Time to face the economic pain

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By Michael Feller

“Peace in our time” is one of history’s most chilling phrases. Uttered by Neville Chamberlain upon signing the 1938 Munich Agreement with Adolf Hitler, Britain’s prime minister had seemingly avoided war Germany by sacrificing the Sudetenland.

Although a highly popular move at the time (unless you were Czech), the pact lasted less than a year before Germany invaded Poland, and the rest, as they say, is history.

On the face of it, there is little in common between the appeasement of 1938 and 2012. For one thing, the Germans are in many respects the good guys in the current economic crisis.

But recent moves by the European Central Bank (ECB) to purchase unlimited short-term peripheral bonds as part of its so-called Outright Monetary Transactions policy smacks not of a long-range financial solution, but merely of economic appeasement.

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Meanwhile, across the Atlantic, Federal Reserve chairman Ben Bernanke is promising to provide a backstop, come what may, to the US economy in the form of further quantitative easing.

And it seems that the markets like what they see in the world’s two biggest economic regions. That’s despite the absence of action that is really needed, namely the culling of excess capacity, painful as such steps will be.

This kind of conciliation to appease bearish capital markets rather than tackling the longer-term woes is putting pressure on China too, despite the appearance of a reformist government in waiting, more interested in long-term solutions than short-term salves of further state-directed, front-loaded growth.

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And while Australia’s central bank has been notably resilient to calls to drop interest rates further in recent months, spending proposals by the Commonwealth – surplus be damned – suggest that economic appeasement policies have invaded our shores as well.

The problem, however, is not just that economic appeasement feeds into an insidious cycle of the market wagging the dog – where bad news becomes good news because it simply means more stimulus – but that the real war for long-term reform is being lost as central bankers play to hearts and minds instead.

And although the ECB is tying its latest efforts to formal sovereign requests for aid (and thus austerity and reform), there is more than a small amount of incentive perversion in all of this. Hence the vehement opposition from Bundesbank chief Jens Weidmann.

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For as much as the received Keynesian wisdom of economics dictates that policy should be counter-cyclical, not pro-cyclical (that is, dishing out rewards when things go wrong, rather than when things go well), these policies can merely encourage recalcitrant behaviour.

Furthermore, for as much as counter-cyclical measures prevented the US from entering a depression in 2008-09, they haven’t proven effective either. And as Americans are still discovering, a policy of all carrot and no stick has failed to fix Wall Street let alone bolster financial risk management.

Moves to lower borrowing costs in peripheral Europe is welcome in the sense that it lessens the chance for a catastrophic breakup of the eurozone and puts a break in the worrying re-emergence of far-right politics (the Nazi party, after all, grew as a consequence of Weimar-era austerity, not hyperinflation).

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Yet perhaps now the pendulum has swung too far and unless politicians and their servants can stay the course and push through the difficult choices, the present opportunity in crisis will have been all but lost.

Neville Chamberlain’s successor, Winston Churchill, learned this the hard way. But unlike Britain in the War, there is no modern equivalent of a Churchill in macroeconomics, leaving out the fringe theorists of Austrian economics or their acolytes like perennial presidential candidate Ron Paul.

Instead we have Lilliputian arguments over who pays for what and who is to blame. Across the entire world, policy is being steered by short-term bargains, not long-term agendas. And while it has always been thus, rarely have the stakes been higher.

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Increasing money and credit supply is not the solution when a lack of demand is the issue. And where recent growth has otherwise come from debt and front-loaded consumption, other factors only can square the ledger. These include productivity, innovation and, unfortunately, balance-sheet consolidation.

With the world facing other, great challenges – ranging from climate change to war and, resource scarcity – the incessant focus on growth at all costs even if artificially induced has wasted time, effort and ultimately money. The focus on economic appeasement has not only perverted rational price discovery, it has distorted rational policy.

We all know how ugly recessions can be, and how tempting it can be to kick the can or sweep something under the carpet. Yet ultimately, a reckoning must come and it may as well be faced sooner than later.

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After all, as the man who replaced Chamberlain once put it: “an appeaser is one who feeds a crocodile, hoping it will eat him last”.