Transcript Postwar US economic resurgence after self destructiopn of Europe

Historical Perspective of the Economic
Crisis and the Recovery
Presented at
The 20th ASA Congress
Taipei
by
卜若柏
Robert Blohm
http://www.blohm.cnc.net
September 27, 2010
2010年9月27日
Download at: http://www.blohm.cnc.net/Taipei
1
1. History
Post WWII US economic resurgence
after self destruction of Europe and
East Asia.
US had become a huge net exporter in
the 1920s & 30s. Militarily weak and
isolationist.
Germany deficit financed itself to
military dominance. Hjalmar Schacht &
MEFO bonds.
War indebtedness and decolonization
by the UK led to the demise of the
British pound as the world reserve
currency which took 20 years to
happen.
The Marshall Plan’s capital inflow of US
dollars into Europe and Japan to
support Social Democracy as an
alternative to Communism widely
diffused US dollars worldwide, was
used in part for purchase of US exports
and led to the creation of the
Eurodollar market and establishment
of the dollar as the vehicle currency
for international trade.
European and Japanese economic
strength in the 1960s as producers of
low cost products began to reduce the
US’s net exporter status.
The Vietnam War and the Great Society
drained the US fiscally. The war and welfare
economy made the US into a net importer by
the late 1960s. A general loss of faith in
economics manifested itself in the US,
Europe and China (following failed economic
policies there) by massive protest
movements of youth driven by ideology. Loss
of confidence in the US dollar prompted
requests to the US Federal Reserve to
exchange it for gold, prompting President
Richard Nixon to take the dollar off the gold
standard and eventually to abandon the
Bretton Woods system of fixed exchange
rates.
The Nixon Administration opted to
expand government spending to
sustain the post Vietnam War
economy through recession.
In the early 1970s the Texas Railroad
Commission ended the system of production
quotas that had kept the oil price low and
stable for decades (and the creators of OPEC
studied that system). The intent was to
increase supply and thereby lower the oil
price to boost the economy. The result was
that remaining reserves in Texas (the Black
Giant) got depleted and the oil price rose.
The result of the two dramatic measures,
floating exchange rates and the formation of
OPEC, has been 4 decades of volatile
commodity prices & exchange rates.
The 2 oil shocks of the 1970s (the first triggered by
the Yom Kippur War, the second by the Iranian
Revolution) drove the US into a deeper net importer
position. President Nixon imposed wage and price
controls, especially of oil prices which only kept oil
consumption high and set the stage for the second oil
price shock which was followed by high oil prices and
huge inflation and economic stagnation in America.
Capitalism was viewed as on the threshold of
destruction as petrodollars had recycled into USdollar loans to developing countries, helping to pay
their oil imports, but setting stage for the developing
world debt crisis of the 1980s as interest rates rose to
break the back of inflation and ultimately raise the
value of the US dollar against other currencies as oil
prices declined in response to downward demand
adjustment to high oil prices.
2 heros emerged to meet the
challenge to the survival of their
respective economies: Ronald Reagan
and Deng Xiao Ping.
The impact of the oil shocks in ending
Japan’s two decades of 10% annual
economic growth prompted Japanese
manufacturing to become ever more
efficient and quality-oriented (partly in
implementing the industrial engineering of
US statistician W. Edwards Deming whose
ideas weren’t so well received in the US).
By the early 1980s Japan exceeded the oil
exporting countries as the biggest net
capital exporter to the US.
Ronald Reagan took advantage of Japan’s
willingness to finance the US deficit to
implement the “supply side” economic recovery
plan of Robert Mundell which consisted of a
tight monetary policy of high interest rates to
fight inflation as successfully done by Jimmy
Carter’s appointment of Paul Volker to the US
Fed, and a loose fiscal policy (the Kemp-Roth tax
rate cuts) to stimulate the economy. This broke
the received wisdom of economists called “the
funnel” which prescribed that fiscal and
monetary policy be simultaneously tight or
loose.
