World: To Adjust or Not To Adjust

The current debate on the world economic condition gives a glimpse of why economics is a very difficult subject to master. There are all the theories, which are fine in themselves because of their own internal logical consistency of varying degree of inclusiveness of factors. The main difficulty is in the diagnosis of the problem, which is subjective and based on experience and judgment. The signs are all there. The difference could be as in the judgments of Dr Watson and Sherlock Holmes (however fictional).

We are all agreed that the world (the US) has gone through a serious bout of asset inflation and the bubble has burst. The adjustment has taken place, not in asset prices but in banks whose solvency has been supported by explicit government intervention. The judgment now is that the worst is over and the world can go on with business as usual.

(a) This supporters of this policy are congratulating themselves that they have done an excellent in preventing an all-out fallout and an inevitable recession which could lead to a depression.

(b) Banks have since recovered apparently and are now back on track to be as good as they had been.

The main argument against this affirmative solution is that there has been no adjustment or that the adjustment is insufficient for real change to take place. Those who had made mistakes in the market (mainly speculators) have not been punished by the market - which the market is supposed to do in order to ensure vigilance and discipline. The same people or type of people are still in charge and playing the game. There is no lesson learnt from the recent problem. The problem will repeat itself because the policy makers are looking for solutions in market behaviours that have brought the economy into problem in the first place.

Real adjustment means structural adjustment where the structure of the market and economy will have to change. There have to be new rules and policies and new ways of doing things. Those who have lost in the market must exit and those who have been disciplined and have capital will have the opportunities to buy foreclosure assets at realistic prices so that a new foundation could be built. In this adjustment, employees will be laid off and they have to readjust also through retraining to learn new and more appropriate skills.

This adjustment is necessary in order that the new world order will be able to come to an organisational structure which will be able to provide sufficient jobs for new entrants into the economy. Whilst in the long run, it may be an observable factor that the demography defines the pace of the economic growth. But, at present, the world is undergoing a truly significant change.

In the west, the baby boomers are now in the sixties and retiring. Being baby boomers, they are the largest representation in the demography. Smaller groups (non-boomers) will have to work the extra hour or so to support the boomers in their retirement. While pensions may be defined in nominal terms, that the inability of the new cohort to produce sufficient for themselves and the retirees mean that (a) there is inflation (if pension payments are appropriate) or (b) there is unemployment among the new cohort (if the aggregate demand is low as the retired boomers reduced their consumption).

In the east, China's increased production of consumer goods has reduced per unit cost as well as increased the global participation in industrial production by workers by a significant amount - which reduces wages (first nominal and then real). This has caused the withdrawal of employment by higher-paid workers in the west. Added to this global work pool is India, in the higher value-added sector of ICT. This sharp increase in the global volume of workers means that the west (particularly the US) has resorted to solving its problem by printing money - which we had seen and still seeing. (Whether they are translating the excess liquidity into rapid loan growth now or not is moot; they had.)

Maintaining an easy money policy is politically advantageous to do. It is like giving morphine. Fiscal policy has run its limits, constrained by common sense about government debt.

I think it was Franco Modigliani who asked the question a long ago in a published paper: Should be foresake stablisation policy, when discussing the relative merits of fiscal and monetary counter-cyclical policies. This question is now moot. We are not talking about stablisation policy. The world has changed. The structure of the world economy has changed. We are now dealing with structural change.

Is it then correct that the US should counter the comparative advantage of China's labour force with a low interest rate for its industries so that its industrial workers can compete - or that has the US actually foresaken its agriculture and manufacturing industries and now focuses on the services sector in order to compete. In the services sector, adjustments could be massive and rapid with a high casualty rate, such as venture capital, stock market, financial instruments, and all kinds of financial products. (It is no surprise that massive financial crimes occur in the US, and elsewhere.) It is also no surprise that WTO pushes for the opening in the east for the services sector.

In globalisation, the problem with using the services sector for growth is that it does not necessarily has to use local workers. Local workers may not be skilled enough or they do not have local knowledge. The services sector, in order to expand, especially for financial services, it has to tap the best brains in the countries they operate. While US firms may grow, US employment may not rise commensurately in that sector. This is the same issue for all MNCs. (It is therefore questionable for Malaysian employment that Malaysian GLCs go abroad and brought back nothing.)

These services MNCs do not need zero interest rate to flourish. They need a policy where credit is easy to get. The banks with their billions of unlent excess reserves would be most happen to fund grandiose schemes by US firms that span the globe.

By not allowing local asset values to adjust downwards, there is no scope for local businesses to flourish as old local businesses could be weighed down by high debt and a long repayment period which chew up revenue and discourage recapitalisation. Those with cash has no chance to buy assets at fair value, and they end up holding financial assets. In a world where excessive wealth is looking for a safe place to park in the financial market, there is always the problem of overvalued of financial assets, as real asset value are kept up by the inability of the market to adjust downward as governments around the world stablised their respective economies with artificial means.

Adjustments of course means hardship and unemployment; but this does not mean they do not exist today when unadjusted. For fear of a flash of pain, one may have to suffer long and quiet.

As economic adjustments are increasingly politicised, it is not surprising that unemployed youth are trying the oust the old and crumbled who are holding to their asset values through long established networks in the only means available to them. Greedy people are trying to hold on to brick and mortar or pieces of paper which enough paper wealth to last them a few generations, at the expense of the new generations of the rest of society. Future values and investments are concepts that need a rethink. In the end, other young people, provided they can get a job, will have to work for the descendants of these old rich.

Economic Readjustment

Those of you who have been following my thoughts here would know that I am quite happy with the recent developments in the economy, i.e., that at least there are some countries such as Malaysia which are beginning to take a stand against the American nonsense (after Japan) of printing money at zero interest rates and holding the world to ransom at gunpoint.

I hope this will lead to a structural break in the global mentality. With higher interest rates, some currencies should strengthen which is a good thing. There should be a way to reflect the weekness of the US dollar. That Malaysia is amon the few countries that go this route is commendabble.

Higher interest rates and a stronger currency may help to restrain some the inflationary pressures coming from the global commodity markets. Malaysia may suffer a bit for commodity producers and the foreign investors who are here to reap the benefits of low wages as a result of the weak ringgit. But these are labour intensive low productivity activities which we could be less dependent on. We should expect some difficulties for these activities. We should expect some difficulties for speculators of properties as well as the stock market. These difficulties are nothing but the needed adjustments for higher interest rates to reduce prices as a result of some difficulties for businesses. Without these difficulties, businesses would continue to live in a dream world of more profits from little efforts and lots of inflation.

These difficulties will be good for making businesses search for higher productivity economic activities. Hopefully, a stronger ringgit will make less unattractive ringgit wages. This may help to reduce the current brain drain and, if possible, to reverse it.

But my great consolation is that with higher interest rates, now or expected, there will be enough fear among speculators. We are now seeing a reaction by speculators in the oil and commodity markets, who think that they may need to reverse their long positions. There is crack here, and the prices of oil and commodities are seeing some selling and a lowering of commodity prices.

This last bit of development, to my mind, is absolutely crucial. The higher global interest rates may mean a weakening of global demand and thus leading to a weakening of commodities prices. If downward adjustment of commodity prices is what the world needs right now. There is a need for the world to insulate itself from America in terms of monetary policy. With lower prices or lower price increases, there is a chance to stablise world politics. When this stability is established, there may be a chance for investments and real economic growth.