WORLD VIEW:Summit in Canada is unlikely to indulge in any existential diagnosis of our economic woes
THE G20 summit meets in Canada after a week that proved anything is possible. Reigning world champions Italy matched France’s ignominious World Cup exit. Brian (he who is never to blame) Cowen admitted that we could kiss goodbye to the €22 billion of our money he had sunk into Anglo Irish Bank.
The G20 leaders, who represent two-thirds of our planet’s population and more than 80 per cent of its trade, will probably avoid any existential diagnosis of our economic woes, opting instead to discuss a range of ad hoc responses. If our economic model is being consumed by its own contradictions, then ad hoc responses are unlikely to offer a solution.
Economic models, such as feudal landowning or the Soviet system, have disappeared before. Our current models are undoubtedly ill, whether that illness is terminal remains to be seen.
Financial services lost all connection with reality over the last decade. Anglo and others borrowed billions to fund property developers to erect buildings for which there was no market, never mind need. It became a contagious insanity infecting other banks, the local authorities in the 11 counties around Dublin who created almost 11,000 hectares of undeveloped zoned land, the government who ignored all the warning signs, and finally a significant swathe of the population.
As our banks and building societies elbowed each other out of the way in a stampede to lend almost anything to almost anybody, they borrowed billions from almost equally short-sighted banks in more rigorous countries. French and German banks are now petrified by the €776 billion of Portuguese, Irish, Greek, and Spanish (the so-called Pigs countries) debt they hold – €635 billion of which is commercial debt.
Those banks are now caught between a rock and a hard place. They want the Pigs countries to rein in their borrowing while at the same time investing enough to guarantee sufficient growth to allow them to repay their outstanding debts. If everybody keeps their nerves and everything goes perfectly smoothly there is a chance that over a few years that might just happen – but the odds are hardly encouraging.
Berlin has now joined the denial club, arguing German virtue against Greek profligacy, while ignoring EU and global market realities. German savers have traditionally preferred pension funds and life insurance schemes to bricks and mortar. This leaves German financial services awash with money on which they can only earn commercial returns outside Germany. Foreign borrowers then buy German industrial exports with German funds. In times of growth a mutually beneficial virtuous circle is created. Break the circle and you not only damage the debtors’ ability to make repayments but also their capacity to buy German products. Berlin now risks creating a whirlpool capable of sucking everybody down.
We are still suffering from the banking crisis, we now have an economic crisis and perhaps most menacingly of all an investors’ crisis. Our two largest sources of investment are institutional – sovereign wealth funds and pension funds.
Sovereign wealth funds, where nation states accumulate their surplus income, have mainly been developed by oil-exporting countries. It is estimated that they now collectively amount to around €5,000 billion. They are dwarfed by the combined weight of pension, mutual and insurance funds which collectively dispose of close to €40,000 billion including some €70 billion of Irish funds. These are the funds constituted by the monthly pension and life insurance payments from ordinary citizens across the developed world.
The basic investment rule that higher risk investments pay higher premiums means fund managers traditionally spread their investments over three areas: government bonds, blue-chip businesses, and some slightly riskier investments, to generate average returns of 12-15 per cent.
Government bonds were the most secure and so paid the smallest return, blue-chip companies being slightly riskier paid slightly more, but an essential part of a fund’s earnings came from carefully considered risk-taking spread over a number of sectors.
Fund managers now face some fairly horrific questions. Which government bonds are really safe? What qualifies as a blue-chip company today? General Motors? BP?
Their task is further complicated by the fact that expanding economies such as China largely finance their investments from domestic surpluses rather than global markets. Investment in China’s growing high-speed rail network might be attractive, but remains effectively impossible.
As fund managers chase better returns by switching their investments, they also add to the very market instability they seek to avoid – a classic “collective action problem”. Myriad individual decisions that are in themselves rational, at least in the short term, create a collectively irrational and potentially self-destructive whole.
If our savings and pensions systems, our largest source of investment funds, are actually undermining our economic models, do we need to think about changing one or both? Such profound questions naturally create enormous anxieties and uncertainties. Which is one reason they won’t be overtly addressed in Canada this weekend.