In his current Asian trip, President Obama visits Japan, then addresses a forum of leaders in Singapore, and eventually ends up in Seoul to discuss nukes and North Korea. But make no mistake, the axis of this week is the time Obama will spend in China, which has catapulted to the forefront of international affairs and is on its way to joining the United States as the alpha and omega of the global economic system.
That China has emerged is secret to no one, but the consequences haven't been fully integrated - either by the United States or by China. The level of intertwinement between the two economies has reached the point where they have effectively merged, forming what I've called an economic "superfusion." But that fusion hasn't yet altered political and cultural mindsets.
]]> The ministers of the world still beseech the United States to "do something" about a weakening dollar, and U.S representatives on the eve of this trip announced that after the financial morass of the past 15 months, the United States "is back." Yes, the United States remains the world's largest economy - though technically the combined income of the European Union is greater. But size isn't everything - just look at Japan, which is still the world's second largest economy but whose influence and impact are substantially less. China may be poor on a per capita basis (perhaps $5000 per person relative to nearly $50,000 in the United States), but it is changing more rapidly and consuming more hungrily that any other society in the world. It is the change factor in the global system.Chinese leaders, however, have a tendency to downplay their outsized presence and retreat to a combination of false modesty ("Who us? We're just a poor, developing nation") and baton-passing ("The Americans are the ones who messed up the system and they are the ones who have to fix it, and oh by the way, make sure that our $800 billion in Treasury bonds and $500 billion in other investments don't lose value!"). Their doctrine of non-interference in the internal affairs of other countries is a welcome relief for some who have grown tired of the American tendency to do the opposite, but it also is an increasingly ineffective dodge of the responsibilities that come with hundreds of billions of dollars of investment in Africa, Latin American and Central Asia, as well as hundreds of billions of dollars in trade with the United States, Japan, Korea, the EU and the rest of the world.
Americans, however, still don't quite get it. China represents the first time in any American's lifetime that the United States is faced with a country that it cannot coerce. Even the Soviet Union was vulnerable in its way to American military might. China doesn't even pretend to compete with the United States militarily (though it is aggressively spending on "asymmetric" warfare such as disruptive communications technologies and other methods that would impede the ability of the U.S. military to operate smoothly in the Pacific Rim). And there is no real stick for Americans to wield when it doesn't like how China behaves, whether that is in the realm of human rights or intellectual property. For America, China is a 'welcome to the real world' phenomenon, a case where the United States has to do what most other societies have learned to do for centuries: deal with things they don't like in other countries without being able to force them to behave differently.
The issue for American going forward has little to do with China and everything to do with America. Can Americans rediscover the energy and innovation that brought such power and prosperity in the first place? Can the United States respond constructively to a changed global status that sees the rise of wealth and prosperity everywhere from Brazil to India to China? And can the U.S. government remove its collective head from the sand and act with the urgency that everything from climate change to economic competitiveness demand?
The problem of China for America is that it is a large but amorphous issue, unlike Afghanistan (do we send troops NOW?) or health-care, with its endless and acrimonious battles in the beltway. There is no vote, or quick resolution or unitary policy that will "solve" China. That allows it to linger as a concern, but not to shape action.
So while Obama's visit is important in form and a start, it cannot be a one-off, full of pomp and devoid of substance. Somehow, the United States must shake of the collective grogginess of Cold War, terrorism, financial crisis and inequalities and grapple with a world that is evolving and changing around us whether we like it or not. There is still time, but that clock is ticking and midnight is approaching.
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But with China now accounting for nearly $1 trillion of American debt, and with the two economies in a symbiotic relationship which neither loves but which neither can escape, the U.S. cant simply insist that China do something about its currency and expect action. These economies are now fused (see my new book <em>Superfusion</em>). Much like the United States for last half of the 20th century, China is becoming a global economic behemoth. It isn't supplanting the United States anytime soon, but it is rapidly joining the U.S. as the other most important engine of the global system. It remains much poorer and less developed, but it is generating a substantial share of global activity and its cascade can be felt from Rio to Melbourne.
