Using the template of America’s economy and its ripple effects – some would say tsunami – across the rest of the global financial system, this article will focus on how and why capitalism as a system works a whole lot better than any alternative. The idea is to disabuse the notions of system failure that are being propagated by the cynics of capitalism, who in any event have rarely added any economic value themselves.

The discussion is topical, mostly for China, where critics of America’s freewheeling democracy have been at pains to point out the fallout from the subprime crisis and other instances of industrial failures such as US auto companies. [1] Other countries across Asia, most notably the ones that were adversely affected by the Asian financial crisis of 10 years ago, usually take their cues from China; hence the need for China to continue on its capitalist path, which includes a continued expansion of its free markets.

It is the attempted perversion of free markets by Asian and other governments that has caused the current turmoil in the global financial system.

US politics, however, represents the greatest threat in this discussion, even if the biggest losers of any turn away from capitalism would be the country’s poor. That’s because the seemingly well-intended advice provided by members of the US government to rescue subprime borrowers [2] and increased protectionism against Chinese goods [3] would inevitably damage the frail US economy. More important for the future of Asia, non-capitalist behavior by the United States that could easily be duplicated by other countries would dent potential growth rates across the region for decades to come. This is one tit-for-tat battle in which both sides will lose.

Case No 1: US subprime

The most recent episode in US financial markets will be mulled and studied for a long time after all Asian banks – commercial and central – fess up to their losses. [4] While the average Western newspaper appears to blame Wall Street investment banks for the mess, they are barking up the wrong tree as usual. It is not the rapacious capitalists on Wall Street who are to blame, but rather the currency-manipulating Asian central banks. The fault lines of the current crisis thus lie in the antiquated policies of Asian central banks that defy the basic principles of capitalism or even enlightened self-interest.

By stoutly defending their currency pegs to the US dollar well past the intended turnaround in current-account surpluses at the end of the 1990s, Asian economies in effect assumed a subsidiary role to US requirements. A ready supply of investments from Asia meant that pretty much “acceptable” security could be sold down, often well below the returns that prudent economic agents would demand.

Asian central banks invested primarily in debt, and were bound by historically inspired mandates of asset quality that relied much on the rating agencies such as Standard & Poor’s and Moody’s. Profit-seeking agents (or normal human beings to you and me), in this case Wall Street bankers, rightly then provided the service of combining the willing lender with those that America’s own banks would not touch with a barge pole, namely the subprime borrowers. Long considered too risky by mainline banks, the borrowers suddenly presented other market folks with exactly the right opportunity, namely the generation of new mortgages, securities on which could be sold to Asian (and European) banks.

I am under no illusion that it was Asia’s voracious appetite for such debt instruments that lies at the heart of the mess. Look at the deal that the average burger-flipper in America’s heartland got: with a minimum-wage job or two, you could qualify for a largish mortgage that could buy the house of your dreams. True, you had to make mortgage payments (which the government deemed tax-deductible, in yet another assault on the free market) but there was always the chance of selling your house to the next chap for a big profit. The stories of many such new millionaires inspired millions to join the grand scheme. As market returns always fall when trades get crowded, so too did this little scam end, with house prices tumbling across the United States and people facing foreclosure.

It was for this reason that I raised the issue of accountability in the aforementioned article – Asian governments too often get away with massive blunders in the name of public good. China’s currency peg is one such policy, designed for largely illusory benefits to its top line (ie, total exports) even as the bottom line (manufacturing profits) went sharply negative a while ago, before commodity prices galloped upward.

As all actions have an equal and opposite reaction, China’s meddling in currency markets has also produced a domestic bubble in property and stock markets. Constant recycling of billions of dollars from trade surpluses allowed easy access to credit for China’s urban masses, and provided in turn the wherewithal to finance new property and stock investments across the country.

As a recession grips the US economy and shakes out excess consumption, China will suddenly find itself all dressed up for a non-existent party. Whether the waxworks in Beijing like it or not, the country has to revalue, and do it soon, to allow consumption to take over from production as the key engine of the economy.

Case No 2: US car sector

In a previous article, [5] I made light of America’s inability to produce good quality cars at the right price. While the focus of that article was the current US administration’s preoccupation with the status quo (itself an anti-market principle), perhaps a more detailed examination of the current mess in the US auto sector is called for. Not a month goes by when domestic manufacturers (I don’t like calling them the Big Three anymore, because they quite simply aren’t) don’t lose market share, and fail to export more to the rest of the world.

How did the country that invented the assembly line get into this predicament? The most often overlooked answer is of course the trade unions, and in particular the United Auto Workers (UAW), that sought to impose exaggerated lifestyle expectations on the auto companies, and eventually caused them to collapse under the weight of their own generosity. Be it the issue of overly generous vacation and holiday entitlement or restrictions on mobility, the UAW did more damage to US auto makers than any of the Japanese manufacturers ever could. It isn’t without adequate cause that top management of US auto companies often refer to the UAW as the “sleeper cells” of the foreign competition.

The second area was the US government’s intransigence in pricing negative economic goods. These are goods that have harmful effects on society – when they are declared free; markets obviously take advantage of the gap. Whether it was tobacco companies or auto makers with their sport-utility vehicles (SUVs), the problem for the United States was the same. Just as most states failed to value the health of their citizens highly and therefore did not tax tobacco sales, the country failed to value intangible items such as air quality and therefore did not implement taxes on fuel as much of Europe and Asia did (it is another matter that generations of Saudi royals have sought to prevent just such an outcome).

The market reaction came in two ways – first US manufacturers moved away from the passenger-car business in which the Japanese clearly had the upper hand, and enjoyed profits for a little while in the 1990s. The aggregate impact of their production on oil demand, though, eventually caught up with them, and as the price of oil surged, these companies found themselves with the wrong product (thirsty SUVs) at the wrong time (an impending recession).

Left to run its full course, capitalism will push the US auto makers to bankruptcy, remove the excess capacity in production, and thereby push up the price of cars. This will reduce total sales in the US market, and also force Americans to pick a fuel-efficient car over “fat” alternatives. The bankrupt entities will be free to reorganize themselves into viable economic units and shed the restrictive union contracts for one, and rationalize their product offerings for another.

From the two cases above, it is clear that free markets work perfectly well if in a “take no prisoners” fashion. The most rational economic choice is always picked, and in the long term resources are aligned correctly with competitive advantages. In contrast to this, government meddling always perverts the course of economies, exaggerating the ebbs and flows of normal market trends. Herein lies the most important lesson for citizens across Asia.

1. Lifting the hood on the car industry, Asia Times Online, May 19, 2007.
2. ‘Cracks’ in credit, ATol, August 25, 2007.
3. , Deja Wu: Why China must revalue ATol, June 30, 2007.
4. The robbery of the century, ATol, July 14, 2007.
5. Garfield with guns, ATol, September 2, 2006.