Saturday, November 22, 2008

The Great Chimerica Depression

Inspired from several articles (Washington Post, Bloomberg, China Financial Markets and Naked Capitalism), there is a history lesson from the great depression that we can learn from given the current credit crisis.

Bottom line: The US is deleveraging from a private consumption-based economy to a more publically financed economy, just as the Europeans did during the 1930s; and, China is subsidizing its export overcapacity in order to prop-up its government's primary objection: sustained growth - just as the US did in the 1930s.

At the heart of this crisis is the huge imbalance between the United States, with its current account deficit in excess of 1 percent of world gross domestic product, and the surplus countries that finance it: the oil exporters, Japan and emerging Asia. Of these, the relationship between China and America has become the crucial one. More than anything else, it has been China's strategy of dollar reserve accumulation that has financed America's debt habit. Chinese savings were a key reason U.S. long-term interest rates stayed low and the borrowing binge kept going. Now that the age of leverage is over, "Chimerica" -- the partnership between the big saver and the big spender -- is key.
From Bloomberg:
China is struggling to stave off the effects of a worldwide economic downturn with 4 trillion yuan ($585 billion) in stimulus spending on new roads, railways, airports and low-rent housing. Asia's second-biggest economy grew 9 percent in the three months from July to September, the slowest pace since mid- 2003, threatening the expansion to which the Communist Party has pegged the credibility of its one-party rule.
From China Financial Markets:

If unemployment is rising, however, it does mean that there will be serious pressure to do whatever it takes to support employment growth. One thing that I am worried about (and this was the subject of the “longish writing commitment” I mentioned above) is that it puts pressure on the government to engineer measures to expand export growth. For example I suspect that the fight over whether or not to continue appreciating, and even depreciate, the RMB is intense. 
But if you think of China’s role within the global balance of payments, it seems to me that this is little more that a form of Smoot-Hawley-with-Chinese-characteristics. Global demand is slowing, just as it did in the 1930s, and China as the leading source of global overcapacity is trying to address its global demand problem by shifting the burden abroad.
In the 1930 it was the US who had huge overcapacity which it exported abroad (via huge trade surpluses) and it was Europeans who were over-consuming, financed by capital exports from the US.  When the credit crunch came it was unreasonable, as Keynes argued bitterly, to expect the rest of the world to continue demanding US goods, especially since the financing of their consumption had been interrupted.  Since US production significantly exceeded US consumption (with the balance consisting of course of the trade surplus), the need for demand creation most logically rested in the US.
Today it is China who is exporting overcapacity and it is the US who is consuming too much, fed by Chinese financing.   With the collapse of bank intermediation US households and businesses are cutting consumption and raising savings.  This is a necessary adjustment. Calling on the US government to engage in massive fiscal expansion to replace lost private demand is crazy.  It means that we should continue the current game that has led us into so much trouble, but instead of having US over-consumption and rising debt at the private level we must have it at the public level.
This can’t work for long.  The world has excess production and there is a need for the US to reduce its demand and increase its savings. The only proper place for new demand to originate is, once again as in the 1930s, from current account surplus countries.  They should be engaged in demand creation, not supply creation.  If they continue trying to export their way out of a slowdown, there will almost certainly be a trade war, as in the 1930s, and the full force of the adjustment will be borne by the current account surplus countries, again as in the 1930s. Remember that back then the current account deficit countries, like Germany after 1932, found it relatively easy to limit the impact of the crisis by forcing balanced trade — which has the effect of increasing demand (domestic) and reducing supply (foreign). 
[remembering that Germany, France and England defaulted on its debts - Germany suffered a tremendous GDP collapse (-40%) between 1929 and 1933. Germany unemployment in the years following 1929 reached over 30% (more than USA) (data from Findlay - O’Rourcke - Power and Plenty - Ch.8).This level of unemplyment was one of the reason that pushed Hitler to power in 1933.It is not nice to say but was Hitler Economic Policy, with substancial deficit spending (to build arms and highways), to reach full employment again in 1937. On my opinion that was one of the reason of the substancial support of German people toward Hitler in the following years (1938-1945).This is a reminder that substancial financial and economic crisis have strong political implications.]
From Naked Capitalism:

Note the Chinese have a problem that probably did not obtain in the US during the Depression: a huge disparity in living standards between the exporter and importers. Remember, there was still a great deal of international labor mobility in the early 20th century, and that helped dampen wage differentials between countries. Presumably, many of the goods the US exported in the 1920s would have been the sort that US consumers would buy. By contrast. a lot of the goods made for export to the US would not appeal to the mass market in China. I do not know how specialized manufacturing is and how hard it would be to reorient production for the domestic market. But American like to overconsume in quantity as well as type (when I lived in Australia, I was struck by how much smaller their closets are than ours. It was refreshing, in a way).


Mike L. said...

Sean, very interesting post. Let's see how the trade deficit will be dealt with in the near future.

Sean M. Broderick, CCIM said...

With the increase in debt, it looks like a supply problem with the amount of debt in the system and the rate may only have one way to go, but up..