[DEBATE] : Martin Wolf: "Asia's Revenge"
critical.montages at gmail.com
Sun Oct 12 05:00:29 BST 2008
Very useful, except the conclusion (still in favor of "liberalized
finance," which is the primary reason many governments began to pile
up foreign currency reserves so much). But why is this article
titled "Asia's Revenge"? Joseph Stiglitz said that "they [banks]
finally had found a sucker who would take them [toxic mortgages] off
their hands -- called the American taxpayer." But the real suckers
are, above all, East Asians, especially Chinese workers and peasants,
and to a lesser extent Russians, Arabs, and Germans. Unfortunately,
the top ten generators of surpluses, as well as the top deficit
spenders, are the very countries where a major political change is the
least likely! -- Yoshie
By Martin Wolf
Published: October 8 2008 19:54 | Last updated: October 8 2008 23:48
"Things that can't go on forever, don't." – Herbert Stein, former
chairman of the US presidential Council of Economic Advisers
What confronts the world can be seen as the latest in a succession of
financial crises that have struck periodically over the last 30 years.
The current financial turmoil in the US and Europe affects economies
that account for at least half of world output, making this upheaval
more significant than all the others. Yet it is also depressingly
similar, both in its origins and its results, to earlier shocks.
To trace the parallels – and help in understanding how the present
pressing problems can be addressed – one needs to look back to the
late 1970s. Petrodollars, the foreign exchange earned by oil exporting
countries amid sharp jumps in the crude price, were recycled via
western banks to less wealthy emerging economies, principally in Latin
This resulted in the first of the big crises of modern times, when
Mexico's 1982 announcement of its inability to service its debt
brought the money-centre banks of New York and London to their knees.
Carmen Reinhart of the University of Maryland and Kenneth Rogoff of
Harvard University identify the similarities in a paper published
earlier this year.* They focus on previous crises in high-income
countries. But they also note characteristics that are shared with
financial crises that have occurred in emerging economies.
This time, most emerging economies have been running huge current
account surpluses. So a "large chunk of money has effectively been
recycled to a developing economy that exists within the United States'
own borders", they point out. "Over a trillion dollars was channelled
into the subprime mortgage market, which is comprised of the poorest
and least creditworthy borrowers within the US. The final claimaint is
different, but in many ways the mechanism is the same."
The links between the financial fragility in the US and previous
emerging market crises mean that the current banking and economic
traumas should not be seen as just the product of risky monetary
policy, lax regulation and irresponsible finance, important though
these were. They have roots in the way the global economy has worked
in the era of financial deregulation. Any country that receives a huge
and sustained inflow of foreign lending runs the risk of a subsequent
financial crisis, because external and domestic financial fragility
will grow. Precisely such a crisis is now happening to the US and a
number of other high-income countries including the UK.
These latest crises are also related to those that preceded them –
particularly the Asian crisis of 1997-98. Only after this shock did
emerging economies become massive capital exporters. This pattern was
reinforced by China's choice of an export-oriented development path,
partly influenced by fear of what had happened to its neighbours
during the Asian crisis. It was further entrenched by the recent jumps
in the oil price and the consequent explosion in the current account
surpluses of oil exporting countries.
The big global macroeconomic story of this decade was, then, the
offsetting emergence of the US and a number of other high-income
countries as spenders and borrowers of last resort. Debt-fuelled US
households went on an unparalleled spending binge – by dipping into
their housing "piggy banks".
In explaining what had happened, Ben Bernanke, when still a governor
of the Federal Reserve rather than chairman, referred to the emergence
of a "savings glut". The description was accurate. After the turn of
the millennium, one of the striking features became the low level of
long-term nominal and real interest rates at a time of rapid global
economic growth. Cheap money encouraged an orgy of financial
innovation, borrowing and spending.
That was also one of the initial causes of the surge in house prices
across a large part of the high-income world, particularly in the US,
the UK and Spain.
What lay behind the savings glut? The first development was the shift
of emerging economies into a large surplus of savings over investment.
Within the emerging economies, the big shifts were in Asia and in the
oil exporting countries (see chart). By 2007, according to the
International Monetary Fund, the aggregate savings surpluses of these
two groups of countries had reached around 2 per cent of world output.
Government spending offsets private cutbacks (US financial balances as
% of GDP); Households move to repair their finances (US private
financial balances as % of GDP); Emerging imbalances (current account
balances as % of global GDP); The costly fruit of foreign exchange
intervention (foreign exchange reserves $'000bn):
Despite being a huge oil importer, China emerged as the world's
biggest surplus country: its current account surplus was $372bn
(£215bn, €272bn) in 2007, which was not only more than 11 per cent of
its gross domestic product, but almost as big as the combined
surpluses of Japan ($213bn) and Germany ($185bn), the two largest
high-income capital exporters.
Last year, the aggregate surpluses of the world's surplus countries
reached $1,680bn, according to the IMF. The top 10 (China, Japan,
Germany, Saudi Arabia, Russia, Switzerland, Norway, Kuwait, the
Netherlands and the United Arab Emirates) generated more than 70 per
cent of this total. The surpluses of the top 10 countries represented
at least 8 per cent of their aggregate GDP and about one-quarter of
their aggregate gross savings.
Meanwhile, the huge US deficit absorbed 44 per cent of this total. The
US, UK, Spain and Australia – four countries with housing bubbles –
absorbed 63 per cent of the world's current account surpluses.
That represented a vast shift of capital – but unlike in the 1970s and
early 1980s, it went to some of the world's richest countries.
