Politics and events remain key
We were spoiled in the 1990s. All you had to do was go into the office. With what we thought was a tightly-controlled Rubin/Greenspan US economy dominating and Friedmanite economics driving the global economy, life was relatively easy – despite the world’s second-largest economic engine, Japan, being out of order for 12 years or so. Strong growth, low inflation and high, but not full levels of employment, drove a more than 10-year bull market, such as we have not seen since the 1920s.
The speculative blowouts around the internet in 2001 and 2002, and sub-prime and insurance monoline crises starting in October 2007 were perhaps inevitable and, given their size, lengthy corrections were necessary. Overall, the past seven or so years have had their share of pain.
The US economy was in a political cycle in 2004, as the government used fiscal spending to stimulate the economy. Rates of growth in US government spending were back to where they were 35 years ago at the height of the Vietnam War. In 2005, the tragedy of Katrina, and the continuing demands of the wars in Afghanistan and Iraq continued to fuel the government spending spree. In 2006, the latter conflict continued the acceleration in government spending.
It is no accident that governments in many countries are the largest advertising spenders: ministries use marketing to reinforce their policies and build electoral popularity. Perhaps for political reasons, President Bush failed to deal with the twin fiscal and trade deficits. He chose not to raise taxes and Federal Reserve chairman Ben Bernanke did not hike interest rates even further.
All this was thrown into sharp relief by the sub-prime, insurance monoline, private equity and house price crises that started to hit hard in the third quarter of 2007. Everyone but Goldman Sachs seemed caught unawares – and even the masters of the universe were, for a short time. Economic policy is in sharp reverse, with massive injections of liquidity and significant lowering of interest rates being the cornerstones of the new economics, as banks continue to refuse to lend to one another and third parties.
General government deficit as % of GDP
- Source: Standard & Poor's
Given the massive Keynesian fiscal stimulus of around $13 trillion and counting being pumped into the world’s economy through government spending and guarantees, there seems little doubt that the current difficulties will be overcome in the short term. After all, the US and UK have even resorted to quantitative easing or printing money. But what happens in the long term? There seem to be two possible routes. First, the hair shirt route of reducing government deficits by cutting state spending and increasing taxes, thus increasing unemployment and encouraging a higher propensity to save. All very painful stuff as we saw on a smaller scale in the 1970s and 1980s. (The three-day week and rubbish piling up in the streets is the nearest, I think, we have been to the current crisis since the Great Depression.)
Or, which seems more likely, we inflate our way out long term. It will be difficult for government or even central banks to know when to withdraw the current support, particularly as President Obama faces mid-term elections in 2010 and Prime Minister Brown by May 2010 and Chancellor Merkel this year.
It would be very unpopular politically to wear the hair shirt by increasing unemployment. Much easier to inflate our way out of it, reducing the real value of debt and increasing long-term interest rates. It is doubtful, however, that the redistributive policies of the new US president will be enough to deal with the debt burden and, in any event, may have harmful effects on entrepreneurial motivation and corporate activity or eventually be rejected at the ballot box.
If this scenario plays out, the high-saving countries – Brazil, Russia (getting its act together again as oil prices rise), India, China and even Japan – will benefit and pull further away from the West.
Inflation, of course, as long as it is controlled, is not bad for our clients or us. By giving our clients pricing power, branding and innovation become even more important, as long as private label does not become too dominant.