Abu Dhabi, UAETuesday 11 December 2018

Financial virtue and vice: both are needed

Often in life and in policy terms, "there can be no virtue without vice".

Often in life and in policy terms, "there can be no virtue without vice". This was the German virtue, as shown by the fierce disinflation policies adopted by the Bundesbank almost three decades ago. But the German virtue was only possible through the vice of countries such as the US, France or the UK, whose expansionary policies sucked in the exports to keep German output from collapsing. If the other countries were to pursue the same virtuous policies as the Germans it would have led not to the same virtuous cycle of growth, but to deflation and a potential depression.

The same dilemmas are evident in the Gulf today, as it is the vice of government spending that is propping up the GCC economies and not the virtue of private-sector investments. The April Group of 20 (G20) leading and emerging economies meeting in London saw the battle lines drawn between the Americans pressing for the "vice" of huge fiscal deficits to stimulate demand, and the Europeans who pleaded they had done all they could safely do.

Indeed, virtue and vice are again tightly entwined just as they were three decades ago between the Bundesbank and the rest of Europe. For how the world's policy makers manage to stave off global crises will go a long way toward defining which countries emerge from the financial debris with the strongest and most virtuous economic systems. The Europeans were seeking to use the G20 meeting to show their own vision of a "newfound capitalism" Franco-German style, built around what would be a more tightly controlled financial sector.

But to the Americans, too extensive a focus on future regulatory policies was a bit like reassessing the safety procedures on the Titanic when it was sinking; certainly important and potentially vital at some point, but missing the bigger, more immediate threat. The American "vice" is mind-boggling in size: an unprecedented US$787 billion (Dh2.89 trillion) supplementary stimulus, only to be surpassed by an even more stunning $3.6tn spending spree for the 2009-2010 financial year.

All told, the US will churn out an equivalent to 6 per cent of its GDP in spending and tax cuts to stimulate domestic demand to help cushion the blow from collapsing consumer and financial sector deleveraging. The American fiscal firepower is being matched for the most part by China, and Saudi Arabia in the GCC. EU officials assert the emphasis must for now be on implementing the plans already under way before taking on another huge dollop of state spending, which is always that much harder than in the US to roll back once recovery has started given the political importance of the public sector in Europe. They also counter that the Americans and the chorus of critics vastly underestimate Europe's more extensive automatic stabilisers during downturns, through the use of unemployment payments.

But sitting it out on the hope that an export-led growth will see them out of the crises may not be an option this time for some European countries. Germany and Japan largely built their post-war recoveries on export-driven economic and currency policies, which have been followed by China, South Korea and South-East Asian countries. But perhaps the single most fundamental change that will be wrought by the Great Recession of 2007-2009 will be the reversal in global demand away from the American consumer as buyer of last resort, to one in which domestic demand will be more evenly supported around the globe.

Exports alone will not do it any more, and resistance to stimulate demand at home could be met by a political groundswell of trade tariffs being imposed in those export markets to offset the leak of stimulus abroad. For all the attention heaped on the Chinese for their exchange rate policies, they for one understand the significance and it is why they are shifting hundreds of billions of those dollars they accumulated over the past decade back into their domestic economy to stimulate more domestic demand.

This has not gone unnoticed in the Gulf states, and there is a quiet but discernible shift of financial assets to their domestic economies to stimulate demand via major projects, with Saudi Arabia leading the way. Volumes will be written on the origins of the current economic disaster and the sins of various policy makers, but perhaps the biggest cause to the spectacular collapse of the western financial system has been the accumulated global imbalances of the non-stop export model to feed the consumption binge in the US and the mostly Anglo-Saxon countries.

This has turned out to merely have been built on a huge bubble of leveraged liquidity, itself inflated by the those recycled export dollar surpluses of the "virtuous" back to the US to finance, through lower interest rates, the "vice-tinged" spending spree until it, too, finally collapsed under the weight of questionable loans and Wall Street gone wild. We have to get out of the mess, and for all to be virtuous such as the oil producers and export-led countries of Asia, we must first all pay homage to the clarity of vice of countries such as the US that still sustain the Gulf economies.

Dr Mohamed A Ramady is a former banker and visiting associate professor, finance and economics at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia