While observing the recent ritual of the Group of Twenty summit in Washington (see Blind leading the one-eyed, Asia Times Online, November 18, 2008), I couldn’t help but think about the old California joke about lawyers; in the weeks following the meeting when we have seen precipitate action by all of these bankers as well as their masters in respective governments; the joke was repeated endlessly in my head. So here it is, albeit paraphrasing the question to: “What would you call an accident that makes all G-20 central bankers sink to the bottom of the sea?” Chan Akya: “A good start.”
Just to be clear, I do not wish physical ill on any of these befuddled academics stumbling their way around the global economy like a resurrected Titanosaur walking around New York as changes in the magnetic field upset the migratory pattern embedded in its pea-sized brain. Despite not wishing them physical harm, there is a part of me that wants to grab them by the collective scruff of their necks and ask them a simple question: “Are you guys completely out of your minds?”
Having been subject to similar diatribes against this species many times before, you may wonder what they have done now. Well, the week produced an absolutely perfect pair of moronic actions from the US and China that helped to set me off on my new line of thinking about a world without these gentlemen; but I jump ahead of myself.
To use the favorite expression of economists, on the one hand you have the US trying to rebuild its productive capacity with greater borrowings while on the other you have China trying to devalue its currency to maintain a competitive edge on exports. Both these stories were covered this week in Asia Times Online, respectively by Julian Delasantellis (see US auto rescue – a society health check , December 11, 2008) and Peter Navarro (see China plays beggar thy neighbor , December 9, 2008).
Don’t get me wrong though – I just am picking up the most convenient pair of countries to discuss. It could have as easily been the European Union, Britain, Japan, Brazil and so on in terms of the sheer nonsense coming out of central bankers these days; as it happens, the most bizarre stories this week were those from the US and China.
The US has run a massive current account deficit for a long time, while China has run a sharp current account surplus. I have argued before that it was China mispricing the debt it supplied to America that kept the addiction going for millions of Americans, in turn creating the housing bubble and the wave of securitization that culminated in the current crisis. That particular feedback loop is outside the scope of this particular article, as I focus instead on the actions being taken by the two countries.
With a current account deficit and absent any willing lenders, the only way forward for the US is to recognize that a rebalancing of its economy away from consumption to production is in its interests. This calls for a number of changes, including an overall contraction of the economy by over 20% and perhaps as much as 30%; for a very sharp decline in wages and other local factor costs of production and lastly for currency depreciation that helps to rebalance its global competitiveness.
As for China with its gargantuan current account surplus, the only way forward is to effect greater government spending (fiscal deficit) intended to spark consumption as it attempts to replace production intended for the export market – primarily to the US market. The resulting Chinese economy will probably be 10-20% smaller, but certainly better balanced and capable of generating more profits than it does now.
Confused bankers, confused markets
Instead of accepting these bald-faced truths, the two countries are trying to sugar-coat the situation by in effect switching their respective medications. The US is behaving as if the government has the wherewithal to fiscally stimulate a broken part of its economy, and China is behaving as if its path to resurgence lies in the age-old production route.
Being primarily academics, most central bankers have the ability to compartmentalize problems and often try to solve a problem by imagining a state of ceteris paribus – or other things remaining the same. My advice to readers who ever hear or read that phrase as part of a central banker’s prescription to a particular problem is either to switch the channel or close the book; for there is no such thing as ceteris paribus in the real world of reflexivity and feedback loops.
The US government, after throwing some US$800 billion at the banking problem and assigning a further $4 trillion to guaranteeing vital parts of the financial infrastructure, now plans to spend more than $15 billion in rescuing the three US automakers – GM, Ford and Chrysler; this could easily increase to over $100 billion. The reason that such a course of action is being considered is that financial markets aren’t levying any penalty on the bursts of irresponsible behavior being exhibited by US Treasury Secretary Henry Paulson and Federal Reserve chairman Ben Bernanke.
If the combined effect of the silly financial rescues had been to push US treasury yields to 10%, the government would have a good reason to keep its financial misadventures in check. Instead, with bond investors cheering every irresponsible move by the government, there is in effect an emboldening of such policies; which is why there is no fear of throwing another few billion into lost causes such as the US automakers.
Most recently, this sent the yields on the US Treasury three-month bill to 0% this week as investors effectively abandoned any hopes of finding assets with acceptable returns. Put differently, the markets are now betting that the wave of deflation coming from the collapse of consumption is so great that even a 0% return on capital would be better than the alternative, namely to lose substantially more in other asset markets.
In any recession similar to what the US is facing now, the effectiveness of monetary policy is highly questionable as the restructuring of balance sheets (companies’ and individuals’) takes precedence to profit-taking. Effectively, consumers won’t care about the price of the car or its maker as long as they do not want to take on another car loan at whatever rate. Even in good times, US automakers saw their market shares decline because of slipshod products; it is highly unlikely that the tide can be turned when the size of the market becomes sharply smaller.
This is the deflationary pullback like the tide going out before a tsunami storms in though; the misallocation of US government resources means that the money that doesn’t get wasted on hare-brained rescue plans will simply end up causing random pockets of inflation. (Note here – pockets of inflation, such as rising commodity prices; rather than a generalized inflationary spiral).
Initially at least, it appeared to me that China had the right approach to the current crisis, namely to increase government spending (fiscal stimulus), encourage greater private consumption, broaden monetary policy measures and so on, with a view to diversifying the economy’s income streams from exports to more domestic means.
That has however not delivered the right results so far. Commercial banks are already in trouble on their stock of bad loans and poor capital ratios as I wrote last week (see Going, going, GOME, Asia Times Online, December 6, 2008); coming as they do after two decades of strong economic growth, there is reason to fear the impact of even two or three years of recessionary conditions.
Chinese investors were burned at the altar of stock and property markets by the central bank’s asinine policy of increasing interest rates and constricting lending in place of allowing currency appreciation from 2005. This decline in Chinese stocks has come about at the worst possible time – before an economic bust – rather than when going into the spiral; that means the government will have to do a whole lot more in China than it would otherwise expect to anywhere else in the world.
Then there are the various other scandals in China, ranging from high-level corruption to the incompetence of regional officials in dealing with the Sichuan earthquake and the Tibetan riots; those with an economic bent of mind would also consider the sharp declines in November trade figures that highlighted the misplaced tight credit policy of the central bank.
Given all this, China appears to have significant self-doubts about the government’s ability to deliver a fiscal stimulus without overcoming high levels of leakage from corruption and plain incompetence; in effect the government’s mianzi – or pubic perceptions of the government’s prestige – from recent events, including the successful Olympics, are possibly seen as insufficient given the negative lian – the confidence of society in the authorities’ moral character – from other events such as recent corruption scandals and builders’ incompetence that was exposed in the Sichuan earthquake.
Doubts over the government’s competence in handling the economic decline mean that attempting new or innovative courses of action would be too risky for the communist party; hence the hankering for the tried and tested formula of stronger exports.
With the medication switched between those who should increase production and those who should increase consumption, we are unlikely to see any improvement to the global economy over the near future.