China and beyond...
I still think that China is one
of the most mis-analyzed countries in the world. It goes back to Richard Nixon
who “opened China” and excited entrepreneurs around the world who dreamed of
selling just one item to everybody in China and getting rich. How did that work
out? China was not that kind of place.
The Chinese were poor; the Chinese were not going to buy anything from you. The
Chinese were going to work and sell things to you. Capital around the world was
going to locate in China. Chinese workers would make things, take your job and
sell things to you, lending you the money to buy from them and to get into deep
debt at the same time. That is the fact it was not Nixon’s dream.
Freak trade
This is the great paradox of
China that no one seems to have grasped. Entrepreneurs in America now think
it’s fair game to pick up a factory and re-locate in China displacing workers in
the United States and producing at cheaper prices overseas. This game works if
the international trade game is fair. We have a watchdog organization that took
over from GATT (The General Agreements on Tariffs and Trade), an organization
called the WTO to enforce free trade rules.
But, in this new regime, no one looks at exchange rates. In this new
regime no one minds persisting and excessive current account deficits or
surpluses. So in this game currencies get misaligned and trade occurs over long
periods -at persistently misaligned exchange rates. That is NOT free trade: its
freak trade.
China, of course, has been one of
the main contributors to the international trade game played on this uneven
ground. Even though China is a large developing nation, during the period when
it developed and attracted huge capital flows from abroad it oddly ran
persistent current account surpluses and built up gigantic foreign-exchange
reserves. This is a country that was supposed to be trying to develop. Instead
of using its resources to improve the lot of its people it simply piled up
money at the central bank. And, as an example of the kind of development it
encouraged, the proportion of consumption in GDP fell dramatically. China was
interested in increasing its share of world output. It was completely uninterested
in improving the welfare of its people. It kept its exchange rate too low. It
paid its workers badly. It polluted and violated international law.
Because of its low costs all was
forgiven and China became a Nirvana for firms looking to cut costs and become
more competitive. But don’t mistake this for something that it’s not. This was
not free trade. This kind of investment is not fair under the rules of
international trade. Since the exchange rates were ‘cooked’ trade was not
occurring under optimal free trade conditions –as if I have to point that
out…but I do..
In the chart below we show the US
current account deficit as a percentage of US GDP. In it you can see that after
the 1980s something rather dramatic happens with US trade. Prior to that time recessions
put the US current account into surplus. The 1991 sharp and brief US current
account surplus was the last that we have seen. Because of China and other
countries that sought export-led growth and pegged their currencies to the
dollar at rates that were advantageous to them, the US was no longer able to
run current account surpluses under any situation. Even in the dear dark days
of the financial crisis when the current account contracted sharply as US
demand dried up… the deficit as a percent of GDP remained around 2.5% to 3% - a
figure we used to think of as huge..
During this period when the US
was running large and persistent current account deficits, it’s important to
note that the exchange rate system was not operated to dissipate the US
deficits. Nor did they operate to dissipate the Chinese surpluses. Nor did they
dissipate the surpluses in any other country that had employed the technique of
export-led growth. Exchange rates were controlled and since the US is the
center country in the system, every other country picked its exchange rate
against the US. Countries have been willing to give up improved purchasing
power in order to gain improvements in output and export penetration. And, this
has thrust the US into deeper debt and made the US less rich, less profitable
and less competitive.
The financial crisis ruined much
of the US economy and other economies as well and made it clear that they could
no longer create the kind of growth they had in the past. China, whose economy
is so big and dependent on exports, suddenly was stymied. Its never-ending
export growth game had, in fact, come to an end.
Because of the realization that
the Western world could no longer absorb the huge flow of Chinese exports,
because the US deficits were too big and its debt was too high and unemployment
rates had skyrocketed, China was forced to look internally for its growth
solution. This brings China to where it is today.
China has been engaged in this
broad game of structural change. No longer able to achieve its growth targets
by siphoning off domestic demand abroad, China now has to develop its own
domestic demand and this is going to change the game dramatically. In order for
China to develop its domestic demand it’s going to have to pay its workers. If
you don’t pay your workers they don’t have any free income to generate any
domestic demand. And if China pays its workers it is going to lose his
competitive advantage. And this is the game that has been in progress in many
other countries in Asia. Recently others in Asia have become lower cost centers
than China. This also explains why China’s growth targets are harder to make,
because the game has changed and China is trying to develop demand at home and
its own service sector.
Because of this, I don’t see the
weakness in China, a weakness that is represented by some minor backtracking in
its manufacturing purchaser index, as meaningful to the global economy. China
is not the export dependent juggernaut that it once was. And so a backing off
of China’s growth does not reflect the weakening in global growth. Instead, it
reflects an irregularity in China’s ability to develop its own domestic demand.
