Stephen King: Economic future not worth the paper it's written on

The Chicago Mercantile Exchange building in Chigao. Photo / Supplied

Pieces of paper. That's all they are. Whether they're cash, government bonds, equities or pension promises, they all amount to the same thing. They represent claims on future economic output.

What happens, though, when we discover these accumulated claims are simply too big to be satisfied? What happens when we discover that the future is neither bright nor orange but, instead, a depressing shade of grey?

This, unfortunately, is the reality that's befallen the Western world. As Western populations age, we end up with an inverted population pyramid: the boomers head off into retirement while the population of those who are working age shrinks.

But if the boomers' savings are made up of pieces of paper - claims on future economic activity - and the working-age population is shrinking as a share of the total population, it's hardly surprising that, collectively, these pieces of paper may turn out to be worth less than they originally appeared to be. If future output is lower than the claims made upon it, those claims will have to be reduced.

And that, sadly, is what we're seeing today. In the eurozone, we're witnessing a struggle between those who own pieces of paper - most obviously German creditors - and those who issued pieces of paper - Greek debtors. The Germans legally have a claim on future Greek tax revenues. The Greeks, meanwhile, are discovering their economy isn't quite as strong as it once was and they'd rather use their - limited - tax revenues for domestic purposes rather than
repaying the Germans.

Elsewhere, inflation is rising, thereby reducing the usefulness of cash. While the upheavals in the Middle East and North Africa have all sorts of causes, there can be no doubt that the rising price of food has contributed to a sense of injustice.

That, in turn, has added to the growing opposition to regimes which have persistently failed to spread economic wealth far and wide. And, for the people of Britain, life has become a lot more expensive, not only because inflation has picked up but because sterling's value has dropped.

When the financial crisis first got going, many thought the problematic pieces of paper were only those that were inherently murky, the things we didn't properly understand: mortgage-backed securities, credit-default swaps and collateralised-debt obligations. As these fell in value, investors flocked to safety, buying pieces of paper they thought they understood better: demand for government bonds went through the roof and, helped along by abnormally low
interest rates and so-called quantitative easing (the printing press, to you and me), so did demand for equities.

Yet as the value of these apparently safe pieces of paper went up, underlying economic performance remained miserable. The Western world may have avoided a Great Depression Mark Two but it has not regained the swagger of old. Economic activity remains depressed. GDP in the United States has only just returned to the position last seen at the beginning of 2008, implying that there have been three "lost years".

The UK isn't even back to 2008 levels of activity. Meanwhile, recent data throughout the Western world reveal the momentum of recovery appears to be fading. And this presents a big problem. Markets are forward looking. Pieces of paper are priced on the basis of expected future economic outcomes. Yet the Western world may now be stuck in an economic "permafrost", whereby no matter how low interest rates are, the pace of recovery is feeble.

And this permafrost, in turn, is forcing investors to ask fundamental questions of the pieces of paper they already own: can they really be worth what they once seemed to be worth if the policymakers' economic tricks are no longer working?

Those of a more optimistic slant might say that, with low interest rates, it is only a matter of time before economies thaw out and end up staging a standard economic recovery. As time goes on, however, the argument is wearing thin. Investors at the beginning of last year thought US interest rates would be rising by the end of 2010, so confident were they in the regenerative powers of the American economy. They were wrong.

Many held the same views at the beginning of this year yet, as recent data have lurched lower, they're having to revise their views again. The message is simple: low interest rates are not so much an early sign of incipient recovery but, instead, an indication of a deep-seated economic and financial malaise: too much debt and too much deleveraging.

So, if activity remains persistently depressed, we will slowly discover that our collective claims on future economic output may not add up: we have been relying on a pace of economic growth which may now be beyond our reach.

This realisation is already establishing battle lines at home and abroad. Should we raise tuition fees or, instead, increase the retirement age? Must we protect the pension rights of the old at the expense of the educational ambitions of the young? Should the Greeks repay their German creditors or, instead, should they look after their own interests, risking a financial implosion across Europe? And, if the Americans cannot resolve their own budgetary difficulties,
will they find a way of shifting the burden on to foreign powers, either through a major dollar decline or through a descent into protectionism?

Fortunately, some parts of the world are doing well. Although they're battling struggling with inflation, many emerging nations - China, India, Brazil - are growing swiftly.

As a consequence, global growth is holding up, despite the West's ongoing malaise. Unfortunately, the Chinese and Indians don't pay US or UK taxes so their success won't, directly, help the West. And, even if our exports to those countries rise in the years ahead, the impact won't be big enough to offset the domestic squeeze.

Emerging nations will increasingly be trading with each other in the future, thereby leaving the West more and more isolated.

Still, at least these new economic superpowers could potentially bail us out. If we want to live the good life again, we could always sell off a few of our prized assets to Chinese buyers: the Greeks could lead the way with the sale of a few of their islands.

If successful, the rest of us could follow suit. After all, California is bust: perhaps it could also be sold to the highest bidder in Beijing.

* Stephen King is HSBC's chief economist.

- Independent