Deng Xiao Ping opened the first 30year phase of China’s reform &
opening up: rural enterprise was
allowed to compete against State
Owned Enterprise, and farm labor was
allowed to migrate to export
manufacturing platforms of
multinational corporations.
Deregulation and marketization
enabled economies to reduce
overhead costs through competition in
the 1990s: “the Washington
Consensus”. Commodities prices
dropped. The Internet Economy
emerged with IT efficiency.
1985 Yen appreciation kept the
Japanese economy in the slow growth
mode it was thrown into by the 1980s
oil shocks.
The Asian Tiger economies roared as
East Asian governments borrowed in
US dollars to develop export industries
expected to pay back the loans.
Super-growth proved to be the result
of migration from country to city and
stopped once that process stopped.
A strong US-dollar US recovery prompted by
a weak US-dollar driven emergence from the
post Gulf-War recession and a “peace
dividend” following the end of the Cold War,
and the completion of urbanization led to the
1997 Asian Financial crisis as East Asian
economies struggled to service US dollar
debt with weak currencies and as their supergrowth that had attracted massive inbound
investment was over. East Asian economies
were forced to internally
restructure/marketize their economies away
from central planning and “crony capitalism”,
the most notable example being the demise
of the Korean Chaebols (conglomerates).
China resisted devaluing the RMB and
instead took advantage of low energy
prices to actively promote energy
intensive industry, while promoting
competition in the energy sector by
inviting foreign investment in it.
In the early 2000s the Internet bubble
burst and the US was attacked on
9/11/2001. Oil prices began to exceed
their long-term average. This undid
deregulation and marketization
efforts, and prompted the Enron
collapse. Low interest rates to support
the economy prompted a subsequent
real-estate boom.
China stopped further development of
commodity market pricing and
imposed regulation of prices to below
world market levels to satisfy domestic
consumers and promote exports.
2. The 2008 Financial Crisis and
Subsequent Great Recession
Financial crises often arise from lack of
supervision and due diligence. This is
due to the human tendency toward
over-confidence. To give a striking
example, the US government’s Brady
Report on the causes of the 1987 stock
market crash (in technical ways similar
to the 2008 crash) is still not available
on line and is available only by mail. In
other words, before and after the
2008 crash, nobody consulted the
Brady Report.
Lack of management oversight of
increasingly technical processes gave
too much discretion to experts. Banks
gave up their credit oversight role of
credit assessment of the customer and
instead lent exclusively on the basis of
collateral and this broke the golden
rule of banking, namely “know your
customer”.
The US government in the form of Fannie Mae and
Freddie Mac, long the subject of media criticism
for unsound finances and management, was a
major force driving excess credit for real estate.
Even China’s government played a role in
facilitating the US real-estate bubble, by investing a
huge portion of China’s export earnings into Fannie
Mae and Freddie Mac bonds, and by “sterilizing”
the inflow of cash into China for speculation or for
goods by using existing RMB (rather than printing
new RMB) to exchange for the incoming US dollars.
That, together with price controls, prevented pricelevel rise in China, and stimulated US consumption
of Chinese products whose low price kept US
inflation low and justified the artificially low US
interest rates which stimulated the housing
bubble.
Meanwhile Chinese consumers facing
artificially low prices for commodities
consumed too much of them, pushing
world prices higher, for example of oil
of which China has been responsible
for 40% of new purchases, which set
the price for all purchases.
That prompted the US Federal Reserve
in early 2008 to suddenly worry about
inflation, reverse course and raise US
interest rates. That caused the
interest rate on the lowest quality
mortgages to double and trigger the
sudden death of the sub-prime
mortgage market.
