Breaking Down “The Crisis” With Martin Wolf

I sometimes think that when future historians ask themselves what was unique, or different, about Generation Y, one of the most interesting themes – and one which I see around me all the time at Oxford – will be the difference between those who, broadly speaking, are interested in NGOs, humanitarian work, international law, and human rights on the one hand, and those who are interested in finance, the business world, the military, and national-level institutions on the other. Sure, there are plenty of other stories afoot in our generation: as economics reporters like Catherine Rampell have reported on consistently, we have trouble finding work, and we’re often unwilling to commit – to long-term careers, trajectories, or relationships. If we look beyond the (tiny) ranks of people in graduate schools, we find other depressing stories: as The New York Times recently reported, more than half of births among women under 30 occur outside of marriage. It can all seem rather grim at times.

But what I’m getting at is a different distinction. Obviously, people have different specificsubject-oriented interests: English literature, Russian history, organic chemistry, materials science, genetics. But I’m often struck by how passionate and romantically individualistic people can be about entrepreneurial activity in the “third sector” – foundations, NGOs, church-affiliated groups – while simultaneously abjureabing much interest in some of the major institutions in American society today: the financial sector, the US military, and the non-financial corporate sector. Some people end up becoming consultants out of a place like Oxford, but many idealistic young people often retain – in my eyes oddly and in an unjustified way – a discomfort and skepticism towards those institutions which can create major social change if only by virtue of their capital and size. I’m still primarily working as a mere academic historian at this stage in my life, but I’ve always been interested in ways I could eventually integrate my own interests into some of these larger institutions, where – in my view – you’re more likely to make an impact on the world in your lifetime than as the founder of an NGO, a writer, or a “human rights activist.”

Martin Wolf, financial journalist, whose Wednesday evening talk I greatly enjoyed

That was part of the reason why I jumped at the opportunity to attend a most excellent lecture by Martin Wolf this previous evening at Corpus Christi College, titled simply “The Crisis.” Wolf, an alumnus of my home college at Oxford (he began as a classicist in the late 1960s before eventually switching to PPE and going on to a career at the World Bank and, eventually, journalism) is well-regarded today as perhaps the leading financial journalist. His columns for The Financial Times offer some of the most in-depth reporting on finance and economics, based out of London but with a global perspective. Perhaps refreshingly for an American audience, Wolf is able to comment on taxation, state fiscality, public debt, and monetary policy in a way that avoids much of the hysteric political rhetoric we suffer from (Obama as a profligate spend-and-tax liberal) on the Right, while also offering a more rigorous analysis of how bankers operate than the Manichean perspective you sometimes get from people affiliated with the Occupy Movement. Lucid, balanced, and connected without becoming fawning are some of the ways I would describe his writing. Between reading the FT more and taking some more technical courses on financial and economic history at Oxford, I feel increasingly well-informed reading the news and thinking about public policy in my own country. (A part of me is tempted at times to become a more technical financial historian – it can seem appealing, rigorous, and free of the pseudointellectual jargon of some other fields — we’ll have to see how things develop!)

Wolf aimed in his talk to give a brief overview of why we’re in the crisis we’re in. In effect, he offered an interesting, rigorous, and dense financial history of the last fifteen years, more or less. Wolf started out on the macro level by noting that, historically, per-capita incomes (a reflection of per-capita productivity) historically diverged substantially around 1800. As shown by economic historians like Kenneth Pomeranz and Eric Jones, at that point in time per-capita incomes diverged substantially between what had been, prior to that, a roughly equally rich East Asian core (northeast and southern coastal China) and northwestern Europe (basically London an the Low Countries). The factors for which this happened – how the West became almost 30 to 35 times as productive as East Asia by the early 20th century – are hotly contested: state fiscality, coal, intellectual institutions (allowing for more invention), are all named.

