Are we in for a Macroeconomic Adjustment?

by Larry Smith

Renowned Bahamas-based financial expert Sir John Templeton once said that the four most dangerous words in investing are: "This time is different."

He was referring to the tendency to predict gloom and doom - often an irresistible urge for pundits.

But with the world economy about to shift gears in some fundamental ways, it is fair to ask (along with analyst James Ledbetter), "are we going to be wearing barrels for clothes and burning Ikea furniture to heat our homes, in a rerun of the Great Depression?"

Of course, we don't need to heat our homes, but air conditioning is just as important. And at the moment our lives depend almost entirely on imports - of everything from clothing to fuel to food. So perhaps we should take a closer look at what may be in store for us down the road.

How bad could things get? Well, let's start with a little background. Economists have identified 10 boom-and-bust cycles in the six or so decades since the Second World War. The average contraction lasted less than a year, while the average expansion ran for almost six years.

Those crises included the oil price shocks of the 1970s, the Latin American debt crisis of the 1980s, the Asian financial crisis of the 1990s, and the Dot.com crash of 2000, which was closely followed by the 9/11 terror attacks.

But those recessions pale beside the Great Depression of the 1930s - the longest and most severe economic crisis of modern times. Beginning in some countries as early as 1928, it led to unprecedented political and social changes and was brought to an end only by the onset of World War II - another great catastrophe.

The American economy shrank by 30 per cent, throwing a quarter of the labour force out of work. Banks failed, businesses went bankrupt, the stock market lost 90 per cent of its value, farm and factory output plunged and world trade collapsed. It took a full 15 years for stocks to recover to their previous level.

During this period, many countries suffered political upheaval. And nationalist demagogues like Adolf Hitler took power, setting the stage for global conflict. Once the Second World War was over, the memory of the Depression played a large role in the advance of socialist policies across Europe.

What caused the Great Depression? Experts say it was brought on by the same problem we face today - banks made loans to governments, businesses and people who could not repay them. In other words, they created a mountain of bad debt.

As a result the banks failed, producing a knock-on effect through the world economy. That explains why US and European authorities have been scrambling to prop up banks like Bear Stearns that have lately been losing billions after investing in subprime home mortgage securities.

The current financial crisis was brought on by the bursting of the US housing bubble in 2006, when rising numbers of homeowners were unable to pay their mortgages. Housing markets in the US and Europe have lost trillions in value as a result, producing a credit crunch that is causing a global economic downturn.

Local financial advisor Dick Coulson, of RC Capital, told me that "the crisis in credit markets is clearly a cyclical problem that will work itself out. You cannot have a worldwide depression when the two most populous countries - China and india - are emerging from the dark ages and booming into the modern world."

But other analysts fear this won't be a normal downturn. Former US cabinet secretary Robert Reich says there’s a "20 per cent chance of a depression", while ex-Federal Reserve chairman Alan Greenspan acknowledges that the current turmoil is the “most wrenching” since World War II.

York University Professor Peter Spencer says financial conditions are so unstable that a policy misstep "could make 1929 look like a walk in the park." And billionaire investor Warren Buffet thinks the gathering recession will be "longer and deeper" than most of us expect.

Meanwhile, in April the International Monetary Fund called the current crisis "the largest financial shock since the Great Depression", and said the world economy will slow sharply this year, with the US definitely sliding into a recession.

Only a short time ago the IMF was confident that we would be able to cope, but it now sees "a 25 per cent chance that global growth will drop to 3 per cent or less in 2008 and 2009 -- equivalent to a global recession."

Andy Cates, an economist at the Swiss bank, UBS, says "the world economy is slowing quite considerably and will be very different from what we've become accustomed to.'' And Financial Times economics editor Woflgang Munchau thinks we are undergoing "a global macroeconomic adjustment" that marks a major turning point in history.

So what does all that mean for us in the Bahamas? Well, unfortunately, a look back at the last recession is not very helpful. It began in early 2001 following the Internet stock crash, and was both short and mild - although made briefly worse by fallout in the travel industry due to 9/11.

The Bahamian economy shrank by a percentage point that year. Stopover visitors fell about 3 per cent, unemployment was up, and government revenues down due to a credit freeze that restricted imports. But by 2002 the economy was growing again.

We have to look past the 2001 recession for a guide to the future.

Today's worries are focused on the twin dangers of slumping growth caused by the credit squeeze and rising inflation due to a less than adequate supply of oil. This means that a slowdown in the developed world will not dampen demand enough to lower oil prices. These are expected to remain high due to soaring demand from emerging markets in Asia, and will therefore continue to fuel inflation.

The result? Stagflation. An unpleasant mix of inflation and economic stagnation that the world last suffered in the 1970s as a result of the Arab oil embargo. Back then, rising fuel costs led to annual inflation rates of more than 14 per cent, gasoline was rationed, airlines stopped flying, unemployment soared and US economic output fell about 5 per cent, making 1973-75 the worst economic crisis since the Depression - up to now.

