Oil’s short-term slump masks conundrum about long-term prosperity

While Gulf markets may understandably be wary still of the depressed oil price, the bigger but related picture internationally may yet be more challenging. That’s if the assumptions behind prevailing global economic strategy prove fundamentally false. It’s an unavoidable, governing issue.

One of the curious features of the modern world is that a G7 finance minister can welcome declining domestic inflation (as in the past week), for reducing cost-of-living pressures, while continuing publicly to impose an obligation on the central bank to get inflation higher again. That indeed is a preoccupation among leading economies, one driving expectations and so performance across financial markets worldwide. It would not be uncharitable to find that juxtaposition rather hypocritical.

In fact Western authorities have become devoted to a 2 per cent annual inflation target, steadily and deliberately eroding the purchasing power of cash, making people struggle to preserve their income and wealth, since money, by government edict, is no longer to be regarded as a store of value. Price stability has been ditched in favour of inflation stability, it should clearly be noted.

While the morality of that principle is debatable, the reality is that the game changed some while back for everyone on this basis. Meantime, the Asian success story has been relegated in the collective imagination, and we’re back to following the traditional sources of policy and outcomes for identifying relevant international trends.

Everybody knows that benchmark stock and bonds are effectively officially-supported markets these days, underpinned by the determination — and now perhaps unavoidable need, having trapped themselves — on the part of the Fed, Bank of Japan and Bank of England to keep stimulus flowing or on standby. Real estate has the same quasi-guarantee behind it. The ECB, confronted by a stressed-out Eurozone, is on the cusp of joining this manipulation.

So investors continue to believe the music will play, the parcel will be passed, and the partygoers will continue to absorb monetary liquidity. The growing belief that this contrivance, while having undoubted longevity, is not sustainable indefinitely is troubling enough to those on the market dance-floor to give a decidedly two-way feel to stock prices now. Added to which in the Gulf, the implications of oil’s steep slide are exercising a drag for the moment, until markets begin discounting an upturn.

It’s not that policymakers want unrestrained, destabilising inflation. They just want enough to help pay down public sector debt, by both deflating its real value at time passes, and by encouraging others to boost consumption (and so economic growth). In that respect they’re merely following the private sector in wishing to deleverage and allow room to spend again in a relatively secure manner, while actually prodding individuals and businesses to spend what they don’t necessarily have.

Sovereign finances

Releveraging is not a sound platform for medium-term growth. As many have argued, the danger grows of simply reinflating the bubble, one whose eventual bursting would be even harder to cope with given already overencumbered sovereign finances. And if continually spending debt-fuelled cash were any foundation for lasting growth and prosperity, then all we would ever have to do is let government throw money around — whether from taxes or borrowing or simply printed — and we would all be driving Ferraris or some-such.

Funnily enough, it’s not that easy. History shows that sufficiently well, if intuition doesn’t cover the point. That’s (amazingly) because creating the value of which cash is merely the paper counterpart is dependent on facilitating the quality of supply not the quantity of demand. It’s just that you can’t convince enough economists of that, at least those advising Western governments. They are typically number-focused, fairly linear in their thinking, and believing that the long term is merely a succession of short terms. You might demur at that truism instinctively too, but the strange worlds of economics and policymaking do often seem to belong to another planet.

While being reminded of all this maelstrom of theorising, currently befuddling critical policy towards inflation and deflation, I came across the words again of the then Dean of Johns Hopkins University several years ago. Jessica Einhorn simply wrote: “Prudent people save [my italics] in the face of rising costs for [everyday] items.” Alternatively put, they don’t spend more, but instead buy fewer items. Obvious, really. She argued that quantitative easing and its inflationary intent therefore pose a negative risk (even if you believe demand is ‘deficient’), contrary to consensus opinion.

Her advice, implicitly challenging the core of mainstream models, unsurprisingly fell on deaf ears. Markets don’t want to know, either. They’re interested only in when the party will be over, to order their taxi so as to be away from the scene at the last euphoric moment. The rest of us can only imagine what kind of financial deluge awaits if this massive experiment in trying to conjure prosperity comes crashing down on all sides.