Jeremy Beckwith; Slowdown is no more than we should have expected

The world’s leaders came together and acted in a co-ordinated manner to deliver the largest economic policy stimulus in history using just about every tool they had: infrastructure spending funded by borrowing; tax cuts; dramatic reductions in interest rates and abundant liquidity in the money markets.

At first it seemed to work; the world came out of recession in the second half of 2009 and continued to grow into early part of 2011. However, performance in both equity and government bond markets since the third quarter is clearly indicating that investors now feel the world is slipping back into recession.

There have been several policy mistakes which have contributed to this. Leaders in Europe failed, or – more accurately – refused to understand that when Greece first fell into debt difficulties that the country was insolvent rather than illiquid. Thus all efforts which involve expecting them to be able to repay their debts are a waste of time and ensure that the ultimate losses will be even larger.

China’s stimulus programme in 2009 and 2010 was entirely devoted to investment and infrastructure spending, rather than to boosting domestic consumer spending. In addition, China refused to let the markets push the renminbi higher against the dollar, meaning that it was able to maintain its enormous trade surplus.

In the US, the Republican party has been determined to make president Barack Obama look as weak as possible ahead of next year’s elections. To that end, the Republicans were prepared to threaten and risk a shutdown of the US public sector and possible default on its debt by not passing an extension of the debt ceiling. The damage to America’s image among its international creditors and its apparent willingness to play politics with the US Treasury market, the cornerstone of the global financial system, was very real.

Policymakers have not understood the true extent of the damage done to the balance sheets of the western banks in the past three years, and that this, combined with much tougher capital requirements, compared with the very lax standards of the previous decade, means that banks are simply unable and unwilling to lend money to small and medium-sized businesses. Believing banks’ promises and aspirations in this regard was folly – a state-owned entity with no legacy of troubled assets would have been far more likely to have succeeded in lending money to this key sector of the economy.

Once again, as in the summer of 2008, the European Central Bank mistook inflationary pressures resulting from strong commodity demand in emerging economies as evidence that the eurozone economy might be overheating when the underlying reality was that of an economy that had already peaked and was being hit hard by severe austerity across many of its constituent nations.

It raised interest rates twice, damaging economies that were already very weak, the peripheral nations with the largest debts and undergoing massive public spending cutbacks, with least damage to nations with the strong economies, such as Germany, which were exporting to China and had little debt and lots of savings.

Only the last of these factors has been an economic misjudgment, whereas the roots of all the other factors lay in politicians trying to ignore the messages that the markets were sending them. However, we should be careful not to ascribe all the blame for the current economic mess on policies pursued in recent years. They may have made things a little worse, but the underlying reality is that after 30 years of debt-financed spending in the western world, we have reached the end of the road in our ability to borrow any more.

The system is forcing retrenchment as banks, governments and consumers are all now seeking to reduce their debts. History shows us first that this is always the response to credit crises following booms and, second, that this is always a long, drawn-out process, often resulting in a decade or more of slow growth.

In other words, the slowdown in growth we are witnessing – after such a disappointing recovery – is exactly what we should have been expecting, given the parlous position of the banking system.

• Jeremy Beckwith is chief investment officer of wealth manager Kleinwort Benson