Given that, why would China decide to disrupt the system simply because it causes consternation in America or Europe? Its economy is booming and its policies, however unorthodox, are working. China will again allow its currency to appreciate when it feels that doing so won't cause a crisis of disrupt growth. Its massive accumulation of reserves is an issue. As the crisis eases, it's likely that Beijing will return to its pre-2008 policy of gradual appreciation, especially now that it is focusing on generating domestic demand and wants greater purchasing power for Chinese citizens. But Secretary Geithner - contrary to the criticisms of Krugman and others - has been exactly right in not publicly calling out China. Such an act would be both arrogant and foolish. In the world today, the United States can afford to be neither. Let's hope we remember that.
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The economic relationship between China and the United States is the defining issue of our day. While debates over health care are vital to American society, and while challenges ranging from Iran to Afghanistan to North Korea are real, nothing will determine the arc of the coming decades - or will shape domestic life and prosperity in the United States - more than the emergence of China as a global economic superpower unrivalled except by America.
The rise of China is hardly a secret, but because it is a complex economic that is constantly evolving, it gets less attention than hot-button issues. Absent a real crisis between the two, the relationship is more about the flow of capital and the nature of global business than it is about heated battles inside the Beltway or on Main Street. And while the rise of China and America's increased dependency on Chinese loans to fund its deficits certainly generates anxiety, it's mostly amorphous barring some specific issue to focus it.
How that relationship came to be is the subject of my new book, Superfusion: How China and America Became One Economy and Why the World's Prosperity Depends On It. While this economic fusion has taken more than two decades to evolve, with the crisis of the past year, it has become both a tighter embrace and one more fraught with tension. It's to the credit of both governments - for now - that those tensions have not boiled over.
]]> For their part, the Chinese are concerned about the viability of the American economic system and about the long-term value of their more than $1 trillion of investments in American bonds. They are also dependent on the market even a recession-mired America offers, with exports to the United States still near $300 billion a year. Americans are worried about the effect of lower-cost Chinese labor on U.S. jobs, even though most of the lost jobs were lost long ago and have as much to do with the corrosive effects of technology on labor as they do with cheap production in China. Meanwhile, China offers turbo-charged growth for American companies, as the Chinese government turns to companies like Caterpillar and GE to help with the industrial build-out and as Chinese consumers buy more goods - even a bankrupt GM sold 1.6 million cars in China this year, more than in the United States.But tripwires abound. The Treasury Department just submitted one of its many required reports to Congress, this one on currency and the Chinese currency especially. The Treasury, Secretary Geithner and by extension the Obama administration decided not to label China a currency manipulator, though the report did express serious concerns that the value of the Chinese currency pegged to the dollar left it undervalued and hence responsible for continued global imbalances.
These reports are dry in nature and are nothing if not wonky. But make no mistake: this was a delicate decision and a consequential one. If the Obama administration had labeled China a manipulator, the next step would be automatic sanctions. That in turn might have generated a domino effect of epic proportions. And given how entwined the U.S. and Chinese economies have become, any negative ripples threaten to halt what is for now a very delicate and incomplete global economic recovery.
For now, the relationship between the two economies is symbiotic, and is providing a degree of stability to both societies. In the absence of Chinese money, the Obama administration could not be spending its way out of recession, and without American companies operating in China and without Americans purchasing Chinese goods, China wouldn't have the money to lend and spend. But no country likes to see its sovereignty eroded and its ability to be master of its own fate undermined - and that is precisely what the economic relationship between the China and the United States does to their respective governments. National sentiment in both countries is also strongly suspicious, and that is likely to intensify.
But for now and for many years to come, we are joined at the hip, China and the United States, and how that relationship is managed by both will determine whether the world ahead is one of increased prosperity or ever-more conflict between winners and losers, between haves and have-nots, and between powers on the rise and powers on the decline.
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While Washington is glued to the drama over health care, over the past few days, Russian Prime Minister Vladimir Putin has been in Beijing meeting with Chinese leaders including Premier Wen Jiabao and President Hu Jintao. In a series of communiqués, they celebrated the "strategic partnership" between the two countries and charted a course of future close relations.
Among others things, Putin - Russia's man behind the curtain who has also been spending considerable time in front of the curtain - signed off on six billion dollars worth of trade deals Chinese counterparts, including moving ahead with a natural gas pipeline to open up the vast Chinese market to Russia's equally vast supply of natural gas. The two sides also discussed policies to contain and manage North Korea. Trade between the two countries is approaching $60 billion a year, and while that is a faction of the more than $300 billion a year between China and the United States, it is hardly negligible.
