West’s failure to accept price of financial crisis leading to postponement, denial and maybe worse

12th July 2016

Jan Dehn, Head of Research at Ashmore, suggests that political leaders in developed economies are in denial about the price to be paid for the Developed Market Crisis of 2008/2009, and are using a two-pronged strategy of postponement and scapegoating to avoid confronting it. If left unchecked, Jan suggests we could find ourselves in a similar position as we did in the 1930’s after the great depression.

 A new kind of politics

A politics of denial now governs decision-making in developed economies. They do not say so explicitly, but political leaders in developed economies understand only too well that there is an enormous price to be paid to fix their economies from the excesses that led to the Developed Market Crisis (DMC) of 2008/2009 and its aftermath. Developed countries face significant debt overhangs, unfunded pension deficits and the growing future health liabilities of ageing populations, while their productivity is declining. The reforms to fix all this would extract an almost insurmountable political cost. The politics of denial is designed deliberately to avoid this political cost for as long as possible.

To this end, politicians are employing a two-pronged strategy of postponement and scapegoating. Postponement is most clearly evident in the extreme imbalance between stimulus and reforms in developed economies. Since the DMC was first and foremost a debt crisis, the rational policy response should have emphasised aggressive deleveraging, better regulation and productivity enhancing reforms – with monetary policy only playing a supportive role during tough reforms. In reality, however, monetary policy easing has been elevated to the be-all and end-all, while practically nothing has been done to raise productivity and cut the debt overhang. Regulation has been recruited into the service of financial repression rather than used to improve asset allocation.

Scapegoating is now becoming far more visible and important within the politics of denial. As successive acts of postponement become ever less effective without actually curing any of the underlying economic problems, voters are increasingly experiencing stagnation. They are getting angrier. Their discontent is made worse by the excessive reliance on asset purchases by central banks, which skews income distributions even more. Scapegoating is rising in importance, because it helps to divert the rising voter anger towards less powerful groups, while giving the impression of action and helping to obfuscate the real underlying problems. Left and Right only differ in their choices of preferred scapegoats. The Left likes to victimise the wealthy, business owners and entrepreneurs, while the Right prefer to targets benefit recipients, unions and foreigners.

Gloomy outlook

Unfortunately, the politics of denial may, if allowed to go unchallenged, end up having far more serious consequences than merely victimising the least powerful in society. Unchecked, politics will logically progress through four stages that ultimately end up in a far uglier place that we see today. Specifically, the politics of denial imply a four stage pathway of demise:

Stage 1 – The decline of mainstream politics: The destruction of mainstream politicians is already well underway across the Western world with the resignation of British Prime Minister David Cameron the latest manifestation. Mainstream politicians are being jettisoned in favour of populists for two reasons. First, they have failed to implement effective economic remedies in the aftermath of the crisis. Second, they are not nearly as good at scapegoating as the populists, who are now gaining ground at their expense.

Stage 2 – The rise of populism: Populist rule will be defined by (a) scapegoating becoming a mainstay of politics and (b) the underlying economic problems get even worse due to deterioration in the quality of policy. Scapegoating itself may accelerate the pace of economic decline, say, if immigrants are forcibly repatriated. The economic decline ultimately undermines populist rule as voters lose faith not just in the populists, but also in democracy itself.

Stage 3 – Authoritarianism: The lure of authoritarian governments is their ability to act decisively, holding up the promise of curing the failures of ineffective mainstream and populist governments. Yet, to be effective the authoritarian state must usurp powers from all spheres of private life from the economic through security to the media. Such a draconian centralisation of power requires a strong nationalistic rhetoric and more severe repression. Since the scope for scapegoating within the domestic economy is gradually getting exhausted it follows that scapegoating must increasingly look to targets overseas. Hence, nationalistic authoritarian governments increasingly come into conflict with other countries.

Stage 4 – War: The explicit objective of policy during this phase is to blame the crisis on foreigner interests as the scope for credibly scapegoating at home is exhausted. Policies of economic nationalism, such as competitive devaluations, trade protection, expropriation of foreign companies, etc. become widespread. Countries with global reserve currencies are significantly better placed to conduct this kind of economic warfare due to captured demand for their currencies and bonds among central banks. International tensions rise and will, in extremis, result in conventional war.


Echoes of darker times

The politics of denial clearly has echoes to the politics in the aftermath of the Great Depression in the 1930s. Then, as now, powerful political forces are being fuelled by anger. Nationalism is on the rise in the US, Europe and Japan, and there is a longing for more stable and safer societies. This desire is likely to morph into calls for a stronger and more interventionist state to deal with economic uncertainty, income inequality and perceived threats from abroad. Similar desires led to Roosevelt’s New Deal and the rise of Communism and Fascism across Europe in the 1930s.

Don’t forget the long-term

Ultimately, we expect developed economies to escape their debt and productivity challenges mainly by means of inflation and devaluation. This bodes well for growth in EM countries, because declining QE currencies will channel capital back into EM. While some EM exporters may find it challenging to cope with stronger currencies the majority of EM countries readily reform when required to do so. Others, such as China, are far more proactive, reforming well ahead of time. They will emerge as the big winners of tomorrow.

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