Economists almost never point out that practically all
financial crises are due to mismatching the term of
assets and liabilities, in particular by borrowing short
term at normally low interest rates in order to use the
funds to buy a long-term asset whose higher return is
fixed for a long period. While financial institutions
routinely mismatch assets and liabilities to profit from
expected movement in interest rates, the US housing
bubble was the first time consumers were encouraged
to do the same thing, but in a highly risky way opposite
from normal. They were allowed to borrow only short
term at prevailing very low rates, to invest in a home
which is a long-term asset. When interest rates are low
you normally borrow long term to lock in the low rate
for the future. Otherwise the short-term rate will rise
later when you cannot pay for that increase from any
increased return from your long term asset.
Robert Mundell, the father of fixed
exchange rates (such as the Euro), believes
that a sudden rise in the US dollar followed
by a sudden dramatic fall causes
recessions. That prompted the collapse of
Lehman brothers and the immediate
financial crisis where Citibank was on the
verge of bankruptcy, and subsequent
recession, and the current possible double
dip after the Euro suddenly depreciated &
then recovered as the dollar depreciated.
The most important single policy
consequence of the financial crisis has
been revival of the attempt at a global
fixed exchange-rate regime like the Bretton
Woods system ended by President Nixon.
The call for a world currency, to some day
replace the US dollar as the “vehicle
currency” for international trade and
investment, is a version of that attempt,
where all surrogate currencies would be
linked in a system of fixed exchange rates
to the world currency and would disappear
if eventually no longer used.
The G-20 is also developing sounder
uniform operating rules for banks,
such as increased capital to more
easily absorb shocks like the financial
crisis.
The emergence of the G-20 itself is an
important result of the financial crisis
in which emerging developing
economies had cash that they were
willing to place to assist the IMF and
that challenged developed economies
did not have.
3. The Post Economic Crisis
The US dollar will not be replaced as the
reserve currency any time soon. The
reserve currency must first be a “vehicle
currency” widely used for international
trade and investment, and a vehicle
currency is convertible. Convertible means
that there is enough of a supply of the
currency outside the country of origin that
is freely exchangeable and exerts supply
and demand pressure on the currency
independent of direct controls by the
country of origin, except by
intervention/participation by that country
in the offshore supply and demand.
While China’s GDP is 12.5% of the
world’s, the Hong Kong Monetary
Authority has estimated that a
convertible RMB would constitute 3%
of world reserve holdings on the basis
of its use in transactions.
In international trade and investment
discussions, economists tend to reduce a
domestic economy to two components,
consumption and investment, & ignore the
third big component, government expenditure.
An economy’s external “balance” is the
difference between these three expenditure
categories and income. A country has a
positive/surplus balance if its income exceeds
expenditure on those three items and the
difference consists of net exports that the
country’s extra income is used to lend to
foreigners to buy. A country has a
negative/deficit balance if spends on net
imports money that it borrows from abroad.
East Asia’s surpluses with deficit countries
like the US are not simply due to too much
consumption in the US and too much
investment in Asia. They are due in large
part to the size of government
expenditure. Imbalances become
unsustainable when the role of
government in their creation becomes too
large.
The more direct solution is to reduce the
role of government rather than explicitly
“target” consumption and investment. If
government has been promoting
investment in China, then reducing
government’s roll could see consumption
rise naturally. In the US, government
spending has displaced investment, while
US consumers did adjust to the financial
crisis immediately by reducing
consumption which is not necessarily good
for the economy.
The Tea Party movement is a revolution in
US politics that aims to dramatically reduce
the role of government in the US economy
by growing the economy and investment
through reduction in tax rates that
eventually lead to higher overall tax
revenue and reduction in the US
government deficit as occurred in the early
years of the second president Bush. The
Tea Party is aligned with China’s interest in
protecting its investment in US Treasury
bonds by assuring sounder US government
finances on the basis of economic growth.
The financial crisis has had the
unfortunate effect of being cited as a
failure of capitalism by those wanting
more state interventionism in their
economy. Market crashes and
recoveries are included in capitalism
rather than being a failure of
capitalism(‘s promise). It’s a fact of
human existence that failures happen
quickly, almost immediately, while
recoveries take time.
China in the past 8 years has moved
toward state capitalism with less emphasis
on the “socialist market economy”,
especially since the financial crisis.
