Shadow from the east looms over Davos leaders
On arriving in Davos on Tuesday, I detected a mood of cautious optimism. Yet, as the week progressed, the mood of this gathering of supposedly strategic long-term thinkers darkened.
Why did optimism shift so quickly to gritty realism and renewed pessimism?
I suspect it dawned on delegates that this was no ordinary economic recovery. Over the last three decades — a working lifetime for most people at Davos — recoveries have been mostly market-led. However, in this recovery the market has not played much of a role.
Interest rates are remarkably low but, rather than stimulating a big increase in credit growth, banks remain cautious and, within the private sector, there's a shortage of willing borrowers. Money supply growth has collapsed. Admittedly, the inventory cycle is still working, but the overall impression is that economies are still on life support, demonstrated by huge increases in budget deficits.
The economic outlook depends, critically, not so much on tried-and-tested market mechanisms but instead, on the choices made by policymakers. And, as the week progressed, there seemed to |be little clarity regarding those choices.
Following last year's promises that any reforms to the financial system would be made under the auspices of the G20, it suddenly appears the appetite for a multilateral solution is fading. President Obama's proposals to reform the banks shows the US has adopted a unilateral approach which may endanger the functioning of what has evolved into a genuinely global capital market.
Then there's the issue of exit strategies from the life supportpolicies which dominate economies in the Western world. Some think it's too early to do anything. Others believe interest rates should rise immediately to reduce the risk of yet more financial bubbles. And there are still others — including myself — who believe it's better to start by tightening fiscal policy, leaving interest rates lower for longer.
This level of confusion is not good for economic recovery. The problem stems, in part, from the distinction made in recent years between the aims of monetary policy and fiscal policy.
This compartmentalised approach no longer works. The scale of budgetary adjustment now required globally is so large it will inevitably have an impact on inflation. That makes life tough for central bankers.
Having had sole responsibility for the control of inflation, they will now find themselves in a power-sharing agreement with governments who will respond to economic necessity, but also electoral expediency.
Indeed, in a speech in Davos David Cameron, leader of the Conservative Party, appeared to be softening his line on the need for aggressive spending cuts in the event of a Tory victory at the General Election. If a changing political calculus determines the amount of austerity delivered, how should the Bank of England react?
Perhaps the biggest concern at Davos, from a Western perspective, was the sense economic power was shifting eastwards. Davos will look very different in 25 years' time. The Americans will still have a voice, but China and India will dominate.
European countries will increasingly, be ignored. And, despite the image of happy families and photo shoots, the world will be dominated by superpower rivalry. International relations are undoubtedly moving in a less harmonious direction as the Western world, economically, struggles to recover.