Using
the template of America's economy and its ripple
effects - some would say tsunami - across the rest
of the global financial system, this article will
focus on how and why capitalism as a system works
a whole lot better than any alternative. The idea
is to disabuse the notions of system failure that
are being propagated by the cynics of capitalism,
who in any event have rarely added any economic
value themselves.
The discussion is
topical, mostly for China, where critics of
America's freewheeling
democracy have been at pains to point out the
fallout from the subprime crisis and other
instances of industrial failures such as US auto
companies. [1] Other countries across Asia, most
notably the ones that were adversely affected by
the Asian financial crisis of 10 years ago,
usually take their cues from China; hence the need
for China to continue on its capitalist path,
which includes a continued expansion of its free
markets.
It is the attempted perversion of
free markets by Asian and other governments that
has caused the current turmoil in the global
financial system.
US politics, however,
represents the greatest threat in this discussion,
even if the biggest losers of any turn away from
capitalism would be the country's poor. That's
because the seemingly well-intended advice
provided by members of the US government to rescue
subprime borrowers [2] and increased protectionism
against Chinese goods [3] would inevitably damage
the frail US economy. More important for the
future of Asia, non-capitalist behavior by the
United States that could easily be duplicated by
other countries would dent potential growth rates
across the region for decades to come. This is one
tit-for-tat battle in which both sides will lose.
Case No 1: US subprime The most
recent episode in US financial markets will be
mulled and studied for a long time after all Asian
banks - commercial and central - fess up to their
losses. [4] While the average Western newspaper
appears to blame Wall Street investment banks for
the mess, they are barking up the wrong tree as
usual. It is not the rapacious capitalists on Wall
Street who are to blame, but rather the
currency-manipulating Asian central banks. The
fault lines of the current crisis thus lie in the
antiquated policies of Asian central banks that
defy the basic principles of capitalism or even
enlightened self-interest.
By stoutly
defending their currency pegs to the US dollar
well past the intended turnaround in
current-account surpluses at the end of the 1990s,
Asian economies in effect assumed a subsidiary
role to US requirements. A ready supply of
investments from Asia meant that pretty much
"acceptable" security could be sold down, often
well below the returns that prudent economic
agents would demand.
Asian central banks invested
primarily in debt, and were bound by historically
inspired mandates of asset quality that relied
much on the rating agencies such as Standard &
Poor's and Moody's. Profit-seeking agents (or
normal human beings to you and me), in this case
Wall Street bankers, rightly then provided the
service of combining the willing lender with those
that America's own banks would not touch with a
barge pole, namely the subprime borrowers. Long
considered too risky by mainline banks, the
borrowers suddenly presented other market folks
with exactly the right opportunity, namely the
generation of new mortgages, securities on which
could be sold to Asian (and European)
banks.
I am under no illusion that it was
Asia's voracious appetite for such debt
instruments that lies at the heart of the mess.
Look at the deal that the average burger-flipper
in America's heartland got: with a minimum-wage
job or two, you could qualify for a largish
mortgage that could buy the house of your dreams.
True, you had to make mortgage payments (which the
government deemed tax-deductible, in yet another
assault on the free market) but there was always
the chance of selling your house to the next chap
for a big profit. The stories of many such new
millionaires inspired millions to join the grand
scheme. As market returns always fall when trades
get crowded, so too did this little scam end, with
house prices tumbling across the United States and
people facing foreclosure.
It was for this
reason that I raised the issue of accountability
in the aforementioned article - Asian governments
too often get away with massive blunders in the
name of public good. China's currency peg is one
such policy, designed for largely illusory
benefits to its top line (ie, total exports) even
as the bottom line (manufacturing profits) went
sharply negative a while ago, before commodity
prices galloped upward.
As all actions
have an equal and opposite reaction, China's
meddling in currency markets has also produced a
domestic bubble in property and stock markets.
Constant recycling of billions of dollars from
trade surpluses allowed easy access to credit for
China's urban masses, and provided in turn the
wherewithal to finance new property and stock
investments across the country.
As a
recession grips the US economy and shakes out
excess consumption, China will suddenly find
itself all dressed up for a non-existent party.
Whether the waxworks in Beijing like it or not,
the country has to revalue, and do it soon, to
allow consumption to take over from production as
the key engine of the economy.
Case No
2: US car sector In a previous article,
[5] I made light of America's inability to produce
good-quality cars at the right price. While the
focus of that article was the current US
administration's preoccupation with the status quo
(itself an anti-market principle), perhaps a more
detailed examination of the current mess in the US
auto sector is called for. Not a month goes by
when domestic manufacturers (I don't like calling
them the Big Three anymore, because they quite
simply aren't) don't lose market share, and fail
to export more to the rest of the world.
How did the country that invented the
assembly line get into this predicament? The most
often overlooked answer is of course the trade
unions, and in particular the United Auto Workers
(UAW), that sought to impose exaggerated lifestyle
expectations on the auto companies, and eventually
caused them to collapse under the weight of their
own generosity. Be it the issue of overly generous
vacation and holiday entitlement or restrictions
on mobility, the UAW did more damage to US auto
makers than any of the Japanese manufacturers ever
could. It isn't without adequate cause that top
management of US auto companies often refer to the
UAW as the "sleeper cells" of the foreign
competition.
The second area was the US
government's intransigence in pricing negative
economic goods. These are goods that have harmful
effects on society - when they are declared free;
markets obviously take advantage of the gap.
Whether it was tobacco companies or auto makers
with their sport-utility vehicles (SUVs), the
problem for the United States was the same. Just
as most states failed to value the health of their
citizens highly and therefore did not tax tobacco
sales, the country failed to value intangible
items such as air quality and therefore did not
implement taxes on fuel as much of Europe and Asia
did (it is another matter that generations of
Saudi royals have sought to prevent just such an
outcome).
The market reaction came in two
ways - first US manufacturers moved away from the
passenger-car business in which the Japanese
clearly had the upper hand, and enjoyed profits
for a little while in the 1990s. The aggregate
impact of their production on oil demand, though,
eventually caught up with them, and as the price
of oil surged, these companies found themselves
with the wrong product (thirsty SUVs) at the wrong
time (an impending recession).
Left to run
its full course, capitalism will push the US auto
makers to bankruptcy, remove the excess capacity
in production, and thereby push up the price of
cars. This will reduce total sales in the US
market, and also force Americans to pick a
fuel-efficient car over "fat" alternatives. The
bankrupt entities will be free to reorganize
themselves into viable economic units and shed the
restrictive union contracts for one, and
rationalize their product offerings for another.
From the two cases above, it is clear that
free markets work perfectly well if in a "take no
prisoners" fashion. The most rational economic
choice is always picked, and in the long term
resources are aligned correctly with competitive
advantages. In contrast to this, government
meddling always perverts the course of economies,
exaggerating the ebbs and flows of normal market
trends. Herein lies the most important lesson for
citizens across Asia.
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