We are already comfortable with the idea of crude oil at more than $100 a barrel, and it is a fact that the price of oil affects almost everything - from travel to the production and distribution of food. And many analysts are more concerned about rising food prices than the turmoil in financial markets. The World Bank estimates that food prices have increased 83 per cent in three years.

Food prices are going up for several reasons. Rising incomes and populations in China, India and other emerging economies are raising demand. Ethanol mandates and subsidies are leading more farmers to grow fuel instead of food. Modern farming methods are dependent on high-priced oil. And droughts and desertification have cut farm output around the world.

Taken together, these factors are producing a global food crisis. There have been riots in some countries (including right next door in Haiti) and export restrictions in others. And importers are warning Bahamians to expect frequent price hikes on breadbasket items like rice, flour, dairy products and cooking oil, all of which have at least doubled in cost locally since the beginning of the year.

This market situation is complicated by the government's nonsensical price control system, which was set up by the Pindling regime during the 1970s recession. It takes up to eight weeks for the government to approve price increases on controlled items (a list that covers about two dozen categories of imports), meaning products must be sold at a loss in the meantime.

Wholesalers are now balking at this, and say they will not release supplies until price adjustments have been made. This could lead to shortages and hoarding - and there are already reports of supermarket shoppers stocking up on sacks of rice. The number of people receiving food aid from the government is also likely to increase from the current level of 3,000, which Prime Minister Hubert Ingraham conceded would cost taxpayers "lots of money."

Rising fuel prices are also affecting local demand for automobiles - one of the main drivers of the economy - while adding dramatically to the household expenses of ordinary Bahamians. Electricity costs are at record highs and BEC is "literally broke", the prime minister says. Higher electricity and transportation costs will also put pressure on tourism, leading to layoffs and cutbacks, the effects of which will percolate through the economy.

What can we do? Well, Dick Coulson says we should concentrate on improving our tourist product (for which there will always be a demand), invest in renewable energy and fix "the shocking inefficiency of a government that can't even collect taxes."

According to economist Ralph Massey of the Coalition for Education Reform, the Bahamas must invest in human capital: "It does not now have the supply of cognitive skills to prosper in the global marketplace or to deal effectively with its problems. The recession may be temporary, but the adjustment will not be pain-free, and In the long-run the most important resource is the human resource."

Bottom line? Although the apocalypse may not yet be upon us, there is little doubt that we should all be looking at ways to adjust to new global realities. Business as usual - for both the government and the private sector - is not an option.

Comments

[C.Lowe]

I agree Larry, but in the private sector, there should never be such a thing as business as usual.
We innovate, take risks, assess logistics, and sink or swim by our efforts.
Our problem, is control. Our governments have practiced an unspoken and at times, spoken policy of controlling the private sector and foreign investment, which leaves us weak in the face of challenges.
Most of the "deals" the government negotiates are ludicrous, laughable, and down right sad. The private sector, has the mind and the willpower to survive, and can do so even with the weight of the government on our backs.
If they would stand back and let us produce, let us help them to understand the environment in which we operate and can innovate, the same environment which they tax for their social programs, we could stand a little stronger.
I still say that Freeport holds a large part of the solution for the country. Its first purpose and oportunity was thwarted, by government, but it is poised with great potential to get a second chance. That rarely happens in the world.

[Bill]

Hi Larry,

I have never seen anything this bad. In addition to that, it will not get better anytime soon.

With that, while price control may be an issue to deal with. Most people attack it, like they do with everything else, with blanket rage and end up throwing the baby out with the bath water.

That being said, we all know that importers would gouge on bread basket items in this country. The market won't adjust to that quite readily. But, I would say let the market run its course on it- won't hurt as much. And, the folks who gouge, will lose out to other importers anyways.

The issue is price stability with the price control structure. Fluctuations in prices, is a critical concern, considering the type of country like ours, which depends on foreign reserves. I say that, because, once we have to keep up a certain stock of USD, if we can't gauge income and savings due to unforseen influx of tourists who also bring in USD, we would end up inflating prices on ourselves when we don't really have to- people who come in with money, to boost our demand figures, way out of true national demand figures. On top of this, importing goods to basically be transferred into USD (reserve system) and putting the Central Bank into unneccesary overdrive...price stablity. You can't have that and put such demands on money supply and the manpower that monitors it.

What does that have to do with the current market? Nothing. But, if I were to jump right back to the point, the US has been in a recession- with a Democrat coming to office, don't expect the stimuus package to do much after November.

Best,

Bill

[C.Lowe]

The "stimulus package" reminds me of a story of a Chinese feudal lord who worried that his successors and neighboring war lords would destroy his turf upon his death, fighting over his wealth.
His solution was to distribute his wealth equally amongst his subjects.
Bottom line is, each peasant got a few coins, as there were so many of them. It dissapated into nothing.
Just an interesting parallel.

[Nanaqu2]

Hello Larry you have a very good blog site here, can you try to make it a little bit more interesting and attractive, I mean the graphics. You have very interesting and note worthy insights, maybe a little more graphics. I am a student abroad and I would like to have alot of info about whats going on @ home.