By Lich, Herbert
Journal of Banking and Financial Services , Vol. 116, No. 6
It has been a roller-coaster journey: early in the year a general upturn in economic activity, now gloom and doubts about any ongoing recovery.
Since the traumatic terrorist events of last September US growth and domestic output and, by implication, global output has declined to its slowest pace in recent history [March 2002 quarter 1.2 per cent GDP growth in the US, June quarter 0.3 per cent growth], while the share market has had its worst decline since the 1987 crash.
The Nikkei fell in October to its lowest close since 1983, and forecast bank failures in Japan, long overdue and actually `encouraged' by Tokyo's new financial regulators, are bound to affect business confidence even further. Elsewhere, both in Europe as well as Asia, subdued growth prevails with no immediate end in sight.
Equipment and software spending for instance continues to slump and consumers have collectively tightened their purses, despite some substantial interest cuts.
It all sounds rather ominous. Yet Australia to date has seen an unprecedented period of bullish economic performance and business confidence remains high with actual business spending in the September quarter reaching its highest level in a number of years. With more recent economic indicators however giving out mixed signals, it is worth reflecting on the likely causes of the economic stability and to speculate on future trends.
I see three main causes. Firstly, balance of payment constraints, which previously inhibited growth, have lost their importance. In the past, too many imports aggravated any existing balance of payments deficits.
Because of deregulation of world markets, international capital now flows more easily to areas where good returns are expected. The freeing up of such capital flows in turn has helped to offset any balance of payment concerns and assisted in the financing of imports.
Secondly, imports in turn are always helpful in easing [any] emerging inflationary pressures, by easing domestic labour resource shortages and lowering prices. This, together with the favourable impact of reduced transaction costs due to technological innovation, eases inflation pressures and encourages growth.
Thirdly, the previous belief that unemployment rates much below 7 per cent would inevitably lead to inflation has been shown to be wrong. This in turn has encouraged growth in GDP and thus aggregate income and expenditure.
These observations should however not be understood as underestimating the role monetary policies can play. But faster growth through excess credit always and ultimately leads to investment in wasteful assets, as was the case in the 1980s. The consequence--declining asset values that inevitably follow a boom--flow through to depressed consumer demand and, of course, bank failures.
On the other hand, interest rates that are set too high can restrict productive investments and instead redirect funds to speculative ventures of little ultimate productive value.
Neither should my comments be seen as necessarily endorsing the uninhibited flow of global capital. Nations that indiscriminately open themselves to such flows face the danger of such investments leaving their shores at the first sign of an economic downturn, as we have seen in Indonesia and elsewhere in Asia.
Such a threat should serve to encourage countries to open their markets to international competition, to increase the transparency of their economies, and to generally build well regulated and broadly based financial systems.
The new economy
There is little doubt the so-called new economy is still driving the global economy, despite the widely reported downturn of the sector. In fact the combination of the new economy with deregulated markets (and in particular labor markets) has fostered sustained growth to date.
The problem is that much of the capital flowed into speculative assets of doubtful value. …