The story has to always start with Asia. [A question to ask is:] is the world Asia-centric or US-centric? At the moment, if you pick up a newspaper you would think it’s US-centric because of what’s happening in US credit markets. The effects are being spread from there to the rest of the world. But what’s happening in US credit markets didn’t have to be the US. Instead, what is happening in credit markets around the world is predominantly a result of some influences that originated in Asia.
Let’s turn to China for a minute. One problem is that you’ve had a huge amount of cash flow go into China. Typically, the more money that’s available, the less disciplined people are when it comes to investing or spending it. One could argue that there are many companies in China that have big order books, but their actual profitability may be quite limited, if not negative. And that’s combined with the fact that people in China are now selling their jewellery in order to buy stocks because they believe that the stock market is a one-way bet to riches. Add to that mix the fact that the United States Congress is becoming genuinely focused on restricting trade with China. Taken together, that’s not a great picture for the world economy’s reliance on China.
There is a threat of protectionism. Of course, that’s extremely worrying. Part of the explanation for the way China behaves the way it does is that its savings rate is almost God given. It’s very hard to change a country’s savings rate. This happens to exceed the investment rate in China, which is also extraordinarily high – it’s 45 per cent or something like that. There’s no reason to believe that they could possibly handle more investment. They have probably got over-capacity all over the place. They just do not have the financial infrastructure to handle that level of investment, nor probably does any country.Enjoying this article? Click here to subscribe for full access. Just $5 a month.
It’s not that the Chinese are incompetent in that respect. I think it would just be extraordinarily difficult to channel that amount of investment each year in a very efficient manner, even in an economy where there is a bottom line and you can fail. It seems rather difficult to fail in China.
I don’t know the answer to this, other than that China is going to continue to do what it’s been doing. US macro-economic policy probably had to do what it’s done. It has basically delivered low inflation and reasonable economic growth for the last five years. What else could it have done? Sure, that means you’ve got a large current-account deficit but I come from a country that’s had a large current-account deficit for a century. So, I don’t tend to get as excited about that subject as the Europeans and Asians do. My worry is moral hazard.
What is the Fed going to do? Wall Street’s holding a gun to its head. Wall Street is saying, “We assume that you’re going to ease by at least 50 basis points and probably before the next meeting (18 September 2007), and we’re all panicking and if you don’t do it the panic will get even greater and we will stop lending to even credit-worthy customers.” This means the Federal Reserve is in a very awkward position.
And the irony is that even if the Federal Reserve cuts the Fed Funds rate, it is not going to save the losers.
I know. It’s an insolvency problem, not just a liquidity problem. If it’s a liquidity problem anyhow, then the thing to do is what the Fed has been doing: make sure that there’s enough cash in the system – I hate that word liquidity – to keep the banks lending to each other. That’s what you do, that’s what Bagehot said in 1880 or so and that’s still true today.
If there’s a macro-economic problem of insufficient demand, then monetary policy is supposed to come in. But what we’re looking is neither a pure liquidity problem nor at this stage a macro-economic problem. It’s an insolvency problem. Lenders don’t know where the insolvency is in the system. In that sense there is a lack of transparency, although I suspect there is always a lack of transparency. It is not as though this is the first time this has happened. There are real losses out there and no one can make them go away. There are real losses in the household sector and in the investment community. The biggest worry is that the losses are not just by people who own things outright. A lot of these investments have been held with leverage, and that means the losses are going to be much, much bigger.