Anyone who has ever managed to get their car stuck in the sand knows the accompanying feeling of hopelessness.
Treasury can help Gulf's economies to gain traction
Anyone who has ever managed to get their car stuck in the sand knows the feeling of hopelessness that accompanies that experience. Whether it's on a beach or in the dunes, it seems no matter what you do, the tyres keep spinning and digging the car deeper and deeper. So it must seem to policymakers trying to dig their countries out of the current financial and economic morass. No matter what they do, the situation just seems to deteriorate. In fact, it sometimes seems that everything they do serves to get them bogged down a little more.
Up to now, global policymakers have been puzzling largely over how to bail out and resuscitate their financial systems. On the flip side, though, is another riddle: how to dig the economy out of recession - as in the US - or avoid sinking into one, as in the UAE. The twin challenges of financial rescue and economic stimulus represent a particularly vexatious conundrum. The most frustrating thing for policymakers is that, just like driving through sand or getting a car out of it, the solutions to a credit-based recession are often counter-intuitive.
That is to say, the monetary and fiscal tools used to pull out of a normal cyclical downturn or recession - usually set off by an excess of capacity - can often seem to make matters worse in a recession triggered by the collapse of credit. What's the difference? Unlike the standard recession, the current crisis has not been caused by an excess of capacity, but rather by an excess of credit. Ballooning credit did produce excess capacity in some industries - US housing for example - but not everywhere.
It could, for example, be argued that there remains a shortage of capacity in commodities. The resources industry has been trying in vain to catch up with demand for years. Now it lacks financing to do so. Prices are now falling along with demand, but supplies remain tight. Likewise, the response by emerging market investors to falling asset prices has backfired. The credit bubble in the US, after all, was fuelled by Asia and the Gulf investing accrued export earnings in the West, primarily in the US. Those investments kept US interest rates artificially low and stimulated risk-taking investments around the world, including back in Asia and the Gulf. Now that the credit bubble has burst, the world is suffering from a drought of funds.
In response, central banks and sovereign investors have joined private investors by moving out of corporate debt and short-term, government-backed mortgage debt in favour of longer-term US government debt. This makes sense as an investor. But from a policy perspective it has been nothing short of disastrous: deepening the liquidity crunch in the US and spreading it around the world, hastening a flight from emerging markets by global investors and raising the overall impact of the crisis on the beneficial owners of those funds.
The key to driving through soft sand or economic downturns is the same - maintain your momentum. This advice is of little use to those economies already mired in recession. But for those that are still moving ahead into a soft global outlook, it's time to rev the engine, economists say, dig deep and spend big to keep business going and avoid further layoffs. Fortunately, governments in Asia, Australia and the Gulf have plenty of money to spend: massive accumulated surpluses, all stored up in central bank reserves and in sovereign wealth funds. These must now be tapped to help maintain the economy's momentum through tough times.
"The government can afford to be generous," said Song Seng Wun, an economist at CIMB-GK Goh in Singapore. "This is the rainy day you guys have been saving for." Many governments are therefore preparing big fiscal stimulus packages, which is textbook Keynesian economics. The key is how to spend that money. The most desirable direction when driving through sand is straight ahead. This is no time for sudden changes in direction that add costs to businesses or consumers. Structural reforms are best undertaken in periods when the economy has firm traction, not when confidence is low.
Fiscal stimulus should instead be targeted at reducing business costs, whether by lowering taxes or eliminating red tape. Countries such as the UAE have no taxes to cut, but plenty of red tape that could be easily eliminated. Unfortunately, policymakers tend to do just the opposite. They ignore prescriptions for painful structural changes when times are good and use economic crisis to gain a mandate for unpopular reform. The result can be a deeper and more painful downturn.
What isn't textbook fiscal policy is for governments with economies not yet in recession to move into deficit. It's contrary to convention and nature. In tough times, our natural inclination is not to spend, but rather to slam the brakes and save. Economists call this the paradox of savings. In an economy where consumer spending represents a significant portion of the economy, this tendency can worsen a recession.
But in the export-dependent economies of Asia and the Gulf, consumers don't have enough horsepower to offset the drag of slower exports. So for them, saving against the likelihood of job losses makes some sense. Governments will therefore need to step in, overcoming their own reluctance to draw down surpluses and even - make sure you're sitting down - run deficits to boost spending. In Australia, where the resources boom has been producing fat government surpluses for years, the government last week answered the call, warning that it might have to go into the red to avoid ending the country's 17-year economic expansion.
Unconventional circumstances call for unconventional, sometimes counter-intuitive, policies. There are arguments to be made, for example, for ditching currency pegs and raising interest rates - but we'll discuss those later. In the meantime, digging into the treasury and even going into the red for a spell is a relatively easy way to make sure Gulf economies don't join the ranks of economies left spinning their wheels.