The World Economy 2015-Quo vadis?
Capitalism is the economic system now used in virtually all countries of the world.
For how long can this be sustained? What are the pitfalls, risks of such a system? What are the possible future scenarios?
Capitalism has proved to be the “best system yet invented” to grow the world’s economies and thereby raise living standards for the majority of humankind, but can such a system be sustained indefinitely? Certain “economic shocks” or economic failures in certain countries have perhaps indicated that capitalism as we know it today cannot survive indefinitely. And what happens then??? What economic catastrophies could then effect most of the 7 billion people in the world?
Some points to contemplate.
-Japan had grown rapidly until it was the world’s second largest economy at the end of the 1980’s. Then everything came “tumbling down”. Property and share prices are still well below their levels of 25 years ago!!
-The “official” United States “government” debt is about 18 trillion US dollars. But what about the “unofficial” or what one might call the “expectation” debt?? – ie the unfunded medical and pensions expectations of America’s approximately 320 million people. Life expectancies are increasing, medical developments enable people to live longer but simultaneously the costs of new treatments increase rapidly. Many of the 320 million people vote for their government in the expectation that adequate pensions and health care will be provided for them in their old age. The present value of this unfunded liability could far exceed the “disclosed” USD 18 trillion. Some estimates put it at 100 trillion USD or more. At this order of magnitude the debt per capita is more than USD 350 000 or over R 4 million in our currency. Somebody has to repay this eventually so each new baby born in the US effectively has a debt of over R 4 million to “start their lives with” !!
-Capitalism “works well” when economies grow and economies grow well when demand increases and this demand has traditionally been “fuelled” by credit. Marketing in its broadest sense has helped create demand- sometimes experienced as “irresistible desires” to buy things!!- and lending institutions have then in turn made it possible to buy these things by providing convenient credit.
-Monetary policy works by reducing interest rates (making credit cheaper) or by increasing the money supply in the economy. The aim of monetary policy is to stimulate economic growth but loses a lot of its ability to achieve this when interest rates drop to near zero-as at present.
-Fiscal policy can also stimulate growth by reducing tax rates or by increasing government spending. However this often requires additional government borrowing and , as with any other borrowing cannot just continue indefinitely!!
What Caused Japan’s downfall.
There is not universal agreement on this but I believe the two most important factors were/are
-The demographics of Japan show an aging and non growing population (Low birth rates, little immigration, increasing life expectancy). This, combined with the need to make private provision for retirement (no pay-as-you go system as in many other first world countries) and perhaps a stronger “savings ethic” anyway, the Japanese save more and spend less than most nations. This creates reduced demand for goods and services.
-With interest rates close to zero, reducing them further to encourage borrowing and spending, is not possible. The Japanese prefer to reduce their debt rather than borrow more, in any case.
-Because of very low GDP growth rates for a long time (and hence low growth in tax) the government has had to borrow to try to stimulate the economy by spending itself. This has resulted in government debt being more than twice GDP-extremely high by other country’s standards.
In summary then, capitalism is not working in Japan and there is no obvious way to get growth going again even though the country seems to be so advanced and efficient. The “secret” of capitalism as I suggested above-viz via the creation of an “insatiable desire” to spend, facilitated by borrowing-just doesn’t have the same attraction there or simply doesn’t have the wherewithal any more.(Too much debt).
The financial crisis of 2008.
This was initially prompted by “bad household debts” . Both the borrowers not having the financial ability to repay their loans and the banks being incentivised to lend to them anyway.
This large scale borrowing led to good economic growth but could not be sustained and the fallout therefrom almost brought the world’s financial systems down. “Capitalism was rescued” by reducing interest rates and governments borrowing massive amounts of money to bail out large companies and, via lending, to sustain spending and thereby at least some growth in GDP.
Conclusions.
Capitalism thrives and prospers on economic growth and the “lubricant” needed to achieve this is money (not only earned from income or profits) but mainly acquired by borrowing.
What happens when people either do not wish to borrow (as in Japan) or are so heavily indebted that they can no longer borrow ?? (As is starting to happen in many other places).
When interest rates are so low that the incentive of lower interest rates is no longer available.
When government “accommodation” by creating money can no longer continue-because further increasing government debt is just no longer viable.
China
China has grown rapidly over the past few decades and has passed Japan as the world’s second largest economy. The following comparison with the US and Japan is instructive:
| China | Japan | USA | |
| Last 5 years’ average GDP growth: | 8.5% | 1.8% | 2.2% |
| Central bank interest rates | 4.85% | 0.1% | 0.25% |
| Inflation rates | 1.4% | 0.5% | 0.0% |
| “External debt” (USD trillions) | 3.0 | 2.9 | 0.25 |
| Govt debt as % GDP | 22% | 227% | 102% |
(China’s govt debt as a percentage of GDP has remained steady, the other two have been increasing significantly)
These figures reinforce the above conclusions that Japan has little room for manoeuvre –Can’t borrow much more and can’t reduce interest rates.
