" ... In 1976, Britain's then prime minister, James Callaghan, delivered a grim assessment of the country's economic situation: "We have been living on borrowed time. We used to think you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists." That warning is still relevant today ..."
In a sobering piece, Satyajit Das suggests that world recovery on the back of fiscal stimulus in the form of huge Government deficit spending may be ineffective.
National and international "committees to save the world" have rushed to announce and occasionally even implement a bewildering and constantly changing array of measures — dubbed WIT ("Whatever it Takes") by Britain's Prime Minister, Gordon Brown — to counteract the financial and economic effects of the global financial crisis.
Governments and central banks have sought to remove toxic securities from bank balance sheets and supply share capital to cover losses from bad debts. In some countries, such as Australia, the government has guaranteed banks' borrowings to allow them to continue to raise funds.
Bank of England governor Mervyn King summed up the nature of Britain's support for the banking system with a Freudian slip: "The package of measures announced yesterday by the Chancellor are not designed to protect the banks as such. They are designed to protect the economy from the banks."
Governments have gone into huge deficit providing fiscal stimulus and, in the US, support for the housing market. Central banks have cut interest rates to levels not seen for decades.
The success of these actions is not assured. John Kenneth Galbraith once observed: "In economics, hope and faith coexist with great scientific pretension."
Credit conditions have not eased significantly. Money supplied to banks is not flowing into the real economy. Governments and central bankers, frustrated at the failure of policy actions to help the resumption of normal financial activity, have started to lend directly to business or drifted towards "directed lending" policies in an effort to get the economy going.
The policies miss the point that debtors still have more debt than they can service. Until the debt is written down and restructured, credit growth may not resume.
In the TARP (Troubled Assets Relief Program) Oversight Panel Report of April 8, Professor Elizabeth Warren observed: "Six months into the existence of TARP, evidence of success or failure is mixed. One key assumption that underlies Treasury's … approach is its belief that the system-wide deleveraging resulting from the decline in asset values, leading to an accompanying drop in net wealth across the country, is in large part the product of temporary liquidity constraints resulting from non-functioning markets for troubled assets.
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Satyajit Das is a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives. His blog can be viewed here