Generation 40s – 四十世代

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Policymakers’ coddling of market failure exacerbates cycles of boom and bust

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South China Morning Post
Comment›Insight & Opinion

Andy Xie

Andy Xie says market volatility is a feature of our boom-and-bust global economy today, and government policies that subsidise speculation by cushioning the downside are to blame

Low interest rates have spawned numerous Ponzi schemes around the world. The time seems to be up, at least for some. The shocks in oil prices, the Swiss franc, internet concept stocks and China’s A-share market are the harbingers of what is to come. For speculators, 2015 will be the year of living dangerously.

The rising US dollar and falling property prices in China are symptoms of an ageing global bubble. They symbolise global monetary tightening in the form of a slowing velocity of money, indicating that less buying and selling is taking place. Bubbles don’t last forever, even with policy support.

When the US Federal Reserve began its quantitative easing policy after the 2008 financial crisis, it triggered a sharp fall in the dollar and inflationary pressure in emerging economies. The latter sparked a credit-cum-investment boom, in China first. The resulting surge in commodity prices triggered an investment boom in emerging economies in general. The boom justified the declining dollar. The declining dollar, rising velocity of money and surging growth in emerging economies formed a self-sustaining dynamic.

An investment boom is a kind of Ponzi scheme; factories make money by helping others to build more factories. The process goes on as speculators increase exponentially. At some point, though, there won’t be enough new speculators joining the game and overcapacity then becomes widespread. Deflation ensues.

Since 2008, China has overinvested by more than US$6 trillion. That overspending was the reason for high commodity prices and the boom in emerging economies. As China slides into deflation to digest the overcapacity, the commodity market is heading into the ice age. The rising dollar is a consequence, not the cause, of the deflationary phase in emerging markets. The feedback loop takes deflation into the developed economies, too.

The emerging market boom has fuelled multinational companies’ profits and, hence, the stock markets in developed economies. That lit a fire in the property markets of major financial centres.

Wherever there has been a surging trend in the world, the odds are that it was a byproduct of the emerging market boom.

The US economy is accelerating. Some say the Fed’s policy is finally working. The reality is not so rosy. Deflation in emerging economies is making goods, oil in particular, cheap for American consumers who are famous for spending their last cent, and then some.

The growth driver is similar to what happened before 2008. But, the US supply side is weakening. The energy sector, such as shale gas and oil, has played a leading role in the US recovery after 2008. Now it has to contract. When the growth dynamic is rising consumption and weakening production, it is not sustainable.

The sorry state of the global economy, going from bubble to bust again and again, is a consequence of bad policies in major economies. For two decades, markets have not been allowed to clear. Every downturn is met with stimulus policies to sustain the status quo.

The global economy has become hopelessly out of balance. But the consequences of the rebalancing that is needed are so frightening that policymakers have buried their heads in the sand and go on talking about expedient measures to shore up the status quo.

This generation of policymakers, financiers and businessmen don’t know what a normal market economy is. Their psychology is shaped by bubbles. Look at the current generation of internet entrepreneurs. They believe their own hype.

When push comes to shove, they make their own bubbles by announcing ever higher valuations in rounds of private financing. When this bubble pops, hundreds of billions of dollars in imaginary wealth will evaporate.

A bubble is, at best, a zero-sum game. Unfortunately, in the real world, bubbles tend to waste massive resources. Plummeting labour participation rates in the West and surging overcapacity in the East symbolise massive waste in the global economy.

The root cause of the global imbalance is government policies that subsidise speculation by cushioning the downside. More and more resources have been sucked into speculative activities.

In the East, governments tend to tax labour to support production. Hence, speculative activities occur mostly during the formation of new capacity. In the West, central banks view financial stability as the key to economic growth. Speculative activities there go into inflating the prices of existing assets. As these activities grow, policymakers literally think of how speculators will react when making policies. Hence, the global imbalance becomes larger and larger.

Rearranging the deck chairs on the Titanic is of little use. The bursting of the bubble may be happening in slow motion. Most policymakers would view it as a policy success. But, what next? Would inflating another bubble be the way to go?

Kicking the can down the road simply incurs higher and higher costs. One day, the problem will be so big that the world just slides into chaos, revolution and armed conflict.

We have been there before. Will we repeat the tragedy?

Andy Xie is an independent economist


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