Needed: A new global system

The crisis in the global economy engages many and affects most of mankind. Like all such issues, we find little clarity but a lot of fire and brimstone. Few have tried to seek feasible solutions. Even fewer are qualified, experienced and with a usefully cosmic view of the world we live in to propose a way out. The global economy expanded at a frenetic pace of over 3.5 per cent annually till it reached the precipice in 2008. Since then, we are seeking to find new ways to get over it, and clearly we are struggling.

In 2016, world GDP totalled about $77.83 trillion. In 1960, it was $6.85 trillion. World GDP was just $1.1 trillion in 1900 and it took half a century to grow fourfold to $4.01 trillion and grew 10-fold in the next 50 years to $41 trillion (1990). The big leaps began after 1971 when US President Richard Nixon unilaterally delinked the US dollar from the international gold standard and opened the dollar floodgates. This, and America’s opening to China forged a great economic and financial system that accelerated world GDP growths to new levels. This was the dawn of globalisation.

Since 2008, however, we are increasingly a world where trust is in deficit. Nations don’t trust each other. People don’t trust their governments. Governments don’t trust their regulators. Regulators don’t trust the banks and the financial community. Above all, governments don’t trust people to back them to do the right things. As Mervyn King, former Bank of England governor (2003-2013), recently wrote: “Trust is the ingredient that makes a market economy work. It is central to the role of money and banks, and the institutions that manage our economy.” How do we find trust again often seems the main issue of our times.

RBI governor Raghuram Rajan, recently wrote: “Politicians know structural reforms — to increase competition, foster innovation and drive institutional change — are the way to tackle structural impediments to growth. But they know while the pain from reforms is immediate, gains are typically delayed and their beneficiaries uncertain.” As a Prime Minister said at the height of the euro crisis: “We all know what to do; we just don’t know how to get re-elected after we’ve done it!”

Now let’s see how the global system actually works. The emerging countries produce goods and services at the lowest costs for consumption in the US, which in turn pays them in dollars, that they in turn deposit in US banks. As money cannot sit still, this money in US banks is then lent to Americans, who today have the world’s highest per capita indebtedness, to splurge on houses, cars, HD TVs, computers and other electronics, that they can often ill-afford. The cumulative debt of US households is $11.4 trillion. The credit card debt of each US household is over $15,000, and there are 160 million credit cards in the US. Clearly, America’s finances, both public and personal, are out of control. But as the saying goes: “When America sneezes, the world catches a cold!” With good reason: the US comprises a quarter of the global economy and the world keeps two-thirds of its reserves in US dollars. So what happens when the US catches a cold?

The irony is that this is well understood, but like those who kept investing with Bernard Madoff, nations like China, Russia, Japan, Kuwait, India and others keep investing in US securities at interest rates of one to two per cent. In effect, the world is giving the US cheap credit, encouraging it to splurge even more. Unfortunately, there is no global regulator to caution the US on its profligacy or force it to mend its ways. There is also no global regulator to ensure that countries like China balance their trade. Thus, it is US profligacy and Chinese surpluses parked in US banks that are the biggest cause of this dysfunction. Many have likened it to the relationship between a drug addict and a drug peddler. The drug addict is now in rehab, and it’s the peddler who is suffering from withdrawal!

At the July 1944 Bretton Woods Conference held under the shadow of World War II, Lord Keynes had in mind an elaborate scheme calling for the setting up of an international reserve currency. This had to be shelved in the face of American obduracy. Keynes’ proposals would have established a world  reserve currency called “Bancor” to be run by an international central bank. This would have the responsibility of creating money and to take action on a much larger scale. In case of balance of payments imbalances, Keynes said countries with surpluses should increase imports from deficit countries and thus create a foreign trade equilibrium.

But since the 1971 dollar-gold delinking, the US has become a great credit factory. It’s the world’s biggest deficit country for decades, with increasing deficits with most nations. But the world largely trusts the US dollar and the US Federal Reserve just kept printing them for the dollar is the world’s preferred reserve currency. This trust is now eroding, and this is the core of the world’s greatest financial problem.

Earlier this year, Dr Rajan wrote: “Arguably, what I have in mind will eventually require a new international agreement along the lines of Bretton Woods, and some reinterpretation of the mandates of internationally influential central banks. Setting the rules will take time. But the international community has a choice. We can pretend all is well with the global monetary non-system and hope nothing goes spectacularly wrong. Or we can start building a system fit for the integrated world of the 21st century.”

Democracy, national sovereignty and economic integration find themselves incompatible. People choose according to their immediate needs and are mostly swayed by manufactured perceptions. The people’s faith in the market to generate prosperity is severely corroded. Is it a failure of individuals, institutions or ideas? Or all three? Eminent people like Mervyn King seek “an intellectual revolution”. But such revolutions only follow a cataclysmic crisis. We had one in 2008, and the next one is also certain. But when?

There are other new realities. The post-Cold War era has seen the economic and political rise of several nations: Brazil, China and India among them. Each one is now a major economic player, with bigger GDPs than many G-7 countries. The economic balance of power is shifting towards Asia. Jim O’Neill, the Goldman Sachs economist who first coined the acronym Brics, predicts: “It’s likely the combined GDP of the four big Brics nations will exceed that of G-7 by 2020.” Since the US and Europe don’t see it in their interest to reform the system, it devolves upon these growth engines to bring more order into the world system. Like Communism, the ideology of the Washington Consensus has proved to be a failure. We must forge a new system, but it will have to be done by more than just the G-7. Another Bretton Woods of the high priests of economics and finance of a much-changed world is needed to fashion a more robust global system.