If one might verbalize the collective frustrations about the global economy
from the world's investors, it would be an agonized and frustrated "are we
there yet?"
The "there" would be marked by stabilized economies in both developed and
emerging countries, currency and equity markets no longer in turmoil, and the
world's trade policies stepping away from the brink of outright protectionism.
But, as 2012 comes to a close, the world is slowly and painfully coming to
terms with the reality that the long debt deleveraging
process set in motion by the 2008 financial crisis is still very much working
its way through the system, and that 2012 may in fact bring more unpleasant
news as the eurozone continues to struggle and China potentially heads towards
an economic downturn.
As everyone comes to grips with the unpleasant reality that our short-to-mid
term economic situation is likely to continue to be difficult, it will be
increasingly problematic for policymakers to prevent economic frustrations from
boiling over and becoming cause for political action.
Whether this political action will be destructive or productive will be
determined in no small part by whether we properly come to terms with what
caused the financial crisis in the first place.
Of particular importance to this determination will be understanding the nexus
between American policy decisions and the role of China in contributing to the
environment where the crisis first occurred. Given America's sour mood towards
China and the tendency to blame Beijing for problems of the US's own making,
this remains one of the more powerful impulses that must be guarded against.
The inter-connection between these two elements - American policy and China's
participation in globalization - is the topic of Giles Chance's new book, China
and the Credit Crisis: the Emergence of a New World Order. As is
written in the forward, Chance "argues that China did not cause the crisis; but
without China, the crisis would not have happened".
Did China contribute to the environment that made a financial crisis a
possibility? Certainly yes; but it equally presented American and European
leaders with a once in a lifetime opportunity to productively channel China's
nascent financial resources in ways that could have benefited everyone.
That this rare alignment of favorable factors was largely used to fuel a debt
binge by consumers and governments that we now regret was not a mistake of
China's making, it was our very own.
Chance's argument is an elegant one in that it manages to capture both China's
significant impact on the world's financial system as well as the sheer lack of
imagination by those in positions of power in developed economies who did not
anticipate what China's entrance into the world's economy might mean.
Chance is particularly rigorous in his analysis of why the US Federal Reserve
did not better position itself to deal with the effects of the Great Moderation
(economic growth without inflation). By coupling the positive benefits of the
Great Moderation accrued to consumers, corporations and government to
artificially low interest rates, central bankers set in motion a risk-forward
up-leveraging process that would ultimately come to a disastrous end in 2008.
As Chance writes: "The search for yield arising from extremely low interest
rates brought aggressive bankers together with yield-hungry buyers. The bankers
needed a new, big, fee-generating arena to play in. The American real estate
marketing provided such an arena."
Writing of what financial historians acknowledge now was the perfect storm,
Chance says, "Securitization provided the weapon. Cheap credit, fueled by
ultra-low interest rates, years of an easy money policy, and the removal of
bank leverage limits in2 005 provided the ammunition."
Critics of China and the Credit Crisis may ask whether it is only really
in hindsight that it is possible to see how China's entrance into the world's
system of trade and financial markets might distort everything. In the book,
Chance quotes Alan Greenspan, the once all-powerful head of the Federal
Reserve, "It became clear to me in early 2006 that we were in some kind of
housing bubble. However, I did not foresee a decline in housing prices because
we'd never had one."
While we may forgive our leaders for not anticipating certain sorts of crises,
a financial system that is incapable of planning for price declines smacks of
hubris, mismanagement and complicity. Air travel is safe today precisely
because pilots prepare for the possibility of a crisis rather than relying on
technology to forever prevent a problem from occurring; finance should be safe
for precisely the same reason.
While it might take hindsight to connect the dots with the sort of precision as
Chance does, American and European leaders were clearly capable of thinking
through the role of potential safeguards given China's contribution to high
growth absent inflation. That they chose not to remains a question readers of China
and the Credit Crisis will find perplexing, as they rightly should.
Chance addresses this by showing the influence Ben Bernanke's 1999 paper
"Deflation: Making Sure 'It' Doesn't Happen Here" had on Greenspan
specifically, and the Fed's policies more generally. According to Chance, "The
paper concluded that it was not necessary to worry about asset price bubbles,
as long as central banks were obviously committed to price stability."
He goes on to write, "Already through 1998 and 1999 the Federal Reserve had
stoked up liquidity. Now it added more fuel, by keeping interest rates low and
encouraging bank lending to stimulate consumers after the dot-com bubble burst
in 2000."
Even though, as Chance points out, this should have triggered inflation, it did
not, which is as he makes clear, one of the ways China did contribute to the
crisis: "China's supply shock ensured that inflation did not increase in line
with demand and money growth, but stayed dormant."
Perhaps realizing that things might be close to getting out of control, yet
fearful of ending things prematurely, Greenspan would timidly move to increase
interest rates; yet, as Chance writes, "By then the damage had been done. The
party was out of control."
It is impossible to read China and the Credit Crisis and not come away
with a clear sense of how American policies have led to the situation the
country now finds itself in. It was our Cold War geopolitical triangulation
which first brought China into the fold, and our desire to see their country
open to trade which propelled their billion plus people into the world's
market.
This triggered a curious high growth, low inflation environment the world has
rarely - if ever - seen before. What did American policy do as this was
unfolding? Our financial policies encouraged cheap credit and risk-taking. No
small wonder the developed world is now choking on debt of their own making and
taking.
In the face of these realities, the clear impulse of Western politics is to
look outside at others as the cause of these problems rather than inwards.
Anticipating this, Chance does a very good job trying to remind his readers
that while China certainly is a large and important country, it is also a very
poor country characterized by any number of social, political and economic
problems that it must navigate to become the global powerhouse many outsiders
say is all but inevitable.
Chance captures this well when he writes, "Although China's leaders may meet on
equal terms the leaders of the most powerful countries in the world, the
country's huge population makes it still a poor country."
There are many good reasons to pick up China and the Credit Crisis.
Chief among them are the previously mentioned challenges the traditional views
on how our own policies led to the current crisis.
In addition, Chance's presentation on what the current crisis means regarding
the future of the US dollar and the necessary adjustment by the world's
financial and regulatory systems to incorporate China's needs are well written,
balanced and satisfying.
Yet the most important reason to read this book may be what it has to offer
about how the current financial crisis will reshape US-China relations.
Towards the latter part of the book, Chance writes, "When the United States
finally recovers from the credit crisis, it will find that its relationship
with China has changed permanently and enormously. The crisis has ended
Washington's role as the place from which the world is unilaterally governed."
(Emphasis the reviewer's)
Whether America comes to terms with this reality peacefully or whether it, like
so many aging great powers before it, feels obligated to fight for its place
may be the most important question of our generation.
If so, Chance's book marks two essential follies that will have made such a
miscalculation possible: the first reckless financiers unwilling to entertain
the possibility that the system could fail, and the second a group of anxious
politicians channeling the public's anger away from decisions they have made
towards the growing "ominous" influence of China.
Given America's recent track record of political acrimony, infighting and
scape-goating, the disastrous miscalculation Chance fears may already be well
underway.
China and the Credit Crisis: the Emergence of a New World Order by Giles
Chance. Wiley; 1 edition (March 1, 2010). ISBN-10: 0470825073. Price US$22, 228
pages.
Benjamin A Shobert is the managing director of Teleos Inc
(www.teleos-inc.com), a consulting firm dedicated to helping Asian businesses
bring innovative technologies into the North American market.
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Whether this political action will be destructive or productive will be
determined in no small part by whether we properly come to terms with what
caused the financial crisis in the first place.