]]> For China, Russia is a vital supplier of raw materials and some ancillary higher-end equipment. For Russia, China is a vast market that is growing, compared to the European Union which is not. For both countries - who were once Cold War allies and then Cold War adversaries, these meetings signal a new move towards creating an economic and strategic access that bypasses the United States, and that alone is part of the appeal.The United States wasn't at these meetings, but it presence was felt nonetheless. For both countries, America remains the great question mark - whether it will help or hinder their desires for greater power and prosperity. Russia is a shadow of what it was during the Cold War, and Putin has clearly chosen a path of autocracy that will work only if demand for raw materials - oil above all - remains elevated. China is the crucial element of that equation. China is emerging as the new power in the global economic pantheon, and it is intent on diversifying away from its dependence on the United States for capital and for markets. While it remains tightly bound to America, its leadership would like to find ways to become less so. Whether they will or not remains to be seen, but the embrace of Russia is a clear sign that they wish to become less engaged with the U.S. rather than more.
For now, the emerging Chinese-Russian friendship is hardly a threat to the United States, but the shifting sands signify that the world no longer needs to go through Washington or through Wall Street. As long as the United States remains as large as it is, it will be an unavoidable market for China and even if Putin bought a house off of Tiananmen Square, all the deals between China and Russia wouldn't change that. But the only way the U.S. will preserve its centrality to the global economy over the coming decades is to recognize that the winds are shifting east and that our attention and energy should be as well. The Taliban, Iraq and even Iran's nuclear ambitions are all vital issues, but none of those may shape the future of the United States and the world at large more than the rise of China.
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As the United States and China wrap up their two-day "Strategic and Economic Dialogue," it's more apparent than ever that the two find themselves in a marriage that neither can easily dissolve and that neither fully wants.
The speeches struck all the rights notes - "the United States and China share mutual interests," President Obama announced. "If we advance those interests through cooperation, our people will benefit, and the world will be better off - because our ability to partner with each other is a prerequisite for progress on many of the most pressing global challenges" Those sentiments were echoed by both Hillary Clinton and Timothy Geithner in an op-ed published in the Wall Street Journal. The Chinese delegation spoke of the two nations as traveling in the same ship, a ship which was wracked by the global financial storm of the past year. In general, the rhetoric could not have demonstrated more clearly that both see themselves as locked in a relationship of mutual dependence.
]]> Yet the words of officials belie the more ambivalent feelings of both governments and especially of domestic public opinion in both countries. The best-selling book in China over the past months has been a nationalist screed entitled "China is not happy," which argues for detachment from the United States as well as divestment from the U.S. dollar and which warns darkly that the ultimate goal of America is to keep China down. In the United States, there remains a strong current of distrust that sees Chinese policy around its currency as purposely aimed at conferring illegitimate advantages for Chinese goods and which views the authoritarian nature of the Chinese government as an absolute obstacles to future concord. And many U.S. economists do not believe that China - reliant as it is on state-spending rather than domestic consumer consumption - has a viable model for long-term growth.While there are positive signs in the discussions around alternative energy, climate change, and the long-term security of the dollar, what's striking is how little has changed between the two as a result of the economic crisis. In fact, the events of the past months have propelled the two closer together, contrary to the arguments of those such as Niall Ferguson who are now predicting an impending divorce. The U.S.-China trade deficit is still immense, running at an annualized rate of nearly $250 billion a year in U.S. imports and $60 billion in exports, down from almost $340 in imports in 2008 and nearly $70 billion in exports (http://www.census.gov/foreign-trade/balance/c5700.html#2009), but still considerable given the sharp contraction in overall economic activity globally. And China has been adding to its dollar reserves every month and has been a steady buyer of U.S. debt, which means it had become an even more significant creditor of the U.S. and a facilitator of U.S. government spending.
For now, elites in both countries speak the mantra of closer integration, but it's fair to say that their views do not accord with popular sentiment. It's also fair to say that neither government is prepared to face the real consequences of their economic relationship, which is a loss of control. China wants to diversify away from the dollar, but it has no alternative; the United States wants to be less dependent on China, but there is no other ready source of loans.
So this phase of the dialogue ends on promising notes. But reality will be harder to live, and its ramifications difficult for both sides to accept. For a 21st century relationship, this looks increasingly like a 19th century marriage, one of convenience and necessity rather than love and affection and one that is nearly impossible to end even if both parties desire it.
