How might markets and economies unfold from here? Probably one of the better persons to ask this question is Robert Barbera, a noted Wall Street economist who has been following economic trends for over 25 years. He is also a professor at Johns Hopkins University and author of a recent book, “The Cost of Capitalism: Understanding Market Mayhem and Stabilizing Our Economic Future” (McGraw-Hill Publishers, February, 2009).
I will be reviewing that book shortly but first, Mr. Barbera’s (paraphrased) answers to some questions I recently asked him.
Q) In your book, you say the big monetary ease in 2001-2003 played a role in the formation of the housing bubble. Will the big easing in monetary policy in 2009 lead to another bubble?
A) First, we have to get through a difficult period and produce a recovery in the economy. After that happens, the Federal Reserve will need to rein in liquidity to keep inflation from becoming a problem. Then the risk remains of creating another bubble like the ones seen over the past ten years. This time, though, I don’t see it happening because I believe central bankers have learned from the financial crisis that they need to conduct monetary policy with an eye on more than just wage and price changes. They’ll also be looking at leaning against excessive risk taking and rising asset prices before they get too far out of line.
Q) In your book, you say the Savings and Loan crisis of the late 1980s and the recession of 1990-91 coincided with the beginning of Japan’s descent. Is China’s investment boom and “heady rates of growth” similarly at risk now that they can’t rely as much on exporting to U.S. and other developed countries?
A) China is definitely feeling the pinch. I was in Hong Kong recently and people there were remarking on how the air was so clean these days. It appears that the factories nearby in China had curtailed production substantially. But the drop-off in exports has led to the Chinese authorities launching a huge fiscal stimulus to build infrastructure and keep the economy running. They appear to be in the midst of replacing export-led growth with consumer-driven growth.
Q) If China is replacing export-led growth with domestic-sourced growth, could this mean U.S. interest rates might ratchet upwards since China won’t have as great a need to peg its currency and thus won’t be buying U.S. dollars as much as before and parking them in U.S. treasuries?
A) I see domestic stimulus by China and other emerging countries as a good thing. For thirty years, the U.S bailed out the world economy by easing its fiscal and monetary policies in response to downturns, which stimulated exports from Asia and elsewhere. We can’t do this again because it will worsen already tenuous structural imbalances. Asia and other emerging countries have to engineer their own growth. China’s fiscal stimulus will help the global economy recover in a way that should reduce structural imbalances such as chronic trade deficits and surpluses. China may buy fewer U.S. treasuries but other buyers will emerge – just the mix of owners will change.