For the Great Plan to Work, Focus Must Not Be Broken

by Inya Ivkovic, MA

Reviving the global economy is not going to be easy. But governments and central banks must not lose their focus, even if the general public insists otherwise. Central banks and governments around the world have started something and, regardless of what one may think of their measures, deviating or faltering from the original plan could potentially be even more dangerous. Perseverance in repairing the global financial systems until all the toxins have been flushed out of them must remain the one and only target. Until then, no one can even start talking about the recovery, let alone growth.

But what is the plan? So far, we have mostly seen paper money printed by truckloads and dumped at the same rate into financial systems. Is that a lasting fix? No, actually, it is merely a short-term, necessary evil, and central banks and world governments are painfully aware of this. A sound and lasting solution is to rid the banking system of toxic assets by forcing the banks to recognize the losses of their non-performing assets and to rebuild healthy capital structure by returning to their core businesses. And, while there appear to be many steps taken in the right direction, it still seems as if only a few have actually yielded beneficial results.

A particularly slow-moving issue has been that of dealing with toxic assets. Granted, getting rid of non-performing assets has been greatly impeded by their complexity and how intricately woven they have become with today’s financial systems. There are also numerous legal limitations; but, most importantly, the political will to fund the less popular and certainly less sexy clean-up job is at dangerously low levels. These three factors put together threaten to delay the recovery, because dysfunctional financial systems cannot be monetarily and fiscally active and certainly cannot jumpstart the economy. In other words, it doesn’t matter how much money gets thrown into the financial markets; without the proper clean-up job, stimulus money will never gain serious traction, but will create only a temporary illusion of growth.

In fact, many seasoned economists are rather afraid of a short-lived recovery. Simply put, banks need their government’s support. They need help flushing out the toxins out of the system. But if the public thinks that recovery is just around the corner, it will demand that the stimulus money be shifted towards sustaining borrowing levels and pushing asset prices up, instead of on focusing on banks’ balance sheets.

So, as government and central banks pump their deficits in an effort to spend their way out of the recession, there has to be both rhyme and reason as to how that spending is executed. Irrational spending has already created enough trouble. What is needed now is a plausible exit strategy. Without it, trillions of dollars in government deficit will be hard, perhaps even impossible, to survive, which may eventually force world governments to cease spending and to increase taxes.

It is painfully clear that developed countries can no longer finance their economic growth through leverage. Borrowing patterns need to change radically and developed economies have to understand that true growth has to come from within, through increased production and exports and through nurturing domestic demand (which shouldn’t be equated with international trade impediments). Credit systems and asset bubbles must also be closely monitored and kept in check with effective monetary policies. Central banks should finally become guardians of last resort, the ones that will raise red flags the moment bubbles start forming.