Easy credit is the steroid of modern economies, but it comes with major health risks, writes Peter Lyons.
There is a fine line between a realist and a pessimist. I am sceptical about the signs of a purported economic recovery. I offer my reasoning and invite criticism.
The recent anaemic growth figure for New Zealand of 0.1% for last quarter could easily be a statistical discrepancy.
Sure, economic activity has been buoyed by rising world dairy prices and renewed activity in the housing market.
Surveys also show consumer and business confidence is surging.
John Maynard Keynes described economic confidence as "animal spirits". It is as fickle as spring weather.
The apparent turnaround in the world economy is based on massive injections of liquidity by governments.
In the United States, the Federal Reserve, in a process euphemistically called "quantitative easing", has left the financial sector awash with cash.
This sector is run by the same executives who ran amok with the easy credit during the pre-crunch years.
Some of this cash has found its way into stock markets around the world, creating a rebound of massive proportions.
Irrational exuberance is making a comeback.
Milton Friedman, the father of modern monetarism, blamed the Great Depression of the 1930s on the newly formed Federal Reserve.
He believed it failed to prevent a major contraction of the money supply and credit in the United States, as bank after bank failed.
It would appear he was right.
During the recent crisis, Ben Bernanke, the chairman of the Federal Reserve, helped avert a financial catastrophe by flooding the financial markets with easy cash.
Prime Minister Gordon Brown did likewise in the United Kingdom.
Easy credit is the steroid of modern economies, but it comes with major health risks.
Their actions helped avoid a financial Armageddon.
But it hasn't resolved the underlying imbalances in the world economy that will wreak havoc again unless addressed.
The key imbalance is that most Western societies have been living beyond their means.
They have been able to do this by borrowing from those countries that are following deliberate policies to ensure they are the lenders rather than the borrowers.
The most obvious practitioners of such policies are China and Japan.
A culture of excessive saving is embedded in Japanese society.
This is particularly relevant for New Zealand.
A good chunk of the money that many of us borrow to fund our lifestyles comes from Japan.
The cultural frugality of the Japanese may be a legacy of the hard times many endured during and after World War 2.
The Chinese Government has ensured China is a net lender by fixing the value of the Chinese yuan at an artificially low rate against the United States dollar.
As a result, the Chinese have a massive trade surplus with the United States and many other countries.
This has allowed them to accumulate a gigantic pile of foreign currency.
This is lent back to the West to allow them to live beyond their means.
In a nutshell, many Western countries are living beyond their means by borrowing from the East and Middle East.
This process cannot continue indefinitely, or all will lose, as shown in recent years.
The huge government bailouts used to fix the broken financial system of the West have had to be funded from somewhere.
Some have come from printing money, which will eventually lead to inflation.
Some funds have come from borrowing, from lender countries.
This means the borrowing binge by Western consumers has been supplemented by a borrowing and printing binge by their governments.
Their economies are still being driven by borrowed money, which is not sustainable.
The solution to this impasse lies to some extent with the lender countries.
Trade is a two-way street. Countries export to allow them to import.
The money accumulated by exporting is only an intermediate step to buying imports.
A shopkeeper cannot operate indefinitely by offering credit to his customers.
If the Chinese allowed their currency to appreciate, this would unleash the purchasing power of the huge Chinese middle class on the world economy.
It would create massive effective demand for exports from countries like New Zealand.
This would ensure a sustained balanced recovery from this recession.
If debtor countries such as New Zealand and the United States continue to accumulate excessive debt, either public or private, this acts as a handbrake on the world economy.
It is ultimately harmful to the lender countries, because a stagnant world economy is not a good market for their exports.
When government borrowing, printing and spending policies prove ineffective in fixing the global imbalance, recession will rear its ugly head again.
This will affect New Zealand's dairy exports, because if the Chinese aren't selling, they are reluctant to buy.
It will affect our housing market, because if overseas lenders become cautious again, our key source of borrowing will dry up.
This recovery appears extremely fragile.
But maybe I'm just a pessimist.
- Peter Lyons teaches economics at Saint Peters College in Epsom and has written several economics texts.
