A comment in the Financial Times, “Prudent Asia is unlikely to bail out the west,” by David Piling, provides a badly needed reminder: societies watch out for themselves first. And the way they define their best interest may not correspond with what we think is good for them.
Forgive us for repeating ourselves, but we have mentioned more than once that we have some reservations about the analogies being drawn to the Great Depression. The vast majority of economists are basing their prescriptions on what the US should do now with what they believe would have worked for the US then, namely, more aggressive monetary easing and fiscal stimulus.
But the US then was the world’s biggest manufacturer and creditor. Its position then is more analogous to that of China now. And recall that Keynes not only wanted the US to run even bigger budget deficits back then, but he also said it was unreasonable for the US to expect is overconsuming, indebted trade partners such as the UK and Germany to go deeper into debt to support the US (and the UK, France, and Germany all defaulted on their government debt).
That suggests that China, and not the US, should be fast to adopt stimulus programs (note that the impressive-sounding Chinese package is estimated to be only 1/3 to as littel as 1/6 of new programs, and most of those take place in teh second year of this two-year effort). It is not clear that trying to restore the status quo ante of a ever-more-deeply-in-debt US funding overconsumption from China and other exporters will work for any length of time.
Pling adds two more unpleasant considerations to this equation. Even if the Chinses accepted the notion that they needed to take up most of the demand slack, their ecnoomy is way too small to make up for the shrinkage of US and European demand in any reasonable time frame. And the Chinses (not surprisingly) have little sympathy for a decadent West suffering the consequences of its lack of discipline.
From the Financial Times:
Profligacy is the new prudence….. After decades of predicating growth on piled-up savings, weak currencies and hyper-demand from shopaholic Americans – hitherto the world’s buyer of last resort – Asians must now start spending some of their hard-earned cash on themselves…
Now Americans are rebuilding their savings. Companies too are forcing some employees to spend less by the simple mechanism of sacking them. That means – short of a collapse in global trade – the surplus-savings countries have to spend more.
On the surface, Asia appears to have heeded the call. The region is awash with stimulus packages…
Yet, if you were to conclude that Asian consumers, flush with government handouts, are about to spend the world out of trouble, you are in for a disappointment. For a start, outside Japan, Asian economies simply lack the scale to act as global locomotive. Stephen Roach of Morgan Stanley shows a bar chart in which Chinese and Indian consumption are barely visible alongside the towering demand of the US and Europe.
But even if Asia had the oomph, it is far from clear it has the will. Hardly surprisingly, it views as foolish the excesses that led the west into so much trouble. While macro-economists dispassionately weigh borrowing and lending and call for a global rebalancing, Asians still tend to view the story as a morality tale of thrift and profligacy.
A few tales from around the region underline the point. In Japan, Kaoru Yosano, economy minister, says he would need a week to consider what to buy. Like many Japanese, he says he has all the modern conveniences he requires. The same is true on a national level, where Japan’s government is worried about public debt – given that it is 180 per cent of gross domestic product, that is hardly surprising – and convinced there is nothing left to spend money on anyway. A few years ago, one rebel economist, who wanted Japan to print its way out of deflation, could think of nothing better on which to lavish a proposed $150bn than on a fleet of 250m-long garbage incineration and fish-farming ships. (The Japanese government did not take up his suggestion.) More than half of Japanese voters, polls suggest, are against the $600 government handout.
Such prudent attitudes are not confined to Japan. Gloria Macapagal Arroyo, Philippines president, proudly insists that she will not increase the budget deficit beyond 1 per cent of output even though the International Monetary Fund, which wrote Fiscal Rectitude 101, told her she could safely double that. And just look at Chinese consumers, 90 per cent of whom, according to surveys, pay for their new cars cash on the nail. No zero per cent financing in Nanjing.
There are good reasons – beyond any questionable notion of natural Asian prudence – to explain such reticence. Asia’s post-war growth was built, by and large, on policies that suppressed consumption and favoured big industry, especially exporters, through government-sanctioned price cartels and undervalued currencies. (Japan has allowed the yen to strengthen, but China’s reflex reaction to the downturn has been to halt, even reverse, currency appreciation.)