In contrast China has scope to do both.
The US could possibly borrow more but interest rates are near zero too.
The Chinese stock markets lost about 30% in 3 weeks from their mid June 2015 peak. The authorities’ response was to take drastic steps to reverse the drop (Interfered with the free operation of their stock exchanges) and the markets have moved back up by about 10%.
It seems to me that China’s rapid growth has had a very different base to that being used in the developed world (ie borrowing to spend) viz the following:
Chinese personal incomes were much lower than those in first world countries and their manufactured items therefore much cheaper. This together with keeping their currency very competitive meant their exports soared. They have also been educating their large population very effectively. This with a seemingly high work ethic too meant that salary growth in China has probably been much higher than in developed countries. This has contributed to their GDP growth by increased domestic spending.
They have therefore not had to use the “first world model” of increasing cheap credit.
If this is broadly correct they are in a much better financial position than the “first world economies”.
Europe.
When the Euro was introduced it implied forcing very different nations with different histories and cultures to follow the same macro economic policies. Greece is now proving that this cannot be sustained over the long term-yet the powers that be are doing everything possible to avoid the economic disruptions that will occur if Greece leaves the Eurozone.
Other Observations/thoughts.
-Demographic factors seem important to the above hypothesis that capitalist growth can “ultimately” only be sustained by increased spending from increased borrowing. This needs more people!! Birth rates in the developed world have dropped a lot. Birth rates in the developing world are still higher and this is probably one reason why the GDP growth rates in developing economies are much higher than in developed ones.
-Contrary to what intuition may suggest, having more children and borrowing rather than saving and even “living beyond one’s means”, is actually good for capitalism in the world as a whole-although obviously bad for individual people!!!
-Throughout the world, the rich are getting richer and the poor poorer-partly linked to the previous point.
-Related to these imbalances/inequities caused by the workings of the system (rich richer, poor poorer) are increasing levels of crime and possibly terrorism and ultimately war as well.
-A key factor in preventing a massive collapse in the “system” is confidence. People need to spend and to invest. Increasing asset values (equity and property values) helps give this confidence. This is part of the reason why the “bail outs” and low interest rates have been provided by the governments. But how long can all this last???
Final Conclusions.
-Although there are very ominous signs that all is very far from well in the world’s economies, there are powerful government forces that seem to be determined to avoid a financial collapse, at all costs.
-Because our capitalist systems permit the rich to become even more rich and more powerful,
individuals, companies and governments will presumably do all in their power to “prop the system up”. A recent example is the US and Europe’s bail out efforts and “monetary accommodation” which involved massive government borrowing. A second is the Chinese “propping up” their stock markets. The efforts at keeping Greece in the Eurozone can be seen in a similar light-to avoid loss of confidence in markets-even though it really doesn’t make sense to permit/force such a very different economy and people to share a currency with a country like Germany-with all the economic consequences to the Greek people (and others in the Eurozone)that this implies.
-From all of the above it seems to me that at some stage some major “happening” has to occur, but if the US and Europe have to follow in Japan’s footsteps the consequences are too ghastly to contemplate!! For this reason alone I think the systems will continue to be “propped up” for the foreseeable future.
-Confidence is key in how long the “evil day” can be postponed and that is one reason why the “US recovery” is spoken about so much and why its massive unfunded social security liabilities are never mentioned. The American people (and companies) need to be convinced
that all is well so that they will keep on borrowing and spending and companies also keep on borrowing and investing and creating jobs.
South Africa.
In the light of the ideas and hypotheses I’ve developed above, our country is not in such a bad position at all! Our central bank interest rate is 5.75 % and our government debt to GDP only just over 40%.
Although our country’s birth rates have dropped dramatically, they are still well above those of the developed world. We have plenty of people, many of whom are unemployed or earn very little. Unlike the “Japanese model” we have plenty of scope for increasing our GDP by increasing domestic demand. Education and job creation is obviously a key requirement here but this is a “management problem” not a limitation of the capitalist system. People who talk about Africa becoming the new “economic miracle” of the world are no doubt thinking along
these lines.
Final Comments.
This short paper has attempted to analyse what may be major shortcomings and risks associated with the world’s current economic systems. It looks at concepts rather than detail-takes a “big picture approach” if you like. The financial authorities and commentators normally ( of necessity) get very involved in detail.
I am not forecasting that major financial turmoil is imminent-my examples go back many years. Japan for as long as 25. The US was in a much more worrying situation 6 or 7 years ago. The “Euro problem” is certainly not a new one and the Chinese stock markets have always been more volatile than most exchanges. However, there do seem to me to be major fault lines in the current systems which one day-no idea when-will likely prove “fatal”!!!
Dave de Klerk
July 2015
(Prepared for the clients for whom I provide financial advice)