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With a slew of major companies reporting earnings so far, it's clear that expectations were severely skewed to the negative. Once again, Wall Street analysts overshot - this time to the downside. The substantial margin expansion reported by Intel; the higher-than-anticipated profitability of IBM; and the blow-out quarters of Goldman Sachs and JP Morgan all stand in contrast to sentiment just a few weeks ago, which was grim and getting grimmer. So what happened?
First, the robust results of some of the banks so far is the result of trading revenue and changes in accounting rules rather than a sudden improvement in losses from bad loans. Still, income is income, and the more they generate, the easier it will be to absorb those losses from consumer, commercial and business loans that will continue to go sour for some time.
]]> Second, the companies that have reported strength for the most part have significant portions of thier business outside the United States - IBM alone derives nearly 25% of its revenue from Asia and almost two-thirds from non-US operations. Intel has a similar exposure. Or take a company like Yum Brands, with its vibrant Kentucky Fried Chicken franchise in China. The market didn't love its recent report, with weak sales at Taco Bell in the US, but it is still expanding rapidly and at high-profit in China. In short, there are pockets of the global economy that are doing considerably better than the United States and parts of Europe, and those companies exposed to those regions have been benefiting.Finally, while subsequent earnings of consumer companies may disappoint relative to what we've seen the past week, it's clear that companies operating globally have been able to escape the worst of the economic downturn at the expense of labor and jobs. They can go anywhere and to some extent shed anyone in order to maintain margins, and that means that they don't necessarily track the economic trends of any particular country and can often do substantially better than any national economy. That should be a lessen in both economics and investing: looking to economic data as an indicator of corporate profitability is a mistake, and that has been starkly evident in the earnings reports so far.
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So the United States lost to Brazil in the final of the FIFA Confederations cup, in that thrilling but painful tale of two halves, with the U.S. up 2-0 only to see Brazil roar back (or rather dance and prance and glide with balletic ferocity) and win 3-2. All I can say is, thank god.
For the past sixty years, the powerhouses of international soccer (a.k.a. football) either have been empires past their prime and on the decline or countries that dream fruitlessly of empire - England, France, Italy, Germany, Argentina, Brazil, and Spain. To bestride the world as a soccer power is to not bestride it as an economic or military power. In its period of global hegemony, the United States was manifestly not a global powerhouse in soccer. It was mighty in everything but the sport that is played by more people in every corner of the world than any other. And so if the United States had magically defied the odds and the gods and beaten Brazil, it would have been the final sign that American is indeed in decline.
]]>Of course, the United States may already be in irreversible relative decline, its near miss against Brazil notwithstanding. But for a moment at least, order was maintained. The other rising global power, namely China, shares with the United States an historical ineptitude for the game. In fact, making fun of the Chinese national team is one of the few outlets for uncensored political expression in China, and indeed the team has been inept. It may be no coincidence that it was once coached by the same coach who struggled valiantly but in vain to remake Americans soccer, Bora Milutinovic (now the coach of the Iraq national team). China even failed to qualify for the 2010 World Cup, which is a feat that will probably elude the United States.
Argentina - with its rich tradition of World Cup prowess, its intellectual sophistication and its astonishing natural resources - was once thought of a hemispheric challenger to the United States, before Juan Peron and Evita cemented the country's fate as a montage for an Andrew Lloyd Webber musical. Its victories in soccer are in almost inverse proportion to its political and economic stability.
Yet, there is the case of Brazil, which has been defying the odds and has started to demonstrate real leadership and success in today's globalized economy. It has a confident and thriving middle class, energy independence and cutting edge use of biofuels, as well as decreasing corruption. That may explain why the national team has struggled of late, as Brazil attempts the rare feat of having both an ascendant national economy and a dominant football team.
For now, the world order is not yet dramatically upended, but as the game demonstrated and as the last year has proven, that order is in flux and the old hierarchies are unlikely to remain in place for long.
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President Obama's speech in Cairo last week as well as the candid and heated debates in Iran during its contentious presidential election provide yet another opportunity to revisit the sterile images of Islam that dominate the discussion both in the West and throughout the Muslim world as well. That discussion is framed by Muslim terrorists or extremists on the one hand squaring off against secular but resentful populations on the other. That is one facet of a kaleidoscope, a potent one but in no way the only one.
