The market will find its balance

In November 2003, Vince Cable, current deputy leader of the Liberal Democrats, posed a parliamentary question to Gordon Brown, then Chancellor of the Exchequer: "The growth of the British economy is sustained by consumer spending pinned against record levels of personal debt, which is secured, if at all, against house prices that the Bank of England describes as well above equilibrium level. What action will the Chancellor take on the problem of consumer debt?"

Mr Brown dodged the (almost prophetic) question and replied: "We have been right about the prospects for growth in the British economy, and the Honourable Gentleman (Mr Cable) has been wrong."

The point is that the current financial meltdown and subsequent government bailouts (in recent days, the Royal Bank of Scotland et al were part-nationalised) could have been averted. Some would say the market should be allowed to punish those institutions which clearly behaved like 'leveraged speculators' rather than traditional banks.

The banking system is, after all, based on the principle that central banks lend money to banks which, in turn, lend to regional banks and so on. The net result, under usual circumstances, is that for every €1 central banks lend, the money is multiplied ten times and this is what fuels the economy. But the capitalist system we all operate in has been encouraging a way of life which is way beyond our means.

This recent, massive correction is merely the market's way of readjusting to past excesses and risky financial management. The question that begs answering, therefore, is: Does the recent flurry of nationalisations of banks solve the problem in the long-term, given the markets' unambiguous reaction? Some would argue that 'crashes' are inevitable, just like periods of growth and prosperity.

In the early 1920s, Russian economist Nikolai Kondratiev came up with the notion of 'major economic cycles': the capitalist system is prone to around 60 years of boom followed by a deep recession. He believed this economic cycle keeps recurring. Economists have since referred to these economic cycles as 'Kondratiev Waves' or 'Grand Super Cycles' and the theory is not without its critics.

The point is that the world capitalist system seems to be built on a 'boom-and-bust' 60-year economic model which goes bust when 'irrational exuberance' becomes a habit that the main (capitalist) protagonists cannot kick. What has happened in the US is a good example of this 'irrational exuberance': private consumption was until recently about 72 per cent of GDP and this consumption was based on negative savings and a growing private debt based on over-inflated house prices.

The average American home owner has, for all intents and purposes, been using his/her home as an ATM and borrowing against rising home wealth (which has since crashed) and spending more than their income. Read Prof. Nouriel Roubini's (prophetic) speech to the International Monetary Fund on September 13, 2007 at www.imf.org/external/np/tr/2007/tr070913.htm. At the time, Prof. Roubini was dismissed as Dr Gloom, but how true his advice now holds.

The underlying truth is that you can't cheat the market. This applies to Malta in particular. If house prices are in need of recorrection due to an oversupply, or if consumers are spending more than they earn, we have to accept that the market will eventually re-adjust or correct the situation.

The fundamentals of economics are like the natural laws of science: undeniable and ever present. We ignore them at our peril.