Globalisation 4, gold, the dollar, Squanderville and Thriftville

I AM sure we all agree that global economic events are useful lessons for us and other nations in other territories, whether in Asia, Africa, the Middle East or South America and today, even in the UK, continental Europe or North America.

As I mentioned in a previous column, if China’s and India’s political leaders put their countries into ‘sleep mode’ for decades before they awoke again, the recklessness and greed of a few American corporate leaders nearly put the world to sleep – though for a few years. We have all got to be careful about squandering a pre-eminence or opportunity. The thoughts expressed this week will, I hope, caution us whether at a personal, corporate or national level. Let me first give a brief background.

Globalisation’s second wave – 1947 to 2000

Many weeks ago I spoke of globalisation’s first wave. The second wave of globalisation was orchestrated by America. The US together with Europe and Japan negotiated agreements to create the WTO, which reduced tariffs and barriers and relaxed rules. If gold was the currency of the first wave in 1947, the dollar was made the currency of the second.

While many countries were ravaged by war and challenged by reconstruction efforts these did not affect the US. There were initiatives such as the Marshall Plan in Europe and the Dodge Plan in Japan, which focused on government programmes to catalyse production.

Japan and Europe introduced incentives to generate personal savings to fund new investment in particularly factories. Consumer credit was limited. Sales and value added taxes were levied on consumption while interest income on savings accounts and stock dividend payments were exempted from tax.

The US – Strongest and richest

The US, the strongest and richest country, undamaged by war led the way in the second wave of globalisation. They reduced tariffs and opened markets much more than others.

While there was discussion to create an international currency, this idea never got off ground due to stiff US opposition. It is interesting that today we are even discussing going back to a gold standard.

Third or fourth wave?

Economists often say that we are now in the third wave of globalisation. There are many critics of market economics and I have contested those critics to say that I always believed in a market economy with desirable and effective regulation.

It is almost three years since the collapse of the Royal Bank of Scotland and the global financial crisis that followed that I have been speaking publicly and writing about ‘A Robust Regulator – A Fundamental Ingredient in a Market Economy’.

But, as with anything else, even in France or Venezuela and in Western Europe or North America, market economic thinkers and practitioners (those who professed the unfettered freedom of the ‘wild entrepreneur’) have gone into the woodwork. They don’t have to, for that may create another extreme.

My personal view is that today it is not a third wave we are in, but a ‘Post Global Financial Crisis – Fourth Wave’; what should be a different, more cautious form of globalisation of trade and development.

Self-inflicted damage

I must stress of course that it is not a move away from market economics and this prompts me to share a story. It is a story of how we can quite easily destroy what otherwise could be a well-regulated but thriving market economy and then have the entire world blame it on the market.

This story, or analogy, will have a learning outcome for those responsible for taking decisions on personal debt whether to engage in margin training or otherwise – to take a simple example, corporate debt or equity through IPOs which are today so easy in Sri Lanka, and leveraged so readily, to engage in ‘new investment’ even without adequate clarity of the new investment or its timing; or decisions on national or public debt as a country. It is about avoiding what we can call ‘self-inflicted damage’.

Soros and Buffett

George Soros and Warren Buffett both predicted the decline of the dollar in 2002. Soros is a currency speculator. Buffett on the other hand is not a currency speculator. He had apparently not bought anything other than a dollar in 2002. But with mounting deficits in the United States he became worried.

The US Government debt has now surged to an all time high of US$ 14 trillion. A news item datelined Washington in our own Daily FT more than a month ago, referred to the US passing what they call “a dubious milestone” and that Congress would soon have to lift its legal debt limit. It says that there will be a fight on Capitol Hill “inflamed by the passions of tea party activists and deficit hawks”.

Buffett cried wolf as far back as 2003 when he backed his words with Berkshire Hathaway’s money by investing for the first time in several currencies other than the US dollar. He said he was doing so with reluctance since the “net worth” of the US was being transferred abroad. Yes, that was as far back as 2003.

Squanderville and Thriftville

Here is that story. It is a story I heard over five years ago – interestingly enough, while I was in China. Warren Buffett shared his concern about the US economy and the dollar by referring to economic developments on two islands located side by side to each other. I have shared this story at lunch and dinner presentations since 2007 at the beginning of the global financial crisis.

Buffett refers to two islands – Squanderville and Thriftville. Land was the only asset on these islands. The inhabitants needed only food. Each inhabitant working eight hours a day could produce the needs of all on each island, he said. For many years things went along smoothly and the societies on each island were content. They were self-sufficient.

Squanderbonds and Squanderbucks

Thriftville all of a sudden is seized by an extraordinary work ethic and they began working not eight hours but 16 hours a day. This results in excess food and exportable surpluses.

This excess food is exported to Squanderville and those in Squanderville began to gradually begin working less and enjoying life more. Over time, some of them quit working altogether.

The people of Thriftville go a step further and are even willing to supply food in return for debt instruments – Squanderbonds. The Squanderbonds were backed by Squanderbucks.

Squander ‘pundits’

A few Squander ‘pundits’ get nervous and express concern, but these pundits are dismissed and accused of being unpatriotic and having insufficient faith that Squanderville’s best days are yet to come. But now the Thrifties have lots of Squanderbonds and are getting worried because they begin to doubt that the Sqaunders will be able to pay their IOUs.

Squanderland

Around this time there is talk in Squanderville about printing more Squanderbucks to create inflation and dilute the value of both the bucks and the bonds so that they are easy to pay off. This leads to the Thrifties selling off bonds and with the Squanderbucks they buy Squanderland.

Facing reality

The Squanders are forced to wake up and face the reality that they have to begin to work eight hours a day to produce the food that they need. But eight hours is not enough for the Squanders now have to work extra hours to also cover the rent on the land that they sold to the Thrifties.

To Buffet, Thriftville was China. Squanderville was the US. Buffett said that he was shifting his money away from the dollar into non-dollar assets to hedge against the Squanderville syndrome.

Austerity or stimulus

While I identify with the concerns of Buffett, not being an economist, I am really not too sure whether the austerity measures of England and Europe are also the right ones.  While I worry about the debts of the US, a market on which we in Sri Lanka are dependent, I hope that the stimulus plans of the US will somehow work, benefitting this “land of the free and the home of the brave” that I also once lived in, studied in, have friends in and yet have considerable affection for.

I hope these thoughts will teach us in Sri Lanka that we have an opportunity which has to be leveraged carefully such that we usher in a new future – but, most importantly, a sustainable new future, for the next generation.