The lack of a social safety net in much of Asia has also added to the propensity to save, forcing people to defer consumption and plan for the future. In China, where private demand is an astonishingly low one-third of GDP, people hoard cash to pay for education, healthcare and retirement benefits that their nominally Communist government entirely fails to provide.
Asia’s propensity to save is engrained more by policy than by culture. But that doesn’t mean it can be quickly or easily reversed.
By contrast, I was in the eye doctor’s office Monday and overheard some of the terms for financing Lasik surgery: no interest for the first 18 months, 9% if you go longer.
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A Clear and Present Danger
AIG is now proving out to be the financial black hole I said it would be when I looked at its SEC-filed documents back in September. Those were a complete disaster, so who knows what the real inside books look like. We know that the Fed/Treasury combined has invested a total of $153 billion in Bernanke printing press money to keep AIG from completely collapsing. Where has this money gone? We don’t know exactly, but we do know that $20 billion of it was used to monetize Goldman Sachs’ credit default counterparty risk (anyone troubled by the fact that taxpayer representative Hank Paulson is an ex-Goldman CEO and current Goldman CEO Lloyd Blankfein was the only non-Govt/Fed person at the meeting which approved the AIG bailout?). We also know that at least $500 million has been spent on executive compensation. This is YOUR tax money at work:
Here’s another $10 billion in failed derivative trades:
American International Group Inc. owes Wall Street’s biggest firms about $10 billion for speculative trades that have soured ..
http://calculatedrisk.blogspot.com/2008/12/aig-black-hole.html
It was announced on Dec 3 that the Fed has purchased another $53 billion in credit default swaps from AIG:
http://news.yahoo.com/s/nm/us_aig_cds
AIG has admitted to underwriting $400 billion in credit default swaps. But this is what can be verified from public documents and disclosures. Please recall that in the case of Enron, we did not know the sum total of the off-balance-sheet derivatives fraud committed by Enron until it was already in bankruptcy and the legal discovery process forced out the truth.
I suspect with a high degree of confidence that: 1) AIG’s admitted $400 billion in credit default swaps will require $400 billion in taxpayer bailout money and 2) that the true size of AIG’s financial black hole, like with Enron, will not be known until AIG is ultimately dragged through bankruptcy liquidation, but that AIG’s ultimate financial exposure will exceed $1 trillion.
And one more point: We know AIG is beyond insolvent. How come AIG is not going thru the legal bankruptcy process right now? What are they hiding? This is your tax dollars going down the drain. I expect to see gold pressing $1000 before we celebrate the New Year.
Yves, I understand the the U.S. cannot continue to borrow to feed consumption without a default. What I don’t understand is what the least bad fiscal strategy for the U.S. is right now. While the government can borrow for free, while the private sector can borrow at 8% (if it can borrow at all), it makes sense for the government to borrow, no?
Yes, it will all end in tears when the U.S. defaults, but that hurts the creditors. It doesn’t hurt Americans.
And the sharpness of that lesson will spur India and China to increase local demand, primarily by trickling the benefits of growth down to the poor, hopefully through nascent social security systems. One can hope. The point is that until something changes, nothing will change. In this case, that looks like the least bad option to me.
macndub,
This is not just a matter of money flows. Over 20% of our chips come from China, and another 50% from Taiwan. The Chinese can threaten to withhold them (and its navy is now an active enough presence locally to make the Japanese nervous).
And last I checked, we do need that Middle Eastern oil. We cannot casually stiff our creditors and expect there to be no consequences. At a minimum, expect all imports to be invoiced in non-dollar currencies, and any future external debt to be non-dollar denominated.
Fantastic post as usual.
the situation wont resolve until we have the populations in India / China into consumption mode. Hopefully in a saner way.
Also macnub, isn’t it possible that by taking up extra burden – US is gaming the system for much protracted and far too much deeper correction.
Third – I think there is a difference between the way a creditor-debtor relationship plays out between corporate parties than when nations are parties. Nations dont have exit route / no mergers or asset stripping!
To a certain extent US troop build-outs across the world were a result of WWII costs that US incurred as the creditor. Now look at China in same place – how will it help US become profitable – cut costs – defense costs? then what? will US agree – hell no! But there will be meaningful pressure.
If a debtor has wherewithal debtor can muscle the creditor out of the equation – is such a scenario likely?
It might seem that I am crazy – but the points here are positive probability events – small probabilities but positive ones.
