It was twenty years ago today ...

It dawned on me this morning that it is twenty years since I packed myself off to Germany to start a new job. Two whole decades! As I reflect on where the time has gone, and why English football is in an even worse state than it was then, I am struck by how much simpler the world economy appeared back in 1996. The world's economic power was concentrated in Europe and the US, which meant that keeping track of the fundamental issues driving markets was a relatively simple task. European monetary union remained an aspiration for policymakers whose aim was to meet the qualification targets for entry into the single currency. Central and eastern European economies were still adjusting to the post-Communist world and were early converts to go-go capitalism which promised a massive rise in living standards. In Japan, we were awaiting a recovery following the bursting of the bubble economy in 1990, whilst southern and eastern Asian economies were regarded as a dynamic, but very unsophisticated.

How times have changed. Two market booms and busts later – the most recent being the most far-reaching since the Great Depression – the position of the US as a kick-ass superpower has changed. It is still the strongest military power in the world but its economic supremacy is no longer unchallenged. European monetary union did happen as promised, but as recent events have shown, it is far from a one-way ticket to prosperity. Many of the smaller nations in southern and central Europe are struggling under the weight of the massive rise in debt accumulated during the boom; we are still awaiting a solid Japanese recovery following 25 years of stagnation and Russia looks more like the old Soviet Union than the engaged partner the west hoped it would become. But the biggest change has been in the perception of Asia, particularly China, which is reclaiming its historical importance as a big player on the world stage.

Of all the events which have taken place over the past two decades, perhaps the most emblematic was the Lehman’s bankruptcy of 2008 which marked a seismic shift in the western world. This signalled an end to the fantasy world of debt-fuelled prosperity and the dawn of a day of reckoning. No longer would we be able to build our monetary Tower of Babel all the way to Heaven (to use Jens Weidmann’s analogy). We would have to be content with a smaller place with fewer floors (or should that be flaws?). As it turned out, the foundations  of our tower were pretty rotten and even now we are still digging them out, trying to construct a more sustainable structure.

In retrospect, we should have foreseen many of the problems which hit us, but most of us did not. As Martin Wolf noted in his book, “The Shifts and the Shocks”, we “lacked the imagination to anticipate a meltdown of the Western financial system.” Perhaps that is because we had created a system which had proved pretty robust to all that had been thrown at it and we simply became complacent. But an additional reason is that we failed to understand the significance of the change in the world economic order. Ben Bernanke argued as far back as 2005 that excess saving in surplus countries such as China was a contributory factor to the boom which preceded the western bust. It is not the whole story, but it indicates that the changed dynamics of the global system meant that western economies were potentially subject to forces which they had not been designed to withstand.

So whilst it may be overstretching it to argue that the 200 year dominance over the world economy enjoyed by the west is at an end, I have long believed that the high water mark of western capitalism was reached in summer 2007. As that particular tide begins to ebb, it will become ever more apparent how important the Asian economies will be to the global economic order. The US and Europe will no longer be in a position to decide for the rest of the world.

I noted some years ago that against this backdrop, Europe will have to be more outward looking; more open to hearing the voice of the electorate in order to shape its liberal democracy to cope with the demands of a 21st century world. Policymakers will have a key role to play in this debate, balancing the need to impose adjustment against the resistance of the electorate to the radical changes which are needed. The signs are not looking propitious. The stresses imposed by the euro zone debt crisis have exposed fault lines in the design of the single currency whilst the threat of Brexit may be the thin end of a wedge which exacerbates European divisions as populism rises up the political agenda.

We can be certain only that the old certainties no longer hold and for that reason it is pointless to try and predict what will happen in the next twenty years. Suffice to say that western policymakers have a lot of work to do to ensure that we will be in a position where we can feel as positive about our future in 2036 as we were in 1996. I would like to be optimistic about where Europe is headed. But until such times as we rediscover our sense of purpose, I suspect the years ahead will be politically and economically challenging.