An unravelling economy

Our national debt levels soared as fiscal facts refused to adjust to reality created by bursting of liquidity bubble.

I’m not sure if the textbook can save us anymore. Ask yourself, what is the nature and scope of the current economic crisis sweeping the world? We misread the 2008 situation by looking at it as a ‘subprime housing’ crisis, whereas, it was quite basically nothing more than the bursting of a massive liquidity bubble. The subprime housing mortgages were only some of the more vulnerable assets that were spread throughout the financial system and as such were an important part of this bubble.

But they weren’t the only part. What we discovered in late 2008 was that, here in Pakistan, we had our very own liquidity bubble that had produced a very short, very intense and very unsustainable growth spurt for a couple of years in mid-decade, the high water mark of the Musharraf regime. And when the bubble burst, it produced many of the same symptoms here, as it did anywhere else: a credit crunch, collapsing asset values and destruction of bank balance sheets.

For instance, we discovered that we had ‘subprime’ assets of our own, even if they didn’t take the form of exotic mortgage products. We gave them the more dreary name of ‘non performing loans’. But what we discovered when our bubble burst was that almost all our assets were subprime assets, especially given the weak enforcement of contractual obligations that is such an important part of doing business in Pakistan.

A lot of consequences came cascading in the wake of this discovery. A sharp slowdown in investments as banks turned extremely risk averse, a recession as corporates preferred to draw down their debt levels rather than invest and sharp increases in non-performing loans which almost threatened the solvency of the banking system by the summer of 2009, according to State Bank assessments.

Our national debt levels soared in the years that followed as fiscal facts refused to adjust to the new reality created by the bursting of the bubble. Furthermore, the appetite of banks for government debt grew as they swung away from private- sector lending, except to a small group of large corporates and standard bread-and-butter lending, to financing agriculture procurement in sugar, wheat and cotton.

Of course, all this mirrored developments everywhere else in the world, with one important exception. We landed up in that group of countries for whom a fiscal stimulus was not an option. Quite the contrary, shunned by global markets and washed up on the doorstep of the IMF, we had to embark on a programme of ‘structural adjustment’, the very opposite of the fiscal stimulus that many other countries were trying to prime their economies with.

Having prevented a major banking crisis in their economies, the advanced countries in the Eurozone and the US cracked open the textbooks and did what the orthodoxy said you’re supposed to do when the economy slows down: borrow and spend. They embarked on some of the most massive spending plans in their history and boosted these with printing of money and purchases of bad assets from the banking system.

It was a stimulus of breathtaking scope, paid for entirely through debt. But then came the problem: despite the massive infusions of cash, their economies failed to jump-start. Instead what they got was a slow, anaemic, sputtering ‘recovery’. This forced a choice upon the governments of these countries: more spending or austerity.

The choice proved politically too polarising. Austerity meant unemployment, one of the most ghastly afflictions to hit an industrial economy. And that is where they stand even today. Bailouts and stimulus spending, or retrenchment and austerity? What’s the path into the future: to continue trying to jump-start their moribund economies, or salvage what’s left of their sovereign credibility?

In fact, the crisis of 2008 never ended. With their fiscal stimuli, the countries of the West only bought themselves a little time, nothing more. Today, neither of the economic orthodoxies are working: not the monetarist one, nor the Keynesian one. And that’s the lesson we need to wake up to quickly, that the textbook is fast going out of date. The crisis that is upon us now is something new, something different and its still not clear what shape it will take. For a state like ours, living far beyond its means, this is a very serious development.



Published in The Express Tribune, August 25^th, 2011.