U.S. President Ronald Reagan and British Prime Minister Margaret Thatcher dance during the final state dinner of Reagan's presidency at the White House in Washington, D.C., in this Nov. 16, 1988 file photo.CHARLES TASNADI
One cannot stress enough how Margaret Thatcher and Ronald Reagan shaped the world we have grown accustomed to over the past three decades.
At the end of the 1970s, the United States and the United Kingdom were miserable from both a political and economic standpoint. In 1976, the U.K. government under Prime Minister James Callaghan made its economic Walk to Canossa when it was forced to borrow £2.3-billion ($3.5-billion Canadian) from the International Monetary Fund, making the U.K. the last developed country to be the subject of an IMF rescue program. The U.S. hit a low point in 1979 when members of the U.S. embassy staff in Tehran were seized as hostages following the Iranian revolution.
However, Ms. Thatcher and Mr. Reagan did much more than just put their countries back on track. They instilled a new (or, more accurately, a renewed) way to look at the world in general and economics in particular.
They saw to it that free market values once again became the progressive ideal worth striving for while government interventionism was marked as a backward concept to be shunned. Similarly, in the current battle of ideas touched off by the recent financial crisis, the accepted wisdom about what is "right" and what is "wrong" is once again being reversed.
The policy-mixes more and more in place in the developed countries form a nearly perfect mirror image of those that were put to work by Ms. Thatcher and Mr. Reagan. Remember, in the late 1970s in both the U.S. and the U.K., unemployment was surging and inflation was running at double-digit rates. Mr. Reagan, and to a lesser extent Ms. Thatcher, tackled both issues through very expansive fiscal policies in the form of tax cuts and very tight monetary policies, which were implemented in the U.S. by then Fed chairman Paul Volker, who ironically enough is now advising the Obama administration.
Today, monetary policies are ultra-expansive with interest rates at zero amid quantitative easing measures. Fiscal policies, which have been very lax in the aftermath of the financial crisis, are now more and more challenged against a background of exploding public debt.
Due to those challenges, the fiscal standing of most developed countries will be neutral at best in 2010 and beyond. But some countries are already seeing a heavily negative impact from fiscal policy on growth. In Greece, for example, we estimate that austerity measures could lead to a decline in the economy of up to 5 per cent this year. This contrasts with monetary policy, which, despite the first signs of a possible tightening in the U.S. or Europe in the second half of the year, will, if we interpret the comments of central banks' officials at face value, remain very expansive for a very long time.
In the 1980s after an initially rather brutal recession, the economies of the U.S. and the U.K. enjoyed a decade of almost perfect conditions. At the beginning of the 1990s, inflation and unemployment were significantly lower. Moreover, the policy mix of loose fiscal and tight monetary conditions paved the way for a decade-long bull market in equities. If we take this experience as the mirror image of what is happening today, what can we conclude?
If opposite causes are leading to opposite consequences, then the current policy-mixes of tight fiscal and loose monetary conditions could, after an initially spectacular recovery (like the one we are experiencing today), lead to much higher inflation and much lower growth than the conditions we have become accustomed to during the past three decades.
Moreover, the bear market in equities could last longer than we currently expect. This is a rather bleak outlook, and it should be taken cautiously, but the current prospects for the pound and the dollar tend to support a more pessimistic view.
In the 1980s, the U.S. and U.K. trade deficits worsened quite dramatically and the U.S. saw a rather strong appreciation in its currency. If we take the opposite here again, then the current trade situation of both countries should improve (at least one positive aspect of the current policy-mix) along with their depreciating currencies.
However, the current weakness in the pound and the likely resumption of dollar weakness once the Greek crisis is solved could very well be the harbingers of a sobering economic environment yet to come.