There are two very different schools of thought on how to exit from the economic crisis. Rob Prugue, senior managing director from Lazard Asset Management Asia Pacific, discusses what investors need to understand from these two diverging economic views.
Like any other social science, economics is anything but exact. This inability to target a clear and undeniable policy will see economists argue it out, just as philosophers have done centuries before them.
Not only are economists unable to agree as to what is the better policy going forward, but also they can’t even seem to agree if the future will prove to hold inflationary or deflationary pricing pressures. Welcome to what I call a regime of uncertainty.
Having a view as to the best way forward will only make intuitive sense if we can agree what path we’re on: inflation or deflation?
What brought this missive was a recent instructive article in The Wall Street Journal. The author wrote about how the Keynesians wrote to The Times of London, urging Britons to spend themselves out of deflation. What’s personally intriguing was that this letter was written in 1932, years before Keynes wrote his General Theory.
Two days after the printing of the early Keynesian manifesto, F A Hayek and other fellow Austrian economists responded in kind. This letter was also published in The Times, where Hayek et al responded to some of the early Keynesian initiatives.
Why didn’t we have internet search engines when I was in high school? Attached are the two pieces, both written well before the world embarked on the Keynesian plan.
As a practitioner and student of finance, what intrigues me most isn’t so much the validity in either claim, but the political overtones this debate has now taken: East vs West, North vs South, Blue vs Red, Keynesians vs Austrians.
If so, and given the current political division on even the most aligned goals (such as healthcare, etc), this political dissolution will only further fuel this “regime of uncertainty” for a longer period.
Far from being an expert of either economic school, pragmatism tells me that if we don’t address the current economic malaise on its own terms, neither history-book approach will work. At risk of stating the bleeding obvious, current conditions are vastly different than those during the 1930s.
Breaking the kids’ piggy banks is not an option today. Unlike our spendthrift grandparents, we (the Queen’s “we” here) broke the kids’ piggy banks long ago.
And why not? Monetary policy at the time encouraged us to do so, ironically around the same time public policy mandated long-term pension savings.
In many ways, our current deflationary threat has more in common with 1990s’ Japan than 1930s US. Like Japan then, the West has recently moved through a secular period of leveraged asset inflation. Asset inflation was near double that of CPI.
This rise in asset wealth was redirected to subsidise increased spending habits, which further spurred on the economy. The more we inflated, the more we used these unrealised capital gains to subsidise our spending. A nice little pyramid scheme, only on a grand macro scale.
As the downturn took hold, the Japanese authorities eventually initiated such a public spending spree that would have made Keynes blush (four-lane bridges to nowhere and paving river beds).
Japanese public debt is today among one of the world’s highest. So while Japanese households and corporate balance sheets both reduced excess debt, ironically any excess savings went to fund this public liability.
Believing the economy was slowly starting to recover, the Japanese authorities curtailed their spending spree, and sought a more Austrian-like responsible fiscal management. Oops.
This was the last nail, as the consequence was only to cement the deflationary spiral for another seven years. But by now, the public had come to expect the spending spree as “normal”, and therefore showed little response to spend.
Even with Japan implementing its ZIP (Zero Interest Policy), households and corporates would rather hoard cash than invest or spend it.
I know, I know. There is MUCH more underlying all these points. Suffice to say that a better economic policy would be to run a proper forensic study to determine how we arrived at where we are, before we replay yesterday’s hit.
Easy for me to say all this from my ivory tower. Whatever decision we take, I still believe that it’s more important to have the right questions than to blindly accept the answers we’re being fed. If so, then how we manage ourselves and our assets through this prolonged period of uncertainty will be of great importance.