Moreover, the emergence of the surpluses was the result of deliberate
policies – shown in the accumulation of official foreign currency
reserves and the expansion of the sovereign wealth funds over this
Quite reasonably, the energy exporters were transforming one asset –
oil – into another – claims on foreigners. Others were recycling
current account surpluses and private capital inflows into official
capital outflows, keeping exchange rates down and competitiveness up.
Some described this new system, of which China was the most important
proponent, as "Bretton Woods II", after the pegged adjustable exchange
rates set-up that collapsed in the early 1970s. Others called it
"export-led growth" or depicted it as a system of self-insurance.
Yet the justification is less important than the consequences. Between
January 2000 and April 2007, the stock of global foreign currency
reserves rose by $5,200bn. Thus three-quarters of all the foreign
currency reserves accumulated since the beginning of time have been
piled up in this decade. Inevitably, a high proportion – probably
close to two-thirds – of these sums were placed in dollars, thereby
supporting the US currency and financing US external deficits.
The savings glut had another dimension, related to a second financial
shock – the bursting of the dotcom bubble in 2000. One consequence was
the move of the corporate sectors of most high-income countries into
financial surplus. In other words, their retained earnings came to
exceed their investments. Instead of borrowing from banks and other
suppliers of capital, non-financial corporations became providers of
In this world of massive savings surpluses in a range of important
countries and weak demand for capital from non-financial corporations,
central banks ran easy monetary policies. They did so because they
feared the possibility of a shift into deflation. The Fed, in
particular, found itself having to offset the contractionary effects
of the vast flow of private and, above all, public capital into the
A simple way of thinking about what has happened to the global economy
in the 2000s is that high-income countries with elastic credit systems
and households willing to take on rising debt levels offset the
massive surplus savings in the rest of the world. The lax monetary
policies facilitated this excess spending, while the housing bubble
was the vehicle through which it worked.
The charts show what happened, as a result, to "financial balances" –
the difference between expenditure and income – inside the US economy.
If one looks at three sectors – foreign, government and private – it
is evident that the first has had a huge surplus this decade – offset,
as it has to be, by deficits in the other two.
In the early 2000s, the US fiscal deficit was the main offset. In the
middle years of the decade, the private sector ran a large deficit
while the government's shrank. Now that the recession-hit private
sector is moving back into balance at enormous speed, the government
deficit is exploding once again.
Looking at what happened inside the private sector, a striking
contrast can be seen between the corporate and household realms.
Households moved into a huge financial deficit, which peaked at just
under 4 per cent of GDP in the second quarter of 2005. Then, as the
housing bubble burst, housebuilding collapsed and households started
saving more. With remarkable speed, the household financial deficit
disappeared. Today's explosion in the fiscal deficit is the offset.
Inevitably, huge household financial deficits also mean huge
accumulations of household debt. This was strikingly true in the US
and UK. In the process, the financial sector accumulated an ever
greater stock of claims not just on other sectors but on itself. This
frightening complexity, which lies at the root of many of the current
difficulties, was facilitated by the environment of easy borrowing and
search for high returns in an environment of low real rates of
A protest against the US banking rescue
These linked dangers between external and internal imbalances,
domestic debt accumulations and financial fragility were foretold by a
number of analysts. Foremost among them was Wynne Godley of Cambridge
university in his prescient work for the Levy Economics Institute of
Bard College, which has laid particular stress on the work of the late
So what might – and should – happen now? The big danger, evidently, is
of a financial collapse. The principal offset, in the short run, to
the inevitable cuts in spending in the private sector of the
crisis-afflicted economies will also be vastly bigger fiscal deficits.
Fortunately, the US and the other afflicted high-income countries have
one advantage over the emerging economies: they borrow in their own
currencies and have creditworthy governments. Unlike emerging
economies, they can therefore slash interest rates and increase fiscal
Yet the huge fiscal boosts and associated government recapitalisation
of shattered financial systems are only a temporary solution. There
can be no return to business as usual. It is, above all, neither
desirable nor sustainable for global macroeconomic balance to be
achieved by recycling huge savings surpluses into the excess
consumption of the world's richest consumers. The former point is
self-evident, while the latter has been demonstrated by the recent
So among the most important tasks ahead is to create a system of
global finance that allows a more balanced world economy, with excess
savings being turned into either high-return investment or consumption
by the world's poor, including in capital- exporting countries such as
China. A part of the answer will be the development of local-currency
finance in emerging economies, which would make it easier for them to
run current account deficits than proved to be the case in the past
It is essential in any case for countries in a position to do so to
expand domestic demand vigorously. Only in this way can the
recessionary impulse coming from the corrections in the debt-laden
countries be offset.
Yet there is a still bigger challenge ahead. The crisis demonstrates
that the world has been unable to combine liberalised capital markets
with a reasonable degree of financial stability. A particular problem
has been the tendency for large net capital flows and associated
current account and domestic financial balances to generate huge
crises. This is the biggest of them all.
Lessons must be learnt. But those should not just be about the
regulation of the financial sector. Nor should they be only about
monetary policy. They must be about how liberalised finance can be
made to support the global economy rather than destabilise it.
This is no little local difficulty. It raises the deepest questions
about the way forward for our integrated world economy. The learning
must start now.
*Is the 2007 US subprime financial crisis so different? An
international historical comparison. Working paper 13761, www.nber.org
**The US economy: Is there a way out of the woods? November 2007, www.levy.org
The writer is the FT's chief economics commentator and author of
Fixing Global Finance, published in the US this month by Johns Hopkins
University Press and forthcoming in the UK through Yale University
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