Of course, that chapter in human history is now over. Starting with the “East Asian Tigers” (Taiwan, South Korea, Hong Kong, and Singapore) in the 1970s, parts of that old Core World started to experience divergent growth (as in faster annual GDP increases) from the established core economies – Japan, Germany, the USA, and Western Europe. More recently – really only since the Asian financial crisis in 1997 – this phenomenon has extended to the truly large Asian economies, like China and India. The economic crisis that has existed since more or less 2007 or 2008 has only exacerbated this phenomenon of divergent growth between Asia and the old Rich World prompting convergent incomes. In other words, the differences between incomes (certainly on an aggregate basis but even on a per-capita basis, too) are rapidly flattening out, especially after 2008: Western economies have experienced stagnant growth, whereas economies like those of China or India’s have sped along at between four and six percent annual growth even since 2008. We’re seeing, in other words, something similar to what went on with American growth between around 1860 and 1930, but at a much faster pace / compressed into a smaller time span. We’re moving from a world of the early 1990s, in which developed countries (the US, Germany/Japan, and the other big European/Anglo countries) produced something like 75% of global output, to the world of today, in which the EU and US combined produce only about 40 percent of global output. By 2016 or so, barring a major crisis, the Chinese economy should be bigger than either the US or EU economy.

Clint Eastwood: standing up for the low-skilled white worker, but not tough enough to take on 2 billion Asians

This “Great Covergence” had a couple of major consequences. As pundits like Thomas Friedman (who incidentally are married into Trustafarian clans and live in huge mansions) are eager to point out to the American worker, the emergence of more or less two billion Chinese and Indian unskilled workers onto the global labor market in the 1980s and 1990s (in addition to NAFTA) gutted the markets for low-skilled labor in Europe and North America. Chinese growth triggered disinflationary shocks (because of the lowered price for world manufactures) but also inflationary shocks (because of the demand for raw materials), too. Most crucially, perhaps – and a definite topic for future historians of China or financial historians, throughout this period of the mid-1990s to today, China accumulated a huge savings surplus. China has had, Wolf pointed out, a higher savings rate in the last fifteen years than the Brezhnev-era Soviet Union did, and for reasons that are not totally clear, Chinese capital-holders put this savings surplus not into their own economy, for domestic investment, but rather into Western government securities, primarily US Treasury bonds. This was part of a broader process from about 1997 (the year of the Asian financial crisis) or 1998 (the Russian financial crisis) to 2006, when a group of countries, dominated by China but also where Germany, Japan, Russia, and other oil-exporters had such large imbalances of trade that they accumulated huge savings. Throughout this period, these capital exporters largely chose to put their savings into the debt of some of the countries that are most troubled today: the US especially, but also the UK and peripheral European economies (which could borrow money at standardized EU-wide rates at the time – a good deal for countries like Greece or Ireland to finance housing booms or bloated public sectors with.

This huge influx of excess capital into global markets had another effect besides inflating housing bubbles in the US, Ireland, and elsewhere. In Wolf’s view (and this part of the talk I found slightly less compelling), because there was so much wealth chasing good opportunities for saving, the cost of saving went up considerably during this period; the real interest rates on US Treasury Bonds declined from about 3.5% in 1997 to about 2% circa 2008 – and now we’re at the astonishing point where the US Treasury has sold negative-interest rate bonds. Absolute differences of a percent or two might sound insignificant, but this meant that the relative cost of saving went up about 40% in the course of a decade or so. In Wolf’s view, this in part triggered the expansion in exotic financial instruments and financial profits during the 1999-2008 window. Outside investors, whether Iceland or municipal communities or pension fund managers, were looking for good deals on where to stick large amounts of money, but there were just too few compelling opportunities for real investment – and too many high-yield financial instruments – for resources to be allocated efficiently. I would have liked to hear more of Wolf’s take on causality here: would we have had the same kind of crisis, or a crisis at all, had this expansion of export capital not coincided with financial liberalization in the USA in 1999?

In any event, the results are well-known and catastrophic: US and European consumers, the financial sector, the corporate sector, and the public sector all dramatically increased their ratios of debt : GDP (or debt : household income, or debt: corporate profits) and mistook easy credit and expanding home prices for  savings. Some wonder whether financial structures in the USA today, most notably the student loan system, still seem like areas in which the American taxpayer is financing malinvestment (in this case in human capital and student loan debt – in people like historians of Germany or the USSR) while the country goes deeper into debt and selling Treasury Bonds. In any event, as Wolf pointed out, since 2008 we’ve seen people trying to shed themselves of this debt, which means less consumer spending and hence a deflationary environment. To counter that, we’ve seen, as Wolf noted, an unprecedented expansion of public debt: the UK in the last three years has seen the largest expansion of public debt since World War II. The only saving grace – and the reason why hysteria about hyperinflation or bankruptcy among commentators like Niall Ferguson or many Tea Partiers is misguided, at least for now – is that the bond markets still maintain an impressive appetite for American, British, German, and Japanese debt. Where else would you put your savings? (Besides under the pillow or into Chinese and Indian stocks).

