So Greece is going down the pan, Ireland’s wobbling again, and Italy is desperately hoping they’re not next to walk the sovereign debt plank. A cooling economy is not hard to spot, amidst the serious debts, stuttering GDP, and increasingly antsy creditors.
But there’s more than one way for an economy to go wrong, and it’s easier to spot the cooling ones than the overheating ones. If you’re growing fast, everyone’s optimistic, you’re a good news story, and the money is pouring in. But it’s highly likely that some of the world’s booming economies are just as unstable as the declining ones.
There are tell-tale signs. Credit lending running ahead of GDP growth suggests that banks are throwing more money at an economy than can be productively used. That can lead to overvalued assets and a property bubble. Growing current account deficits during boom years are another thing to look out for, meaning a country has been seduced into demanding more services than it can afford. Lower than average unemployment might look like good news, but it might also suggest a labour shortage, which in turn pushes up wages and costs of production.
The Economist recently attempted to combine these various warning signs into an ‘overheating index’, checking emerging economies to see how sustainable their growth levels might be. It concludes that Argentina, Brazil, Hong Kong, India, Indonesia, Turkey and Vietnam are all “flashing red”.
China emerges pretty well in the Economist index, but it too has its fair share of unwelcome trends. The newly built cities standing empty are particularly eye-catching, but China already knows it has to slow down a little. Interest rates have been raised three times this year already, and the new five year plan actually makes slower growth part of the strategy.
After centuries of market speculation, from the South Sea Bubble and tulip fever onwards, you’d think we’d be better at this by now. Recent history says we haven’t learned a thing, but of course it pays well not to think long term. And that’s the fundamental problem – not a lack of information, or a failure to spot trends, but the inherently unstable nature of free market economics. Markets are not impersonal forces, but lots of people making decisions in their own interests without considering the implications for the whole. Michael Lewitt explains:
Human beings tend to extrapolate current conditions indefinitely into the future. Based on the assumption that positive economic conditions will continue, people let their guards down with respect to risk, which leads them to take more of it. As each individual takes more risk, the overall riskiness of the system increases.
We know that bust must follow boom, in what Hyman Minsky unapologetically called ‘ponzi economics’. It always has done and always will, although plenty of money can be made by guessing who can deny this the longest. I’m not going to offer any predictions about who or what falls next. My suggestion is that we should spend less time fretting about stimulating growth and delaying the inevitable downcycle, and more time working out how to create a stable and sustainable economy that doesn’t require the impossible in the first place.