COVER STORY: Economic bounce masks deep structural crisis
by Patrick J. Byrne
News Weekly, August 8, 2009
Despite the economic bounce, there are no economies capable of pulling the world out of the current crisis. Unless fundamentally flawed economic systems are reformed, the crisis may persist for years, writes Patrick J. Byrne.
Today's recovery has been the result of low interest rates (which can't go much lower) and massive stimulus packages (which are running out) undertaken by governments worldwide.
Globally, the problem is that there is no major economy capable of driving a recovery.
The US is crippled by massive banking and consumer debt. Beijing's domestic stimulus package will work for a time, but China is banking on a quick US recovery that would reignite its vital export sector. However, an American recovery could take a decade or more, and China can't sustain its current government spending for that long, not without choking off its lending to the US and thereby cutting off any US recovery.
East Asia and Japan are heavily dependent on supplying China and the US. Europe is in the same state as the United States. Checkmate!
The current economic crisis is tracking closely the early stages of the 1930s Great Depression, as shown by Martin Wolf, associate editor of the UK's Financial Times (see News Weekly, July 11, 2009).
While currently there is an upswing, it should be remembered that there was a similar recovery, then a long stagnation in the early '30s. There was another sharp downturn in 1937. President F.D. Roosevelt, under pressure from economists, withdrew his New Deal stimulus packages too soon.
The world economy recovered only after economists forgot worrying about government deficits. It became more important for the US and its allies to win World War II and defeat Hitler, who had ridden to power on the social upheaval inflicted on Germany by the Great Depression.
After the war, governments regulated the international trading and financial systems to prevent another catastrophic meltdown occurring.
From the late 1970s, the policies of globalist free-market ideology dismantled that framework. In its place, globalism created two fundamentally flawed, mutually dependent economic models. Both will require painful, tectonic shifts in policy that could bring major political upheavals in our region of the world.
• The US capitalist model - based on imports, borrowing, debt and deregulated, highly leveraged banking - is no longer sustainable.
• The East Asian capitalist model - based on low wages, low exchange rates, large volume cheap quality exports to the US and lending to the US to buy these goods - is now unsustainable.
These models have been mutually dependent. The artificially-created huge trade surpluses of China, Japan and East Asia have been loaned to the US to buy East Asian goods. The money was loaned through deregulated, highly leveraged banks that squandered the money through speculation and creating massive asset bubbles in the property, stock and other financial markets.
This economic bubble has burst, like all economic bubbles in history. No longer can the US afford to keep losing industry to East Asia and then borrowing from the region to buy the goods America no longer produces.
So far, economic response packages have not addressed the fundamental issues.
The US model
US consumers have been the driver of world economic growth. From 2000 to 2007, their consumption spending accounted for 77 per cent of US economic growth and made up one-third of the total growth in world's private consumption since 1990. This was fuelled by soaring US household debt (which peaked at 138 per cent of household disposable income in 2007) and shrinking personal saving. (McKinsey Global Institute's Perspective report, March 2009).
Now US households are curbing consumption spending and saving more because of uncertainty of job security and falling asset values. In the US, after 36 weeks, unemployment benefits stop. Since the financial crisis started, the US has lost 6.5 million jobs.
Further, working against President Obama's big stimulus packages are the American states. They are slashing budgets and jobs because they are constitutionally required to balance their budgets. California is the world's eighth-largest economy (making up 13 per cent of the US economy), yet is virtually bankrupt.
Then there is the possibility of further bank failures. It was the highly leveraged US banks that lent excessively to consumers and created the economic bubble.
As a result of the Great Depression, the Glass-Steagall Act was passed in 1933. It separated retail from investment banking, as the renowned economist Lord Robert Skidelsky explained, on the "absolutely clear" basis that "banks whose deposits were insured by the taxpayer should not be allowed to speculate with their depositors' money" (Project Syndicate, July 2009).
This and other banking regulations were done away with in the 1980s and '90s.
Incredibly, as Skidelsky has pointed out, the Obama Administration's planned reforms have rejected a new "Glass-Steagall" approach to bring structural reform to the banks. He writes: "Instead, the reform proposals have opted for a mixture of higher capital requirements for leading banks and pre-funding of deposit insurance by a special levy on banks."
Further, as Joseph E. Stiglitz, chairman of the UN Commission of Experts on reforms of the international monetary and financial system, has warned, the big banks that have failed the financial system need to be broken up. He says: "It has long been recognised that those America's banks that are too big to fail are also too big to be managed." (Project Syndicate, June 2009).
Continuing instability is likely to see US consumers saving more and spending less for a long time. That spells trouble for East Asian nations.