Even now as we have been forced
into this change by events beyond our control (or at least by events we chose
not to control) we have still not re-balance the world economy. Germany now has
the largest current account surplus in the world. When Germany grows, because
it’s the most important economy in the European Monetary Union, its growth
boosts the EMU growth rate; but its growth is not necessarily helping Germany’s
fellow EMU members. In fact German growth may be a detriment to growth in its
fellow EMU members as a highly competitive German economy swoops in to take the
modicum of domestic demand that is there in fellow EMU nations, leaving less
for domestic companies in its fellow EMU countries.
How did this happen?
Under a system of fixed exchange
rates based on the gold standard, a persistent current account deficit causes a
country to lose gold. The US would never have allowed China to amass the kind
of surpluses it did were we on the gold standard– especially the bilateral surpluses
against the United States. Under that system the US would have raised its
interest rates to keep capital at home and that hike would’ve slowed the
economy and slowed the demand for foreign goods, reduced domestic inflation and
improved US competitiveness. US growth and development would’ve been restrained
in order to keep our gold reserves intact. There likely would’ve been other
political developments to try to restrain China (and others) from predatory
export practices. But under a fixed rate system their rates would also be
FIXED.
Under a fluctuating exchange rate
system, a country that builds a surplus should see its currency appreciate, with
that currency rise eventually undercutting its competitiveness and causing its surplus
to be reduced, leaving the country with higher purchasing power. The deficit
country would see its currency drop; that would cause imports to be more
expensive and exports to be cheaper. Those forces would help to equilibrate a current
account deficit. These things simply haven’t happened because exchange markets
are BROKEN.
If you say bad things about free
trade, they revoke your PhD in economics. As a result everyone has been a
cheerleader for this expansion in world trade. However, if you look at what has
happened during this period you find that trade did not occur under the
conditions we associate with free trade. Exchange rates did not behave the way
they would under a system of market-determined exchange rates. Current account
positions do not conform with the ongoing economic conditions in various
countries. Current account surpluses and deficits persisted for periods far
longer than one would expect if the system of exchange rates were market
determined. Surplus country currencies did not rise. Deficit country currencies
did not fall. There were no ‘equilibrating forces.’ And as a result of this
China and some other Asian countries became the persistent low-cost providers
and capital accumulated there instead of accumulating in other places. As a
result China and other Asian countries have developed remarkably. Some of the
more traditional core developed countries have been starved of the kind of
investment that they should have been able to attain. They now suffer lower
growth rates as a result.
The impact of these export flows
and capital investment shifts was blunted at first because as China exploded with
growth, it also invested funds abroad in its target export markets. The free availability of capital covered up
the erosion in US competitiveness. But eventually the excess capital that was
floating around in the US got into the inexorable mess it was bound to find. There
was way too much capital in the United States and not enough productive
investments to absorb it. Crazy mortgages allowed unqualified buyers to
purchase lavish properties, at least for a while.
Aftermath
What we are left with in the
aftermath is an economy that is no longer very competitive. The US has a very
high rate of unemployment and we have workers lacking the skills that they need
to compete in the global economy. Our educational system has gone to pot
because we care more about preserving the jobs of teachers rather than making
sure that they really educate students. Our political parties support these
various interest groups and attract contributions from corporations that want
to continue to place the factories overseas where the labor costs are still
cheaper – while that game is still in play.
Democrats and Republicans would
prefer to point fingers of blame at one another rather than to look in the
mirror and place the blame where it belongs. We have a bipartisan system and
we’ve got into this mess under a combination of Democrat and Republican
administrations. To me it’s a clear signal that our economy has been failed by
our leaders. That 47% of the people who file federal tax returns and pay no
federal income tax is a sure sign this economy is not generating the kind of
jobs it used to. And with our dependence on buying goods from abroad,
stimulating demand isn’t an option since demand stimulus will only stimulate
output from overseas. What we need to do is to stimulate output United States.
That’s a much more difficult job.
In part that means putting rules
in place that will keep factories here. This is not an argument for trade
restrictions or investment restriction. This is an argument to make exchange
rates fair. This is an argument to make sure the countries that run surpluses
do not run them forever. This is an argument to make sure that the dollar,
which is the central currency in our international trading system, is fairly
valued in all of its bilateral pairs. It’s also a warning that developing our
energy sector and reducing our current account deficit by reducing energy
imports and increasing energy exports does not by itself change any of this.
The US non-oil trade deficit, which excludes oil and oil products from exports
and imports, is still worsening. That’s a sign of still fading US
competitiveness.
It’s a lot easier to find boogie
men than it is to find solutions. In my view China has been a pariah of
international trade. It has been allowed to develop under the fiction of international
free trade and the pressure from US corporations that were looking to exploit
the cheap labor in China regardless of the cost of that on America. Even Wal-Mart,
a company that has no operations in China has continued to seek a strong dollar
because it’s wanted to access cheap goods in the Chinese market to sell to its
customers.
