The former Governor of the Bank of Mauritius, interviewed by Abdoollah Earally, gives his views on the trend in the evolution of the world economy. He also comments on financial and economic issues related to Mauritius.

Q. Is the world economy recovering?

Let me start with the US, the world’s largest economy, the growth engine of the world economy. In the last 20 years prior to the current crisis, economic downturns lasted for only 8 months. This US recession started in December 2007. You will recall the National Bureau of Economic Research – the institution that certifies the beginnings and ends of economic recessions - had announced that the US economy was in recession 11 months after it had actually set in. In May last the Committee members of this Bureau could not unanimously and conclusively reach a consensus on likelihood of an economic upturn. The duration and severity of the recession has made it hard to determine with authority that recovery has indeed started.

The US is going through one of the largest fiscal expansions in human history and its fiscal deficit is escalating with no sign of an improvement in the foreseeable future. National debt is staggeringly high. Its external liabilities are unprecedentedly high. Trade imbalances remain unsustainable. Consumer spending is depressed. As many as 10 per cent of the US population are dependent on stamp food for survival. Despite a surfeit of sustained fiscal and monetary stimuli including sustained zero interest rate the US economy is still in a comatose state. It seems almost certain that the present recession will last longer than the 16-month recessions of 1973-75 and 1981-82. These had been the longest downturns since the 43-month period from 1929 to 1933 of the Great Depression. The current one will turn out to be the longest in the post-Great Depression period. The symptoms of the US economy tell us we have a got a very sick patient indeed.

Q. And on the other side of the Atlantic. What about the Eurozone ? 

The Eurozone, a collection of welfare services-ridden economies, is afflicted with unsustainable levels of debt and fiscal and trade deficits. Only last week the OECD reported that its own leading indicators of the UK for August fell for the six successive months. The UK could witness a renewed downturn. The only Eurozone economy that has recovered from the latest economic and financial mess is Germany – partly thanks to the weakened euro.

The US, UK and to some extent the Eurozone are going through a period of what some observers have referred to as the Great Correction. Japan has been desperately trying to emerge from its financial and economic debacle since the 1990s. The Japanese tried every conceivable policy measure from monetary stimulus, to fiscal stimulus and further to credit easing and quantitative easing and kept at it for 20 years. Nothing happened. Kaput!!!!

What’s clear is that the free fall of Western economies, in particular the US economy, has been arrested. The gravitational pull of the recession is very strong this time. It’s beyond the cognizant event horizon of anyone to authoritatively say that a determined upturn in world economy has begun or about to begin.

Q. So there are reasons to express pessimism about a possible economic recovery?

I’m not a politician. Nor am I a partisan economist in my views. I just like being realistic. There are more believable reasons to say that the world economy has yet to recover. No booster rocket can move the economies of the afflicted countries so long as consumers are incapacitated by debt. It’s a basic and very simple truism of life that one cannot keep borrowing money indefinitely for a living. The same is true for a sovereign country.

Q. And it brings us back to the case of the US. Isn’t it ?

Yes, because American consumers spent more than what they produced. The excess was met by borrowings. Just imagine the magnitude of debt escalation US consumers are mired in: household debt in the US stood at around US$680 billion in 1974. Over the years it shot up to a mind-blowing figure of nearly US$15 trillion by 2008, equivalent to the GDP of the country. Any money borrowed has to be repaid - capital plus interest at some stage - in one form or the other. Milton Friedman said it fittingly and beautifully, “There is no such thing like a free lunch.” In the wake of the financial crisis, banks are reported to have written off US$1.8 trillion. Trillions of debt has yet to be written off. The UK debt and deficit story is not much different from the US. The PIGS countries in the Eurozone suffer from the same infectious disease.

The US, UK and the other afflicted countries have realized that they can no longer spend with abandon. The Great Correction will take time. The financial crisis has been an economic game-changing event. Sustained recovery would only be possible if debt, whether household debt or excess sovereign debt is finally purged out of the system. The final days of reckoning are here, very much present in all its nakedness. The free ride has come to an end.

