BEIJING, Dec. 17 -- Recently productivity in the
United States rose more than forecast, while labor costs increased less than
anticipated. Usually, that is a good sign. But these are no ordinary times. More
than 1.5 million jobs have already been lost this year, and there is worse to
In the next few weeks, aggregate demand will decline
significantly in relation to supply. Companies are reducing capacity feverishly
in housing markets, durables, the car industry, and in others. As the U.S.
negative demand shock spreads internationally, it will reinforce the worldwide
The writing is on the wall. Historically, world trade
has been driven by the decline of transportation costs and tariffs. However, the
Doha Round collapsed this summer, while the Baltic Dry Index (BDI), a barometer
of global trade, has fallen 93 percent. Even the price of oil has plunged from
150 U.S. dollars to less than $50. In the past, cheap oil was a blessing;
today, it reflects the decline of world trade - for the first time in 30 years.
The U.S. economy entered a recession in December last
year. Although the official confirmation came recently, the facts have been
known since summer last year. After the housing bubble and the credit squeeze,
Dow Jones has declined by 40-45 percent from its peak.
In the 1970s, the energy crisis pushed the world
economy into stagflation; in other words, slow growth plus inflation. Today,
U.S. recession is pushing the world economy toward redeflation, or recession
The severity of this crisis is now comparable to the
explosive threats - the mix of recessionary forces and deflationary pressures -
that were seen last right before the Great Depression in the 1930s.
How did we get here?
The global financial crisis does not originate just
from the US subprime mortgage crisis. It stems from the 1980s, when deregulation
of financial markets contributed eventually to the savings and loan debacle, and
the 1990s, which provided a powerful catalyst to US productivity and growth but
also gave rise to low interest rates and the explosive growth of the unregulated
derivatives - or the "financial weapons of mass destruction", as the investor
Warren Buffett called them.
After the collapse of the tech bubble in the early
21st century, the economy needed a stimulus. However, the Bush administration's
tax cuts did not benefit the U.S.
As fiscal policy stepped aside, monetary policy had
to step in. The Federal Reserve (Fed) responded by flooding the economy with
liquidity. In the past, that might have contributed to the growth. After the
burst of the Internet bubble, however, excess funds were not put to productive
use, but flew into the next big bubble - the housing market.
The original objective of the subprime market seemed
well-founded - to ensure that home ownership was not just the privilege of the
few, but the promise of the many. Similarly, securitization was hardly something
negative; it made markets more efficient and contributed to consumer welfare.
And so it was with the Internet, which facilitated and globalized these
Still, in the early 21st century, deregulation,
securitization and Internet-driven transactions led to massive distortions,
while giving rise to an unregulated and shadowy world of finance.
Low interest rates and easy access to funds
encouraged reckless lending, which led to the subprime mortgages that allowed
home buyers to be afforded mortgage for a house they were never qualified for
and would never be able to pay off. Behind the facade, bankers were talking
cynically about Ninja-loans (no income, no jobs, no assets).
Initially, the subprime mortgage crisis was a US
problem. In a less globalized world, it might have remained so. However, it was
disguised into derivatives that were misunderstood as "safe", as investment
banks sliced and packaged the risks worldwide, which then spread - like a
Soon thereafter the multi-billion dollar write-offs
ensued as some of the world's largest investment banks, from Bear Stearns to
Lehman Brothers, had to acknowledge that the derivatives they were holding
proved almost worthless.
The subprime mortgage crisis morphed into a credit
squeeze as these assets then forced the banks to deleverage quickly. Soon the
crisis finally affected inter-bank lending worldwide and morphed into a global
financial crisis. By mid-October, the world financial system was - as the
International Monetary Fund chief Dominique Strauss-Kahn, noted - "on the brink
of a meltdown".
Through decisive, coordinated and international
action, the meltdown was averted after the world's industrial leaders convened
in Washington. Although these G7 nations still govern the world economy, growth
is primarily now in the large emerging economies and oil producing nations.
The initiative thus shifted to these G20 nations,
while French President Nicolas Sarkozy outlined the need for Bretton Woods II.
But much has changed since 1944, when the international financial architecture
was created for the postwar era.
After World War II, the Bretton Woods conference was
prepared for months and led by the U.S., which, at the time, accounted for half
of the world GDP and was the world's greatest creditor. Ironically, last month,
the G20 conference in Washington lasted two days and was hosted by the U.S.,
which now accounts for only 23 percent of the world GDP and is the world's
The participants agreed to cooperate, and formulated
lofty objectives and will meet again in April next year. However, the markets
live in real time and will not wait. Despite multiple massive bailouts
worldwide, policymakers have failed to get credit flowing and to prop up
In Washington, Obama is putting together a large
stimulus plan, which is rumored to amount to 4-5 percent of the U.S. GDP, or
600-700 billion dollars. The capital provision is perceived as necessary to
restore the ability of banks to lend and unfreeze the credit markets. The goal
is to stimulate consumption, which accounts for more than 70 percent of the U.S.
Indeed, rising consumer demand for goods and services
has been a key element of U.S. economic growth. But its current level is
Between the 1960s and 1990s, personal spending,
adjusted for inflation, tracked the overall growth of the economy. During the
past decade, that pattern has changed.
Before the onset of recession in December last year,
the 10-year growth rate for consumption was 3.6 percent, versus GDP growth of
2.9 percent for the same period. This difference represents an enormous gap.
Between 2001 and last year, the extra spending amounted to about 3 trillion
dollars. Much of that money was spent in the housing market.
Global growth has been driven by the U.S. consumers
who have been living beyond their means, and by banks that are now falling
apart. The past level of U.S. consumption is no longer sustainable.
Typically, the impact has been felt first on imports,
which is now exporting the U.S. redeflation worldwide - while causing the demise
of export-driven growth.
The ongoing worldwide recession is not the result of
cyclical fluctuations. It reflects the structural transition of the world
economy - from global growth driven by U.S. consumption to a new kind of growth
driven by multipolar economies.
In the past, global growth had been too dependent on
one nation; in the future, it will be more diversified and less risky. But the
transition is wrought with peril.
(Source: China Daily)