The present crisis undermining the very fabric of the United States financial
and economic system has conjured up the shades of the crisis that came with the
collapse of the economic bubble in Japan in the mid-1990s.
Yet Japan, whose financial system has been in continuous recession for more
than a decade, is, ironically, relatively sheltered from the current credit
squeeze. It has now come under
US and European Union pressure to try to stimulate domestic demand through
Kaoru Yosano, Japan's minister for economic policy, attacked calls for higher
public spending, saying Japan could not afford to add to its gross public debt,
already about 180% of national output, the highest in the advanced world. The
government is hard pressed to find many worthy targets for stimulus funding.
The only possible option is faster expansion of the national Shinkansen
high-speed rail network.
Yosano urged more spending on unemployment benefit, saying the government could
mitigate the social effects of recession by, for example, doubling to a year
the period that benefits could be paid. Japan had learnt that deficit spending
was dangerous, leading to uncontrollable inflation. Japan could not be a
locomotive for the global economy besides bolder emergency fiscal measures and
try to stimulate personal consumption in the medium term. The country's economy
is unlikely to respond to a planned fiscal stimulus but will have to endure
higher unemployment and possibly a return to deflation and shrinking output,
according to Yosano.
Yosano painted a gloomy economic picture, saying that companies were preparing
to cut thousands of non-permanent jobs at the end of 2008 when fixed-term
contracts expired. Japan's labor market had become very fluid, with more than a
third of workers in non-regular employment. As a result, the jobless rate,
which peaked at 5.5% in the previous recession, could rise more steeply from
its present 4.1%. Yosano, a fiscal hawk, played down the likely impact of a
planned 5 trillion yen (US$52.3 billion) package, saying that most of it was
credit guarantees rather than genuine new money.
Germany, Russia accuse US of cheap money cure
German Chancellor Angela Merkel, normally a faithful US ally and a converted
free market conservative who grew up in socialist German Democratic Republic,
joined Russian President Dmitry Medvedev to accuse the US and other
suddenly-interventionist neo-liberal governments of making more "cheap money" a
central tool of their financial rescue strategy, thus planting the seeds of
another greater financial crisis in five years, repeating the Greenspan
approach of creating another bigger bubble to cushion a bursting bubble.
"Excessively cheap money in the US was a driver of today's crisis," Merkel told
the German parliament. "I am deeply concerned about whether we are now
reinforcing this trend through measures being adopted in the US and elsewhere
and whether we could find ourselves in five years facing the exact same
The chancellor defended her government's modest fiscal stimulus of 12 billion
euros (US15.3 billion) over the next two years - as a "measured and
proportional response ... tailored to the situation". Merkel's comments came as
the EU proposed a 200 billion euro economic stimulus plan aimed at avoiding a
deeper recession through tax cutting and infrastructure spending plans. The
proposals envisage the 27 states in the EU contributing 170 billion euros with
the European Commission and the European Investment Bank providing the
remaining 30 billion euros, partly through accelerated fiscal spending
programs. Doubts immediately surfaced as to whether the 27 member states would
back the proposed measures.
President Dmitry Medvedev of Russia, in a speech on October 10 at a conference
at Evian hosted by French President Nicolas Sarkozy to discuss the
international financial crisis, called on European leaders to create a new
world order that would minimize the hegemonic role of the US, by asserting that
the US was at the root of the global financial crisis. In order to end the
"unipolar" model in which the world depended on failed US leadership, he
proposed creating new financial systems to challenge the dominance of the
International Monetary Fund and the World Trade Organization, both of which had
been under Washington's hegemonic control since the end of World War II.
Effect of EU slowdown on China
An economic slowdown in Europe was a key factor behind the late November
decision by the People's Bank of China (PBoC), the central bank, to lower by
108 basis points its one-year lending and deposit rates that banks are allowed
to charge, the biggest cut in a decade. The move reflected concern about a
collapsed domestic housing market and declining export demand from both the US
and the EU concurrently. China had hope that the EU economy would provide a
counterbalance cushion for a US slowdown, as the EU market has recently
surpassed the US market for Chinese exports.
EU-China trade has increased dramatically after WTO accession in 2001, doubling
between 2000 and 2005. Europe is now China's largest export market and China is
Europe's largest source of imports. In 2007, EU goods exports to China were
71.6 billion euros and EU goods imports from China were 230.8 billion euros.
Chinese exports to the EU in 2007 were 23% of its world total of US$1.3
US consumer spending falls
US consumer spending is facing sharp long-term decline in a downward spiral
that could last several years. At its peak, before the credit crisis imploded
in August 2007, US domestic consumption reached 72% of US gross domestic
product (GDP), which constituted more than 20% of world GDP. This was for a
population of 300 million in a world of more than 6 billion people.
By the end of 2008, US consumption can be expected to fall below 70% of the
country's GDP and can be expected to fall to 65% or less in future years if the
economy fails to recover due to inflation targeting that keeps asset prices
above the level supportable by personal income. In the third quarter of 2008, a
fall in consumption to 70% of GDP subtracted 2.25 percentage points from GDP
growth. This was the first quarter with a decrease in consumption spending
since 1991. A downward spiral has begun for the US economy.
Durable goods purchases in the US decreased most rapidly, by 14.1% in Q3, 2008.
Spending decreased in all categories - motor vehicles, furniture and household
equipment - with spending on motor vehicles seeing the largest drop. Spending
on non-durable goods also decreased, with spending on food seeing the largest
drop. The fall in house prices continued to depress new residential
construction. The decline in residential investment subtracted 0.72 percentage
points from GDP growth in Q3 of 2008. Consumption declined sharply as a falling
percentage of GDP which also declined as a result.
