The Last Ditch by Tom Paine

Evan Davis, the BBC Economics Editor is addressing the conference I am attending in Paris. My God, but he’s condescending. He is so used to addressing the peasantry on IngSoc TV that he seemingly cannot adjust to an intelligent audience. The moderator praised him for "making complicated things seem simple," but his style of presentation annoyed the hell out of me. Ignoring the "Play School" tone of voice and listening to what he’s saying, however, it’s quite interesting.

He is positing three scenarios (and putting a 33% probability on each of them);

1. Rebalancing: Americans, Brits et al  have been spending too much and saving too little.
   The Germans, Chinese et al have been doing the opposite. This will now reverse and after a pause all will be well.
2. Inflation: If you have overgrown the economy "beyond its true
   capacity" by 2-3% a year for a few years, you get inflation. You need a
   slowdown for a corresponding period to squeeze inflation out of the
   system. It limits the ability of the central banks to reduce interest
   rates. This is a slowdown as medicine and it has to hurt to work. If this scenario is correct, then the mistake we made was to assume that the China effect was permanent
   not temporary. In other words, we took the price reductions on cheap goods from China
   as being permanent and adjusted our lives accordingly, forgetting that China’s increased output would lead to increases in raw materials prices and other costs.
3. Recession: Clasically, this is defined as two consecutive quarters of negative growth, but is better thought of as a vicious circle. A feedback loop of slowdown causes more slowdown and so on. Individuals are afraid of the slowdown they see around them, rein in their spending and save for what seems an increasingly likely rainy day. It’s a matter of “behavioural economics,” where people cease to be rational actors. The confidence factor is crucial and a collapse of confidence can be disastrous. That’s what happened to Japan in the 1990’s and it could be as bad as that for us in the West this time as it was for them, if the irrationality of the downside mirrors the irrationality of the recent upside. The parallels with Japan continue as their slump was associated with the sort of banking crisis we are having now. On the positive side, our banks are acknowledging their losses more quickly and (apparently) more honestly than the Japanese banks which went into denial and consequently leaked bad news over a long time, undermining confidence in the process.

He concluded by blaming the central banks of the world (especially the most aggressive ones, such as the Fed) which have encouraged us to spend to the detriment of our personal balance sheets. First we fooled ourselves with the dot com bubble and then we fooled ourselves with a property prices bubble. We are unlikely to find another bubble with which to make us comfortable with spending money on Chinese goods, however aggressive the central banks try to be.

He took a straw poll of the people in the audience which showed us as divided 50:50 between his scenarios 1 (optimism) and scenarios 2 or 3 (pessimism). He commented that the proportions were very similar when he did the same thing at Davos recently. I fell into the pessimistic camp, but only because he asked it about the Western economies specifically. I am quite bullish about the emerging markets of the world in general, and in Russia/China/India in particular. Davis was inclined to agree, commenting that the "catch up element" in their growth will allow them to do better, although their growth will be slowed by the global slowdown. However while he acknowledged there is a view that  emerging Europe and China have "decoupled" from the United States economy, he remains skeptical, commenting that it’s what people want to believe.

Given that he had no view as to which scenario was most likely, it’s hard to know how anyone in his audience should adjust their business plans. However, since he gives equal probability to his two pessimistic scenarios, he seems to share my view that the question is (for the USA, Britain and Western Europe, at least) not "will it be bad?" but "how bad is it going to be?"