The political pressure for this continues.
US businessmen see it as their right and responsibility to save money by moving
capital equipment into China to take advantage of low costs. But now China
labor costs arising. And if China’s exchange rate also rose to reflect its
wealth and undercut this competitiveness we would find China a much less
attractive place to be. If China plays by the rules its ability to continue this
game will be limited. And now circumstances are forcing China to play this game
differently. And so it may be that the competitive pressures on US firms in the
future will be less but we still have the legacy of past investment in China to
deal with.
When you look at the US economy
you see jobs as a problem. But jobs do not spring forth out of the head of
Zeus. They come from businesses, businesses that locate in United States,
expand or develop de novo when circumstances warrant. When it comes to US competitiveness
no one has been minding the store. Our two political parties have been much
more interested in satisfying the global interests of US multinational
corporations than forcing them to pay attention to their obligations at home.
Having pressured China earlier on its exchange rate could have – could have,
but did not – change the way corporate America saw its incentives. Once Nixon
opened the China firms viewed China as a safer place to do business; the new
game was on.
When Japan developed and when its
exchange rate was forced higher Japan naturally sought to extend its factories
into the Asian region around it, where it felt comfortable. US firms did not
have the same comfort in that area. But eventually as the area developed, their
comfort level improved.
Previously, US interests had been
focused on Latin America. Here’s a revelation: Latin America is not Asia. In
Latin America consumers love to spend money. Business was much more lax and
less ready to be highly productive. When you lent money to Latin America demand
boomed. When you lent money in Asia supply boomed… and American jobs
disappeared.
Economics is largely about
understanding how these large systems interact with one another. And forgetting
the attributes of free trade and using that name to justify so much, does a
great injustice to the US economy and to the science of economics. We still
have no foreign-exchange police. It’s clear that markets do not perform this
function. In a country like China the currency is not market-determined. And so
the exchange rate result that you get needs to be part of the bargaining
process- not part of the unilateral fiat.
To me China is simply an example
of something gone very wrong. And even for the Chinese it has not gone terribly
right. China has amassed a great deal of capital. Its workers are not
well-paid. Its consumption is a small part of its GDP. Its property right
enforcement is suspect. Piracy is commonplace. Trade-marks are not protected.
Its investment capital has been poorly put to work in public structures as
buildings and bridges are constantly collapsing. China is mired in terrible
pollution. China is a classic example of a country that has developed far too
fast. Its banks are banks in name only and God only knows the value of the stuff
on their books that they call assets.
But China’s supercharged growth
phase is over. In America there is a new richness in energy that’s been
discovered and possibly can be harnessed to recharge the economy. However, it
also can be misused. And it can be developed in a way that will make it seem as
though the economy has been righted even when it hasn’t. I don’t see anything
in the political sphere that makes me think that our politicians have learned
any lesson or that they are any different than they have been... I don’t see
that they are being better-policed by the public to pursue the public interest
instead of their own personal interests.
I am concerned that the economy
that produces jobs for half its people that are of such low quality that taxpayers
can’t afford to pay federal income tax is an economy that has failed.
I am further concerned that when
an economy fails this way someone looks to rearrange the deck chairs on the
Titanic by increasing taxes on those who have been successful.
For a time, there is probably no
other choice. But as a tactic it undermines capitalism just as surely as having
jobs that are too poor for half the population undermines capitalism. If capitalism
is not fair to the people in its country the system will not endure. You can
look across America at cities that have been governed by Democrats persistently
or by Republicans persistently and you will find that poverty has hardly been
eliminated. Some states have huge debt bills and as far as I can see little to
show for it.
We need to rethink what we’re
doing. We need to live within our means. The same old same old is not going to
cut it. That China will be less of a competitor in this new environment is only
a small bit of solace. The bigger challenge is for us at home. We have
challenges of fairness, of equal opportunity and of improving our
competitiveness. And this is not some sop to ethics. It’s a realization that if
an economic system isn’t fair, it can’t last and it won’t last. And we already
have the trappings of a system against which people are rebelling.
Capitalism is a very subtle
thing. People need to sign onto it and believe in it in order for it to work.
You don’t think about all the little things that make it work; there many
things you simply accept. And when you stop accepting these things, you no
longer see the system as fair and you stop obeying its rules. And that’s when
things get out of hand.
I’m worried that were getting
close to this boundary. The tax share of GDP is already historically high and
yet we’ve got Obamacare in the works and we have an aging population that is
going to put even more strain on government finances. The solution is not more
taxes or higher taxes on the higher income members of the population. The
solution is better productivity, more growth, and more jobs. The solution is
better education. And these are solutions that will take a great deal of time
to implement. And so I’m concerned that that figure that Mitt Romney uncovered
in his lost bid for the presidency is already at 47%. What’s next?
