08/08/2012

By Michael Baxter, economics writer

Imagine the economy is an onion. Tear off the skin, and then remove the next layer. Keep peeling until you are left with a core.

What lies at the core? Until it is identified we cannot produce a plan to work out how to wipe away the tears that permeate the global economy.

The outer layer is called greed. Or you may prefer to name it banking excess. But where does it come from? The answer probably lies in what’s called group compliance, group polarisation and an economic crisis from almost 40 years ago. Studies show we tend to comply with a group, even when the group is wrong. Other studies show that groups of people tend to exaggerate. A mild tendency or view held by an individual becomes exaggerated in a group, until it becomes extreme.

By the late 1970s the UK populace had had enough. The old way of doing things, of a massive public sector, trade unions’ power, and an attitude that seemed to suggest business existed to create jobs rather than make a profit no longer held sway. But as we reacted against the old ways, new ideas steadily became exaggerated. When the Soviet Union collapsed, some suggested it was the end of the history of ideas, that only capitalism was left. The new ideas that emerged were largely appropriate for their time, but they became polarised. Markets were held up as being all wise, greed was seen as good, profits were all that mattered, and regulation was seen as bad. These views were not just held by a few, they were commonly held by the majority of the electorate.

So complete was this transfer of new ideas, that in 2006 the IMF said that thanks to such financial innovations as mortgage securitisation the chances of a banking crisis had decreased.

Pull back that layer, and look beneath and you see pre-occupation with the idea of investment in property. It may have begun with the dotcom crash. In the aftermath of this crash, investing in dotcoms was seen as a guaranteed way to lose money. But where would we be without the dotcom bubble? Just as the telegraph and railroad booms of the 19th century created much of the infrastructure that made the US so successful, the dotcom boom may have accelerated the digital revolution.

But in the aftermath of the bust, investing in entrepreneurs was seen as risky, whereas property was safe. The FTSE 100 peaked on January 30 1999. We began to rely on our property providing our future pension. Would-be entrepreneurs were seduced by the miracle of buy-to-let, instead of becoming wealth creators.

Alas, we may have enjoyed growth on the back of a mirage. The economy grew as households funded spending via the rise in their value of their home.

Strip off that layer and what do we find? Answer: technology and globalisation, which resulted in money and information travelling at the speed of light. Alan Greenspan called the crisis of 2008 a once in a hundred years credit tsunami, but he was surely wrong. Thanks to modern technology, the chances of so-called perfect economic storms had risen.

Look beneath this layer and you see global imbalances, coupled with the beginning of the end of dollar hegemony.

And then tear off this layer, and observe the core. Staring at us is demographics. As we age, we worry more about our pension. Since stocks peaked at the end of the last century in 1990, we can’t rely on equities. House prices are too expensive, so we can no longer rely on our home going up in value. So we save more.

This happened in Japan 20 year ago and that, even more so than zombie companies, is why Japan’s lost decade is now in its third decade. Ageing is now more advanced in Europe and Russia. In the US, the challenges are peculiar. The US is becoming an increasingly unequal society, and the haves, who benefit from good education are seeing their population dwindle, while the have-nots are rising in number.

Later this decade, China will run out of workers to migrate from the country into cities. When this happens, the impact on global wages and savings, and indeed interest rates, may be massive.

So those are the problems, what are the solutions?


Michael Baxter, mike@iabn.co.uk

Editor the investment and Business news newsletter , blog.share.com and author of the Blindfolded Masochist