Crisis debate skims over causes

This is my latest comment from Fund Strategy.

Last week the media discussion of the world’s economic plight started to shift from DD to D. A debate emerged about the possibility of another great depression rather than a simple double dip. Another D could be used to describe much of the debate: dumb.

As is often the case, Paul Krugman, Nobel laureate and unofficial cheerleader for the Obama administration, was a leading figure in the debate. He wrote in the New York Times that the world was facing a full-on depression. If European governments and American conservatives were not prepared to maintain the fiscal stimulus the consequences would be terrible.

Fiscal hawks predictably rejected his argument. Typically, they suggested that if deficits were not tackled quickly the consequences could be disastrous. Excessive public spending is, they argue, a drag on growth.

Despite their differences, both sides tended to ­follow the same basic approach. One said the data suggests that economic activity remains weak, therefore further stimulus is needed. The other argued that, since recovery is underway, tightening is appropriate.

Discussion of policy was remarkably detached from any examination of the underlying causes of the crisis. Of course, the whole story of the downturn cannot be told in one article. But, more generally, the discussion of the world’s economic difficulties is sadly lacking. Attention has largely focused on scapegoating factors external to the real economy – greedy bankers, overconsumption, excess Chinese savings – rather than examining economic fundamentals.

In Krugman’s case the emphasis is on weak demand as a result of a liquidity trap. From this premise it follows that a liquidity injection is key to overcoming economic lethargy. But if the problems are more deep-rooted than he suggests his proposed solution will at best only postpone economic difficulties.

Given the superficiality of the discussion, the annual report from the Bank for International Settlements was a welcome read. It reminded readers of the basic point that “what is true for medical illness is also true for a financial and economic crisis: policymakers must address its symptoms and at the same time press ahead with reforms aimed at its causes.”

Arguably the causes it identifies also fail to get to the root of the problem. For example, on the macroeconomic side (as opposed to microeconomic) it focuses on global imbalances and long periods of low interest rates. But this begs the question why such ­factors arose in the first place.

It has reached the stage where a fundamental reassessment of the real economy is vital.