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INSIGHT-West in political crisis has echoes of 1930s =2

Sun, 1 Jan 2012 12:59 GMT

Source: reuters // Reuters

downturn.

But elections alone may not prove the answer. To break the paralysis, political leaders need to offer a new vision, one that rebalances the cozy linkage between finance and politics, otherwise the credibility of the political system will remain compromised, said Scheherazade Rehman, professor of international affairs and finance at George Washington University.

"There has to be a shifting of our institutions. The banking system is at the heart of our economic system and with it extraordinary ties to the political system. We have to rethink the close relationship that caused the breakage," she said.

The political crisis shot to the foreground this year as voters lost confidence in how governments responded to the 2007-2008 financial crisis, global recession and the resulting explosion in sovereign debt levels. Two narratives have emerged of what went wrong. The left casts the banker as the prime villain, unpunished by the political elite who allowed CEOs to violate all the principles of fiduciary and moral responsibility in pursuit of personal gain, which fuels the perception of a political system in collusion with a criminal financial elite it is unwilling to punish.

The right-wing narrative casts big government as the villain for exploiting the crisis to expand its regulatory powers that intrude on free markets, and to spend money on huge bailouts and social welfare programs that have only exploded the budget deficit.

In both narratives, the victim is the average citizen who is left paying a gigantic bill - through high unemployment, higher taxes and lost economic opportunity. Either way, the compact between political governance and economic life has broken.

"The political reaction, whether big government is seen at fault or big business, the reaction is that the system is tainted and there is too much crony capitalism at work," said Raghuram Rajan, finance professor at the University of Chicago and former International Monetary Fund chief economist.

There is a distinct possibility that political dysfunction will continue well after the 2012 elections - held in May for France and November for the United States, while China completes its leadership handover by the spring of 2013.

In the United States, voters could return a divided and polarised Congress again, continuing the legislative standoff. One-party rule may prove little better, if the path chosen toward budgetary discipline is excessive taxation or ultra-steep budget cuts. In France, the election winner's relationship with Germany and fellow EU leaders will prove critical.

Although Western democracy has demonstrated the flexibility to reform when facing severe challenges, the shadow of the 1930s looms large. This uncertainty over whether strong political leadership can emerge in 2012 is haunting markets.

John Browne, senior economic consultant to Euro Pacific Capital, is among the pessimists. He told clients in his year end note that American and European Union politicians have shown utter unwillingness to take tough decisions they know should be enacted to avoid looming global economic disaster.

"With an estimated $6 trillion plus solvency shortfall of the euro zone banks, and $16 trillion in U.S. public debt, it will take leadership of far greater caliber to avert a disaster. Such leadership is nowhere in sight," he said. (Reporting By Stella Dawson; editing by Claudia Parsons)