Policymakers are focusing too much on the costs of fiscal stimulus packages, rather than their benefits, said Joseph Stiglitz, Nobel laureate and former chief economist at the World Bank, on the opening morning of the Credit Suisse Asian Investment Conference in Hong Kong yesterday.
Consequently, these spending programmes may be too tepid, especially when, as in the United States, they contain too great an emphasis on tax cuts, and are neutralised by a contraction in expenditure by revenue-starved local authorities that are compelled to balance their budgets.
Stiglitz was also sceptical about US Treasury secretary Timothy Geithner's plan for a public-private partnership to buy "toxic assets" from banks because it might turn a "zero sum" game into a "negative-sum" game, by leaving taxpayers with losses while providing opportunities for profits for gamblers and fraudsters in the private sector.
In response to concerns about governments and central banks laying the seeds for future inflation through their massive spending programmes and ultra-loose monetary policies, Stiglitz argued that deflation would be far worse. It creates a deleterious chain of damage, as fixed debt obligations become more expensive, leading to individual payment defaults, worsening bank balance sheets and a further contraction in credit. The subprime calamity is already morphing into a wider crisis as it spreads to prime mortgages, car loans and credit cards.
But Stiglitz did warn that inflation can happen suddenly and unexpectedly, and that the US Federal Reserve was courting danger by artificially reducing long-term interest rates by buying commercial assets, such as corporate bonds, rather than just Treasury bills.
However, he was also scathing about the past behaviour of Federal Reserve officials and commercial bankers who, he argued, have a myopic concentration on price stability, while missing the far bigger threat of inflated asset values supported by inadequate financial structures. The housing market was the most egregious manifestation of that short-sightedness.
Stiglitz, who is currently a professor at Colombia University, pointed out that the past economic model -- US consumption supporting world trade -- is unlikely to be resurrected, as the US savings rate increases in tandem with the uncertainty of a higher unemployment rate. So, we should not anticipate a return to the conditions similar to the beginning of the boom in 2002. Most importantly, US exports and investments must show signs of picking up, while the engine of domestic demand must shift to other parts of the world.
Stiglitz is "very optimistic" about China, although he is conscious that as an outsider he might be viewing the country with rose-tinted glasses. He praised the recent fiscal stimulus programme, with its emphasis on developing a social safety-net by devoting spending to education, health services, insurance and pensions. The population should feel more secure, he said, which would lead to a pick-up in domestic consumption and moving the economy away from its reliance on exports. However, he noted that the Chinese savings rate is not abnormally high; it's just that household income as a proportion of GDP is low, while corporate profits are correspondingly high. Hence, wages need to increase, which might be facilitated by an expansion of the small-and medium-sized enterprise sector. However, he is worried that too much consolidation in key industries might reduce China's efficiency, and that the government may be reluctant later on to cut what are effectively subsidies for natural resources that will artificially boost corporate profits.
Commenting on Asia in general, Stiglitz said that it is understandable that the "class of '97", the Asian countries whose sovereignty was effectively taken away by the International Monetary Fund and US Treasury policies during the crisis a decade ago, has focused on building up foreign exchange reserves above all else since then. However, as a result they have become victims of the "paradox of thrift", ever dependent on a profligate US consumer to support positive trade balances.
But, he was encouraged by developments such as the expanded Chiang Mai Initiative currency swap arrangement, which he sees as a potential nascent regional currency reserve system that, if combined with similar support agreements in Latin America, for instance, might evolve into a viable global reserve system, replacing the increasingly discredited US dollar. The dollar, he said, is no longer a good "store of value": It is volatile and diminished by the printing press, and the confidence on which it should be predicated has been lost due to political and economic instability.
One day, Stiglitz believes, the world will have a genuine "super currency" as Keynes originally desired back in 1944 at the Bretton Woods meeting, which did so much to shape the post-war financial landscape.