October 11, 2011
Photo: John Mayer
“Birds of a feather flock together”, the old saying goes. So, too, do investors.
Today, those investment birds are a depressed lot. Increasingly, talk is of a “double-dip recession”, “Euro zone collapse”, and the United States and Europe “turning into Japan” — i.e., years of economic stagnation. It’s enough to knock any bird off its perch.
And it all comes down to “animal spirits”, a phrase much beloved by economists, especially birds of a Keynesian feather. Optimism and pessimism (the “animal spirits”, coined by John Maynard Keynes) drive investment but also household consumption and saving. The resulting ups and downs in demand shape rates and patterns of economic growth. Indeed, animal spirits may ultimately determine the rise and fall of nations, including the present shift in global economic power to the “South”.
Signs of depressed spirits are everywhere. Turn up at a US bank with US$50 million or so, and you might have to pay them to take your deposit. Perhaps not a problem for the average reader, but it is one for cash-rich corporations. Rather than investing in new plants or machinery, they prefer to pay the bank to hold their cash. Result: few new jobs, especially for young job seekers often saddled with college debts. Investment recovery will be crucial to renewing job creation in the United States and Europe. Otherwise, protectionist sentiment will take hold, to the cost of the South’s exports and jobs.
Further, folk are buying US bonds at yields implying a loss in real terms (and despite te recent downgrade of US debt by Standard & Poor’s). When their money is returned, it will purchase less than when they lent it. Pension funds rely heavily on bonds to meet their commitments, and the prospects of a secure retirement income are diminishing in the rich world. One result: more older workers are delaying their retirement, again to the cost of young job seekers.
Gold has climbed over the last five years, albeit with a recent dip, thereby delighting gold bugs everywhere. August marked the 40th anniversary of President Nixon’s decision to suspend the dollar’s convertibility into gold (marking the end of the Bretton Woods System of fixed exchange rates that underpinned recovery after the Second World War). We continue to live with the results. The Japanese and Swiss central banks struggled to contain recent currency appreciation, to the detriment of their growth (and, in Japan’s case, recovery from this year’s devastating earthquake). Fundamental shifts in currency regimes often mark the transition between old and new economic eras. The survival (or not) of the Euro will ripple beyond the continent itself.
Gold bugs were a species thought to be extinct only a few years ago. Keynes dismissed gold as “that barbarous relic” (not surprising given the gold standard’s deflationary effects in the 1920s). But the relic has been taken off the shelf, not least by central banks themselves, who are buying more gold for their reserves.
This should delight gold producers, especially the smaller and poorer countries — Papua New Guinea, Mali, Ghana and Tanzania are at the top of that list. Tanzania’s gold exports by value have tripled, to reach US$1.5 billion, over the past few years. Countries seeking to diversify their foreign exchange reserves out of low-yielding US treasuries might well buy more of Africa’s gold.
But commodity-exporting countries need to watch out. Commodity prices have ridden the wave of “quantitative easing”. Further quantitative easing cannot be ruled out, pushing yet more money into commodity market speculation and pushing prices up. Economists argue among themselves as to whether such speculation is a strong driver of commodity prices. Certainly it has become a bigger factor in the oil market in the past few years, and also in global food markets.
Speculation can push prices down as well as up, and the sell-offs can be sudden and sharp (any sign of China’s growth slowing always hits metals prices, for example). High volatility in export and import prices has always been a challenge for low-income countries. It causes havoc in budgets and planning development expenditures. And food prices hit poor consumers hard unless adequate social protection is in place (often not the case, and almost never so in the “fragile states”). This volatility is unlikely to ease, and could well intensify.
Now is, therefore, the time to accelerate diversification. China’s success with industrial policy has captured the world’s attention, not least in Africa. Policy makers searching for ideas should take a look at Justin Lin’s WIDER Annual Lecture (held in Maputo this year, the first time in a developing country).
”By following carefully selected lead countries, latecomers can emulate the leader-follower, flying geese pattern that has served well all successfully catching-up economies since the eighteenth century”, writes Dr. Lin, Chief Economies and Senior Vice President at the World Bank. He emphasizes the opportunity now awaiting low-income countries as “China is on the verge of graduating from low-skilled manufacturing jobs and becoming a ‘leading dragon’”. This will free up nearly 100 million labour-intensive jobs — a tremendous opportunity for Mozambique and other African countries to grasp, especially for their young job seekers.
The lecture “From Flying Geese to Leading Dragons: New Opportunities and Strategies for Structural Transformation in Developing Countries” is available online, as is Dr. Lin’s paper on the topic. And Dr. Lin discussed these ideas further at UNU-WIDER in Helsinki on 5 September.
In sum, high risk is priced into the global economy. But much risk is also mispriced — a characteristic of panicky times. Amidst the pessimism, it is important not to lose sight of the resilience, so far, of growth in the emerging and developing worlds. Rising living standards make domestic consumption a more important part of their growth story, reducing their vulnerability to shocks from the “North”. US and European corporations increasingly see their profit growth driven by the markets of the bigger emerging economies. And the Chinese dragon and the Indian tiger are certainly creatures with spirit.