Thursday, April 02, 2009

Odd disconnects in global economic discussions

Re-reading an earlier post, Australia's fascinating economy, I saw one thing that I need to correct, a case of loose wording. I wrote on 3 March 2009:

I do not have time today to look properly at the numbers. However, nothing that I have seen causes me in any way to switch my previous position (on the economy). To my mind, the real crunch point is still some months away.

I had been discussing the way in which rapidly changing data had affected commentary on almost a daily basis, positive one moment, negative the second.

My core position for many months has been that it was just going to take time for current economic problems to work themselves though, that the effects of the various packages intended to stimulate consumption in different economies were likely to be limited, that on the Government side we had to wait until the capital spend measures kicked in and that this would take time.

I have also generally been more positive than most of the commentary, especially so far as Australia is concerned. In December I summarised my position this way in a magazine article:   

The problem with economic statistics is that, by their nature, they tell us what has happened in the past and with a lag.

It is now clear that the US and international economies were already slowing rapidly at the time the global financial crisis broke. This explains in part why the financial crisis flowed through so quickly and dramatically into contraction in the real economy. However, the scale of the existing slow down was not clear at the time the global financial crisis broke.

All Governments responded to the crisis with action to prop up their banking systems to try to break the credit gridlock that had brought world financial markets to a halt.

As the scale of the crisis in the real economy became clear, Governments then responded through fiscal policy. This took two forms – actions to try to encourage consumption and consumer confidence, followed by stated plans to expand capital investment especially in infrastructure.

From an Australian perspective, several important things should be noted about this global response.

The first is that actions to encourage consumption have not been very successful to this point because they do not address the underlying causes of the problem in the first place. They are best thought of as an asprin to try to ease the immediate symptoms, one that will leave most Governments with high medical bills in the form of increased budget deficits.

Capital spend is different because, sensibly done, it adds to productive capacity and social infrastructure. So there is an immediate economic impact from the spend, followed by a longer term pay-back.

The difficulty is that capital spend takes time to ramp up. The trillions of dollars now committed to capital spend will really begin to affect the world economy about eighteen months out.

The world is now awash with liquidity that nobody wants to use, interest rates are at historic lows, while the global inflation that seemed such an emerging problem only six months ago has vanished.

As global Government capital spending really starts to kick in, the stage is set for quite rapid economic expansion. In the meantime, the economic flue is likely to continue.

Against this background, I wanted to qualify and amplify my use of the words "crunch point". By this I simply meant that it would still be some months before we would know whether the optimists like me or the pessimists were right.

If I am right in my analysis, we will see a growing stream of good news in the midst of the continuing bad leading to a clear bottoming of the downturn and then growth. Here my main expressed concern has been that the liquidity washing round in the global system might then force governments into contractionary action, prematurely curtailing the upswing.

I am not opposed to stimulatory measures. However, I do think that we should be paying more attention to ways of managing the after affects of the combined stimulation measures.    

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