Another Dimension of The Dollar Crisis: Causes, Consequences, Cures?
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Richard Duncan

I noted with extreme interest reports of your conclusions about problems affecting the global financial system (eg.'The Dollar Crisis: An Interview with Richard Duncan', 8 November 2003)

Your analysis seems very significant in demonstrating (amongst other things):

• how the breakdown of the Breton Woods system (and the convertibility of currencies into gold) allowed a trade imbalance to persist;

• the inability of the US to continue driving global growth with a 5% pa current account deficit - and how this must break down (probably triggering a massive deflationary slump) when it proves impossible for any US institutions to be able to service increasing indebtedness;

• how economic bubbles can result from trade surpluses (by injecting new deposits into surplus nations' banking systems which allow a then-self-reinforcing expansion of credit);

• the emergence of an enormous global credit bubble - a problem which traditional economic policy tools can not cope with, and which requires a huge new source of net global demand;

While any claim that I might make to expertise in relation to financial and monetary systems would be laughable, I suspect that there is a dimension of this situation which, if taken into account, might affect your conclusion.

Based on a 15 year effort to 'reverse engineer' the intellectual basis of East Asian economic 'miracles', I should like to submit for your consideration that the present situation can not be properly understood without considering the implications of neo-Confucian traditions on which East Asia's radically-different monetary and financial systems have been based - as these seem to impose an inbuilt and intrinsically unsustainable 'demand-deficiency' on the global economy. My hypothesis is supported by an independent account of this arrangement in relation to the Japanese system.

A general outline of what may be involved is presented below.

This reaches a quite similar conclusion to your own, but looks at the subject from a different perspective. It implies that the breakdown of the Breton Woods system was necessary for the rise of persistent trade deficits, but not sufficient. Moreover it suggests that East Asian economic systems (especially those in Japan and now China):

• impose a structural deficit in aggregate demand on the global economy - for which the US's demand stimulus through its current account deficits (financed by increasing its debt levels) has provided a temporary covering;

• did not achieve economic 'miracles' merely because of the credit stimulus of trade surpluses - but because of social and institutional arrangements which facilitated rapid economic learning;

• the latter involves a catalytic role by social elites under arrangements which target market share rather than investment profitability. The result is that (irrespective of any 'bubbles' due to trade surpluses) their financial institutions carry large quantities of bad debts, and require a large balance of payments surplus to protect then from the need to obtain an international credit rating;

• can never themselves provide the current account deficit to drive global growth - because this would require that financial institutions be able to gain a favourable international credit rating;

• must eventually decline economically because resource allocation based on maximizing turnover is less productive than that based on seeking profitability;

• have in Japan's case been directly boosting the growth of US money supply - ie by near zero interest credit, much of which has been shipped to the US (the Yen carry trade);

• might do relatively well by comparison with Western societies in the event of a global financial crisis (because economic transactions are coordinated by social relationships rather than by financial outcomes), providing their political systems did not fail in such a crisis (as Japan's did with the rise of militarism in the 1930s, and China's would seem likely to do today);

I would be interested in your reaction to my hypothesis. I have made a start on factoring your analysis into my own - but still have still a long way to go. Any comments on the undoubted deficiencies of Structural Incompatibility puts Global Growth at Risk would be greatly valued.

Regards

John Craig

Centre for Policy and Development Systems
CPDS supports leaders developing enterprise, economic, community and governance systems

A DIFFERENT PERSPECTIVE ON THE ECONOMIC BUBBLE

Current fiscal imbalances affecting the US economy which many observers (including the Bank of International Settlements) have seen as a threat to the sustainability of US and global growth (and which are encouraging the US to seek seek changes in other's monetary and economic policies) may be the result of (universally ignored) structural incompatibilities between different economic systems.

Though the 'solutions' to these imbalances the US has officially been seeking (eg revaluation of China's currency, faster growth in Europe) have been inadequate, there may none-the-less be a critical problem.

An hypothesis about this (which is at best a work in progress) is outlined in Structural Incompatibility puts Global Growth at Risk .

In brief it suggests that:

• global growth has been critically dependent on demand from US consumers;

• this dependence (and the current account deficits which have thus emerged) are the result of structural differences - namely that:

  • the US economy tends to be consumer driven, whilst some others (especially many in East Asia) have emphasised the development of an export production capacity which is significantly greater than aggregate domestic demand; and

  • the US economy is coordinated by financial outcomes, while those of major East Asian economies tend to be coordinated by social relationships amongst elites. The latter promotes nationalist goals but also results in poor financial outcomes and a need to accumulate large foreign reserves to protect institutions with bad balance sheets from the need to obtain an international credit rating;

  • while China's economy now involves 'markets' those markets (like their Japanese equivalent) are anything but free;

• a clear outline of those differences is contained in Why Japan can not deregulate its financial system . This refers to arrangements which are likely to appear inconceivable to Western observers who lack an understanding of (a) social and governance arrangements that allow financial profitability to be viewed as virtually irrelevant, and (b) methods for problem solving which make it possible to run partly-successful industry policies. This has implications for:

  • the existence of a potential demand deficit in the global economy in recent decades;

  • the counterbalancing growth to now critical levels of US current account deficits (and debts), and the need for European countries to run large fiscal deficits to sustain sufficient growth to keep unemployment under control; and

  • the consequences of the Louvre Agreement - ie it suggests how agreements to 'stimulate' the Japanese economy could only have the effect of increasing production, rather than consumption;

• the real issue in resolving unsustainable US current account deficits is not (a) currency exchange rates which have been the US's focus for attention (because this can not really affect the current account deficit) or (b) US savings rate (because trying to force an increase in savings would have very large adverse impacts on global demand) or (c) a new tariff regime - which would suppress global trade and potentially result in an economic recession or worse. Rather the main issue must be the mercantilist framework in which some financial systems (especially those of Japan and China) are regulated to direct finance to production but not to consumption;

• a plausible outcome of almost any effort to correct the unsustainable US current account deficits will be the emergence of an Asian Financial Crisis - Stage 2, in which China will take the unfortunate lead role because:

  • its economy (and now others throughout Asia who hove been incorporated into the Chinese economic system by providing component inputs) is critically dependent on foreign investment - whose ultimate justification has been US demand growth;

  • direct investment seems invariably to have been unprofitable for investors - making it quite similar to the massive 'dot-com' investments of the 1990s which involved rapid business growth rates but no real prospect of profitability;

  • such investment will be exposed as a 'bubble' when US consumption demand stalls / falls and no replacement has emerged elsewhere (as seems unavoidable sooner or later). This would in turn take away the foreign exchange reserves (which China accumulates due to capital inflow) and expose its essentially insolvent financial institutions to the need to seek an international credit rating. Given the lead role which China seems to have been playing in Asian economies, its financial crisis would be bad news all around;

• the world may well be on the point of a 1930s-style 'demand deficit' driven recession - which might require re-invention of something like a Keynesian solution and again raise risks of the emergence of autocratic governments.

Some indications of the character of the East Asian economic models (which China's reform is likely to be a particular example of, through a process of intelligence gathering and networking) are referenced in Competing Civilizations. The problem is that no matter how those methods are deployed, they will intrinsically not produce economic 'success' if this is measured in terms of financial outcomes. Thus progress must fail (a) when domestic demand is increased sufficiently to erode reserves of foreign currencies (b) when US demand fails; or (c) in the long term because of poor resource allocation due to economic strategies that emphasize turnover rather than profitability.