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When historians look back in 100 years time – what will they make of the sub-prime crisis and all that followed?  What links will they make between the rise of China as a mega-industrial nation, buying huge amounts of dollars, keeping their own currency low, and costs of borrowing low for developed nations.  Of course we are talking about a wider issue than China, but China is a dominant force in this regard.

The fact is that China’s willingness to buy dollars and euros in the 2000s provided a very welcome boost for developed nations – providing a lot of money at low interest rates.  Both governments and individuals took advantage of this to spend on things they thought were important at the time – running up huge debts, and driving these economies into a long boom, creating local jobs, improving infrastructure, health care and education.

China and other exporting nations also benefitted from the boom:  more people were able to buy more Chinese goods and services – so everyone was happy, for a while.

When the sub-prime crisis hit (caused by stupid lending on a massive scale to people who were very bad risks), governments for forced to bail out banks, adding to their own debt.  Some of these governments were then at risk of becoming insolvent themselves – creating a vicious circle, since much of their own debt was held by…. Banks…. 

So the sub-prime crisis linked to mortgages became a banking crisis became a government crisis, and then became a new (and even more serious) banking crisis.  But this time, the only way that some governments can raise more cash to save themselves and their banks is to print money – the oldest trick in government finances. 

These days, a single mouse click on an Excell Spreadsheet in the Treasury can make millions of dollars of new virtual money – washed into the nation’s systems as “quantitative easing” or some other financial device.  But the concept is fundamentally similar. Governments are making virtual money to buy up their own debts.  By early 2012, the UK government alone will have created around £300 billion of new cash – enough to buy around a third of its own debt.

President Mugabe embarked on physical money printing recently, as the only way he could afford to pay government workers and the army.  The more notes he printed, the less they were worth.  Money printing led to a 1 billion % inflation rate – I have a 10 trillion Zimababwe dollar bill to show for it, which on the day it was printed would have bought half a loaf of bread.  The German government went down the same disastrous route in the 1930s – which is why the German people are so keen today on low inflation and prudent government finances.

At some point there has to be a huge and painful adjustment to the global reality which is that emerging nations are continuing to grow, and developed nations are in decline.

No amount of government borrowing or artificial stimulus from emerging nations can disguise this decline.  The end result – either gradual or sudden – will be a massive transfer of wealth from declining nations to emerging nations.

This global equalization process will transform the political landscape for the next three hundred years, and will have more impact on social justice, improvement of education, access to health and so on for the poorest in our world, than the entire combined total of global development aid over the last five decades, a hundred times over.

In the meantime, governments like the UK are quietly discovering the benefits of inflation – running at over 5% at the end of 2011, wiping out tens of billions of government debt in a relatively painless way.  Painful though to anyone who has cash – who is seeing the value of their savings eroded rapidly.  High inflation with low interest rates is a way of taxing savers, and rewarding borrowers.

Inflation may reduce the debt mountain – but may also give future lenders a scare, so they start demanding more interest to persuade them to buy (yet) more government debt, or to re-buy debt that has to be repaid to them by certain dates.  And then as interest rates rise, so do risks of another big recession – or worse.

In the shorter term the UK government is not too worried by inflation, as most of the money it needs to borrow is tied up in long-term low interest contracts which do not expire until 2013-4, very different from Greece of Italy which keep returning to the markets with billion dollar begging bowls every few weeks.

Article written: 1st November 2011

Countries Visited

Patrick Dixon has given keynotes on a wide range of trends to audiences in North America, Central America, Latin America, Western Europe (European Union), Central Europe, Eastern Europe, Baltic States, Scandinavia, Africa, Central Asia, South East Asia and Asia Pacific.  Countries visited include: Australia, Barbados, Belarus, Belgium, Brazil, Burundi, Canada, China, Czech Republic, Denmark, Democratic Republic of Congo, Egypt, Estonia, Fiji, Finland, France, Germany, Greece, Estonia, Hungary, India, Italy, Ireland, Kazakhstan, Kuwait, Latvia, Malaysia, Mexico, Morocco, Netherlands, Nigeria, Norway, New Zealand, Panama, Poland, Portugal, Romania, Russia, Saudi Arabia, Singapore, Slovakia, Slovenia, South Africa, Spain, Sweden, Switzerland, Thailand, Turkey, Ukraine, Uganda, United Arab Emirates, United Kingdom, United States and Zimbabwe.

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