Plotting a path from global economic turmoil to transformation

 

BOOK REVIEW: When Markets Collideby Mohamed El-Erian; McGraw Hill Professional; £15.99 (€17)

AS A winner of the Goldman Sachs business book of the year and a Wall Street Journal bestseller, El-Erian’s book comes with some heavyweight approval. Understandably so, for in the midst of the current global meltdown, it elegantly identifies the origins of this turmoil.

It convincingly argues that this economic crisis is caused by the markets, ideas and institutions of tomorrow colliding with their counterparts of today. Our economic future is reaching out to us in the present and causing the crisis that we are now looking to safely navigate.

The author worked with the International Monetary Fund, investment banking and was the president of the firm that managed Harvard University’s investment fund. He is well-placed to analyse how and why this collision is happening.

Our current markets and economic ideas are dominated by the might of the US economy. The book describes the “global handover” that is occurring as the emerging economies challenge this dominance. At one stage, the American current account deficit consumed 90 per cent of the world’s savings. This, the author argues, will change with profound consequences for the US and the West.

This relationship is at the heart of the unravelling of the economic system. American consumers purchased goods and services from Asia. However, these same consumers were spending more than they earned. This was financed by greater debt or the refinancing of homes.

These increased debts were then split up and sold (securitised) and purchased by Asian or oil-rich economies that were producing many of the goods and services in the first place. This, the book argues, will change. Emerging economies had become export machines.

These economies will become oriented towards their own consumers. They will become less focused on buying US debt and their own wage levels and costs will begin to rise.

What will this mean for us? Global interest rates will increase as other buyers for government and corporate debt are sought. Wage inflation and higher commodity prices in emerging economies will mean an end to the low inflation that has charmed the global economy. This journey, or what the book terms, a new “secular transformation” will be exceptionally volatile due to the unravelling of exotic derivatives.

The transformation to this new world will be so profound that many will be unwilling to accept that it will be occurring or deal with the consequences. The book offers advice about how the investor should analyse signs from the financial markets when making investment decisions.

Unsurprisingly, global diversification is essential for investors to prosper in the new world. They must specify their target returns and how much risk they are willing to tolerate. This appears to be a desire for a return to rational decision making in investment decisions that was lacking in the creation of the asset bubbles.

I found the book interesting as it outlines what can be done to manage this profound change. He points to the need to strengthen regulatory authorities. They must be able to manage off-balance sheet activities and “other forms of financial alchemy and regulatory arbitrage”.

The book does sound a strong note of optimism as it points to what could make this journey easier. In a book full of elegant phrases, the author describes these forces as “circuit breakers” that might lessen the pain of the worlds of the present and future colliding. He notes the willingness of politicians and central bankers to intervene and experiment to save the banking system. There is a considerable amount of fresh global capital that could provide extra liquidity when banks badly need it. Finally, the emerging economies have a resilience they have lacked in the past. This will provide a stronger spine to the global economy.

This book illuminates the new financial and economic horizon that is causing such turmoil. Many books now claim to do this. However, When Markets Collideis to be highly recommended as while the sweep of the analysis is global, the depth of analysis is impressive due to a combination of theory and practical experience. This makes it required reading for anyone seeking to understand our difficulties and plot a course through them.

Paschal Donohoe was formerly the commercial director for Procter Gamble Ireland. He is a member of Seanad Éireann