A 2-hour commute from Dublin - yours for only ...

In other words, the story that Wolf insisted he was telling was one decidedly not about public debt (at least before the crisis) and was about a balance of payments crisis; it was a balance of payments crisis funded by the new core economies (China, Singapore, Japan, Germany), going to fund capital-importers (subprime American homeowners, Greek bureaucrats, Irish homebuilders, etc.). Wolf noted that some commentators (again I think of Ferguson here) like to moan about how much large national debts caused this crisis, but he showed – in a convincing chart – that if you looked at debt : GDP ratio of some of the most crisis-racked economies – Greece, Portugal, Spain, Ireland – they were actually doing fine (with very low debt : GDP ratios between 30 and 70 percent) up until 2007. It was the explosion in the cost of borrowing, and the Keynesian response of some of these governments with stimulus packages that exploded their debt : GDP levels and has helped to further drive the cost of borrowing up.

But this was the result of the crisis, not its immediate cause. The more fundamental cause of the crisis was that these economies – PIIGS – could afford to borrow for so cheaply for so long from the rich world to finance things that were not increasingly real wealth. In fact, at the same time that they were borrowing so much, Wolf pointed out, unit-labor costs in Greece, Spain, and Italy relative to those in Germany were going up by 60% since 1999. (This is part of the problem when you hear about inefficient businesses in southern European countries, or inefficient and overpaid Greek bureaucrats). The real solution would be for these countries to have their wage levels fall by about 50 percent overnight, Wolf suggested, but that is politically impossible whether carried out by a popular government in Athens or German financial ministers. More realistically, Wolf urged that the EU core economies – if they want to maintain the European project – continued to finance Greece, encourage structural reform, and pray for decent growth in their own economies so that Greece retains markets to export to. Hopefully, he suggested, Greece can see low inflation, while Germany and the core EU countries see high inflation. But if there is fiscal tightening in the core (France and Germany), and low demand for Greek imports, the project is finished.

So what does this mean for the Generation Y that I began this comment with? Wolf noted that we’re looking into a future world of limited resources, in which fiscal policy in both the USA as well as the UK and other Western economies begins to look more and more like a zero-sum game. If we went on the route of hyperinflation, say (in order to make it easier to pay off the large US national debt), young people should be overjoyed (since we by and large don’t have savings to be wiped out, and in many cases are heavily indebted), but the old will tremble. Similarly, it’s important to realize that discussions about cutting government spending (as opposed to raising taxes) have a gender dimension, too: many of the areas of the US economy that are financed in large part by government (think education, the bureaucracy, and healthcare to some extent) have many more women in them than men. If we’re keen to cut (or shift from straight-up public schools to semiprivate charter schools), that could have a profound impact on gender relations among Generation Y, perhaps adding to the documented woes of all of the single ladies out there. Meanwhile, the areas of the private sector that are likely to see renewed growth sooner rather than later – construction, finance – tend to be male-dominated, so if we pursue a “pro-growth” agenda focused on the domestic energy industry, “brown jobs,” construction, and finance, an important part of the agenda for politicians of either party will be figuring out how – short of convincing huge numbers of women to work in construction – to promote other dynamic areas of the economy (say, small-scale personal services) where female entrepreneurs might be more common.

Time to put on that hardhat or become a banker?

You could break down this analysis along age or educational attainment lines, too: the point Wolf was making, it seems to me, is that in a low-growth world, zero-sum politics becomes more salient, and clever political strategists will have to think even more carefully about realignments, constituencies to grab or alienate, and so on. We’re unlikely to return to a 2000-2007 world in which, for example, the less-educated white lower-middle class that was, arguably, bought off with cheap housing credit, is likely to simply take the (bad) lot given to it in America today. Here’s hoping our young aspiring politicos are listening.


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