Without Chinese economic reform, global recovery may be doomed
Pastor Dale Morgan
Without Chinese economic reform, global recovery may be doomed*
China needs to boost domestic consumption rather than relying on
exports, or the world will be flooded with goods that nobody wants
o Larry Elliott
o guardian.co.uk, Monday 18 January 2010
It's only the third week in January but already the big economic themes
of 2010 are clear. It will be a year of recovery, a year of banker
bashing, a year of debt reduction and a year of growing protectionist
pressure. And it will be a year of two distinct halves, with fears
growing about the durability of the pick-up as the months roll by. Make
the most of the good times.
The short-term picture is certainly better than it was 12 months ago.
China is booming on the back of exports growing at an annual rate of
40%. The leading indicators for the United States, which in 2006 and
2007 anticipated the downturn, are now pointing to growth of about 3%
this year. City analysts believe the UK economy expanded by about 0.5%
in the final three months of 2009.
With policy likely to remain loose for some time to come, these trends
will continue. But unless this recovery breaks with historical
precedent, some words of caution are in order. In the past, severe
crises in the global economy have persisted for several years and gone
through distinct phases. America during the Great Depression, for
example, saw a deep plunge in output after the Wall Street Crash,
followed by a fairly brisk recovery in the mid-1930s and then a further
serious setback in 1937. The economy only really returned to permanent
health when the US went to war in 1941.
Uneasy stability
It was a similar story in the 1970s and 1980s. The postwar boom was
brought to a halt by the oil shock of 1973, with the recession of
1974-75 followed by a period of uneasy stability in the late 1970s
before a second oil shock led to an even bigger slump in the early
1980s. In both cases, the economic crisis took more than a decade to
play itself out, which was hardly surprising given the structural
weaknesses that needed to be addressed.
So what's different about this crisis that should make us believe that
the global economy can return to rude good health within three years?
Not a lot, as it happens. The fundamental imbalances have yet to be
addressed, while the necessary reform of the financial sector has not
yet gone nearly far enough.
That's not to belittle what Barack Obama did last week when he announced
a levy on 50 large financial firms. "We want our money back," he said at
the White House. "And we are going to get it." After spending most of
his first year in office adopting a softly-softly approach to Wall
Street, Obama has at last responded to the anger on Main Street at what
the president called "the massive profits and obscene bonuses" that have
only been possible because of taxpayer bailouts.
The public finances in the US � as in the UK � have deteriorated
significantly as a result of the crisis, so the $90bn (�55bn) raised
from the levy is not to be sniffed at. It will put some (albeit
insufficient) limits on the growth of banks and hence, indirectly,
tackle the "too big to fail" problem. But it will also limit private
sector credit growth, thereby intensifying and prolonging the period of
debt deleveraging already in prospect for the next half-decade.
A report by the McKinsey Global Institute last week outlined the
position well. It noted that a long period of deleveraging nearly always
follows a major financial crisis, with these tending to last for six to
seven years and leading to a reduction in the ratio of debt to GDP of
25%. The study identified households and the commercial property sectors
in three mature economies � the US, Britain and Spain � as being most
vulnerable to severe debt deleveraging. No real surprise there, since
they were the three countries to have the biggest property bubbles. By
2007, bank lending for residential mortgages was equivalent to 81% of
GDP in the UK and 73% in the US. In comparison, bank lending to
businesses was equivalent to just 46% of GDP in the UK and 36% in the
US. "If history is a guide," the MGI report says, "we would expect many
years of debt reduction in specific sectors of some of the world's
largest economies, and this process will exert a significant drag on GDP
growth."
MGI says that little deleveraging has so far taken place, because any
decrease in private-sector debt has been matched by increases in public
debt: "We therefore see a risk that the mature economies may remain
highly leveraged for a prolonged period, which would create a
potentially unstable economic outlook over the next five to 10 years.
"The bursting of the great global credit bubble is not over yet."
It is that backdrop that raises doubts about the durability of China's
recovery. Everybody knows what should happen in theory: the Chinese need
to boost domestic consumption rather than relying on exports. Otherwise,
with America unable to act as the world's consumer of last resort, the
world is going to be flooded with goods that nobody wants. The lack of
global demand will force down prices, making the threat of deflation
extremely real and adding to pressure for trade barriers.
A 'globalised Japan'
Some analysts, such as Stephen Roach at Morgan Stanley, think Beijing
"gets it" and that China is about to take dramatic action to rebalance
its domestic economy. Let's hope Roach is right, because the alternative
is that the whole world economy becomes like Japan after its bubble burst.
"The elements of a 'globalised Japan' are being put into place," Charles
Dumas of Lombard Street Research said. "Government debt is increasing,
seemingly without limit, in response to the bursting of a private
debt-fuelled asset-price bubble. The onset of persistent deflation is in
sight. Also slower growth seems probable, that third element of Japan's
'long night of the 90s'."
Dumas believes that far from �re-engineering its economy towards
domestic consumption, China has returned to its comfort zone of
export-led growth. In the short term it is able to do so because the
renminbi is undervalued, particularly against the euro. News last week
that German growth stalled in the fourth quarter of 2009 was
significant. It was an early sign that the inventory-driven pick-up in
Europe is running out of steam.
Against this backdrop, it is difficult to see why the recovery should be
smooth. McKinsey sagely anticipates a prolonged period of cold turkey as
debt addiction is sweated out of the system, and that's even without the
process being interrupted by a fresh shock.
The banks are still in a weak state, markets are febrile, the public
mood is sour. Dumas is concerned that by late 2010 or early 2011 there
will be a second leg to the global downturn, this time with political as
well as economic ramifications. If he's right, things will then get very
nasty indeed. As I said, enjoy it while it lasts.