US's road to recovery runs through Beijing
By Francesco Sisci and David P Goldman
English author G K Chesterton rhymed about "the night we went to Bannockburn by
way of Brighton Pier", and it may seem no less whimsical to argue that the
United States' road to recovery, as well as Barack Obama's path to presidential
greatness, run through China.
In the rush to prop up America's financial institutions, foreign economic
policy seems remote from Washington's agenda. America wants to revive the
mortgage market and consumer spending. The effort is doomed to failure. For a
quarter of a century the American consumer has been the locomotive of the world
economy, and now the locomotive has derailed and taken
the rest of the world economy with it.
Recovery requires a great change in direction of capital flows. For the past
decade, poor people in the developing world have financed the consumption of
rich people in America. America has borrowed nearly $1 trillion a year, mostly
from the developing world, and used these funds to import consumer goods and
buy homes at low interest rates. The result is a solvency crisis of the
American household, which shows up as a solvency crisis for financial
institutions. If we reckon the retirement needs of households as a liability,
the household sector is as good as bankrupt.
No recovery is possible unless American households can save, and they cannot
save in an economic contraction when incomes spiral downwards. To save,
Americans must sell goods and services to someone else, and a glance at the
globe makes clear who that must be: nearly half the world's population, and
most of the world's capacity for economic growth, is concentrated in China and
the Pacific Littoral.
China's economic problem is the inverse of America's: China has achieved fast
rates of growth at the expense of huge disparities between the prosperous coast
and the backward interior, as well as excessive dependence on foreign markets.
China's policy response to the economic crisis is far more radical than
Washington's. Rather than attempting to patch up the situation and restore the
status quo ante, China plans to spend nearly a fifth of its gross domestic
product on an internal stimulus focused on infrastructure in its interior.
Severe execution risk attends the Chinese proposal, and markets remain to be
China can reduce the execution risk of its great economic shift towards home
consumption, and America can solve its savings problem, through a grand
partnership. This partnership need not be exclusive to America and China, but
it must be founded on America and China, two of the world's largest economies.
India and the other Asian economies should be encouraged to join this
partnership. A great deal has been written about prospective conflict between
China and the United States, but very little explanation is offered as to what
issues might arise between China and the United States. China and America have
far more to gain from cooperation than from conflict.
America's objection to Chinese foreign policy center on China's pursuit of
commercial interest with countries (Iran, Sudan) whose behavior America
considers unacceptable. America stands to gain an ally in questions of
rogue-state behavior, terrorism, nuclear proliferation and other matters of
national interest, in return for helping China achieve its legitimate goals.
The goals of the partnership should be to:
Support China's internal development by re-orienting export flows towards China
and other emerging economies from the United States and other industrial
Transfer technologies and other expertise to the emerging economies.
Make the emerging economies partners in the recovery of American asset prices.
Fear and risk-aversion rather than trust and optimism conditioned the two-way
capital flow between emerging markets and the United States during the past 10
years. After the 1997 Asia financial crisis, and the 1998 Russian bankruptcy,
investors in emerging markets lent their savings to the American government or
its quasi-governmental agencies to diversify their portfolios into safe assets,
while Westerners invested in local emerging market currencies for higher
As one of the authors reported recently at this site (See
Who will finance America’s deficit? David P Goldman, Asia Times Online,
November 13, 2008), global financing of the US government deficit drew on
leverage in emerging markets. De-leveraging of the world financial system
sharply curtails the availability of overseas financing for the Treasury
America's economy model is broken. The tape cannot be run in reverse: America
can't rescue an economy based on rising consumer debt and zero savings. America
must become a technology exporter. Throwing more money into consumer stimulus,
bailouts for the automobile sector, and so forth will fail miserably. America
should recognize that the deformation of its economy is the inverse of the
deformation of the Chinese economy (as well as other emerging economies), and
that their common problem has a common cure.
The trouble in the world economy has been that a rich Chinese won't lend money
to a poor Chinese, unless the poor Chinese first moves to America. China bought
American mortgages, including poor-quality assets dressed up as high-quality
assets, because China does not have the financial, legal and administrative
capacity as well as the trust to write sufficient mortgage business at home.
China's efforts to spend a fifth of its GDP on infrastructure face enormous
problems of governance. In the United States, voters most approve most public
spending at the local level, and the federal system provides checks and
balances against abuse of public funds. Emerging economies must rely on the
probity of a small number of officials with enormous power, a far less
effective check against corruption.
China can use America's help in shifting its economy towards the internal
market. Ironically, American officials have been trying to persuade China to
import the American financial model for years, and the collapse of the American
model has made the prospect less attractive. But it is a very good moment for
China to bring in American banks, and start up a consumer lending market. The
failures of the American consumer market do not wipe out a century of banking
experience in evaluating and securitizing consumer loans. To help import the
American model, China should be given the opportunity to purchase major
American institutions in return. Citicorp, for example, could be bought today
for about $50 billion or Capital One for $13 billion.
America remains the most technologically advanced economy in the world. China
needs American high technology. In many instances, America restricts the sale
of technology to China due to security concerns.
The United States should offer China a general reduction in restrictions on
imports of American technology and acquisition of American companies, in return
for a treaty linking Chinese and American security interests. The treaty would
A system of royalties for technology transfers and guarantees against pirating.
Freedom for Chinese companies to acquire American companies, including
Agreement on a common stance towards rogue states, nuclear arms proliferation,
terrorism and other issues of mutual concern, covering such issues as Pakistan,
Sudan, Iran and other areas of past diplomatic conflict.
An agreement on strategic arms deployment in Asia.
A roadmap for China's democratization.
Environmental and energy-efficiency goals.
Stabilization of China’s yuan against the dollar to support free capital flows
between the US and China.
There are close to 2 billion people in China and the countries in its immediate
periphery, and a further 1.1 billion people in India. Half the world's
population lives in emerging Asia, and its productivity could triple in a
generation. Out of the present crisis, the world might enjoy one of the longest
and fastest economic booms in history - or it might remain in an economic mire
for a decade. The incoming American administration might be remembered as one
of the worst, or one of the best, in American history.
David P Goldman was global head of fixed-income research for Banc of
America Securities and global head of credit strategy at Credit Suisse.