A Dummies Guide to the Western Economic Crisis

Friday 05 Aug 2011

It's absolutely critical that this crisis is communicated to the general public more clearly. Although some journalists, such as Anatole Kaletsky of the UK Times, understand what is going on, far too many are focused on either superficial details or the inevitability of Western decline.

The Economist Magazine and The Financial Times, for example, avoid looking deeply into the heart of the problem and constantly talk about short term fixes such as low interest rates, quantitative easing, fiscal stimulus, bailouts, bond market interventions etc. These journalists are stuck in a short term surface analysis which offers no proper long term resolution of the crisis; they think of the crisis as a coincidence which can be fixed by tinkering, rather than a symptom of a much deeper long term malaise that needs more radical attention. In the FT yesterday one article proposed zero rating corporate tax to revive the US, and another article suggested the ECB buy vast quantities of Italians bonds to revive the Eurozone. I think I have only come across one article in the FT, written by a Turkish technocrat, which really talked about fundamental economic reforms instead of plasters and painkillers. So these journalists are what Stiglitz (the Nobel Prize winning economist) calls antediluvian deniers of the "new economic paradigm" who focus like data junkies on superficial economic statistics and propose naive simple technical measures to repair the world.

It is precisely because elected Western politicians are still treating the crisis in this shallow way that the markets are falling. Traders want to see radical economic surgery not a bunch of Central Bankers constantly inventing new adrenaline or tranquilizer shots. In the last few weeks we have had a series of hopelessly shallow policy announcements, such as the US deficit deal and the EU's July bailout revision. The most absurd example of this superficiality occurred on Thursday when Berlusconi, the Prime Minister of Italy, staged an emergency press conference to address the developing loss of confidence in Italy. Traders were hoping for shock and awe economic surgery, I mean blood all over the walls and screams etc, but instead Berlusconi said everything's just fine and we should all stop panicking. He called himself a "tycoon", he said the markets are stupid and he knows better, he said "this crisis won't get any worse", and once the world hears his silken reassurance everything will go back to normal. The Italian stock market promptly dropped 5%, making it the biggest faller that day in the developed world.

So traders don't want to see short term tinkering or hear politicians assuring them that there isn't a problem, they want to hear and see politicians engaging in the sort of radical economic surgery that goes way beyond even the sort of simple austerity measures announced in the UK. For example, look back at the Thatcher / Regan revolution. Thatcher was austere and Regan was profligate, do you see that this revolution had nothing to do with austerity, the revolution really revolved around shaking up the labour markets to make people more productive? Traders are looking for the same kind of thing today, the paradigm change isn't about austerity or stimulus or bailouts etc, it's at much more fundamental level. The FED and the ECB can only play a limited role, the problems exist at the political level. So the endless articles calling for new superficial interventions, written by 'technical journalists' at the Economist Magazine and The Financial Times, are just clouding the issue and preventing a more intelligent response.

Another group of journalists echo the sense of inevitable Western decline perceived by the masses, but they don't even bother talking about reform, they just passively surrender to decline. This mood started developing about two years ago, Niall Ferguson was one of the first commentators to talk about Western decline (eg The decade the world tilted east), and since then the theory of Western decline has become almost universally accepted. Yesterday, an article in the UK Telegraph said Asian kids are brought up by Tiger Mothers and Western kids are spoilt rotten, it's obvious that China is going to kick our butts. But in Japan and Singapore politicians are fighting back by trying to put more Tiger into their school system, they are trying to compete with the Chinese not giving up. In today's UK Times Rees-Mogg writes about 'the fall of the Western Empire and the rise of Chinese Empire'. He says it's OK to let go of leadership, the Chinese aren't going to invade us. The Dutch lost their empire hundreds of years ago but life in Holland is still very pleasant. But there is a huge difference between not being a superpower, and being on completely the wrong side of a paradigm change. We must not surrender, we must fight to keep up with the Chinese or we will ultimately end up like a third world country on completely the wrong side of history.

So the Western press is largely splitting into two camps - the pessimists who have given up trying, and the optimists who refuse to accept a shift. Over at the The Economist Magazine and The Financial Times the optimistic journalists are still fighting against the idea of Western decline. They say the idea that the West is on the wrong side of history is absurd or pessimistic or hysterical etc. They constantly talk about China following the West, the idea that China is doing something completely new is dismissed out of hand. But like incumbent politicians they fail the smell test, anyone who reads their commentary carefully can see their arguments are built from blinded self interest. They deny the paradigm shift because it violates everything they have been saying for years. They are like Berlusconi, to admit the failure of Western economics is to admit personal failure because they are precisely the experts who have been in charge. Their egotistical refusal to face up to their personal failure forces them to call this crisis a technical failure rather than a revolution. You can recognise the "paradigm shift skeptics" by their constant attempts to talk down Chinese economic success and talk up the success of emerging markets run on Anglo-Saxon principles, such as India. These people are extremely dangerous to the world because they prevent us coming to know ourselves and improving ourselves.