If there's any doubt on that score, a new documentary focusing on the career of Senegalese singer Youssou N'Dour should dispel it utterly. "I Bring What I Love" is an elegiac, beautiful film, years in the making, and it will start playing in New York this week and then in Los Angeles and elsewhere. Like all documentaries, it will be dwarfed by the summer blockbusters that surround it, but this film deserves an audience.
]]> N'Dour speaks passionately in the film about his love of God and his devotion to the Koran, and explains that he could think of no better way to honor his faith and his God than by putting those verses to music, as generations of Sufi mystics have done. His album ultimately won a Grammy, and in 2008 N'Dour was named one of Time Magazine's most influential people. But even without that recognition, N'Dour, his music, and this film would stand as a testament to the immensely complicated tapestry of global Islam, which cannot be defined by what clerics in Saudi Arabia or the mountains of Afghanistan say, or by the rhetoric of angry parties in Lebanon and Iran. Youssou N'Dour lays as much claim to speaking for a true Islam, and he does so with poetry, grace and beauty. That not only deserves a place at the table; it must be there, and as long as individuals like N'Dour can pour forth their hope in humanity with such mellifluous joy, it will be.For a look at additional blogs and other writings of mine, feel free to visit River Twice Research.
Each month, the Federal Reserve releases its latest minutes of its last meeting along with its projections of economic activity (www.federalreserve.gov). The minutes just released indicate that its prior forecasts have been tweaked a bit, with update projections for unemployment over the next two years, GDP growth, and inflation. As new data become available, the hundreds of economists at the Fed revise and recalculate numbers, which means that any forecast rarely lasts more than a few months.
And yet, the Fed's forecasts - along with the World Bank, the International Monetary Fund, the Office of Management and Budget, the Congressional Budget Office and various others - are used to frame every single meaningful discussion about the economy. They become the fodder for media reports, for budgetary decisions made by companies, and for individuals who digest the sound-bites - "Fed predicts unemployment will level off at 9% next year" - that shapes their sentiment. Investors also turn to these signposts as markers to navigate a complex world.
]]> Our economic data is only one stream in a vortex of global capital flows and other countries' statistics. We barely understand how various factors interact in our own local economies, how for instance sentiment affects spending (does it?) or just how many people are actually overextended on their credit cards (we say it's a lot, but then again, 92% or more are current on their payments). We have no way of processing and analyzing how the layers of the global economy interact, though don't tell that to a macroeconomist. There are theories, for sure, but reality hasn't been playing nice with theories of late.Some have already noted the incredible gap between our hunger for certainty and predictability in an otherwise unpredictable world, from Josh Cooper Ramo in his latest book The Age of the Unthinkable to the now-ubiquitous I-told-you-so mantra of Nicholas Nassim Taleb and his black swans (www.fooledbyrandomness.com). Yet the overwhelming majority of people and institutions aren't ready to abandon the illusion of predictability. That includes government budget offices and investors advisors, CFOsof major companies, and individual households trying to gauge college costs years down the line. Most cleave to admittedly faulty models and sketchy data becausethe alternative - no models and sketchy data - seems worse. And face it, most of us prefer being wrong in groups than wrong all alone. Even if our predictions and data are flawed, if everyone else is relying on it, then most of us go with the herd.
For now, the consensus about the future, based on predictions that have never been right in the past, is for anemic economic activity through the fall and then fairly decent into next year with still high unemployment. That of course may be correct, but then again, it almost never has been before. Better to be nimble and humble, and not pretend foresight we don't have, then guesstimate about a future that is increasingly hard to gauge. There are things we can know - but that's for another entry.
For a look at additional blogs and other writings of mine, feel free to visit River Twice Research.]]>But bad fundamentals are only one aspect of what is going on. What makes the present that much worse is a complete meltdown of confidence about the very possibility of a more balanced future. And it's not just an erosion of confidence. It's the flourishing of our destructive instincts, the opposite of the "better angels of our nature," the demons, the whispers in the night that all is about to go up in flames.
We all have our fears, whether we admit them or not. But this has gone too far. In the financial world, there is a game of one-upmanship to find more dire adjectives, and any who dissent and suggest that yes, there will be a tomorrow and yes, there will be a future of growth, moderate and different, but still motion forward and movement upward, they are treated with contempt, not barely disguised, no: contempt on the order of those made to walk the streets during the Cultural Revolution with dunce caps and signs of shame around their necks.