China's countercyclical market response
In the face of falling consumer demand in EU and US markets for Chinese
exports, China took countercyclical monetary and fiscal measures to try to
moderate expected fall in its economic growth rate from double digits to as low
as 6% in 2009, below the critical level of 8% needed to keep the economy on an
even keel to provide jobs for the 20 million new workers who enter the labor
force every year.
China has instituted an all out effort to maintain an 8% growth rate. Surely
such a growth rate could not be sustained by exports alone even when the global
economy was robust. It can only be maintained with a policy to develop the
domestic market. Because of an under-funded social security safety net and an
inadequate medical care insurance regime, Chinese consumers prudently save a
large portion of their income. Consumer spending constitute only 35% of GDP,
falling from 50% in the 1980s, compared with 72% in the US.
Accordingly, it is reasonable to expect the stimulus package to reinforce
China's neglected social safety net. From that perspective, the 4 trillion yuan
(US$586 billion) stimulus package announced last month, to be spent over a
two-year period, is grossly under funded unless high leverage is used.
G-20 Meeting in Brazil
Five days before the November 15 White House Summit of the Group of Twenty
(G-20) countries, which together produce 90% of global gross domestic product,
finance ministers and central bank governors from the G-20 closed their annual
meeting in Sao Paulo, vowing in a joint statement that the G-20 has "a critical
role to play in ensuring global financial and economic stability".
(The G-20 members are: Argentina, Australia, Brazil, Britain, Canada, China,
France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia,
South Africa, South Korea, Turkey, the United States, and the European Union.
The G-20 members account for 80% of world trade, and are home to two-thirds of
the world's population.)
The group agreed that tax cuts and increased fiscal spending are necessary to
avoid a global recession. However, the joint statement said "each country will
take actions according to its own situation". The emerging BRIC nations
(Brazil, Russia, India and China) asserted jointly that they, together with
developing economies, must be given a bigger voice in supranational
organizations, such as the International Monetary Fund (IMF), the World Bank
and the World Trade Organization.
China's monetary response
On November 14, 2008, immediately before the G-20 White House summit, the PBoC
new lending rate was lowered to 5.58% and the new deposit rate to 2.52%. The
central bank had already cut the benchmark rate three times since September 16
and the benchmark deposit rate twice, by 0.27% age points each time. The PBoC
also reduced the percentage of assets that large banks must hold as reserves by
1 percentage point, and cut the reserve requirement by 2 percentage points for
smaller banks. To give banks an extra incentive to lend money instead of
hoarding reserves, the central bank also lowered by 0.27 percentage points the
interest rates that it pays banks for reserves deposited with it.
The same day, the government announced its 4 trillion yuan "stimulus package".
In its Five-Year Plan spanning 2006-2010, the government earmarked 5.1 trillion
yuan for spending on infrastructure projects.
China must shift from low-value exports to high-value-added exports and to
redeploy manpower and investment toward production for the domestic market to
reduce the economy's excessive dependence of export. It must boost domestic
investment financed by sovereign credit denominated in yuan to balance
overdependence on foreign direct investment, which tends to concentrate in the
export sector located in the costal provinces.
More critically, China needs to stimulate domestic consumption by raising wages
aggressively. This cannot be done as long as the economy is dominated by the
export sector, which must use low wages to compete.
It is imperative that the stimulus package be focused on combating the serious
problem of migrant unemployment in the stalled export sector. Laid-off migrant
workers should receive government assistance to return to their home villages
to work in government-supported new enterprises that produce for the domestic
market. The stimulus package should not be used to bail out failing
foreign-owned export firms of labor-intensive, low-tech manufacturing that have
been concentrated in the Pearl river delta near Hong Kong and the Yangtze river
delta near Shanghai.
China must use the opportunity offered by the current global financial crisis
to restructure and reorient its economy toward domestic development financed by
sovereign credit denominated in yuan away from excessive dependence on exports
for fiat dollars to feed profit to foreign investment.
This shift requires a period of strict capital and currency control until China
is free from the effects of dollar hegemony which inhabit the application of
sovereign credit for domestic development. In this uncertain climate of
international financial turmoil, China should refrain from further measures to
move its currency towards free and full convertibility in the global currency
markets. Appreciating the exchange value of the yuan will only strengthen
dollar hegemony while doing little to solve China's problem of export
The amount of sovereign credit needed to develop the Chinese domestic economy
will be enormous and much larger than China's current $2 trillion
foreign-currency reserves. Any further move toward free and full convertibility
of the yuan will restrict China's ability to finance its much-needed domestic
development with massive sovereign credit.
Until foreign trade is reduced to around 35% of GDP, China will find it
counterproductive to let the yuan appreciate against other currencies. The
domestic sector must accelerate its growth to reduce the current level of
foreign trade from its 70% of GDP to around 30% of GDP, and to increase
consumer spending to 70%. This means the domestic sector must grow at a rate
double that of the export sector.
Four days after the G20 meting in Brazil, President George W Bush warned in New
York a day before the Summit in Washington:
This crisis did not develop
overnight, and it's not going to be solved overnight. But our actions are
having an impact. Credit markets are beginning to thaw. Businesses are gaining
access to essential short-term financing. A measure of stability is returning
to financial systems here at home and around the world. It's going to require
more time for these improvements to fully take hold, and there's going to be
difficult days ahead. But the United States and our partner are taking the
right steps to get through this crisis.
It is true that the
crisis took over two decades of flawed policy to develop. But surely the rescue
cannot be allowed to take two