manufactured goods to the developed world, while Brazil supplies raw materials to China.  When the developed world slows, the demand for both country's goods understandably drops.  But both also face an overall slowing growth rate, largely because of their own success; both countries now have a middle class (which was the primary object of their growth spurts) but both also face a slowing growth curve as the middle class now wants to spend a bit of its savings and enjoy its leisure.  The growth of the middle class also means that international labor arbitrage is less likely to be used by corporations in moving to these countries.  In addition, as China shifts to a more consumer driven economy, commodity exporters like Russia and Brazil will have lower demand for their goods.

In short, it's distinctly possible that the era of the fast growing BRICs is simply over.  The situation is explained very well in this video from the Economist:

While other countries are now taking up the rapid growth mantel (Turkey, Columbia, Peru and Vietnam) these countries are simply too small to meaningfully impact world growth.  

And finally, there is Europe.  I previously noted that Europe is currently in a situation akin to the US under the Articles of Confederation.  We have a group a states who have created a liberalized trading code between themselves, but who also lack enough centralized authority to meaningfully implement effective macro level policy.  The Greek situation is a great example of this problem.  Greece has been fiscally reckless for some time (as in years); their budgetary policies were usually in violation of some EU covenant.  However, the central EU authority didn't have the requisite political power to stop Greece from enacting policies that violated EU dictates.  So, the only way to actually solve the problem occurred when Greece was ready to default on its debt.  Also consider the policy problem faced by the ECB; they have to set interest rate policy for strong countries like Germany and weak countries like Greece and Spain.  In short, it's an insane proposition from a policy implementation perspective.

The EU needs to implement it's own version of the US' constitutional convention.  They need to establish a new series and set of responsibilities and relationships between the central government and the individual countries.  And this will mean the individual countries ceding a certain about of power to the central government.  There is no other way for the group to survive without it.

In making this call, the primary objection would be that the convention could lead to a break-up of the union, which could lead to a world-wide recession or depression.  I would have to concede that point on a theoretical level but not a practical.  The union has already been in place for over 15 year; institutions and norms have already been developed and implemented.  Integration has already taken place on numerous levels which can't be undone.  In short, the union has come too far to stop now. 

To sum up, we have the following propositions.

1.) The US needs to engage in infrastructure spending.  Although easily conceived, practically impossible to implement considering the political players involved.

2.) The BRICs are no longer the source of massive global growth.  While a lowering of interest rates in each region would help to mitigate the overall slown all the countries are experiencing, the basic model of growth in these countries is fundamentally changing.  China is changing to a consumer led economic model, which is lowering its demand for commodities, thereby lowering the growth rate of other BRICs.  More intractable problems in Russia, India and Brazil further hinder the possibility of a return to rapid growth.

3.) The EU has serious structural problems that need to be overcome.  While their integration has come too far to be undone, the continent may lack the overall political will to meaningfully solve their problems in the short or medium term.

Put another way, muddling growth is probably here to stay for awhile.