Those who bet that the market will go down until there's nothing left to lose, who are convinced that value will be permanently wiped out - the shorts and the traders - they are enjoying their moment in the sun, and some are undoubtedly profiting from the collective misery. There's nothing wrong with that in small doses, and almost everyone can benefit from hedging their bets in the market. But you can't be short forever, and you can't ultimately profit from everything going down. A few can make money for a while, and if you believe that it's all survival of the fittest, then you probably don't care if 99% suffer as long as you're part of the 1% that prosper. The sheer delight in "burn, baby, burn" is hardly unique to our age. We've been there before, and it leads nowhere, except to a whole world in flames.
So yes, millions are losing their jobs and their homes and we are struggling to figure out what is real and what was fueled by debt dreams. And yet, there isn't mass starvation, mass homelessness, imminent physical danger, certainly not in those parts of the world that are suffering the most from this credit crisis - the United States, Europe, Japan. The fears and hysteria are based on more intangible issues, though the fear of total loss of home and livelihood and health is just as intense.
While we need to respect that this is a pivotal moment for us all, we also need to halt this pernicious slide into unrelenting negativism. We need to say "enough already," and recognize that we are hardly the first generation to face challenges, and that a dysfunctional financial system is not of the same order as war, pestilence, and social chaos. The economy contracting by 4% or 5% for a few months is a shock, but it is not an excuse for announcing our collective obituary, unless, of course, we want to dance on the abyss and court disaster.
So, enough already. Our problems are real; but we are pulling ourselves into a vortex of gloom as powerful and destructive as our one-time belief in our endless capacity for reinvention was powerful and constructive. We can make this better, or we can make it worse. It's a choice, not a destiny.
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We will never know if another plan, a different plan would work better or whether this plan in its details will be heralded as the key to a recovery or excoriated as the cause of a depression. We will never have an opportunity to play out different scenarios in some massive game-theory experiment. We will only have this particular plan and these particular actions, in conjunction with the stimulus spending of the Chinese government ($600 billion or more), the French, the British, the Japanese, the South Koreans, and dozens of others amounting to hundreds of billions more, as well as rate cuts by central banks around the world, all ad hoc, but all amounting to massive government spending and globally low interest rates that in theory make the cost of capital cheap even as banks make it scarce.
History will one day be written of today, though we don't yet know if this is a middle act or a denouement. Historians like commentators today will attempt to weave a cause-and-effect story of what happened and why, but much as we now endlessly debate the New Deal, they wont agree about what caused what, about what worked and what did not.
But this much is certain: we are now cleaning up a mess, and even if we inadvertently add to it, we are no longer feeding it. The massive leverage generation that took place between 2005 and 2007 has been halted. The layering of debt onto the shakiest flimsiest pillar of the U.S. economy is no more. While debt will rise as a result of spending, it will be based on the entire system as collateral, and not a subdivision in Henderson, Nevada. That at least is a move forward we can celebrate.
So let us pause for a moment and be thankful that the next stage is at hand. As muddled as this one may be - and all major measures taken in crisis usually are - it is born of the drive to reconstruct and not profiteer, and that alone is progress to applaud.
For a look at additional blogs and other writings of mine, feel free to visit River Twice Research. ]]>Just because people making under $30,000 a year tend to be at higher risk of defaulting doesn't mean that they should be denied access to vital credit. People at that income level represent as much as 40 percent of the country, according to census data, and while granting someone with that income a $300,000 mortgage is absurd, so is granting them zero credit or credit at rates that would make a loan shark blush.
The experience of Grameen Bank, founded by Noble prize winner Muhammad Yunus in Bangladesh and now operates one branch in Queens, New York. A pioneer in microfinance, Grameen lends mostly to women, and in small amounts, but has a repayment rate that any commercial bank would envy. By maintaining close community ties and an on-going relationship between borrowers and lenders, the bank never forgets that one of the best risk controls is making sure that those who lend money have some direct relationship with those who borrow.
The experience of Grameen should be a reminder that credit is a vital source of economic activity and growth, especially for the less affluent. Demonizing credit creation because of prior lax standards risks an excessive caution against further debt, and that is exactly the wrong path. Debt is a powerful tool that can help generate robust activity is used and created wisely, just as it can be immensely destructive if allowed to spin out of control.
