Credit crisis the solution, not the problem
Chinese inflation and US indebtedness can work to the otherÆs benefit, if policymakers in both countries allow it, says Lombard economist.
According to one economist, China and the US suffer from mutually reinforcing problems that can begin to be solved, thanks to the subprime-triggered liquidity crisis, if Beijing lets it.
Charles Dumas told the audience at last weekÆs AsianInvestor annual Asian investment summit in Hong Kong that heÆs optimistic about the future of both economies because the solution to each of their problems is compatible û provided that policymakers and politicians in Beijing and Washington step back and let market forces work.
Dumas is chief economist and head of world service at Lombard Street Research in London. His argument for the past several years is that the main source of imbalances in the world is not US profligacy but a savings glut in Asia, notably in China. The solution is to allow excess savings in creditor nations to flow to the US û but in the form now of equity, not debt.
Essentially his analysis says it is now the Chinese who have the power to sort out these issues, because they are the ones who drive the exchange rates and who have the choice to either retain control over the nationÆs assets û thus continuing their own problem of inflation, and preventing capital to flow to distressed sectors in the US û or to ease capital controls and let market forces go to work.
This is now required because the nature of the savings glut has changed. Initially this money accumulated in Asia because of lack of domestic demand. This was an inherently deflationary phenomenon that, following the dot-com crash in 2000, required the US to slash interest rates to soak up these surpluses.
The US trade deficit ballooned and America got rather carried away with borrowing, to the point where it was no longer able to service its debts. The borrowing even continued after the US housing market saw prices stop rising in 2006, but Wall Street kept securitizing pools of increasingly dodgy assets, spurring the economy û until now.
When subprime mortgage terms reset, the housing market crashed and consumption halted. ôIt is the end of 30 years of leveraging,ö Dumas says, noting that private non-financial debt is now 175% of US GDP.
ôThe credit crunch is the first stage of the solution to global imbalances,ö he says. ôIt is not the problem. The problem in America is too much debt.ö
In the flight to quality of late 2007, huge amounts of savings went into US Treasury markets. But this is the last thing the US needs û more debt. The US could pull itself out of crisis if it could devalue the dollar, but it canÆt û as Dumas notes, ôThatÆs up to Beijing.ö
What the US financial system and general economy requires is equity injections, to reduce indebtedness. What China needs is to put its excess savings to work overseas, because right now these trapped assets are now fuelling inflation.
WhatÆs happening now is a mimicry of what should take place, mostly to ChinaÆs detriment. Last year ChinaÆs foreign reserves rose by $600 billion, the bulk of which went to short-term Treasury instruments. Treasury bills return 1-2%. The Fed, meanwhile, has just taken a quasi-equity stake in Bear Stearns to the tune of $29 billion û the amount of dubious assets it took onto its balance sheet in order to convince JPMorgan to buy the ailing investment bank.
ôSo China is lending to the US government at the T-bill rate while the Fed puts that money into the US stock market,ö Dumas says. ChinaÆs not getting much value for its savings, while the US is effectively nationalizing parts of the financial system and leaving taxpayers with the risk; meanwhile low interest rates are only spurring oil traders to buy more futures, driving up the price of commodities at a time when consumers are losing their homes. This not only hurts US consumers, but it drives up ChinaÆs import bill and fuels its inflation.
When the savings glut emerged, it was because there was no domestic demand in China; now there is plenty of domestic demand: in fact, too much. Without a release valve, this has transformed a deflationary trend into an inflationary one. And when the US economy does recover, it is likely to import Asian inflation, because its own workers will demand wage increases to match those that will have already taken place in China. This could force the Fed into painful interest rate hikes.
Dumas says China should allow the renminbi to appreciate and to relax capital controls on its citizens. ôChina needs a sea change from building infrastructure, raising production and increasing income levels, to allowing people to manage these new assets. There is a natural synergy in letting its people invest in US equities and to stop accumulating foreign-exchange reserves, which will only spur domestic inflation. The solutions are consistent for the US and for China, which is why I am optimistic û if only their politicians can overcome certain attitudes.ö
Charles Dumas told the audience at last weekÆs AsianInvestor annual Asian investment summit in Hong Kong that heÆs optimistic about the future of both economies because the solution to each of their problems is compatible û provided that policymakers and politicians in Beijing and Washington step back and let market forces work.
Dumas is chief economist and head of world service at Lombard Street Research in London. His argument for the past several years is that the main source of imbalances in the world is not US profligacy but a savings glut in Asia, notably in China. The solution is to allow excess savings in creditor nations to flow to the US û but in the form now of equity, not debt.
Essentially his analysis says it is now the Chinese who have the power to sort out these issues, because they are the ones who drive the exchange rates and who have the choice to either retain control over the nationÆs assets û thus continuing their own problem of inflation, and preventing capital to flow to distressed sectors in the US û or to ease capital controls and let market forces go to work.
This is now required because the nature of the savings glut has changed. Initially this money accumulated in Asia because of lack of domestic demand. This was an inherently deflationary phenomenon that, following the dot-com crash in 2000, required the US to slash interest rates to soak up these surpluses.
The US trade deficit ballooned and America got rather carried away with borrowing, to the point where it was no longer able to service its debts. The borrowing even continued after the US housing market saw prices stop rising in 2006, but Wall Street kept securitizing pools of increasingly dodgy assets, spurring the economy û until now.
When subprime mortgage terms reset, the housing market crashed and consumption halted. ôIt is the end of 30 years of leveraging,ö Dumas says, noting that private non-financial debt is now 175% of US GDP.
ôThe credit crunch is the first stage of the solution to global imbalances,ö he says. ôIt is not the problem. The problem in America is too much debt.ö
In the flight to quality of late 2007, huge amounts of savings went into US Treasury markets. But this is the last thing the US needs û more debt. The US could pull itself out of crisis if it could devalue the dollar, but it canÆt û as Dumas notes, ôThatÆs up to Beijing.ö
What the US financial system and general economy requires is equity injections, to reduce indebtedness. What China needs is to put its excess savings to work overseas, because right now these trapped assets are now fuelling inflation.
WhatÆs happening now is a mimicry of what should take place, mostly to ChinaÆs detriment. Last year ChinaÆs foreign reserves rose by $600 billion, the bulk of which went to short-term Treasury instruments. Treasury bills return 1-2%. The Fed, meanwhile, has just taken a quasi-equity stake in Bear Stearns to the tune of $29 billion û the amount of dubious assets it took onto its balance sheet in order to convince JPMorgan to buy the ailing investment bank.
ôSo China is lending to the US government at the T-bill rate while the Fed puts that money into the US stock market,ö Dumas says. ChinaÆs not getting much value for its savings, while the US is effectively nationalizing parts of the financial system and leaving taxpayers with the risk; meanwhile low interest rates are only spurring oil traders to buy more futures, driving up the price of commodities at a time when consumers are losing their homes. This not only hurts US consumers, but it drives up ChinaÆs import bill and fuels its inflation.
When the savings glut emerged, it was because there was no domestic demand in China; now there is plenty of domestic demand: in fact, too much. Without a release valve, this has transformed a deflationary trend into an inflationary one. And when the US economy does recover, it is likely to import Asian inflation, because its own workers will demand wage increases to match those that will have already taken place in China. This could force the Fed into painful interest rate hikes.
Dumas says China should allow the renminbi to appreciate and to relax capital controls on its citizens. ôChina needs a sea change from building infrastructure, raising production and increasing income levels, to allowing people to manage these new assets. There is a natural synergy in letting its people invest in US equities and to stop accumulating foreign-exchange reserves, which will only spur domestic inflation. The solutions are consistent for the US and for China, which is why I am optimistic û if only their politicians can overcome certain attitudes.ö
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