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Capital punishment

Capitalism has survived a series of crises and it will survive this one but recovery will not be easy

Capitalism and its merits has been very much in the news recently. To date, the system has survived every crisis in its 200-year history. There were many recessions during the past century but only two periods of general crisis, in the 1930s and 1970s.

Taking a long view, one might argue that the upswing which ended in 2008 began not in 2001 or 1991 but in the early 1980s, with the defeat of inflation and an economic revolution – dubbed Thatcherism in its UK variant.

This had the growth of financial markets at its core and was accompanied by increasing access to credit and a major shift in the balance of power between capital and labour.

This long cycle was punctuated by two short and shallow US recessions (1990/91 and 2000/01), easily dealt with by cutting rates, or rate cuts and devaluation in the case of the UK.

It was also punctuated by a number of asset bubbles – the two big ones being the equity bubble of the late 1990s and the housing bubble of the 2000s.

It seems fairly obvious that this is not a typical post-WW2 recovery situation. Why else would Bank of England rates be at a 300-year low, with talk of more quantitative easing?

It was the bursting of this later bubble that triggered the series of events beginning back in 2007. We are still living in the shadow of that period and creating conditions for a new global upswing – arranged along somewhat different lines – will not be a quick or easy process.

It seems fairly obvious that this is not a typical post-WW2 recovery situation. Why else would Bank of England rates be at a 300-year low, with talk of more quantitative easing?

The recovery has developed against a backdrop of unres-olved issues from the credit crunch. Both the supply and demand for credit has been damaged so it is difficult to reignite growth by cutting rates and encouraging debt-funded consumer spending. The balance-sheet recessions are characterised by reduced demand for money, which becomes resistant to cuts in interest rates as people seek to pay down debt rather than borrow more.

Over the past year, global output has risen by around 4 per cent but the level of output in the developed world remains some way below where it would have been if the crisis had not occurred.

We are assuming recovery in the developed world is weaker than in previous post-war recoveries, as deleveraging forces in household and public sectors act as constraints to growth. In contrast, we expect growth in much of the emerging world, led by Asia, to remain strong.

The UK aside, inflation in the developed world should stay low, given the scale of spare capacity following the recession. Even in the UK, we do not expect underlying inflationary conditions to gain traction, especially in the labour market.

On the deflation question, history would suggest, with the notable exception of Japan, that sustained deflations are very rare in fiat (paper) money systems, whereas under commodity standards (gold or silver), they were common.

Although there are some similarities with the Japanese experience, especially in the US, there are key differences – more aggressive monetary response, both in terms of interest rates and QE, and a quicker recapitalisation of the banking sector.

Ian Kernohan is economist at Royal London Asset Management

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