Technology can be used to create better risk controls, just as it was used to fashion quantitative models that would have made Pollyanna look like a sourpuss. Robert Shiller, the Yale economist has some novel ideas about how to use derivatives as a risk-management tool for the individual home-owner (for more on Shiller, see my piece on him here: http://www.newsweek.com/id/181266 ). Not all will agree with his ideas, but financial innovation can be a tool for greater prosperity - after all, once upon a time a mortgage was a new and untested innovation, and on the whole has been of more societal benefit than not, current morass notwithstanding.
Debt can be good, bad or indifferent. Denying it to a wide swath of society that can and does use it constructively is as distorted as the profligate dispersion of debt that we have just witnessed, and it will make it that much harder for millions of people who are determined to improve their lot in life. Finding the right balance between too much and too little is never easy, but replacing one extreme with another is no solution.
For a look at additional blogs and other writings of mine, feel free to visit River Twice Research.
Six months ago, the relationship between Wall Street and Main Street was almost a complete inverse. Main Street believed that things were grim and getting grimmer; Wall Street thoughts things were bad, but manageable. Now, judging from polls and the wide-eyed wonder at the inauguration, Main Street thinks things are bad but that finally there is a chance of change for the better. Some big non-financial companies like Johnson & Johnson and IBM are holding their own, indicating that all is not lost in the real world. Wall Street, meanwhile, has become a basket case.
The financial world is caught in a negative feedback loop. As earning plunge and write-offs on bad loans continue, banks are forced to set aside more reserves against future bad loans and losses. Mark-to-market accounting rules demand that they value even illiquid holdings at current prices, which has the unintended consequence of devaluing almost everything. In a world where there are no buyers, everything approaches zero; if you have to sell today, you take what the market will give you.
The more financial institutions are forced to recognize losses that are technically unrealized, the more they have to hoard cash and turn to the government for infusions; and the more that the stock prices crash, the more margin have to be made or met, which accelerates the need to raise cash. There is also the psychological aspect: most of the people who work at these institutions are paid in part in the stock of their employers, and they have seen their personal net worth cut by 50% or 90%. That isn't a call for sympathy for the affluent, but it helps explain why many of the people manning those ships are mired in their own personal depression.
This vicious cycle has to stop. Many pensions hold these stocks and retirees as well, because until a few months ago, they paid reliable dividends. Now those are being slashed. Some say that we should let the equity of these companies be wiped out as they accept more government money, and with the sell-off we are getting there. But halting that slide is important, both psychologically and for the public good. Desperate times, you know, require unusual measures.
As government exposes more of public money to the private banking system, why not halt trading of these companies for an extended period, perhaps for weeks or even months? Suspend some accounting rules. Take direct equity stakes rather than simply injecting capital. Some will cry foul and decry the interference in the free-market, but in times of crises, expediency must trump ideology. Main Street is starting to roll up its sleeves and get down to business; Wall Street needs to do the same but clearly is in need of supervision, and intervention. Government is not a long-term solution, but neither is temporary hospitalization for a patient on suicide-watch. The bailout package passed in October may have been a solution had it been consistently applied; the result is we now need more. But it is now time for Wall Street to follow, not to lead.
For a look at additional blogs and other writings of mine, feel free to visit River Twice Research.
Everyday, my mailbox gets inundated with reports from strategists and economists. Two years ago, most were predicting a fairly rosy scenario for the global economy - and to be fair, so was I. Today, most are predicting a dire future of negative growth and economies mired in a deep and intractable recession. The predictions of the past were mostly wrong; there is little reason to believe that today's forecasts will be much better.
When people look to the future, they tend to take the present and extrapolate. Industrial production is plummeting, so people forecast that it will be terrible in 2009. Unemployment is rising steeply and quickly, so predictions are that it will get much worse before it gets better. Past patterns are used as the basis of those predictions, but few question whether those patterns are indeed useful.
We should, because they aren't. Nothing quite like the present crisis has happened before. There has never been a simultaneous, global halt of economic activity. Before the information technology revolution, there couldn't have been. There weren't global synchronized supply chains and credit systems and capital flows that could halt in sync. Now there are, hence the simultaneous, nearly instantaneous cessation of activity after the failure of Lehman Brothers in September.
