Wednesday, July 26, 2023

The Mess In the World

It is obvious that the world is in a mess.

I thought I would set down my thinking of how we got here.

For decades, it was obvious that the relentless pumping of money into the world economic system would one day lead to massive inflation - in the minds of old-fashioned economists.

The main counter-arguments was that extra liquidity was needed to fuel the new economy that was the digital boom. This was indeed correct, and for decades the world economy could grow rapidly with little or no inflation. At the same time, technological advances and economies of scale drove down prices of electronic goods.

While relentless investments in the digital economy was driving advances in that part of the world, the liquidity that had resulted in those investments had got bankers excited and they worked in cahoots with real estate developers, leading to the real estate boom around the world. There was obvious massive asset inflation in the real estate sector and everybody was happy because they felt richer and richer.

The key question I have been having in my mind for those decades is this: under what circumstances would the economy explode? There must be a point where asset prices cannot go up very much further. The point must be when householders cannot afford to buy houses based on their prevailing incomes. Commercial properties can still be driven by corporate profits, so long as the real economy is doing well. So I was waiting for real wages to fall, meaning that prices are rising faster than wages - that this probably would have to go on for quite a while, several years or decades. It is quite funny that when the money illusion sets in, the illusion could be sustained for a long time. Households are able to get extra credit from their banks based on the real estate inflation - the difference between the current house prices and their respective current loan outstanding. Inflation feeding on itself.

When it looks like economic theory is not doing its job in curtailing or moderating the runaway economy, the impact of the excessive printing of money comes out in the politics of the beneficiary economies - China and Russia. The liberals might have thought that the printing of money might liberate the world of totalitarian states. But the accumulation of wealth by totalitarian states has made them confident, an increased belief in themselves and their superiority. China began to defy the orthodoxy of western democracy. Russia wanted to reclaim its lost empire glory.

The world economy that was working almost working like a well-oiled engine was beginning to splutter.

Not going into the question of how did the covid come about, the issue of interest to us is that the advent of covid and the political reaction to the public health concern was to disrupt the global supply chain, whereby factories everywhere were asked to shut down. With the total shutdown of supply, it is not surprising that there should be inflation due to a sub-optimal operation of the global supply chain. Cost of operations shot up and so the prices at the retail stores.

But the most significant cause of the current inflation problem is the escalation in the price of oil, and that higher cost is pushed through the entire supply chain. As the cost of oil takes up a substantial portion of the household budget, the quantity that can be consumed on the non-oil budget must surely be sharply reduced. This is where the present cry by the public is.

It does not help that the war affects the supply of grains and other foodstuff.

The central bank of the reserve money, ie, the US Federal Reserve, then decided to raise the interest rate from near zero to now more than 5% pa. This cannot be a proper response to the cost-push inflation. But its immediate impact is to worsen the budgets of households directly. In the rest of the economy, firms who are all indebted with massive loans have to find cash to service them, at a time when cost-push inflation and the disruption from covid is causing problems for businesses. 

In Malaysia, the attempt by Bank Negara to slow the rise of the local interest rates in relation to the global interest rates has the effect of sending the ringgit into depreciation as local funds leave to enjoy better returns abroad. This is the price to pay for trying to prevent the inevitable adjustment to the real estate sector, for trying to ease the problem of their major borrowers who are mainly the real estate borrowers, and for trying to ensure that banks themselves should loans begin to become non-performing on a massive scale.

Is it possible for the Malaysian policy makers to avert the macroeconomic adjustments that are inevitable in the economy without too much pain? This is the time for the local central bank must act boldly in accordance with basic economic policy principles. It is just a question of when.

No comments: