Fixing Global Finance: Who is responsible? (2009)

• Comments
• Review

Introduction

In a review  of Martin Wolf's book, Fixing Global Finance, one observer (Wayne Yang) suggested that Professor Wolf was wrong to pay so much attention to China's / Asia's 'savings glut'.

The key themes of Wayne Yang's review (which is reproduced below for convenience) were that:

• Wolf argues that China and emerging markets foisted a 'savings glut' on the US - which encouraged excess US consumption;
• the growth of excess savings in Asia (and elsewhere) reflected the best defence against speculative foreign investment that had led to the Asian financial crisis;
• Wolf absolves the US of blame, and criticises Richard Duncan (and others) for suggesting that the problem arose from a money glut in the US - even though admitting that the latter was a problem that could have been reduced / avoided;
• the US Federal Reserve does not carry out its role out of a desire to benefit the rest of the world, and its loose monetary policy was simply a self-protective device related to bursting of US stock market bubble. If this helped others, it was to further prop up the myth of Pax Americana;
• Wolf's book has unfortunately come out before the crisis has ended, and there is growing concern elsewhere about the $US's status and value in view of exploding US debts;
• Wolf's real goal in Fixing Global Finance was not to assign blame, but to highlight the alarming economic imbalance - and was a warning shot across the bow of the developed world. However, his view that governments need to create institutions which promote trust in financial promises, was implicitly a criticism of US prolificacy.

Comments

Both Professor Wolf's book and the above review seem to suffer from the same limitation - a failure to consider the way in which the economic models that have been the basis of rapid development and growth in East Asia depend critically on maintaining 'excess savings' (see Understanding East Asia's Economic Models).

Those models, which appear to involve coordination of economic activities through social relationships amongst nationalistic elites rather than profit-seeking by enterprises, tend to generate poor balance sheets in financial institutions. The latter can only avoid crises if protected from the need to borrow in international markets by the cash flow associated with a large current account surplus.

On this basis it is also suggested that:

• Japan, which originated the economic model that has been adapted in various ways throughout East Asia, was a major source of a 'savings glut' long before China or anyone else adapted that model, and has continued as a major source of external capital boosting US consumption. Thus Japan's role in the process should not be neglected (eg see Focusing on Japan and the Global Financial Crisis);
• there is no doubt that growth of excess savings in Asia (and elsewhere) accelerated as a consequence of the Asian financial crisis. However that crisis was as much a consequence of weaknesses in local financial institutions as a result of the economic model Japan spread throughout the region, as it was of speculative foreign investment;
• it is meaningless to suggest that blame should be placed on either an Asian 'savings glut' or a US 'money glut', as these are simply two sides of the same coin. The US could only absorb Asia's 'savings glut' because consumer spending was strong on the basis of a household wealth effect created amongst those with significant existing assets by the 'money glut';
• contrary to Wayne Yang's suggestion, the US Federal Reserve did seem to carry out its role for the benefit of the rest of the world. Alan Greenspan as Fed chairman frequently referred to the need to guard against the risk of deflation as the reason for what others saw as excessively easy monetary policy - though deflation was a risk which Japan faced, but the US itself didn't. This strongly suggests that: (a) in setting monetary policy, the Fed was in close communication with Japanese officials; and (b) US monetary policy was being used to try to ensure that global growth was maintained in the face of the structural demand deficits (ie savings surpluses) in East Asia and elsewhere;
• in so far as Wolf's book constitutes a 'shot across the bow' of governments in relation to their responsibility to promote trust in financial promises, this would apply to socially-rather-than-profitability coordinated economies in East Asia (and to many emerging economies) as much as to the US.

Review by Wayne E. Yang of Martin Wolf's Fixing Global Finance  

In Fixing Global Finance, Martin Wolf (the must-read Financial Times columnist) argues that China and the emerging markets have hoisted a "global savings glut" onto the United States. China's savings, as measured against its gross domestic product, have reached an unhealthy level, it is generating too much excess capacity and the country needs to encourage its people to consume more. The country is in the odd historical position where it is both the world's fastest growing economy and its largest exporter of capital.

That strange status stems in part from the tack that China took after the Asian currency crisis of 1997. China saw the crushing speed with which "fast money" (speculative foreign investment dollars) left the Southeast Asian economies, bursting the region's market bubble. Putting that experience in the rearview, the Asian economies, and subsequently, an emerging China, decided that the best way to defend against such financial fickleness was to build overwhelming foreign reserves. To Wolf's mind, China drew the wrong conclusions from the Asian economic crisis, however. Though China started from a lower baseline, the restarting of its large economic engine has distorted the global economy as it has accumulated and recycled a torrent of U.S. dollars back into the United States. Wolf says that China is much too large to follow the model of smaller economies like that of Korea and Taiwan.

In his critique of China's role in the global economic imbalances, Wolf seems to largely absolve the United States. He criticizes Richard Duncan and other writers for believing that our problems stem from a "money glut", a position that essentially paints China and the other emerging markets as passive victims of U.S. dollar "hegemony". According to Wolf, monetary growth until fairly recently was considered to be contained (a debatable point, depending on what measure of monetary growth you use) and inflationary expectations have remained muted (suffice it to say that the verdict on that score is still out). The United States, in the short-term at least, still benefits from the perverse idea that U.S. Treasuries are a safe investment, even though the country is leveraged to the hilt. Wolf admits that the money glut thesis is not without merit, since "American policy makers had at least some influence on whether the counterpart of the inflow would be consumption or investment." True, he admits that the United States has an "exorbitant privilege" in being able to issue debt in its own currency, the world's de facto reserve currency, but he readily buys the idea that the United States acts as a good citizen in accepting and recycling surplus dollars, a dynamic, which in reality has helped birth the many asset bubbles that we have experienced in recent decades.

The U.S. Federal Reserve does not accept and carry out its role out of any great largesse for the rest of the world; the overly protracted, loose credit policy that it effected during the early part of the decade was a self-protective response to the bursting of a U.S. stock market bubble, and subsequently helped to create a new bubble in U.S. real estate. If it also helped to re-stimulate various export-oriented economies, it was at the cost of further propping up Pax Americana, the myth that U.S. assets and financial instruments were worth more because the evermore deeply-in-debt American consumer was somehow the engine of growth for the world. The global stock market collapse in 2008 should have shattered that illusion. The United States has chosen to be a borrower; China, a lender.

The misfortune is that Wolf's book has come out before this crisis has run its full course. Despite the arguments of raging bulls, who have been fueled by a too-quick return in stock market values, we still face the prospect of rising U.S. unemployment, an exploding amount of U.S. government debt, a weakening U.S. dollar, and the specter of rampant inflation. Charles Kindleberger warned that when a government faces the hard choice of asking its citizens to sacrifice and strengthen the country's financial position or to debase the currency, governments seem to inevitably choose to debase the currency. In the same way that Rome once debased the precious metals contents of its coins, the United States and Western Europe have begun running its printing presses at a lightning clip. Brazil, Russia, India and China -- the so-called "BRIC" nations -- have begun expressing more concern over the U.S. dollar. China, in particular, has been trenchant in its criticism of the United States' exploding debt.

Wolf's real mission in Fixing Global Finance, however, is not to assign blame but to highlight the alarming economic imbalance. His proposals include growing the still nascent bond markets of the emerging markets and issuing bonds denominated in emerging markets currency baskets. The mid-year purchase of International Monetary Fund (IMF), special drawing right (SDR)-denominated bonds by the BRIC nations was relatively small, but in a sense, it was a warning shot across the bow of the developed world.

If, as Wolf says, "the essential role of government is to supply the institutions that create and sustain trust in financial promises," the profligacy of the United States is irresponsible, given its key role in the global economy. What we all fear is that a day of reckoning could be coming. "Sophisticated and dynamic modern economies depend on pyramids or promises far more impressive and complex than those of stone constructed by the pharaohs almost five thousand years ago," writes Wolf. "Yet the confidence that sustains them could all too easily prove misplaced. People would then end up with promises not worth the paper they are no longer printed on."

--  Wayne E. Yang lives and works in New York. His writing has appeared in The North American Review, The Christian Science Monitor, Dim Sum and other publications.