Apologies for what seems like idiotic shock and awe.
There’s a much greater chance that the Chinese government falls than the US over this crisis. For one thing, the Chinese don’t regard their government as the definition of their culture. They’ve had dozens of revolutions before. The US is defined by its revolution.
re: the article. Lumping the Philippines in with Japan and China is silly; it is quite different in terms of culture, religion, language, history and national wealth.
Also, the writer can’t decide ‘those Asians’ are culturally frugal, or if it’s a result of policy. The result is a scattered article.
@ Yves,
“Forgive us for repeating ourselves, but we have mentioned more than once that we have some reservations about the analogies being drawn to the Great Depression.”
You just go on repeating yourself. In the world of media, blogging, reiterating the same point over and over is what it takes in order for it to sink in amongst your readers.
btw, I already learned from your posts on the GD, along with RK’s inputs back in Oct, I believe.
re: Chinese stimulus…pettis pointed out a blog dedicated to chinese politics…the blogger basically posits that the majority of the fiscal stimulus is designed to help a lot of state-owned-entities (SOE’s) simply avoid bankruptcy…
“Basically, Chongqing SOEs, which focus on land holding, real estate, electricity, and financial services, are in deep trouble. Land prices in Chongqing have fallen by over 70%. The electricity group is in the red by about 250 million RMB. The debt asset ratio for the 8 major SOE groups in Chongqing has risen to 72%. No details are given about the financial holding companies, but considering that their main role is to inject capital in the other SOEs, they can’t be doing too well either. Things are not pretty, and the well off SOEs have to inject capital in the problematic ones.
So, the central government rolls out a 4 trillion stimulus package. As I pointed out in the last note, only a part of the money will be from the central government, but at this point, local governments are desperate to get this part. Thus, a massive fraud whose working and purpose are perfectly clear to all the players involved is perpetrated. Basically, local governments propose projects which may or may not be implemented with the sole purpose of receiving central funding and “supplementary” (peitao) bank loans from the state banks in order to stave off the bankruptcy of local SOE groups, which are heavily indebted at this point.”
This is the deal:
In this harsh environment, the advantages to strapped companies of outsourcing and offshoring persist and are intensified.
This means there is no source of job recovery, none, nada, zilch – under any feasible scenario. That means there is no strong recovery possible, after this storm passes.
There is one caveat. If the scenario changes wrt our trade policies, then we have a source of job growth.
We need tariffs. They will be an advantage to us. This is so because the flip side of American overconsumption is Chinese overproduction. Tariffs will result in import substitution, resulting in American jobs.
This will be harsh for China, but they’ve been employing mercantilism for their own purposes for quite awhile now, and that’s the breaks.
Dear Yves,
I enjoy your blog and normally agree with what you write. But when did the UK default on its government debt in the 20th C? There was a multi-month period of the redemption of many kinds of financial instrument at the beginning of WWI but I am not aware of a default on UK debt, unless perhaps you count coming off the Gold Standard. Since the “This time it’s different” Rogoff paper on defaults doesn’t, I think your standards are harsh if you do! (And the US has done the same).
Also, I agree that China is where the US was in the Great Depression: a mercantilist, urbanising agrarian power with no useful welfare state and a weak financial system. But this analogy suggests an imminent collapse in the Chinese economy, and the descent of the US into hyperinflation, revolution and default like Continental Europe in the 30’s….
I will need to check dates, but Great Britain did partially default on its WWI war debt to the US via making only partial payments (less than half) to force renegotiation.
Actually, the other borrower countries (ex Germany) got through the Great Depression with less pain than the US. The US and Germany suffered the worst dislocation.
“More than half of Japanese voters, polls suggest, are against the $600 government handout.”
According to a poll in Germany, 78% of Germans find the idea of the government handing everyone a couple hundred euros to be bad. 28% of 18-29 year olds approved of such a stimulus, of those over 60 only 14% approved.
I don’t think Germans will participate in the rebalancing of global (or eurozone for that matter) demand. Or maybe that should be, Germans won’t participate in balancing demand upwards. The largest exporting nation in the world might very well participate strongly in the downward adjustment.
