21.3.2017 Tommi Kemppainen

Beggar Thy Neighbour – the whole picture of over-indebtedness and protectionist trade policy

Talk the talk – walk the walk
What's behind the current stock prices, and why does this really matter?

What is a balance sheet recession? It is a situation where the high indebtedness of consumers and companies makes them focus on paying off their debts instead of consuming and investing. The term balance sheet recession was launched by economist Richard Koo (born in 1954). It has much in common with a similar situation, described by economist Irving Fisher (1867–1947), during the Great Depression in the 1930s. The balance sheet recessions of our time are the Lost Decade in Japan (1991-2000) and the U.S. subprime mortgage crisis (2007-2009).

If there is no consumption and investments, money doesn’t circulate in society. In the end, there are three ways to tackle the balance sheet recession: 1) austerity measures to reduce public debt, 2) debt cancellation where repayment is no longer realistic, and 3) quantitative easing (QE), which means increasing the amount of money to compensate the decreased consumption and investment spending. When examining central banks’ functions (monetary policy) over the past ten years, it seems that central banks operate by compensating this decreased consumption and investment spending by consumers and companies. The investor Ray Dalio has described this observation in his work “How the Economic Machine works”.

On the other hand, the fiscal policy of governments does not appear as clear as the central banks’ monetary policy. The situation is similar in all industrialised countries, so we can take an example from near – Finland. If asked, a Finn would probably answer that our country is currently running heavy austerity measures. The reality, however, is that as a country we spend with the help of old debt and we take on more debt each year, even at the moment. So the amount of debt is constantly rising, and instead of saving the country is doing just the opposite. Without taking any political stance on fiscal policy, we can certainly say that political debate would be much more fruitful if the current state of affairs was better known to all. We should be able to view the current situation without having to take any political stance.

As regards fiscal-political decision making, there seems to be another illusion about the current state of affairs. The fact is that the Finnish government – like the governments of other industrial countries – will become more indebted regardless of the direction of political steering. This conclusion based on a simple equation was presented already in 2009 by expert Jagadeesh Gokhale. As a nation, we already have approximately 800 billion euros of hidden debt (page 8). This hidden debt arises from the fact that our population structure is changing due to aging. Over the next decades, a lot of people will move from the giving end to the receiving end. Our country will hardly cut social security spending by 800 billion euros or raise taxes to 100 percent. Therefore, in the future, we can expect more government borrowing to compensate the low private consumption and business investment. In addition, we need quantitative easing (QE) and debt cancellation as well as austerity measures.

I dare claim that the usefulness of political debate would improve if we dared to look the truth in the eye and admitted that as a nation we will become indebted even in the future. Along with getting into debt over the next decades, we will have to implement heavy austerity measures and accept some debtors’ insolvency, in other words, to forgive debts.

In his book “Hall of Mirrors” that was published in 2015, the economic historian and economist Barry Eichengreen (1952) thanks the central banks and monetary policy for the fact that with lowered interest rates and quantitative easing, unemployment in the US was dropped from 10 percent in 2009 to 7.5 percent in 2013. According to Eichengreen, by these means, a severe depression was avoided. In addition, he states that economic policy as a whole (both fiscal policy and monetary policy) managed to resist the temptation to change commercial policy so that it would have favored own production at the expense of imports, for example by tariffs and restrictions on trade.

In the long term, the global economy is ultimately about focusing on comparative advantage, which maximises global wealth (economist David Ricardo 1722-1823).

TALLINN WINTER OLYMPIK 2017 EXHIBITION. A trio’s comparative advantage in value-creating collaboration: by #HCPSPIRIT &artist Bruno Maximus @ Kuku klubi, Vabaduse väljäk 8, Tallinn, Estonia

It was already the economist Adam Smith (1723-1790) who described the losses caused by such restrictions on trade. A trade policy that pushes trade restrictions is called “beggar-thy-neighbour“. According to Barry Eichengreen, such a policy was what ultimately led to the collapse of international trade in the 1930s.

Aggressive protectionist trade policy is difficult to assess because it can bring a country more work and money in the short term. How the short-term popularity and short-sighted policy bend back to form a long-term, self-reinforcing spiral (reflexive process), is a great challenge.

In commercial policy worldwide, one can see a growth of aggression, and the world’s over-indebtedness has not been resolved. Therefore, in the HCP Black fund’s investments, I will continue to concentrate on active diversification.

Talk the talk – walk the walk
What's behind the current stock prices, and why does this really matter?
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