A
major theme is missing from the central bankers'
annual retreat at Jackson Hole, Wyoming. Everyone
is talking about collapse of the US home-price
bubble and the danger of recession, but no one is
talking about the suckers who financed the bubble,
namely the savers of Asia.
Asia will do so
no longer. If the United States wants Asian
investors to continue to take risk on its shores,
it will have to
allow them to buy solid US
companies, rather than the sort of debt
derivatives that blew up this summer.
One
exceptional fact accounts for the instability in
financial markets during recent weeks: the Chinese
and many other Asians save about half their
income, while Americans save none of their income
at all. Foreigners, mainly Asians, invest US$1
trillion a year in the United States, because
their home economies cannot absorb so much
investment, or because the political risk attached
to local investments is too great.
In the
present iteration of Aesop's fable, American
consumers are the grasshoppers and Chinese (and
other Asian) savers are the ants. The trouble is
that Asians have put their savings into the
balance sheet of US consumers.
Outside the
US, it seems incomprehensible that the average
family would save nothing for retirement or
against a rainy day. But God takes care of drunks,
small children and the United States of America.
In other words, the typical American family
expected the value of its house to keep
appreciating at nearly 10% a year indefinitely,
eventually turning into a retirement fund. US home
prices appreciated by 86% between 1996 and 2006;
like the Cargo Cults that proliferated in New
Guinea after World War II, Americans seemed to
think that this would go on forever.
Delusional expectations about home prices
justified a trillion dollars of loans to borrowers
with poor credit or inadequate income ("subprime"
loans), and that is the proximate cause of the
bubble. World markets have swooned in response to
what the media call a credit crunch - the
reluctance of investors to accept the Frankenstein
monsters of financial engineering. In the case of
US mortgages of poor credit quality ("subprime"),
derivatives technology sought to make a silk purse
out of a sow's ear, but it is a purse that still
goes "oink" when opened. This has produced
consternation across Asia, where many financial
institutions invested heavily in obscure and
complex instruments that cannot be sold today
except at a severe loss.
When the world
throws money at a national economy, large or
small, credit is easy and stupid investments are
made. America's subprime-mortgage problem
uncannily resembles the Asian financial crisis of
1997. Ten years ago, investors couldn't put enough
money into high-yielding investments in Thailand,
Malaysia, South Korea and so forth, and financed
an enormous real-estate bubble. When the bubble
popped in the spring of 1997, Asian stock markets
and currencies crashed. Asians have not forgotten
the pious lectures about profligacy they suffered
from the West just 10 years ago.
Many of
the economists who offered opinions at Jackson
Hole warned that the bursting of the home-price
bubble might lead to a severe recession. If the
rout on financial markets turns into economic
distress, Western governments will have no one but
themselves, and nothing but their own hypocrisy,
to blame. After instructing China for years on the
benefits of free markets, Washington, Brussels and
other Western governments have imposed the
strictest sort of mercantilist barriers upon the
free movement of capital.
It seems obvious
to ask why Asians should have bought exotic debt
instruments, rather than buy brick, mortar and
machinery in the United States and Europe. The
answer is that the US and European governments
will not allow them to do so. The specter haunting
Western financial markets is not proletarian
revolution, but the sovereign funds of China,
Singapore, the Persian Gulf states and others,
ready to invest hundreds of billions of dollars a
year. But the West does not want to allow Asians
to control major companies. The Chinese have told
the US government that they will buy virtually any
large US firm that the government allows them to -
but the US government fears the political fallout.
Of course, one feels sorry for autoworkers
in the US state of Michigan, who earn $30 per hour
and expected to do so in perpetuity. Sadly for
them, workers earning a tenth of that amount can
assemble cars just as well. If I were a sovereign
investment fund, I would buy Ford Motor Co, shut
down all of its production facilities in the US,
and keep the nameplate as an emerging-markets and
European brand. But that sort of rationalization
is precisely what any US government will try to
prevent.
The excuse Washington and
Brussels offer for ring-fencing their companies
against Asian investors is that the prospective
purchasers are sovereign funds, that is, agencies
of the state, rather than private individuals.
With the poor development of Chinese and other
Asian capital governments, the state becomes the
only entity capable of supporting national
savings. Singapore created the model for this in
its admirable pension program. China has no real
pension program, but its more than $1 trillion of
foreign-exchange reserves constitutes the
rainy-day savings of the Chinese people. The
Chinese authorities have begun to permit Chinese
citizens to buy foreign securities, but for the
moment the savings of the Chinese people are held
in large measure by the government.
Why
have Americans tolerated China's penetration of
its market for manufactured goods, at the expense
of US manufacturing employment? Part of the
answer, of course, lies in the fact that Americans
are able to buy much cheaper goods. But a more
important part of the answer, perhaps, is that
China's reinvestment of its export earnings in US
debt instruments forced down the cost of capital
in the United States, as Federal Reserve Board
chairman Benjamin Bernanke has observed over the
years. Cheap capital fueled an asset-price bubble
in the US, generating capital gains for US
households that made savings seem unnecessary.
If, as some of the voices from Jackson
Hole predict, US employment falls as a result,
protectionist measures against Chinese exports
become quite probable. Cheap Chinese goods at
Wal-Mart and cheap loans from the banks make a
convincing case for free markets only when one has
a job, and a house; if enough people lose their
jobs and their homes, their first instinct will be
to blame the Chinese. Democratic presidential
hopeful Hillary Clinton has already embraced
protectionism against China, an ominous sign.
China may have to shift economic gears in
a hurry, spending more on its internal market and
infrastructure, using if need be some of the
foreign-exchange reserves accumulated during the
past several years. It will have to seek markets
outside the United States, especially in the
emerging world. The transition may be painful in
the short run for China, but I do not expect the
Chinese economy to collapse even if the US throws
up protectionist barriers against Chinese imports.
China already has moved most of its young people
out of the countryside into the cities, and there
are reports of a shortage of young workers in
Chinese cities.
Americans will have to
work harder and save more. If the US wants to
remain the magnet for world capital flows it
became during the 1990s, it will have to allow the
savers of the world to become partners in the US
economy, that is, to buy into its first-rank
companies. This is not a matter of US discretion;
at some point, the United States will have no
choice but to allow more foreign ownership. If
Washington delays the inevitable, the price of US
companies will fall, and Chinese and other
sovereign investors will buy them cheaper.
(Copyright 2007 Asia Times Online Ltd. All
rights reserved. Please contact us about sales, syndication and republishing.)
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
