A few nights ago, American PBS aired Ascent of Money, a non-fiction film presentation of Dr. Niall Ferguson's book of the same title. This fast-paced, somewhat erratic 2 hour film provided some history about the evolution of the role of finance in economic development. Perhaps the 6 episode series which aired on British Channel 4 might have been more comprehensive, less jagged, more thematically coherent, but the survey of historic financial collapses substantiated two notions: the prevalence of a herd mentality which drives asset prices and that markets and market makers have a great grasp of mathematics, but a bad sense of history.
Since markets and businesses are not immune to cyclical shocks, there are lessons to be learned from prior downturns. For example, tight monetary policy after the 1927 stock market crash failed to right the economy, in fact it made it worse. Central bankers have not made the same mistake since. More recently, the export-based, Asian 'tiger' economies experienced a financial crisis in 1998. Though a single cause to the crisis is still disputed, high levels of external debt, fixed exchange rates, and a sharp fall in 'hot money' capital inflows all contributed to the collapse of the Thai, Indonesian, and South Korean economies which required IMF intervention. During the last decade of recovery, these three countries as well as China and Vietnam have accumulated massive dollar-denominated foreign exchange reserves which will insulate exporters from demand shocks. Again, another lesson learned.
Despite only scant treatment of how the 1998 Asian crisis relates to the present day, Dr. Ferguson, in the latter portion of the documentary, hints that the byproduct of high savings rates and Asian central bank 'sterilization' policies will further strain the tenuous Sino-American economic relationship, cleverly dubbed 'Chimerica'. Of course, albeit briefly, he drew the parallels between this two-headed entity to the mythological creature of similar name.
What can one extrapolate from the status quo? In the present situation, high Chinese consumer savings rates make it possible for the People's Bank of China to purchase more US Treasury bonds. This policy keeps the yuan from strengthening too quickly as well as maintains the competitiveness of Chinese exports. The idea is pretty incestuous where the seller finances the debt of buyer while simultaneously selling the buyer goods. Though China became a net importer several years ago, its export sector makes up a great deal of national income. If the government did not bolster exports through intervention, then China would not be able to run current account surpluses. So what might happen as China's economy will eventually switch to higher productive industries, as the government pledged billions to economic stimulus through infrastructure improvement, and as domestic demand becomes the driver of economic growth?
The prospect of Asian central banks calling in American debt is unlikely, however, the volume of US treasuries held in foreign countries will likely decrease despite an eventual increase in US interest rates. The worrisome prospect is probably the last and most plausible change to the status quo. Economic growth will precipitate in some institutional changes, though not necessarily all for China, of the 'softer' aspects of society such as definition of civil and property rights; more efficient delivery of public service through government or market mechanisms; and better legal protection of contracts and settlement of disputes. The Chinese government has obligations to preventing social unrest as well as to foreign governments and transnational firms. Presently, it does the bare minimum to forestall social revolution, but as Chinese industry matures by utilizing higher productive technologies, government obligations to foreigners will not be as important since it will have a huge domestic market which may be poor now, but will become a grwoth driving, consumer society in the future. Its policies and strategies will move more inward when Chinese firms can receive a good rate of return domestically.
As China will eventually decouple from foreign firms certain bits of its economic growth agenda, the domestic markets of those foreign firms will suffer, particularly that of the United States. The American economy has shown its resilience against financial meltdown, but the government has had to borrow extensively to do so. When foreign appetites for American debt wane, future borrowing costs will be significantly higher. There may be negative real interest rates presently, but that will not last indefinitely. A future with a weak currency, a high propensity to import, and high interest rates will cripple an American economy so dependent on financial instruments as both means facilitating production and consumption. In such a future, will social unrest become an American rather than a Chinese problem? Could it lead to war?
The fundamental point of the documentary is that money borrowed ought to be paid back. Trying to reinvent this system has resulted in calamity. It is tough to believe that the solution to clearing the bad debt caused by securitization of sub-prime mortgages is more debt, but the Depression taught the world the dangers of freezing credit markets. Yes, dispersing risk amongst variegated holders with different exposures has theoretical benefit, but the transfer mechanism is a circuit, not a ray. When everyone is trying to get paid, but no one can get paid, all the creative financial engineering is meaningless. At some point, the government under the new administration must come forward and admit that the most crucial objective of the next term is not climate change, terrorism, or conducting a war. It is servicing debt, and it will require a combination of higher taxes and less spending. Here's to a future where assuming responsibility such as debt is once again a virtue, and dickless, rich kid politics - failure to bite the bullet, squeamishness to take the pain, and being saved by the bell conveniently to duck the punishment - will never get another chance to fuck up the lives of millions.
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