Government led investment provided a
temporary basis for growth during the
crisis. China faces the choice of performing
the next stage of reform-and-opening-up in
the form of decontrolling the Chinese
economy, or declaring a New Paradigm.
Predictions that the New Paradigm will
shape a new world economy may be as
exaggerated as the hubris expressed at the
peak of Japan’s economy in the late 1980s,
and manifested in the short-lived 1987
stock market crash that the Brady Report
attributed in part to massive selling of US
Treasuries by Japanese institutions.
Instead, because Japan has still not
sufficiently reformed internally, Japan fell
into irrelevance.
Mainland Chinese companies don’t know
very well how to manage global business
enterprises and those businesses are
overlaid by a Party Secretary structure
appropriate to domestic enterprises.
Japanese companies had extreme difficulty
expanding abroad partly because of
cultural refusal to confide in foreign
managers. But the Japanese auto industry
has been a resounding success of global
expansion, to the point that one of the
companies has a foreign CEO and uses
English in all internal communication.
Chinese are excellent portfolio
investors and small business operators
with history’s greatest diaspora of
capable people, primarily business
owners and professionals. Portfolio
investment may be the only feasible
way for China to finance its huge trade
surpluses by investing into the
importing country’s economy rather
than in its government.
China’s export driven, capital control model is
unsustainable because there is a natural limit on
reserve accumulation by a single country of
government securities by another single
country. Both countries ultimately give up
sovereignty to one another and that only drives
up political tension in both countries. China’s
Central Bank has financed America’s War on
Terror while China’s Foreign Ministry might not
agree. Americans who perceive China is
influencing US government policy through its
investment in US Treasuries could become
opposed to importing goods from China.
The IMF has been concerned by increased
imbalances between countries that lead to
overall huge reserve accumulations that
are destabilizing by the very ability to use
them to manipulate currencies’ values.
That growth in imbalances and overall
accumulations lends urgency to the need
to reform the world exchange rate
mechanism into something resembling the
old Bretton Woods fixed exchange rate
structure.
China faces serious internal governance
issues: financial reform of the currency and
banking, wage increases, and commodity
price increases to world market level.
China’s banks practice collateral-based
lending (as the US did before it led to the
sub-prime crisis) not credit-analysis based
lending. There is no true money market in
China whereby banks manage the
economy’s daily cash float and dispense
cash to borrowers as needed. Instead loan
proceeds are disbursed immediately and
the property market is used by borrowers
as a parking lot for excess cash.
The property market wildly
appreciates because it is serving the
multiple purposes of missing markets.
Property is bought not for use as much
as for appreciation. Meanwhile the
increasing unaffordability of housing
to the middle class is creating wage
pressure.
China’s resource for future growth is
general decontrol of the economy and
the movement of the manufacturing
economy to the interior. China’s
demographic clock during which it can
achieve this may run out in 20 years,
as population growth stops in ten
years and migration from rural to
urban completes in 20 years.
Inflation is not price increases, nor a
valid reason to resist wage and price
increases. Wage and price increases
matched by productivity increases are
not inflationary. Such increases in
China are necessary and structural, not
inflationary.
The result of too slow reform is US
pressure to appreciate the RMB. Better to
increase wages and prices in China than
the RMB, or than tariffs on Chinese goods
by the US (which the WTO could rule
against but the whole process takes a very
long time while US actions can exact
immediate damage). RMB appreciation
would have the effect of diversifying
China’s investment in US Treasuries among
potentially several East Asian countries, a
politically more palatable alternative.
So, I predict that as much as the financial
crisis can be used to make a case for the
end of capitalism, a case can be made for
the end of socialism. We may ultimately
see enormous government divestiture of
assets in Europe and America (if not in
China), in other words privatizations, a
return to marketization. Even Cuba is firing
a tenth of its government employees
despite a push toward socialism by a few
commodity exporting countries with excess
cash to dispose of.