In early 2007, when the world was awash in liquidity and asset prices were soaring worldwide, economist Jim Walker warned of a "coming Apocalypse". In the two years since, the global economic plot has unravelled pretty much as Walker prophesied. And even today, Walker's outlook on the global economy -- and his assessment of the policy responses worldwide -- is grim. In this second and concluding part of an interview to DNA in Hong Kong (the first part appeared in Thursday, March 12 edition), the founder of Asianomics warns of prolonged economic agony. Excerpts:
Are we now anywhere near the end of the unravelling of the apocalyptic scenario you outlined two years ago? The 'end of the beginning' would be a better characterisation than 'end'. We now know that there is a crisis, and we're also aware of the nature of it. The question is what governments will do about it. There's a danger that we'll elongate the potential recovery. We've seen that in Japan over the past 20 years; various policy mistakes have led to the Japanese economy being basically in recession for nearly two decades. Although there was a recovery, the Japanese people don't sense it.
Western governments are making a lot of the same mistakes: they seem unwilling to recognise what the problem is. The real problem is that there was a tidal wave of credit and money that came into the real economy via the financial system, which distorted the industrial sector -- not just in the US and Europe but in China, in particular. When the realisation comes that that was an unsustainable structure, it has to correct itself; there has to be a consolidation; there has to be a move away from some of the old spending patterns towards new savings patterns. And, thereafter, the economy can start getting up and running again. But unfortunately, a lot of the governments' efforts are in maintaining that old industrial structure that cannot be sustained.
So, we're potentially going down a route where, instead of a one- or two-year recession -- even if it's a deeper, nastier and painful recession -- we could end up with something like 5 to 10 years of very insipid growth in the global economy.
The subprime mortgage contagion seeped through the entire financial system. Are there any more shocks we've not yet uncovered? It actually spread quite rapidly from subprime to every aspect of the financial system. However, it has taken slightly longer on a geographical basis to be clear where it's going; if you remember, even a year ago, the flavour of the day was 'decoupling' (the theory that Asian economies would be insulated from a slowdown in major developed economies); that was never likely but people didn't recognise it. After the US and western Europe, export-led countries in Asia, including Japan, were in trouble. Now eastern Europe is in deep trouble. But people are still very sanguine about China. And that's probably going to be the next phase, where people realise that China has problems as well.
And along with China, commodity-exporting countries will be very adversely affected. So, most of the problems are relatively clear; now there are still elements of hope that are going to be dashed.
Is there anything else that could come out from unexpected places? Insurance companies are probably the next big problem area in the financial system, because they have so much of the unwanted paper and their capital base is shaky. Local municipal governments in the US will start defaulting on bonds because their revenue streams are based on property. We've not even begun to see credit card defaults in a dramatic way, but with rising unemployment that could come up. Commercial property is another area. These are probably 'known problems' that are going to become more intense.
What are the unknown 'unknowns'? At the moment, I think we've uncovered most of the rot. The biggest one out there is that people just haven't quite understood the effect of the credit tsunami on places like China, and what it has done to the Chinese industrial structure, the malinvestment there.
Can the crisis in eastern Europe blow up? Things are pretty bad in eastern Europe. Actually, it was quite easy to spot how bad it was there. The IMF was putting together a table a couple of years ago in the light of the 1997 Asian crisis. It looked at things like current account deficit, credit growth, credit growth relative to GDP growth, and the local banking system's liabilities with foreign banks, particularly the big western banks.
All of these indicators are kind of standard matrix for flagging potential problems. Eastern Europe at the beginning of this crisis looked much more imbalanced than Asia did in 1997. All the 'flags' signalled there was a major problem. A lot of currencies in eastern Europe have fallen sharply -- not just against the dollar but against the euro, which was their base currency. There hasn't been sufficient appreciation of the crisis in eastern Europe -- probably because there were crises everywhere. But there's going to be a much more severe disruption -- possibly even social and political instability -- over the summer in eastern Europe.It's winter now, and spring and summer are when you see political and social activity. It's going to be a long, hot summer for many governments in eastern Europe.
Are you inspired by the policy response of the Obama administration and other western governments? I'm not inspired at all; in fact, I'm quite distraught. For example, the central banks moving very swiftly towards a zero interest rate policy...