8.6 Economic Problems Facing the world today

 

 

 8.6 Economic Problems Facing the world today

Of course, it would be misleading to understand all economic problems in the world as simply symptoms of a limits to growth crisis. There are other processes going on too that contextualise the situation in which engineers are working. Two other processes in particular are having dramatic consequences for economic activity: financialisation and changing competitive imbalances between countries.
 

8.6.1 Financialisation

This is the growth and influence of the finance, real estate and insurance sector in many countries has transformed what were service activities into being effectively the dominant sectors in economies – with considerable influence in political systems. Globally the number of transactions involved in trading financial and other assets, transactions in foreign currency exchange, in borrowing and lending, as well as the transactions which are essentially bets about the forward prices of currencies, interest rates and financial assets are all, taken together, much greater than the number of transactions involved in the production of goods and services in the so called “real economy”. 

As a general rule the finance sector attempts to put all of the risk of borrowing onto the borrower. Other forms of capital provision approaches are possible – for example capital providers and capital users can share profits and losses. However, most Western debt finance involves requiring borrowers to forfeit collateral, for example their house. Thus modern financial systems tend to lend very little to what are seen as risky businesses ventures – instead a large part of lending is for land and buildings and indeed most bank lending is collateralised against the housing and property markets.

Another part of finance sector lending is to governments. If states cannot pay their lenders then the practice enforced by economic orthodoxy is now to privatise their assets – as in the current Greek crisis. Of course, in theory countries that issue their own currencies can always get their central banks to print more to pay their debts and mainstream economists are typically disapproving about this. “Monetizing state debts” risks creating too much money chasing too few goods – in other words it is said to risk inflation and a fall in the value of money to the detriment of savers, typically pensioners. Thus the Treaty of Maastricht bans central banks in the European Union from directly providing money for state bonds. And of course in the eurozone member states cannot print money as they do not issue their own currencies.

This is somewhat ironic because when the money supplies of countries have been created and controlled by the private banking sector in a completely unregulated way then money creation oscillates between the over creation of money which inflates asset prices (particularly land and house prices) and the under creation of money which leads to recessionary conditions. This should not surprise. Banks lend when they and borrowers are most confident, which is during periods of expansion. They thus create credit money and purchasing power when it is not needed and thus tends to over hype the booms. Land prices and rents in particular are inflated because the supply of land and locations is fixed. So wealth concentrates in property and credit is created to cash in on rising property values, which pushes rents and prices up even more. This is a speculative bubble which ends typically because servicing the debt accumulated when buying at the higher and higher prices becomes unsustainable.

Subsequently, in the recession, sentiment is pessimistic so banks are cautious about lending and borrowers cautious about borrowing. So banks create debt money when it is not needed and do not create it when it is needed.

None of us have a divine gift of being able to foresee the future which remains inherently uncertain. This is true also for players in the financial markets who, when they commit money, are making judgements about what they think will happen motivated by the prospect of gain and the fear of loss. So how do they make these judgements? The answer is that, to a large extent, they go along with what other traders are thinking. Markets are powerfully driven by crowd...or herd...psychology. In a speculative boom optimism prevails. In a recession pessimism is infectious

Indeed a largely ignored economist called Hyman Minsky described bubbles as “the euphoric economy”. In such periods of over confidence ethical restraints also tend to loosen. A professor of economics and law, William K Black, estimated that there were at least one half a million crimes committed in the period of the sub prime bubble in the USA. Reckless lending to people with no income and no assets brought the brokers bonuses and then the risks of these unsound loans were parcelled up into collateralised debt obligations and passed on to unsuspecting investors like pension funds and banks on the other side of the world.

As Black observes, neoclassical economists like to point out that when economic actors pursue their private interests through markets that a self organising process occurs that leads to the provision of the goods and services that people want. But the same self organising process, motivated by self interest, will also self organise the provision of ‘bads’ too - for example, a market for crooked accountants to look the other way during a bonanza of predatory lending.

Another important observation is that financial markets (and the politicians looking after their interests) are incredibly short term in their thinking. It is these markets, and their players that have most influence over governments and preoccupation with short term financial issues tends to crowd out consideration of the long term issues that is needed to take decisions about sustainability.
 

8.6.2 Competitive imbalances between countries

Debt and financial problems are compounded by changing power relationships between nations and parts of the world. Borrowing is a mechanism for dealing with imbalances – if an individual, company, state or nation is spending and consuming more than its income this is possible by running down savings and/or by getting into debt – but only up to a point beyond which crises loom. As competitive imbalances between countries grow, a mechanism for rebalancing exists in changing the exchange rate between their currencies. If the dollar falls against the Chinese yuan then American people have to pay out more dollars to buy yuan and pay out more dollars to buy Chinese goods. At the same time American exports to China would become cheaper in China. It is therefore controversial that the Chinese peg the yuan to prevent this at a rate that makes Chinese imports into America cheap.

In the eurozone, member countries have given up national currencies and therefore lost a mechanism adjusting for competitive imbalances. The southern eurozone countries are sending their purchasing power abroad to buy German goods more than the Germans and northern Europeans are buying in the southern countries and Ireland. This produces shortages of purchasing power – and then unemployment not to mention causing shortages of state revenues and increased state support expenditures in the countries of the south. To a large extent the budgetary crisis in the southern countries are an indirect result of the inability of southern countries and Ireland to compete with Germany. The budget and state debt crises of these countries cannot be solved by cuts and tax increases as this only drives these economies deeper into recession causing state revenues to fall even more in a vicious circle. The other aspect of the crisis has been a property bubble – cheap finance from eurozone banks created speculation in the building and property that burst and leaving southern and Irish governments to bail out the banks.