Annual Report 2011 - Hong Kong Monetary Authority

Is this the end
of the market economy?
In 2009 GDP in the industrialised countries shrank 3.7%,
marking the worst recession since 1945. In some respects
it was even reminiscent of the Great Depression of the
1930s. Fortunately at the global level the shock was cushioned
by positive growth in the emerging economies, especially
China’s (illustrating how globalisation though often
harshly criticised has its advantages). The recovery that
began in 2010 was greeted with relief and many observers
quickly concluded that the crisis had blown over.
Actually, nothing could have been further from the truth.
The global economic comeback is in jeopardy. Although
the United States may well avoid a double dip this year, the
same cannot be said for Europe. France and Germany
hope to stay ahead with growth just inside positive territory,
but Italy and Spain will inexorably slide back into
recession. On the face of it Euroland as a whole should
see its GDP fall 0.5%, making this a “controlled” slump
compared with 2009.
Yet the economic environment throughout the West is far
more daunting now than it was three years ago. Jobless
rates are high, banks have been weakened and public
finances are in tatters. Between 2007 and 2011 the average
budget deficit in the OECD countries rose from 1.3%
of GDP to 6.6%. During the same period their public
debt soared from 73% of GDP to 102%. In these conditions,
fiscal stimulus is now simply out of the question.
Meanwhile the strain on government resources has
mounted in line with unemployment, which in the United
States has doubled since 2007 and grown by half as
much again in the euro area, where it currently exceeds
10%. Finally, the long-ignored problem of debt servicing
has suddenly reared its head.
Commercial banks and private investors, fearing a cascade
of defaults, have dumped the sovereign bonds of the most
vulnerable countries and triggered an unbearable rise in
their yields. At the same time, legitimate determination to
shore up the banking system has prompted authorities to
demand higher capital ratios. Banks are therefore having
to tap the markets to increase their shareholders’ equity
even as the reputed safety of their government debt portfolios
has been compromised. A tempting solution for
them is to reduce their assets (i.e. loan books), depriving
12 2011 ANNUAL REPORT - BANQUE PRIVÉE EDMOND DE ROTHSCHILD SA
companies and consumers of credit. A mood of mistrust
has settled over the Continent, with lending institutions
refusing to take any more risks. The interbank system has
seized up, forcing the European Central Bank to move in
and replace it.
Keynesians and monetarists succour
the global economy
A series of financial crises since 1990, the year of Japan’s
banking and real estate collapse, has challenged the
legitimacy of the market economy. In 1937 the brilliant
American economist John Maynard Keynes won widespread
praise with his book The General Theory of Employment,
Interest, and Money, which offered solutions to
end the long slump brought on by the 1929 Crash. Keynes
rejected the laissez-faire doctrine of the 18th century
encapsulated in Say’s Law, positing that supply creates
its own demand. He took the opposite view, preaching
state intervention via public spending to get economies
back on track after a major spill.
This strategy, much vaunted by politicians, lost some its
relevance during the stagflation of the 1970s. Rightly or
wrongly it was blamed for simultaneously aggravating
unemployment and inflation. So the world went back to
the basics advocated first by Adam Smith and, in the
1980s, by Milton Friedman and the so-called Chicago
School, a modernised neoclassical approach that inspired
Ronald Reagan, Margaret Thatcher and others. The fall of
the Berlin Wall in 1989 helped to assert the superiority of
the market economy, championed by the monetarists, over
the centrally planned economy.
Ben Bernanke, chairman of the US Federal Reserve, also
subscribes to this view. He believes the debacle of the
Dirty Thirties was brought on by a shrunken money supply
rather than by the fall in investment that Keynes identified
as the cause. The 2008 subprime crisis came as an excruciating
trial for supply-side economics. Even today the jury
is still out. US President Obama, borrowing straight from
Keynes, opted for massive government expenditure when