Q. How in your view will the debt be purged out of the system?

Indications that the US debt will be internationalized and destroyed through an inflationary process are littered in everyday market reports. One of the Fed Chairman’s speeches has an irreverent one-liner: "The US government has a technology, called a printing press that allows it to produce as many US dollars as it wishes at essentially no cost." This is the ultimate option, the ‘nuclear option’ of the Fed. Fiscal stimulus has failed to stimulate the US economy. Zero interest rate policy failed. Credit easing policy failed. Quantitative easing policy of the Fed also failed. All conventional macro-economic policy instruments have miserably failed to stimulate the US economy. The only policy in the monetary policy tool-kit of Fed is to go for more aggressive quantitative easing and that, correctly interpreted, means  debt destruction, inflation and debasement of the US dollar and hence the tantalizing uneasiness of China and the Eurozone. Both the US and China find themselves trapped in a typical Prisoner’s Dilemma situation. Either they cooperate or get themselves and the rest of the world in a worse-off situation.

Q. You seem to lay much emphasis on the US. Is the US still a dominant player in the world economy despite the emergence of the BRIC countries with full force?

The emerging BRIC countries are still emerging. As I said earlier they are essentially regional in character although their collective shares in world GDP and world trade have gone up. China which is now the second largest economy of the world is registering high growth rates as usual. India, Brazil and Russia are maintaining their trend growth rates. But these economies are not yet strong enough to power economic growth world-wide. In my view they are still characteristically regional and will remain so for years to come.

Q. So you can`t beat the US ?

Where you are seated affects the way you view the world. It’s best not to be seated at a single spot all the time. The US remains an important engine of growth. It’s the country that has an undisputed inventive capacity it invents and keeps re-inventing. The rest of the world mostly consumes US technology. Like it or not the US has been the most important source of new ideas, technical and creative, economic and political. No wonder, with only about 5 per cent of the world population, this is a country that has produced not less than 25 per cent of world output for over a century. The US remains an economy to be reckoned with although its relative share in the world economy is called to decline. In the years down the road, the world would most likely have a satellite of small powers but only one superpower and that will be the US. It will take decades before any other country would emerge robustly to match the political and economic might of the US.

Let us not forget that any country with an economic might and strong financial force has to have its currency internalionalized. I do not see the currency of anyone of the BRIC countries soon emerging as an international currency although China is actively driving the yuan into this direction. Giving birth to a currency that bears intrinsic confidence is certainly not like instant coffee. It will take decades. The present international monetary system hinges on the US dollar since the breakdown of the Bretton Woods system in 1971. Despite the on-going self-inflicted wounds and blows the US dollar will rebound in the longer run. The world will have to bear with the US dollar for many more years. There is no alternative credible currency yet. Isn’t it well said, ‘faute be mieux on embrasse sa femme’?

Q. How long in your opinion is it going to take what you refer as the Great Correction to be over?

Whatever Presidents, Prime Ministers, Ministers of Finance and Governors of central bankers have uttered about their respective economies since August 2007, quite the contrary has happened. While politicians have smartly used obfuscation to veil the emptiness of their utterances, most central bank governors of the afflicted countries have skillfully used it to keep out the wild elephant in the room from public view. The reality show of events as they have been unfolding belied all of them.    

In the absence of bail-out policies, the excessive debt would have been destroyed. All businesses with excessive debt would have gone broke. Households that spent more than they could afford would have gone broke. Government debt that could not be paid back would go into default. Debt would have been destroyed and disappeared. Problems solved. The world economy would have been back on real and durable growth path. Of course, this course of action which is essentially a debt destruction programme would have been excruciatingly painful. But politicians the world over do not like to inflict pain on voters. Politicians and central bankers in the West have chosen to inflate their way out of the recession. For the first time in history, almost all the developed countries are running regular, structural deficits at the same time like in a war situation. They have travelled deeper and deeper into debt. There does not seem to be a way other than allowing inflation to do the dirty job. It’s going to be a rough ride for one and all. No one has the oracular abilities to say when would the debt be purged out of the system. Willhem Buiter, a former member of the Monetary Policy Committee of the Bank of England, made a very bold statement that the US should go for a ‘savage austerity’ and for this to be accomplished the US has to get of the kleptocratic oligarchy.

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