The current chaos in the world economy is not a crisis of capitalism, but of governance. Few people like economic downturns, especially the politicians who are blamed for the economic stagnation and job losses, and are punished accordingly. Monetary authorities at the behest of governments have played fast and loose with money and credit in order to smooth economic troughs.
The result has been a long period of continuous growth, but one achieved by flooding the markets with cheap money and easy credit. It accumulated, sending false signals which led to asset bubbles such as that in housing, and to credit so easy that people became careless about their ability to repay. Markets did not behave recklessly because they lacked proper regulation; they acted on false information which monetary authorities sent into them. The regulation was certainly inappropriate, in that it reassured people that inherently risky activities and investments were safer than they were in fact.
Quantitative easing is now hailed as a solution, which it is not. We are to respond to the excess of easy credit by printing more money, sending more false signals into the markets about the level of real demand. The result will be to build levels of inflation into the economy which will be difficult to take out. We are told this will prevent the ten years of deflation which the Japanese economy suffered, but there is little sign of that deflation, and ominous signs that expectation of inflation are creeping in. Inflation-protected bonds are up 8 percent in the last few months, but the regular ones show no change.
Nobody likes unemployment, but economic downturns do weed out businesses using capital inefficiently and predicting demand incorrectly, and replace them by ones which do not. They improve the overall health of the economy, whereas lifelines to sustain ailing firms do not, despite their popularity with politicians.
Amid much smoke and spin the G20 achieved little not already announced or in process. We should be thankful it failed to endorse the massive new fiscal stimulus that some proposed. This has been a cyclical downturn, and a bad one because previous ones were held at bay by political manipulation. Yet recovery will come. For some countries it will be this year, and for most others it will happen next year. Future growth will be achieved by capitalism and free trade, not by government demand management and micro-tuning; they are not clever enough and do not know enough.
The staggering levels of government debt and liabilities can be cleared eventually by economic growth, but the huge monetary growth already built in, with more promised, will continue to distort the economy for years to come, and will retard and confuse the recovery instead of aiding it.
