The Reckoning

Decoupling From Reality

Gigling while Rome burns …

Photo by Joe Raedle/Getty Images

I know these things, and you may know them, too. But it is still somewhat jarring to hear them pronounced as a “given” at an international investors conference today in Moscow.*

As recently as 1999, the Group of Seven economies (the United States, Japan, Germany, France, Italy, the U.K., and Canada, roughly in that order) constituted more than two-thirds of global economic activity. Today, the share of global GDP held by the old G7 is below 50 percent and steadily falling, with little prospect of a reversal.

This is a startling turnabout, and one that is well-documented. Yet leaders of the G7—from President Obama to German Chancellor Merkel to British Prime Minister Cameron—have failed to absorb the implications. And so have their political opponents.

Rather than face up to this historic challenge and implement radical structural reforms of pensions, taxation, and employment laws (and in the eurozone’s case, of banking and fiscal rules), our politicians sink deeper and deeper into the irrelevant “tax vs. spend” dogma of the 1980s.

The French Socialists, who just swept to power, are tacking disastrously left as if money grew on the storied grape vines of the Rhone. The U.K.’s Tories, along with their Republican cousins in America, are charting their own course to economic demise in precisely the opposite direction. Japan is moribund; Germany is trapped between the rightful anger of its taxpayers at being asked to fork up yet more for “Europe” and the reality that doing so is probably the only way to salvage their hard-won leadership of the EU’s economy.

Yet anyone, right or left, who is still using the rhetoric of the 1980s as some kind of economic touchstone is completely out of touch with modern economic reality. We need to cut and tax—the numbers don’t lie. But our leaders decidedly do, even if they’re also lying to themselves.

Compared to today’s globalized economy, the 1980s was a small, cozy cottage industry in which the main concern of the G7 economies was preventing fellow G7 club members—the Germans and Japanese in particular—from taking too large a slice of the export pie.

Oh, to have such problems today!

Paul Collier, the Oxford economist and chronicler of civilization’s relationship with globalism, chided an audience of investors in Moscow about their overinvestment in the economies of the West. 

The “home bias,” as he called it, may prove impossible to unravel, dooming the great banks of the United States, Europe, and Japan to returns that barely meet expenses for a decade or more as G7 economies struggle to manage 1 percent annual GDP growth. His observations could be summed up neatly in this triptych:

·      The West is overinvested, and don’t we all regret our holdings now?

·      The BRICS are oversubscribed (the smart money having got in early, and their rise in their power already “priced in” and thus very expensive to join now).

·      And the future? In investment terms, at least, the future belongs to “underpriced” fast-growing economies in what the financial world designates “frontier markets,” from Africa to Southeast Asia to Central America.

Eleven countries in sub-Saharan Africa have grown at 7 percent or more for a decade now, and the rich world’s self-inflicted wounds have not slowed them much. They start from a “low base,” of course—but so did China. And Brazil. And India, and many, many others.

Of course, these countries have their problems, and some will squander their chance to move from low- to middle- to upper-income nations. Investing in them takes long-term determination and a stomach for risk.

That’s precisely what investors in the new United States—Dutch, French, and British, primarily—felt 200 years ago, as we emerged from our own post-colonial haze. We, too, were an emerging nation once—a slave-holding, unformed, and barely regulated Wild West. But wise investors got in early, and they now see similar opportunity elsewhere.

How did this shift in global capital flows happen so quickly? Well, history has a habit of sneaking up on you, especially if you’re busy watching the Jersey Shore on a 68-inch flat screen in your five-room air-conditioned McMansion bought with 5 percent down. But let’s trace the path anyway.

The G7’s fall from the towering heights started slowly with the oil shocks of the 1970s, picking up speed—but only a bit—after the fall of the Berlin Wall in 1989.

During the decade that followed the end of the Cold War and China’s conversion to capitalism, 3 billion new workers joined the 1.5 billion in what used to be called the “capitalist world.”

This new labor competition chipped away at manufacturing at the low end first. Remember, for a decade at least after the end of communist central planning and its state socialist (aka India) offshoots, the emerging economies had their hands full learning the ropes of global trade and supply chains, efficient management techniques, and, not incidentally, how to manage all that while providing more and more political space for their populations.

As the 20th century came to a close, the G7 had seemingly held its own, even though Japan stumbled into a prolonged slump from which it has yet to emerge.

But in retrospect, the millennium truly does represent the dawning of a new era. Deregulation went from an argument to an article of faith in our economies. The debt-fueled, asset-bubble-inflated growth that central banks reported each year during the first decade of this century seemed to keep the West ahead of the rest.

In truth, it concealed a profound shift in global economic power, and that shift has failed to register in the economic debate that supposedly dominates this American election.

The fact is, the United States will once again survive this crisis in better shape than most. As Fareed Zakaria pointed out during the same investor conference, the United States is the only developed economy that consistently innovates and is also demographically dynamic—i.e., we still add 3 million people a year to our population, while Germany, Japan, and the rest of the G7 club of atrophying nations are in demographic decline. (Immigration, by the way, is a major component of this blessing, but it, too, is an issue stuck in the ‘80s).

Nonetheless, the oblivious flavor of our economic “debate” should make even the world’s biggest economy worry.

For now, the world needs our Treasury bills as a safe place to store their profits. But even if many of those McMansions are now sitting empty and unsold, there will come a day when the rest of the world decides not to lend us the money to build them. Believe me, they cannot wait. “But T-bills are different,” I hear some of you say. Right.

We should be talking about that inevitable day a bit more in this election year.

*This observation was made by Stephen Jennings, CEO of Renaissance Capital, my boss, at the opening of the bank’s annual Moscow investor conference. As my regular readers know, I rarely mix business and blogging, and I’m frank about my feelings about the recent missteps of the financial sector. But in this case, the two worlds collided. So full disclosure is satisfied to my mind, but there’s a freebie for my comment-board criticsfire when ready! I only ask that you deal with the substance of the post, too, as you fashion the club used to bash the messenger.