A Weak Economy and Disconnect Between People and Finance

WASHINGTON:  There they sat on October 9 interviewing each other, the famous writer who exposed Wall Street’s excesses, and the elegant French woman who leads the international agency set up to is assure financial stability. Big Short author Michael Lewis and International Monetary Fund chief Christine Lagarde agreed  that eight years after the financial crisis progress has been made but more work is required to avert future catastrophe.

Lewis, who worked at Solomon Brothers before an illustrious career in journalism and books, told the audience at IMF headquarters, “the toxic relationship between the financial sector and the public has not been addressed.”  Financial instruments, he said, remain too complex, salaries are still excessive.  The problem began, he continued, when banks became trading entities and downgraded the services they provide to customers.  Likewise, said Lewis, well-intentioned efforts to safeguard the public went astray—regulations became burdensome, complicated and poorly communicated.

The encounter between Lagarde and Lewis culminated six days of discussions by financial policy makers and a separate gathering of several hundred bankers.  The mood was somber.

David Stockton, a former Federal Reserve official who prepares economic forecasts at the Peterson Institute of International Economics, gloomily observed that the U.S. economy is mired at two percent growth in a three percent world economy. He said “we’re a driverless car stuck in the slow lane.” IMF economists also have repeatedly downgraded their forecasts.

What went wrong? Why is the recovery from the great recession of 2008 so slow?

One economist with an answer was Mohamed El-Erian who invented the term “new normal” at the Pimco investment firm in 2009.  El-Erian argued that the magnitude of the financial crisis was so severe that recovery would be slow and of long duration. “The advanced economies,” he said, “had bet the farm on the wrong growth model.”

Carmen Reinhart, now at Harvard’s Kennedy School of Government, argued that because the great recession was triggered by a financial crisis recovery would inevitably be very sluggish. Reinhart said that on average it takes about seven and a half years for the average advanced economy to regain its previous peak of output.  By that standard Reinhart believes the U.S. recovery is on track and further advanced than Japan or Europe.

The really pessimistic group is the bankers. European bankers were particularly gloomy saying it is impossible to make money when interest rates are at zero. There’s too much regulation, they complained, and they don’t like revealing detailed financial data to regulators, fearing it could fall into the hands of rivals.

Andreas Treichl of Erste Bank in Vienna worried about potential disrupters, financial versions of Uber or Airbnb. Uncertainty reigns concerning London’s role as a financial center in the wake of Britain’s vote to leave the European Union. Share prices of European banks languish near historic lows and the continent’s biggest bank, Deutsche, groans beneath the weight of a huge fine from the U.S. Department of Justice.

Banks are on their back foot, laying off thousands of workers as they seek a new business model. The best and brightest university grads no longer flock to New York and London. Finance, as chronicled by Michael Lewis, is no longer the elixir of quick riches.

Larry Summers, the former treasury secretary, observed the somber mood at the Washington meetings. “The specter of secular stagnation and inadequate economic growth,” he said, ”and ascendant populism and global disintegration…led to widespread apprehension.”

El-Erian was even equally pessimistic.  He said central banks have lost their edge in an era of low and negative interest rates and that a low growth economy can’t endure. “The new normal is coming to an end,” he said, “the reason is simple: it has lasted for so long that it is now breeding the causes of its own destruction.”

But to end on a bright note, officials from emerging market economies say they no longer worry about the impact of Federal Reserve moves to normalize interest rates. “The Fed has communicated its intentions very clearly,” said South African ReserveBank chief  Lesetja Kgangyago.  “Our reserves are bigger,” he said, and there is unlikely to be a repeat of the 2013 “temper tantrum” when equity markets temporarily tanked when the Fed indicated that quantitative easing would be scaled back.

 Barry D. Wood has been covering global financial meetings for over three decades.  

Greece..Economy Stabilizing

Thessaloniki: In the short-term more protests are coming. On November 6th, about the time the troika of Greece’s creditors arrives, a 24-hour general strike is planned. There will be more complaints that citizens have endured too much austerity and can’t take more. They’re wrong; much more needs to be done.

Greeks desperately need the structural reforms that will boost competition and bring down the high prices that daily afflict consumers who have seen their wages fall while supermarket prices are mostly steady. Analyst Miranda Xafa in Athens writes of, “an urgent need to improve the business environment by reducing red tape, regulatory obstacles and barriers to competition.” Examples, she says, are government-mandated rules prescribing who can sell what, dictating shop-opening hours, and setting unnecessary standards to limit competition from imports.

Economist Megan Greene, an astute observer of the Greek economy, relates a personal encounter with the over-regulated small business sector. Visiting a new bookstore cafe in downtown Athens, she ordered coffee and was surprised to see the waitress dart across the street to fetch the coffee. The owner explained that she couldn’t obtain a license to sell coffee. Wanting to buy a book, Megan was told she couldn’t because it was after 6 p.m. and books couldn’t be sold after six.

Prime Minister Samaras pledged in a recent speech at Washington’s Peterson Institute for International Economics “to replace red tape with a red carpet for foreign investors.” That’s a tall order as nearly half the members of parliament come from protected, privileged professions.

Greece’s leading economics think tank, IBOE, says the economy “is very near the stabilization point.” While a further 4% fall in gdp is likely this year, that projection is mildly improved from six months ago. There is improvement in public finance as both the trade and budget deficits have narrowed.

The biggest plus is the turnaround in tourism, a main driver of the Greek economy. Reassured by relative social peace this year and bargain hotel prices, tourists have been flocking into the country. 2013 is set to be a record year for both tourist arrivals and revenue. The tourist association says arrivals are up 15% and that 2014 should be even better. Tourism, it says, is likely to account for 35% of anticipated gdp and job growth over the next decade.

                                              Beans on sale at Thessaloniki outdoor market

Here in Thessaloniki, a commercial center rather than tourist destination, hotel prices are down at least 20%, a pattern replicated throughout the country. Unemployment approaches 25% while wage reductions have not been matched by price cuts, severely squeezing household budgets. With the economy in its 6th year of recession, a recent survey shows that many households will cut back on home heating this winter because they can’t afford heating oil. Statistics suggest that household incomes are down 40% from 2006 while house prices are down 35%.

This kind of internal devaluation, say troika economists, is the only way an economy can regain competitiveness when it is locked in a common currency zone. While doomsayers at the depth of the crisis predicted Greece would abandon the euro, such a drastic response was opposed by government and the public. A May 2012 survey showed that while Greeks opposed austerity, 88% wanted to remain with the euro.

An engineer I met on a Thessaloniki bus commented, “there is no question we lived far beyond our means after joining the euro in 2001.” His remark matches the assessment of Harvard economist Carmen Reinhart who observed that household debt in Greece exploded from 6% of gdp in 2001 to 50% in 2009. Low interest rates in a traditionally high inflation economy arrived in Greece with the euro. Not surprisingly, a borrowing binge was the result.

Reinhart also observes that Greece has been so profligate in public finance that it has been in default for half the 180 years since independence. Some time ago, a participant in the Greek financial rescue told me, “they have to become poorer.” Well, that happened. They are poorer. But contrary to expectations the government is taking the reform medicine. Greece has made considerable progress. But more hard work is required. #