Wednesday, 8 December 2010

Deja Vu...

Hello there. This is my first post and I suppose I should introduce myself. Well, I won't do it right now, I'll just say that I am from Athens, Greece which has been in the spotlight this year, unfortunately for all the wrong reasons.

What is increasingly on my mind lately is how much the way things are going makes me think of the years after the Great Depression. Let me explain my line of thought.

We hear (or actually read) a lot about how one Emerging Market country after the other is imposing some form of capital controls to reduce hot flows into the country in an effort to minimize their undesired side - effects. The ones that instantly come to mind are appreciation of the local currencies and the fueling of asset bubbles.

Another likeness to the Great Depression (from now on the GD) this time comes from the run-up to the current crisis. During these years we saw a series of de-regulation in the banking sector, with the most striking example the repealing of the Glass - Steagall Act that was in place since 1933 and distinguished between investment banks and commercial banks in the USA.

Notice that the Glass - Steagall was enacted right after the Great Depression as a response to the banking sector meltdown. The modern day answer to the Glass - Steagall Act is the Dodd–Frank Wall Street Reform and Consumer Protection Act and the Volcker Rule as well as the eventual toughening of the Basel set of rules, but we have to wait and see when the impementation of the latter will actually commence.

The years that followed the GD, trade was not free at all, something that to a large extent can be attributed to the Smoot - Hawley Act and to the retaliatory measures taken by the USA trading partners. Of course goverments didn't just clamp down on free trade they also restricted capital flows. Enter capital controls...

Coming back to modern time, USA rhetoric accusing China for currency manipulation surely brings tarrifs and quotas to mind. Things in Europe could easily head down that road too. Pretty much everybody is trying to export their way out of recession which is simply not possible since someone has to actually be a net importer. Each country is trying to defend their interests but I cannot recall any such confrontation that ended with everybody involved being satisfied by the outcome.

Political leaders are trying to appear before the eyes of their voters as if they are fighting to promote their best interests. In the case of emerging markets the perception of that appears to involve a curtailment of short term hot flows and in the  case the "western world" a curtailment of cheap imports from emerging markets that appear to drive local producers out of business.

But popular perceptions are not always right and may actually prove to be damaging. Emerging markets already started imposing capital controls giving western leaders an alibi to answer. The fragility of the global recovery makes politicians be cautious of the measures they take, which can prove to be actually a good thing.

My view is that all involved will be harmed by a trade war. Emerging markets will see their exports, hence their growth rates, dwindle and western countries could see their inflation rates surge, since local producers will have more pricing power and will face reduced low - price competition. Will developed countries' unemployment rates go down ? It is far from certain and I think that in the short term employment gains will be limited. Of course, if a trade war breaks out it will force EMs to rebalance their economies, which will cause some pain in the short term but will prove beneficiary for them in the long run.

Will the 21st century be a 20th century re-run with just separate countries and regions roles reversed? Let's stick around to find out...

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