Friday, March 20, 2009

Micro as important as the macro

All the talk of the global downturn always seems to focus more on the macro numbers and what governments need to do in order to help to stabilise economies.

In fact, it would seem as if the whole world has shifted from the reliance on the market economy, and has now placed responsibility for development on governments, leading many to say that the era of the market economy is over as the market has not proved to be an efficient tool for development. The argument is always" see what it has done. It has set us back decades." Of course nothing could be further from the truth, but that discussion is for another time.

In discussing the macroeconomies and what role governments must play, we must remember also the importance of the micro sectors - businesses and individuals. Many times we forget that the macro economy is nothing more than the accumulation of all the micro players in it. So, for example, when we speak about the national debt of over J$1.1 trillion, we tend to forget that the debt is made up of thousands of individual borrowers and recipients of those debt funds.

Options faced

The government cannot accumulate debt if personally we do not spend more than we earn and/or if we are producing more than we consume. The demands for government expenditure are in the final analysis to support our own total consumption. One could argue, though, that the government's role is like the father who should ensure that he implements fiscal discipline on the children to ensure that they spend within their means rather than mortgage the house to support their unacceptable lifestyle.

The point therefore is that dealing with the economic downturn is more going to be about how we deal with it individually rather than what financial support government can provide. We can, for example, support behaviour that is continuing the excessive use of resources above what we earn, but that is certain long- term destruction.

It is therefore important that the correct fiscal policies be put in place to cause a shift in consumption and production behaviour patterns. This structural change in behaviour will no doubt be forced on individuals as the economic situation forces change. As an example, as economic activity slows down it means that there will be less disposable income, which in turn means that people will be able to afford less and businesses will get less money, causing the start of the cycle all over again. Faced with this situation, we can choose to do one of three things:

1. We can seek to borrow money to afford the luxuries we are normally used to, such as high-end cars etc;

2. We can adjust our lifestyle by reducing our debt and not spend on unnecessary acquisitions; or

3. We can seek to produce more at our individual levels and so maintain our income levels through greater production.

Obviously the third option is the most desirable, but it is going to take some time for that behavioural change to take hold. The first reaction of many people will be to see if they can borrow more to maintain the lifestyle they have become accustomed to, and this includes businesses as well. My advice would be that in our current economic situation this would be the wrong choice for long-term sustainability. The best action is to first put in place option two above, shortly followed by option three. The reason why people seek to act on option 1 first is because for sentimental and other emotional reasons they try to hold on to what they know.

It is because of this why I have been saying that the world not only faces economic challenges but also psychological challenges which must be addressed. This is why it was refreshing for me that the RJR Group put on the "Yes you can survive in 2009" public seminar last week. They correctly identified that a wide cross section of professionals, including bankers, psychologists, and accountants, are necessary in oder to open this debate with the public. More important than the stimulus support that governments put in place will be our own behavioural changes to determine whether or not we are able to cope with the changed economic structure of the future.

Looming transformation

Let us not kid ourselves, Jamaica and the world are going to see a forced transformation of the economic structure. The boom in credit that we have become used to is at an end, and with that we will see a change in the face of businesses and a tempering of economic activity. Even after economies have stabilised and started to recover, for a very long time people will stay away from debt as they restructure their own portfolios.

This is as much a wake-up call for businesses as it is for individuals. When people call me about what to do with their businesses, as they have seen a significant decline in activity, I advise them the same way I would an individual. They need to speak with a professional and have that person lead them in at least a two-day strategic retreat where they look at their business and determine (1) its viability given what changes will happen; and (2) if there is a way to restructure their companies to take advantage of a changing marketplace.

If they determine that it is not possible then there is one best option. The worst thing to do for an individual and a business is to hold on to something that cannot survive because of sentiment. The long-term effect is even more devastating.

In addition to the current situation, I expect that there are going to be some more challenges that consumers, particularly in an open economy like Jamaica, will face. At the start of the year I indicated that I expected two global events to happen this year - (1) that oil prices will go back up, because of supply concerns and an indication that demand is returning to the US; and (2) that the US dollar will devalue against the other major currencies. Therefore, based on this, I see that the world could see another round of inflationary pressure.

Both expectations are starting to happen. Oil prices are slowly inching back up and I think as early as 2009 to 2010 we could see oil prices back at US$100 per barrel, and the US dollar has already started to lose value. And if the US dollar goes above the 1.40 to 1.41 mark against the Euro, then it could easily trade back up closer to 1.60. Both these factors will prove to be inflationary and if prolonged we could see people shying away from the US dollar as a reserve currency. This is even more dangerous if China decides to unload the US debt they hold, having already expressed concern about the stability of US debt.

Bernanke's move to indicate that the Fed will be buying back over US$1 trillion of US government debt will also mean increased money supply, lower borrowing cost, and higher inflation. This move by the US to get the economy going with an emphasis on credit is a wrong long-term strategy.

In the final analysis though, while stimulus packages can help to stabilise economies by providing much-needed economic activity, the ultimate solution is going to come from how we act as individuals.


David Mullings said...

I am happy to see that you say that the most important change required in this crisis is a fundamental shift in our thinking.

Debt has never been and will never be the answer. Unfortunately, the USA does not seem to understand that and continues to be fixated on credit.

Jean Anita said...

It's a tough year - the most important thing for me is to save the jobs of my employees - we are cutting back in all other areas.

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