This article first appeared in Forum, The Edge Malaysia Weekly on May 30, 2022 - June 5, 2022
No one likes pain; everyone wants a free lunch. Electoral politics means that politicians will avoid pain, pump up the welfare goodies and end up promising heaven but delivering hell. After years of avoiding “paying for it now”, we have growing debt, massive inflation or looming default. The chickens are coming home to roost. This is the consequence of treating everything we do as “of no consequential cost”. The ancients call a “bad today” the retribution for doing “bad yesterday”.
In the 1970s, the US didn’t have enough gold to pay for her current account deficit and opted to delink gold from the dollar. As the US continued to spend on fighting the Vietnam war, inflation rose as imports got more expensive and the US economy reached full employment. So Federal Reserve chairman Paul Volcker decided to squeeze out inflation with a sharp dose of high interest rates in the early 1980s. Since then, global inflation has moderated, because China gave the world a huge supply shock of cheap labour and manufactured goods when she opened up in 1978. But this benefit is waning as Chinese labour ages.
The world enjoyed a Great Moderation from 1980 to 2007, when central banks kept lowering interest rates in a situation of good global growth without inflation. It is now acknowledged that lower interest rates caused high real estate prices, while middle-class workers in the rich countries lost ground as their manufacturing jobs disappeared. Conditions were therefore created for the populist uprising and social polarisation of today from growing income and wealth inequalities.
Long periods of prosperity gave rise to policy complacency, which explained why at the outbreak of the 2008 global financial crisis, central bankers loosened monetary policy with no fear of inflation, as if laxity in monetary and fiscal discipline had no consequences. Inflation is now back with a vengeance. Supply bottlenecks from disruptions to energy and food from the Ukraine war, exceptional hot weather disrupting agricultural output, combined with loose money, created far higher inflation than central bankers ever anticipated.
The West forgot that the Soviet Union collapsed because it had no “hard budget constraint”, meaning it was simply printing money and not making structural adjustments. The rich Western countries appear to be in the same boat four decades later. Stagnation is the only outcome if no one is willing to make painful adjustments.
Every major global economic forecast has cut the growth projections for 2022/23 by at least one full percentage point from those made as late as January 2022. A range of institutions from the International Monetary Fund (IMF) to the United Nations gave warnings that rich and poor countries alike have reduced monetary and fiscal policy space to get out of the current mess. Europe faces a massive task of rebuilding Ukraine, assuming the war will end and not drag on. Few are paying attention to climate action, as long as the Western public bays for more defence spending on the war. Meanwhile, the emerging markets worry about food shortages, debt default and social unrest. If the US dollar continues to strengthen, expect a raft of defaults by highly leveraged dollar borrowers. Sri Lanka is only the first of the countries to ask for IMF aid.
Can the rich countries continue to put off painful structural adjustments to growing imbalances by simply using quantitative easing? Attending the recent Emerging Markets Forum in Paris, participants from Africa, Latin America and Europe all expressed dismay that we are again being haunted by the Ghost of Bancor.
The late European central banker Tommaso Padoa-Schioppa (1940-2010) argued in his last paper on the proposal of John Maynard Keynes for a multilateral currency (Bancor) that the world is ill-served when the global interest conflicts with the national interests of the reserve currency issuer — in this case, the US.
The world has always been threatened by a strong dollar, because those who borrowed heavily in dollars (around US$12 trillion worth) will suffer when their debt appreciates relative to their domestic currency. During the phase of higher interest rates and tightening monetary policy, the shortage of dollars will cause debt defaults, which was exactly what happened during the Mexican crisis of 1994 and the Asian financial crisis of 1997/99.
Currently, just under three-quarters of the US net investment position of an US$18 trillion deficit is owed to East Asian surplus countries, from Japan to China to Singapore. When financial sanctions threaten China in the event of decoupling, all surplus countries may reduce their dollar holdings, which will put the US in a bind. The US can spend more on defence by funding it through more borrowing in dollars. But the weaponisation of the US dollar makes all foreign exchange reserves a vulnerability rather than an insurance. A gradual shift out of the dollar will happen to avoid being sanctioned.
In other words, the world is crying for a politically neutral and independent “central banker and currency” that would increase or decrease global liquidity as needed, without fear of sanctions or confiscation. Currently, that “exorbitant privilege” or near monopoly belongs to the US.
As interest rates rise and liquidity tightens, the price of cybercurrencies has dropped, while the price of gold has remained steady, even as commodity prices rise. All these exacerbate the social, wealth and health imbalances at the national and global levels, which is why the IMF has warned that social protests have risen sharply since the pandemic and the war. Having spent their political capital, politicians are now short of tools that can be applied without pain.
Prevention is the name of the game, but it is precisely because politicians are unable to get out of the collective action trap that they keep on relying on the easy way out — printing money and accumulating debt. Debt postpones pain, but in the end, pain breaks out in a crisis.
In short, crises force us to undertake adjustments if politicians are not willing to implement painful policies. This is precisely shown by the dilemma of providing petrol subsidies versus hiking prices to market levels. Higher oil prices restore our fiscal coffers, but continuing to give subsidies depletes them. Malaysia is enjoying the highest oil and gas prices and palm oil prices and the tech industry is getting a bumper order book. Oil subsidies can be wasted because a lot of cheap petrol would be used by the rich and lost through smuggling. If instead we raised prices gradually, plus give cash subsidies to the poor to compensate for higher petrol prices, the market would adjust better while helping those who need aid most. Markets do work, but they need a nudge to help those left behind.
We should never waste a crisis. The Ukraine war has given Malaysia a new boost from higher commodity prices (not forgetting that even semiconductors are commodities). Now is the time to do some major structural reforms while the wind is behind our backs. When the world gets into crisis — which is a matter of when and not if — then we may once again be behind the curve.
Tan Sri Andrew Sheng writes on global issues that affect investors
Save by subscribing to us for your print and/or digital copy.
P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.