The East Asian model
For East Asia, exports are worth a massive 47 per cent of the combined value of the East Asian economies. The smaller nations export either directly to the US, or else send intermediate goods to China where they are transformed into finished goods and then exported to the US. This model started with Japan's exports to the US after World War II.
In stark contrast, US exports to the world make up only about 7.5 per cent of the American economy.
The East Asian nations have depended on US demand rather than on foreign capital to develop their economies, as Australia has done since first settlement.
Even though most of President Obama's stimulus package has gone to consumers, US household debt, as the Financial Times's Martin Wolf points out, has fallen only about 3 per cent.
With households overburdened by debt, breadwinners threatened by unemployment, falling asset values and possibly falling wages, US consumption is winding back and it will take many years before more stimulus packages restore confidence to American consumers.
In this case, the East Asian nations will have to find a new economic model.
Writing in the US Council on Foreign Relations' journal, Foreign Affairs (July/August 2009), Brian P. Klein and Kenneth Neil Cukier have argued that as China and East Asia can no longer build on exports to the US, they will have to build a prosperous middle-class to develop their own economies.
While spending on consumer goods has made up over 70 per cent of the US economy, in East Asia the figure is much less. In China, consumption is only 35 per cent of the economy, and that proportion is falling.
To expand consumption levels, Klein and Cukier suggest that China and the low-wage East Asian nations should double workers' wages. They point out that Henry Ford did just that in 1914, declaring "that he wanted to pay his workers enough for them to be able to buy one of the cars rolling off his assembly lines".
They argue that "changing the structure of the labour market and paying workers more would boost the overall economy and fuel domestic consumption. ...
"[Further], Asian countries must establish viable social safety nets. The lack of basic economic safeguards is the biggest reason why Asians save so much, and reducing those savings would unlock consumption."
Creating a large middle-class will encounter stiff resistance. As Klein and Cukier explain, despite Asia's massive economic growth, the growth of its middle-class has been stunted. Although many more people are better off from East Asia's fast economic growth, over the past decade domestic consumption stayed roughly the same or actually declined relative to the region's gross domestic product. "In China, it dropped from 45 per cent to 35 per cent of the economy," say Klein and Cukier.
During 1997 to 2007, Chinese wages actually fell, as a proportion of the Chinese economy, from 53 to 43 per cent. The lion's share of East Asia's growth has gone to profits or been creamed off by governments.
The concentration of economic wealth and political power among the region's elites has created economic distortions, such as big business financed at the expense of the much larger small business sector, profits at the expense of wages, a focus on exports rather than on domestically-focused industries, and lack of investment in education, health, welfare and infrastructure.
A Western democracy can adopt Henry Ford's approach to building a large middle-class that drives economic growth. In East Asia, such policies will be opposed by powerful vested economic and political interests. But failure to do so could well see these countries slide backwards, followed by civil and political unrest.
For the US to climb out of this slump it will have to restructure and downsize its large banks to smaller, more manageable institutions; recreate domestic industries to provide the goods it will not be able to import; and maintain big stimulus packages for some years.
East Asia, including China and Japan, will have to redirect wealth to create a middle-class that is well educated, that is in secure well-paid jobs and that has a new form of welfare safety net. This will be needed to create markets that will drive their own economic development.
Both options are barely being discussed by governments. The process will be long and painful and may create major political upheavals in East Asia. It is absolutely vital that Australia now get its house in order.
- Patrick J. Byrne is national vice-president of the National Civic Council.
"Will US consumer debt reduction cripple the recovery?", Perspective (McKinsey Global Institute, Washington DC), March 2009.
Joseph E. Stiglitz, "America's socialism for the rich", Project Syndicate (Prague), June 2009.
Robert Skidelsky, "Risky risk management", Project Syndicate (Prague), July 2009.
Patrick J. Byrne, Economic crisis parallels the Great Depression, News Weekly, July 11, 2009.
Brian P. Klein and Kenneth Neil Cukier, "Tamed tigers, distressed dragons: how export-led growth derailed Asia's economies", Foreign Affairs (Council on Foreign Relations, New York), Vol. 4, No. 88, July/August 2009.
"A little clear thinking ..."
If our poverty were due to famine or earthquake or war - if we lacked material things and the resources to produce them, we could not expect to find the means to prosperity except in hard work, abstinence, and invention.
In fact, our predicament is notoriously of another kind. It comes from some failure in the immaterial devices of the mind, in the working of the motives which should lead to the decisions and acts of will, necessary to put in movement the resources and technical means we already have.
It is as though two motor-drivers, meeting in the middle of a highway, were unable to pass one another because neither knows the rule of the road. Their own muscles are no use; a motor engineer cannot help them; a better road would not serve.
Nothing is required and nothing will avail, except a little, a very little, clear thinking.
Extract from J.M. Keynes, The Means to Prosperity (London: Macmillan, 1933), Chapter 1.