So whilst every newspaper has the crisis on its front page the general public by in large still don't have a clue about what this crisis is really all about. Although the masses now generally agree that elected politicians are woefully incompetent and the West is in inexorable decline, there is no popular consensus about what's actually wrong with the economy. Some people talk about too much debt, others about asset bubble deflation, others about corrupt bankers, others about the impossibility of the Euro etc. It's like an AIDS patient who is unaware of his underlying illness complaining about multiple symptoms and looking for multiple cures. As long as this state of confusion persists incumbent politicians can play one group off against the other and maintain their grip on power. I hope readers of my blog are better informed, but let's spell out the basic substance of this crisis in the simplest possible terms, and hope that someone responsible will communicate this message to the public:

So what is this crisis really all about? We can explain it very simply at the mechanical level by way of an analogy. It's as if we have been driving an old car that has been breaking down for many years but in the past we always managed to patch it up with short term fixes, and sometimes we even thought we were motoring along quite nicely. But now we are realizing that our old car is totally shot and needs completely rebuilding, but the horrible truth of the matter is that we don't have the skill required for such a huge undertaking. You would think we could just bring someone in to help us, but you have trust a person to let them help, and we just can't find that trust because we haven't quite come to terms to our own hopelessness. Whenever we meet a professional mechanic he starts talking about things that are just so far from the way we do things it annoys us, so we turn away from him and keep tinkering. Of course it doesn't help that the people we choose to supervise our repairs keep trying to pretend they know what they are doing to avoid loosing their jobs. For the last few years we have been putting higher octane fuel in the tank to keep the wheels moving, but of course we all know we that's just creating more long term problems. It's looking like it's just about the end right now, and the last remaining short term fix is rocket fuel, which will burn for a while and then explode.

Explaining mechanics to the masses is too difficult, so perhaps the vital message we need to communicate to the Western public is: "Your life is on the line and what is going on is more complicated that capitalism or socialism or stimulus or austerity, the repairs we need are both absolutely staggering and way beyond your comprehension, so get yourself some professional advice ASAP".

Yet some people won't listen, they won't accept that they know nothing about mechanics, so can we summarise the philosophy of this paradigm shift even for the average man? If you go to Niall Ferguson's homage you will see videos of him asking school kids what made the West outperform in the first place. Ferguson says that to understand what's going on we need to figure out what propelled the West to ascendancy in 18th Century. Lets put it like this: back in the 18th Century the Confucians who ran China were focused on peace and harmony and things like that. They were happy living the philosophical life up until Western powers such as Great Britain sailed East and started subjugating them. The Western powers had been at war with each other for hundreds of years, and they had consequently developed all sorts of scientific techniques that gave them various powers. The technology gap was so vast that the poor Chinese were all but wiped out. It took the Chinese a long time to recover and start taking an interest in science and industry, but now they have taken it to a whole new level.

It's like Napoleon said: "Let China sleep, for when she wakes, she will shake the world." How can we described what the Chinese have done? It's a bit like the comparison between post-industrial revolution and pre-industrial revolution Britain. Before the industrial revolution a lot of people used to think of themselves as creative entrepreneurs and craftsmen, but looking back they were basically lazy ill disciplined uneducated amateurs. Think about science fiction films, people who don't like China call it the "Star Trek Borg", people who do like China call it the advanced disciplined scientific Zen Master like collective of the future. Do you want a physical example of this Roman Empire vs Greek Democracy like economic difference? In America the government spends 5% of government revenue on infrastructure, in China they spend 50% of government revenue on infrastructure. Right now the American government is borrowing 40% of what it spends, to get to where China is at it has to not only close that revenue gap, it has to close the investment gap. Do you understand what an absolutely mind-blowing challenge that is? Back in the 1960s America went to the moon, but if you are into economics instead of space travel the accomplishments of the Chinese are absolutely staggering. I could go on forever with examples, everyone has heard of the Three Georges Dam, the Olympics etc. But did you know they built a single city to supply up to 80% of the words jeans? Did you know that in five years their scientists have completely taken over the ultra-high tech world of high speed train? Did you know they have over a hundred nuclear power stations in construction and pretty soon they expect to have the cheapest electric in the world? The Germans, the last great hope for the Western World, are building wind turbines right now, one day they are going to wake up and realise they have priced themselves out of the market. The average man in the West has realised that something in going on in China, but he has just no idea how vast the scale of it is. The Western elite are turning a blind eye to what is going on. It's like the old British General who sent a message to his troops in Singapore during WW2: "Don't worry about the Japs, they're just a rabble of little yellow nips, they can't even see straight let alone shoot straight" he said. The next day the British army were totally wiped out. The contrast between Chinese and American professionalism is already bigger than the contrast between Germany and Greece, and everyday the West spends sitting on their hands the gap just grows and grows. It's tempting to throw in the towel, but to do so would be extinction.