When ‘growth’ is not good

For a narrative to work, it should have a dramatic resolution. If that is not possible, an emotional resolution is a must. I thought of this thumb rule of storytelling when I read the news today about Bernard L. Madoff’s admission in a US court that he had run a vast Ponzi scheme (US$65 billion)—a representative story of Wall Street’s ‘breathless search for profits’. His ordering to jail may provide emotional resolution to the thousands who lost their money in the Wall Street meltdown but this is definitely not a satisfying denouement.

And I’m not alone in holding this view. “…There can be no restoration of confidence in the banking system—and therefore no hope for an economic recovery—until Wall Street comes clean,” says William D. Cohan, the author of “House of Cards: A Tale of Hubris and Wretched Excess on Wall Street” in his 11 March op-ed piece “A Tsunami of Excuses” in the New York Times. “If the executives responsible for what happened won’t step forward on their own, perhaps a subpoena-wielding panel along the lines of the 9/11 commission can be created to administer a little truth serum.”

I doubt if that’ll ever happen but the seriousness and the sincerity of Cohan’s demand cannot be questioned. The current global financial crisis, issuing from the greed of the ‘prodigals and projectors’ of the Wall Street, has attacked and weakened the very foundations of the capitalistic system—the system that underpins the globalised nature of trade and life in the world today. While for dramatic reasons the spotlight might remain on the Madoff saga for a while, the actual debate has moved on, to focus on the nature and future of capitalism itself.

The future of capitalism

“Capitalism—our ability to buy and sell, move money around as we wish, and to turn a profit by doing so—is in deep trouble,” says Professor Paul Kennedy in an article in the Financial Times.

Nobel Laureate Amartya Sen even argues for making changes in the capitalistic system. “The question that arises most forcefully now is not so much about the end of capitalism as about the nature of capitalism and the need for change....the crisis, no matter how unbeatable it looks today, will eventually pass, but questions about future economic systems will remain,” argues Sen in his piece in the Financial Times.

Surely, this is not the end of capitalism but the questions about the economic system are aplenty.

Peak Credit?

One of the most important questions is about credit and its scant availability (in the current scenario of credit crunch) for companies.

“Credit is the oil of the economic engine, and credit ultimately is a creation of confidence” writes management guru Ram Charan in his recent book, Leadership in the Era of Economic Uncertainty (MacGraw Hill, 2009). “Until all players are confident about the intentions and strengths of the others, there can only be stagnation.”

Charan’s advice to CEOs and business leaders, in this environment, is to conserve cash. “Your focus must shift from the income statement to the balance sheet,” he says. Protecting cash flow is the most important challenge almost all companies face today whether they realise it or not.”

Clearly, the importance of cash flow and credit availability cannot be overemphasised. In the unending cycle of inputs and outputs, driven by profit motive, credit plays the god—both for the producer and the consumer. But peer inside this god and you will say, well, the devil is in the detail. Here are some figures to help you gauge the monstrosity of the credit problem.

For some years, credit growth has been surpassing the growth of economic activity. In 1980, for example, debt levels for US banks were running at 21 per cent of gross domestic product (GDP). By 2007, the figure had grown to 116 per cent of GDP.

Isn’t this jump monstrous? If you thought so, what would you call this one? For the US to create its first trillion dollars took its entire history of two hundred years. To create the next trillion took the last 6 months. We are creating a trillion dollars every 6 minutes!

What kind of growth is this? Does it have any relation to the reality on earth? No wonder then that now even ordinary readers are ranting against the global monetary system. “Banks and Central Banks create money out of thin air,” complaints a reader in a blog. “When you get a loan they give you money by a tract of a pen, just like printing new notes. This is just ‘not fair’ even if the government makes it legal. Moreover, it creates profound imbalances into (sic!) the economy, by permitting people that did not produce anything before to buy goods and service. Invest without produce and save. Investments without real savings… The very basic economic law is that you produce then you save and then you consume. The way around is physically impossible. You cannot consume what you have not produced.”

Repeat of past mistakes

And what’s been the government response to the credit crisis the world over? Cut interest rates, print money, slash taxes, get credit flowing. This might work in the short term but this is not a long term response: a recipe for a W-shaped cycle of bust and boom.

“Expansionary monetary policies are the wrong medicine to solve current problems,” said Dr Doom, Dr Marc Faber, at a dialogue in Singapore in February. “They can address the symptoms of excessive credit growth, but not the cause.”

Moreover, as the US government is pumping trillions of dollars in the rescuing the banks, does anyone know who will purchase the $1,750 billion of US Treasuries to be offered to the market this year? And in 2010, then 2011? China is already saying that it is ‘worried’ about the safety of U.S. Treasuries.

During the crisis, governments have to choose between a rock and a hard place, said Nobel Laureate Joseph Stiglitz, in an interview in the Financial Times. But a long term solution has to be found, he emphasised.

Is there a long-term solution then? Yes, there is.

Go for smart growth

“For the first time since World War II, global growth is forecast to turn negative—and that's an optimistic forecast, relative to the possibility of a global lost decade,” says Umair Haque, director of Havas Media Lab, an innovation advisory company. “Today's leaders are plugging dikes, bailing out industries and banks as they fail. Yet, what negative global growth suggests is that the problem is of a different order: that we have reached the boundaries of a kind of growth.” Umair’s manifesto for smart growth is worth reading.

Obviously, with the changing circumstances, and in the face of the gawking absurdities of our growth model, we ought to respond to the crisis with a paradigmatic shift. Call it smart growth (Haque) or humane capitalism (Sen) or less selfish capitalism (Richard Layard), its time has come. The sooner we set about figuring it out and implementing it the better, for we are running against time.

(First published in MIA Asia blog)