Davos: An Unrealistic View from the Mountain
ANALYSIS, 7 Feb 2011
For those at the Davos World Economic Forum the future looks bright – but the truth may be bleaker for the rest of us.
The theme of Davos this year was “shared norms for the new reality”, one of those phrases where the words can be rearranged in any order and remain utterly vacuous. Business leaders, policy leaders and the world’s smartest academics had five days in the high Alps to work out what this actually meant. Despite much head scratching not one of them could.
If there was a shared norm at the World Economic Forum, it was that things are looking up. The chief executives who make up the paying clientele at Davos have had a much better year than they were expecting 12 months ago. In January 2010, there were fears of a double-dip recession with even über-optimists expecting a year of only tepid growth. In fact there has been a robust bounceback from the deep slump of 2009. Profits are up and so are bonuses. From the boardroom, life is sweet.
And should remain so in 2011. The emerging markets – China and India are booming. Growth in the US is picking up helped by a fresh injection of policy stimulus. After a year of indecision, Europe is finally getting to grips with the sovereign debt crisis that required bailouts for Greece and Ireland. Big companies, having cut costs aggressively in the downturn have hundreds of billions of dollars in the bank, ready to be unleashed in a wave of investment spending.
Above all, the world is in the middle of a period of stupendous technological change. Kris Gopalakrishnan, chief executive of Indian technology company Infosys, noted that most business leaders were using smart phones and tablets at Davos this year with laptops very much yesterday’s kit. The global economy is in the early stages of one of the big structural changes that happen every 50-60 years, a so-called Kondratieff cycle in which new industries appear. It is this combination of innovation and rapid growth in Asia and Latin America that has convinced some economists, such as Gerard Lyons of Standard Chartered, that the global economy is a decade into a 30-year super-cycle of fast growth as seen after the second world war.
This is the world as seen from Davos. The crisis of 2008-09 was a near-death experience for the global economy but it was a one-off from which lessons have been learned. Bob Diamond, chief executive of Barclays said the message from 40-odd banks that met finance ministers on Saturday was one of heartfelt thanks for the help provided by governments. But the City and Wall Street strongly voiced the opinion that it is time to stop the banker bashing and move on.
Life looks different from a Swiss ski resort than on the streets of Cairo or in a dole queue in Detroit. Gopalakrishnan posed the question of whether Davos is disconnected from the world, and the only honest answer to that is “yes”.
Here’s what is happening. Economic power is shifting from west to east in an acceleration of a trend that has been happening for two decades. Production was moved from developed countries to emerging markets, where labour was cheap, boosting profits and cutting inflation. Low inflation led to low interest rates, and the cheap money that resulted financed asset price bubbles. Some of the money found its way into property markets in the west – in the US, Britain, Ireland and Spain – and the rest was exported overseas as fund managers sought to find better returns than they could at home.
In the 1990s, emerging nations felt the strain as hot money flows created property booms and pushed up their exchange rates, causing balance of payments deficit and eventually painful crashes. But the problems of Mexico, Thailand, South Korea, Indonesia and Russia were merely dress rehearsals for the global crisis of 2007, when the contagion burrowed its way to the centre of the global economy. The housing bubbles went pop, the banks were left in hock to the taxpayer, and unemployment rose.
In the economics textbooks, the cure should have been for exchange rates to fall in countries such as the US and Britain, and for exchange rates to rise in countries such as China running big current account surpluses. But the text book solution has not worked, partly because China has only permitted a gradual increase in its nominal exchange rate, and partly because the manufacturing bases in the US and Britain had been so hollowed out by years of neglect that there was insufficient capacity to take full advantage of cheaper exchange rates.
Faced with stubbornly high levels of unemployment, policymakers have responded in two ways. They have turned the heat up on Beijing to revalue the yuan and they have printed money in an attempt to drive down the value of the dollar. Fred Bergsten, director of the Peterson Institute for International Economics in the US, said Washington should consider bringing a case against China at the World Trade Organisation for what he dubbed the biggest act of protectionism since the second world war. Such a move would inevitably lead to retaliation from China.
The quantitative easing from the Federal Reserve has had some nasty side-effects. In a re-run of the 1990s, much of the money has leaked into speculation, either in commodities or in emerging markets, where higher levels of risk mean higher yields.
Some lessons have been learned from the 1990s, when the International Monetary Fund insisted developing countries abandon controls on capital, thereby rendering themselves defenceless to the boom-busts caused by volatile flows. As Stephen King, chief economist at HSBC notes, quantitative easing in the US has been met by quantitative tightening in the emerging world through curbs on credit and the imposition of capital requirements.
High commodity prices are adding to strong inflationary pressures in emerging markets and putting a fresh squeeze on real incomes in the west. Central banks are under pressure to raise interest rates even though this would cause havoc in countries such as Britain where debt levels remain high. China and the US are involved in a blame game at a time when economic governance is dysfunctional.
In their take on Davos, Lombard Street Research call the situation a lull between storms and that looks right on the money. The “new reality” in Davos looks suspiciously like the old unreality.
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