I agree with the contention that the situation now may not be analogous to the great depression. I would also point out that the various initiatives reduced unemployment from 25% to 15% – which is better than nothing, but on the other hand, something that is hard to imagine as sustainable.
and
“While macro-economists dispassionately weigh borrowing and lending and call for a global rebalancing, Asians and FRESNO DAN still tend to view the story as a morality tale of thrift and profligacy.”
Frankly in India at least – there is a lot of postponing of long term shopping. Cars, bikes, houses and many other durables computers – even expensive holidays are being postponed.
But then Indians are ultra-conservative and super-price sensitive if they smell an upcoming price-cut they postpone purchases.
Further with job cuts and salaries going flat to lower – this time its a little more – empty malls and stuff. (also terror attacks)
This is anecdotal evidence – it is manifesting itself in the numbers.
Great Britain did partially default on its WWI war debt to the US via making only partial payments (less than half) to force renegotiation.
There was a chain reaction of WWI war debt defaults in the early 1930s. The UK owed the USA while the other Allies plus Germany owed the UK. The British also held a lot of bad loans to eastern Europe and Russia.
Actually, the other borrower countries (ex Germany) got through the Great Depression with less pain than the US.
They did better once they stopped paying their own war debts to the UK.
The US and Germany suffered the worst dislocation.
Massive loans from the US were the only reason Germany was able to pay any of the Versailles “reparations” to Belgium, France and the UK.
Now add in the USA’s current account surplus and creditor position in the 1920s. This all starts to sound very familiar, doesn’t it?
This will be harsh for China, but they’ve been employing mercantilism for their own purposes for quite awhile now, and that’s the breaks
Slap’em on. Environmental tariff, OSHA tariff, social security tariff, health insurance equalizer, currency exchange rate rigging penalty…
To describe trade with China under the current conditions as “free” is just an Orwellian abuse of language. It’s true there a lot of greedy useless eater fronts in the USA who mouth the Chinese line for purely selfish reasons. These “subprime skilled” people (who include Paulson) can be safely ignored as no more substantive than Chinese commission shoe salesmen.
So rtah100: “I agree that China is where the US was in the Great Depression: a mercantilist, urbanising agrarian power with no useful welfare state and a weak financial system.” That is a remarkably succinct assessment; I may even quote you. The social differences between US 30 and China 08 are major, with different trajectories implied, but the categorical similarities at the gross level match your choice sentence. You left out that both societies at the comparison point had comparatively puny, underfunded, and technologically second tier militaries.
“But this analogy suggests an imminent collapse in the Chinese economy, and the descent of the US into hyperinflation, revolution and default like Continental Europe in the 30’s.” Not so much. For one thing, the US in 30 had a truly massive speculative bubble in equities and debt securities. China at present has its own internal weaknesses, yes—but nothing of the same scale. They couldn’t afford it. Their property sector is going to take a big hit, but I seriously doubt that it will be on the level of US property valuation declines in the Great Depression. China just is not as vulnerable.
A second dissimilarity regarding the possible outcomes for the US in the next five to ten years is that the political instability in Europe of the 30s had _non-financial_ causes. Germany, Italy, Spain, Russia, Roumania, Greece, in a different way France all had either conservative political apparatuses which had suffered mortal damage to their credibility in WW I, failed state inability to make the transition to industrial capitalism, or doses of both. Even in good economic times they would have been politically unstable; in bad economic times the economy was used as a wedge and a weapon for interests pursuing their own agendas. The US just is not in a comparable internal divide. We may very well get a burst of hyperinflation at some point in the US, yes. I would see us more as, say, Argentina in the 1950s. But there is not a really good prior instance of comparison: we’ll blaze a new path of nonfeasance, I think. We will most likely look like the UK in the 30s until we bumble our way into the war which undoes us right and proper. *sigh*
@Yves
I’ve never heard of us defaulting on our US WWI debt. If so, at least we got our revenge in early for the terms of Lend-Lease and, worse, its sudden cancellation! (The USA would never have dominated post-WWII without confiscating British technology during the war and Axis technology afterwards).
By the way, my thinking about the China/USA parallel started with your China=Alpha Creditor post. Thank you for the insight.
@Richard Kline
Thanks – and I like your point about the military parallels.
The tendency of history to rhyme if not repeat is worrying me over whose prospects are brighter, the creditors or the debtors / defaulters.
