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The folly of cheap money

The Age of Oversupply: Overcoming the Greatest Challenge to the Global Economy, by Daniel Alpert

THE author, Daniel Alpert, is the founder and managing partner of the New York-based investment bank Westwood Capital. He is also a fellow of one of America’s oldest think tanks, the Century Foundation.

The Age of Oversupply offers a troubling insight that should be of concern to all in business.

The global economy has an oversupply of labour, productive capacity and capital. “Oversupply” is a relative term, and is in relation to the demand for labour, products and capital.

Alpert’s explanation of this phenomenon makes it clear that it is here to stay. More worryingly, none of the economic solutions offered by the economic policies of the largest nations can address it.

The causes of this situation originate in the emerging nations.

The Chinese Communist Party leadership issued a communiqué in December 1978, which committed the party to far-reaching economic reforms.

These reforms set China down a road to becoming the fastest-growing economy in the world. The consequence of the reforms was the enormous increase in the global supply of cheap labour. That led to a flood of cheap money.

In underdeveloped countries with inadequate safety nets in the form of social security, people tend to save more of their earnings. By contrast, people in developed countries tend to spend not only what they earn, but more than that.

Four years later, Mikhail Gorbachev, in his capacity as general secretary of the Communist Party of the Soviet Union, initiated a series of far-reaching economic reforms. Ultimately, these reforms brought 400 million people previously living under communist rule in the USSR and Eastern Europe into the global market economy.

By the early 2000s, Russia had become the world’s biggest energy exporter. This earned the country a half a trillion dollars in foreign reserves and created nearly 100 dollar billionaires. This created another pool enormous pool of money looking for investments.

Economic liberalisation in India, a country with the world’s second-largest population, added to the vast pool of labour. India would later become an economic powerhouse, with foreign reserves larger than Germany’s and more than 60 dollar billionaires.

The abundance of workers entering the market is not restricted to the uneducated. In China, the number of students graduating from universities annually rose eightfold in the last 15 years to 6.8 million. India had only 390 000 places at universities in 2000; today there are 1.5 million.

Similar changes have been happening in other developing countries. China, Russia, and India are merely the largest examples of the trend.

With the oversupply of workers comes the “sea of cheap money”. Between 1990 and 2010 the contribution of emerging markets to global GDP almost doubled – from 20% to 38%.

China, for example, holds $3.21trn in dollars and as well as other currencies. Their GDP hit $7.3trn, and they had an estimated $3.8trn in gross savings.

Money never sits around, it looks for a place to be used. When money is plentiful, it is cheap. The governments of Europe and America were spending more than they should by providing ever-expanding public services and lower taxes.

Governments won votes and the public was happy. 

In the developed countries, private savings are almost non-existent. Deregulated lending puts cheap credit within reach of all. Credit cards abound and anyone with a home used their bond as an ATM.

As we saw in 2008, what cannot last, does not last. The consequences of this folly were widespread and painful.

This last recession has been longer than previous ones, and has been more fundamentally disruptive. Economists and policy makers have tried to stimulate the economies of the largest countries by making it easier for businesses to borrow and grow. Their view is based on supply-side economic theory.

Simply put, this entails making it easier for businesses to grow by reducing taxation, removing restrictions, and reducing the cost of doing business. The expected result is that the economy will grow, jobs will be created, and taxation of the many will compensate for the lower tax rates.

This supply-side theory, Alpert argues, is simply wrong. It is unproven and has a number of logical flaws. However, even if it were right, it could only work when markets are functioning properly. They are not. As I have explained, the supply of global labour and capital is just far too great. The demand for goods and services in this age of oversupply is, relatively, far too weak.

And nothing is going to change in the foreseeable future.

Alpert suggested solutions are most relevant to the US and Europe. They may help if governments and policy makers could and would take heed. For the most part, they cannot do either. Politicians need to be re-elected and their constituents do not like pain.

South African business people would do well to focus on the two most compelling arguments Alpert makes: there is a glut of cheap money, and there is an oversupply of labour at all levels.

Factor these into your strategy; they are not going away.

Readability:       Light ----+ Serious
Insights:            High -+--- Low
Practical:          High ----+ Low

 - Fin24

*Ian Mann of Gateways consults internationally on leadership and strategy. Views expressed are his own.

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