Will more drinks cure a hangover?

Seemingly, the world is going to hell in a hand basket (or is the darkness just a dawn precursor?).

National governments are thrashing around, talking a lot (too much?), laying off blame to distant/overseas causes, and regularly attending high-level conferences that churn out communiqués prescribing what we should do (spend more), and what we should not do (indulge in more protectionist policies).

Meanwhile, back at the ranch, the average person (frightened by all the politicians’ doom-saying) is ignoring the communiqués, and is repairing individual balance sheets by saving more. Governments, with an eye on rising unemployment and the next election, are slipping in the odd protectionist measure or ten (e.g., dairy exports in Europe, steel in the USA, cars most everywhere, and - perhaps broadest of all - the “buy local” campaign), and weakening their own balance sheets.

What’s going on? Policymakers face a very difficult policy dilemma.

The good news is that most individuals are probably doing the right thing in terms of their personal accounts. They’ve re-discovered, and are more sensitive about, risk, debt, debt-servicing requirements, and the important concept of living within their means. This is a sensible correction to past indulgences. (If you are partial to “green” sentiments, it’s all about getting back to sustainable economic ways.)

Ominously (given their power), government actions are more questionable. While individuals are attempting to correct their profligate ways, government responses (in part, at least) may reflect ultimately futile attempts to paper over - not correct - past excesses. Worse, if they fail, individuals will have to worry about servicing yet another balance sheet liability - increased public sector debt. This additional debt-servicing burden will come via increased taxation withdrawals from their incomes.

It’s really not quite as simple as this, but it’s getting close. Let me elaborate.

The current global financial and economic correction (a.k.a. crisis) has been spawned by two key effects:

1. there’s too much debt outstanding; and
2. key asset prices (houses, other property, shares) got far too high, so now they’re falling - a lot.

We can debate the underlying causes of these effects.

Was the money supply allowed to grow too fast? Were capital requirements (e.g., for banks) both inadequate and pro-cyclical in operation? Did housing policy in the USA push home ownership too far onto people who couldn’t afford the debt? Did the financial community slide away from worrying enough about risk in a mad rush to generate more profits from leveraging more debt via dodgy “securitised” assets (a new oxymoron?) and other funny bits of paper? Is it all Alan Greenspan’s fault?

The answers to these and other questions, in part, are probably “yes”.