My post on FTAlphaville was more detailed – speculation rather than wisdom, I’m no China macro-specialist – but my worry is that China is going to suffer the external demand shock and internal financial crisis that 30’s America suffered when her Continental markets and borrowers defaulted.
Some of the default was explicit, some of it was through hyperinflation/monetisation of debt because their internal and external political weakness made this the only credible option. over renegotiating their obligations with foreign and domestic creditors and rebalancing government income and expenditure.
Yet in the 30’s, as Yves points out, the defaulting nations bounced back quickly (if unsustainably), through rearmament, fascism and eventually plunder. Meanwhile the USA went sideways for a decade.
The UK was not such a bad place to sit out the 20’s and 30’s in comparison. The question is, will America be in the inter-war British position (as military hegemon, reserve currency and a major banking centre)?
Or, will Europe be in the bystander position this time around while America’s weaknesses of political economy (conservative political apparatus without credibility; refusal to raise taxes and cut spending; weak federal system with limited transfer payments to states; patchy welfare state; red/blue division) produces something worse? Will Obama be a Weimar president?
I think your analogy with Argentina and Peron is intriguing although hardly encouraging! Still it is better than – and this may seem far-fetched, but it makes a point – remembering that Texas has oil and the right to secede and did not Vote For Change.
Another analogy worth exploring is the position of Japan (and, to a lesser extent, Korea and Taiwan)? Her heavy investment in China puts her in a similar to position to Britain w.r.t. to the USA in the 30’s.
A factor which was not present last time around is the existence of the petro-states. In the 30’s, these were under the control of Britain and today’s balance of payments and sovereign wealth phenomena did not arise.
Where they spend their capital, how they balance their budgets, which currency they accept for oil and – ultimately – whose help they accept to maintain internal and external security will probably be decisive.
There are opportunities to supplant America for Europe (nukes + potential reserve currency + their biggest market) and Russia (nukes + the rest of the world’s reserves + will pay anything for an Indian Ocean port). China has much less to offer – and India perhaps has the most to gain of all, since it is her back yard….
Just before Britain was about to default, they sent the reserve status and debt to the US, the hot potato is now in our hands.
The British were combating their own inflation at the time when the Germans decided to help it along by counterfeiting the same amount of Bank of England notes that were already in circulation. Prisoners of war were forced to do the counterfeiting.
North Korea was/is? expert in counterfeiting US currency. The US had/has every right to bomb the snot out of them.
This has a detailed discussion of Depression events:
Premier Broquiville of Belgium resigned after informing the U.S. that Belgium would default. England and Italy decided to meet just one more payment, due December 15, 1932. Hungary and Poland defaulted.
Congress preferred economic war to economic recovery.
Congress responded with speeches advocating the waging of economic war on errant debtors and the closing of U.S. securities markets to them. What political brilliance! What did they think the Smoot-Hawley Tariff was, an olive branch? And who would buy foreign securities now, anyway?
England shipped her entire payment – $95,550,000 – in gold to emphasize the plight of the debtor nations…..
At the end of 1933, there was still no formal debt settlement. However, most of the debtor nations sent, at most, only token payments. War debts and reparations were effectively ended, but the complex trade war system of tariffs, capital controls, quotas, licensing requirements and other trade restrictions remained to frustrate the revival of international trade.
http://www.futurecasts.com/Depression_bottom-1932-1933.html
Thank you, Yves. A good reminder of the symbiosis between debtor and creditor.
I agree that the prospect of a U.S. default down the road is… unsettling. I suppose the Taiwanese could stop sending chips to us, but then where would they sell them? Same with middle eastern oil: where would it go?
Back in the 30s, the default was always hard money: no cash for you! Today, it would be more likely to be inflationary, which wouldn’t be sudden, and wouldn’t even look like a default until some time has passed. And every. single. country. in this situation either defaults or wishes it did.
Canada did the same, with the loonie depreciating to $1.60/USD in order to pay for the 80s public debt hangover. It hurt, but it worked out with very little pain to the ordinary citizen.
At least with a demand side stimulus, we have the prospect of rebuilding a frayed infrastructure and promoting environmental restoration (I imagine at least some of the stimulus will be directed towards CO2 reductions). If it means a higher chance of $100/bbl oil in 3 years, well, that’s in 3 years, and we’ve already been there.
This is the box that we’ve put ourselves in.