This also means, however, that the engine could start again in unexpected ways with unanticipated speed. I'm not saying that it will, only that the possibility shouldn't be as discounted as it currently is. Again, no one knows outcomes here, and past patterns are a misleading guide to the future. All that seems certain is that people rarely get future scenarios right, and there is no reason to believe that current projections of a dire future will be any more accurate than past projections of a rosy one.
For a look at additional blogs and other writings of mine, feel free to visit River Twice Research.]]>While the financial crisis has affected almost all countries, lines can now be drawn between those who have cash and reserves, and those that don't. The ones that do - China, Russia, Brazil, Saudi Arabia, Japan, Norway - are in the catbird's seat. Those that don't - ranging from tiny Iceland to the United States - are facing the constraints of being debtor nations.
But while the structural reality of the world has changed dramatically, the cognitive reality hadn't - until now.
If you had followed the coverage of the summit of the world's leading economies (the so-called "G20″) held in Washington on November 15, you could be excused for thinking that the meeting was a flop. Other than vague promises on the part of the collected leaders to do something about the world financial system, there was no bold plan announced, no specific solutions to the world's problems. The coverage in the United States treated the summit as a non-event that amounted to a photo-op for world leaders and a lame-duck American president.
In fact, however, the G20 summit revealed a developing world brimming with confidence about its ability to solve current problems and a developed world lost in the mist. That was reinforced at the meeting of Asian-Pacific nations last week in Peru, which led to the declaration: "We are convinced that we can overcome this crisis in a period of 18 months," the leaders said in the statement. "We have taken urgent and extraordinary steps to stabilize our financial sectors and strengthen economic growth." Sometimes rhetoric matters, and the fact that most affirmative statement of confidence in the ability to solve the current credit crisis came not from New York, Washington, or London speaks volumes to the world as it now is.
Today, the rest of the world is forging new links with one another in recognition of the fact that they will have a central role in shaping the future. That is why outside of the United States, images of President Hu of China speaking candidly with President Lula of Brazil, or both huddling in serious discussion with Singh of India and Medvedev of Russia matter. For years, these countries looked to the United States as either an adversary or a bulwark, and assumed that in the end, action by the United States would determine outcomes for better or worse. No longer. The contrast between the Washington summit, where the U.S. leader was mute and ineffectual, and the summit a week later in Peru where the tenor was "yes we can!" rather than "how can we?" was stark.
For sure, banks in many parts of the developing world have taken hits, as they were exposed to the same toxic assets that have brought the credit system to its knees. Yet banks in many of the emerging countries are not as vital to the system, especially in places like China or parts of the Persian Gulf, where government spending and state-capitalism are the major source of economic activity. 50% of China economic activity is spending by the state.
The developing world is now helping bail out the financial system of the developed world, with cash injection (Abu Dhabi into Barclays; Prince Alwaleed of Saudi Arabia in Citigroup, and soon perhaps China into AIG) and developed world governments are abandoning the model of bank-led capitalism and taking a much larger role in the economy. "Their" model of strong state intervention in the economy is now the one becoming universal, not "ours."
The crisis has radically shifted the way that the emerging world views its role. To borrow from psychology, the implosion of the western financial system has created that cognitive break, and rather than finding themselves brought low, emerging nations have been able to weather the storms. They have faced no strong outcry domestically and if anything have gained in stature by swift and strong action to address root causes and fix what's broken. China's vast $600 billion dollar stimulus package is one example; Abu Dhabi guaranteeing the debts of Dubai is another; and President Lula of Brazil declaring an end to the developing world's dependency on finance from the developed world yet another.
Having been forced to abandon the psychological dependency on the United States, they are taking responsibility for shaping the world around them. In the past week, there have been major meetings between Russia and Brazil, between China and Brazil, between China and multiple countries. Many say that the lesson is no longer to treat the United States as wiser and stronger economically, and not to look to Washington for lasting solutions. The crisis is their wake-up call about their own importance, and they are seizing the moment.
Given the despair and confusion in the developed world, this is a good thing. The global system is too big for any one country to sustain it, and while it'ss a painful time, it might just lead to greater balance and stability going forward. The new leaders recognize that no one of them can create that world alone. With the new Obama administration in Washington, and Hillary Clinton at the State Department, they might find a partner who understands that as well.
For a look at additional blogs and other writings of mine, feel free to visit River Twice Research.