The Hindu Business Line : Are we in for a Mexican standoff?

As the immediate threat of a total collapse recedes, the need for co-operation will diminish. It will become like a Mexican Standoff, where a bunch of gunmen are pointing guns at each other but no one is willing to fire first because that would lead to almost everyone getting shot dead. Yet, someone does fire eventually, says T. C. A. SRINIVASA-RAGHAVAN.

“Operation successful, patient dead” is an old chestnut. It is also like playing a perfect hook-shot — everything looks wonderful until you get caught on the fine leg boundary. Therefore, it seems to me that the time has now come to start asking whether the same thing could happen with the ‘rescue’ packages that the governments and central banks of the world have devised.

There are three major elements in the rescue package. The last two flow from the first. The first is the clear and unequivocal statement of the determination by all governments that they will not allow the global financial system to go down.

As the saying goes, the guiding principle — attributed variously to Thomas Paine, Benjamin Franklin and even Louis VI of France is: “If we do not hang together, we shall surely hang separately.”

The second, therefore, is the decision to flood the system with money and, as far as possible, act in a co-ordinated way. Both, however, have limits once the immediate danger has receded.

The third element is the agreement that no one will start becoming protectionist because, in the end, what exacerbated the financial crash of 1929 was extreme protectionism. The breakdown then was accompanied by trade disruption of monumental proportions because the world was not so much about nation-states as about empires, which had a different dynamic.

If one examines these three elements, it is clear that the first decision, to save the financial system, strictly speaking was not a decision at all. The game had to be played because there was no choice.

But the second and third decisions entail a lot more choice and discretion. How much money to pump in, whom to bail out, how far to act in concert with other countries, what sort of promises to give on trade, etc., are all a part of that discretionary choice.

The trouble, however, with discretion is that it introduces a very large element of uncertainty. No one knows which way the cats will jump.

Looked at that way, the situation has, if I may put it like that, become an n-person, non-cooperative game but with the characteristics of what is called a Mexican Standoff (in game theory related literature).

This consists of a bunch of gun-toting men, each pointing his gun at someone but no one willing to fire first because that would lead to almost everyone getting shot dead.

This is only going to make things even more uncertain because as the immediate threat of a total collapse recedes, the sense of purpose and unity shown so far will diminish.

Who will shoot first?

Politicians, ever mindful of their prospects in the next election, will turn their attention to domestic consequences. Someone is bound to lose his nerve and shoot first, perhaps the next US president (with outsourcing, say). It is this aspect of things that everyone needs to start focusing on now.

The most immediate fallout will be the political need to counter the criticism that governments are bailing out the rich and the crooked. This means focusing on the real sector, where the bulk of the jobs and voters are. That is why our Prime Minister is now talking about real sector investment. He doesn’t want to give the Left another stick to beat him with.

But where will the money for all this come from? Most governments, after they are done with saving the rich and the crooked, will be broke. Most already are. Nor can they borrow much more because most are already at their borrowing limits.

So, to use the patient analogy, maintenance drugs are going to be in short supply. This means the patient could still conk it, in that global GDP may fall by as much as 30-40 per cent for a couple of years.

Indeed, in an intuitive sort of way the stock markets have already worked this out, which is why everyone is so busy selling off what they have.

Massive inflation

And this is where the hammer really falls: global output shrinking when global liquidity has already gone up hugely, especially after you take into account the usual multiplier effects.

The overall consequence, as Mr A. Seshan (who used to head the research division of the RBI) has already pointed out in these columns, is a very strong likelihood of massive inflation.

So prices-wise, the next two years are going to be very scary. The wise and the rich should switch to the traditional stores of value — gold and land.

But there are very few rich people, and even if we assume that all of them are wise, there is still the problem of those who are not rich, and indeed, who may even be poor (or even very poor). The coming inflation will hit them the hardest.

This is the key difference between the Great Depression and now. There was deflation and unemployment then; there is going to be inflation and unemployment now. However, while that one lasted eight years, from 1930 to 1938, the pain this time will be for three years at most, but more likely two.

China and India

Why? Because of India and China. Neither of them can allow the distress to go on for as long as the 1930s politicians did. Both have to worry about the political consequences of a prolonged downturn.

China probably has a more serious problem on its hands because of its export-led growth model. India, warts and all, now looks a lot safer. What this means is that China must now start selling more to India. But India needs to find the money to finance the imports.

This takes us straight to the heart of the exchange rate problem. A massive increase in imports is not possible unless the rupee appreciates. That looks unlikely now but given how good the Indian economy will look in comparison to the rest of the world in a few months from now, this should not be a problem. Much of the capital that has flowed out will come right back in.

If you accept this analysis, it seems evident that as far as the exchange rate goes, the RBI needs to just hold steady with its current policy, and not give in to strident but immature advice in some newspapers, advice that the Finance Minister seems receptive to.

What about interest rates then? Again, the same thing holds. There is no need to be jumping about like a monkey in the belief that it constitutes purposive action.

Inflation is just waiting around the corner. Output must increase, but the immediate focus should be on infrastructure, not private sector capital spending. Given the political uncertainties — Mayawati as PM, say — interest rate cuts will not help very much.

It is not all about the equity and money markets; it never has been, even for a country like the US.

( blfeedback@thehindu.co.in)

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