How far you can go depends on how deep your thought is; similarly, how well you can solve a problem, depends on how well you understand the problem.
The process of problem solving can always be broken into a process of 3, identifying the problem, understanding the problem as well as fixing the problem. As for now, the best angle so far to understand of the crisis that we are witnessing and experiencing is to view it as a combination of both a structure problem and a cyclical one, for both western developed economy and the emerging markets.
While it is a consensus these days for quite a number of people (Still not for all definitely) to admit that it is such a combination case in the western world given the shadow credit/banking system that was in place for the past few years to create, artificially, a vast demand for the products of yields without scrutiny of the credit quality behind the Triple A label provided by the credit rating agency, whose paycheck was largely dependent on the issuer of those securities. However, it is somehow, still a bit unrecognized a fact that the structure problem also exists in the emerging world, albeit not in the form of an over-leveraged household and financial sectors but in a form of its structurally less-demand, given the productivity advance that we have been enjoyed for the past few decades plus a huge pool of vacant resource there.
If one is willing to extend its mindset a bit further in terms of the time frame scope, it is not difficult to find out the fact that the history of global economy after WWII, has always been a game of the mobile capital chasing cheaper cost and higher return, on a global scale, from the Marshall Plan in EU to the return of Macarthur to Japan, from Asian Four Tigers to the ultimate BRIC; regionally speaking, from EU’s economic invasion to the Iron Curtain area to US’s Mexico Policy, from Asian countries inter-regional trade zone to Sino-Au resource partnership. And all of the above now, seems to come to a stage that we are not only interrelated much more than we used to be; but on an absolute basis, given the resources that we had, we are having much bigger a power in terms of production and supply than the real final existing demand. To go one step further and to be clearer, we had modernized the style of production of our goods and services by the mobility of capital worldwide, but on the other hand the demand had not yet caught up, neither its style nor its scale.
Having said that, it would be much easier for us to understand why the developing world is also facing a structure problem and where this problem is originated, though for a convenience people named it as over-capacity relatively, while in reality it is more a problem of lack of real demand absolutely.
Given this situation, it makes more sense for us to understand why central banks and Governments worldwide are viewing deflation as their top enemy while preferring a small percentage of inflation as their target, not only because the vicious cycle that deflation would bring to the whole society as a result of the contraction of the economy but also because deflation itself is totally out of their hand of control, given the advance of the productivity is of a fundamental underlying essence.
With the above being said, we now should focus more on the side of the solution of our problem. It has been a huge debate in both the academic side and the industrial wide for the right way to fix the problem that we are having now, which to some extent shows how harmony a world that we had been living in and enjoying for the past few decades. So hiding from all those famous legacy players, I would like to share with you some of my thoughts here.
While it is like a typical Keynesian’s solution to use both monetary and fiscal policies to deal with the cyclical problem, and to let the Government take over the task to keep the economy, or at least to try to push the economy, back towards the point of full employment, those are ineffective to solve the structure problem that we are having at the same time this time. What we are having structurally in the developed world is an over-leveraged household sector as well as a financial market dysfunction as a result of the legacy assets sitting on their balance sheets. For that matter, however hard that you are trying to stimulate the economy, it is still going to be a failing game so long as the structure issue is not being addressed accordingly and timely. And that is indeed, where the Fed and other parts of the western world failed to act, at the early stage of the crisis.
And now, especially after the fiasco of Lehman and the shameless AIG’s repeatedly trials of asking for more funding, Tim Geithner’s recent PPIP program, from my humble opinion, is the point where they recognized, or were forced to recognize the importance and the urgency of solving the structure problem. Even it is essentially a program to entice private players to buy banks’ asset at their mark-to-model value to bail those banks out, the trick is private players are still having the possibility to enjoy the upside in the long term by having Treasury as a non-recourse source of funding, and no doubt it will all end with the taxpayers to pay the bill without any participation of the upside. However, realistically speaking it helps those banks to replenish their books; and indeed it is the way to fix the system, if we can rationally put aside the fairness for just one second.
There are people out there questioning the feasibility of the PPIP, given there will be a gap between the market price that those private players are willing to pay and the marked book price that banks are willing to sell. While this is definitely a question to ask, in essence it is no more because of the participation of public funding actually changed the risk/reward profile of the trade and it is the very thing that those private players are looking at rather than simply the price. For them, it is always a better deal to have a better risk/reward profile on the same capital base, even if the price (not necessarily the capital) paid is a bit higher. While to me the real feasibility is on the fairness side because it is another game of privatize the gain while socializing the loss, and it would be a big question mark for the already angry taxpayers and the congress to let the program go ahead if they find out the truth. Again, if this trick could really be played out, it is definitely the one to buy time for all, especially for those banks.
Now let’s turn back to the other side of the coin, with the focus on China.
While people, at least for now, are enthusiastic with the potential recovery of China, compared with its western counterparts. To me, however, it feels exactly the opposite because of the structure problem that it has, described above; and the difficulty that it has to turn the structure problem around as a result of its less democratic political constitution.
Since the entry of WTO back in 2001, China has enjoyed a tremendous growth out of its participation in globalization. And as stated above, during the past few years, while the productivity of China has been explored to a great extent (though not fully explored and far from there yet), the domestic demand side has always be a huge lag which was only covered by the explosion of exporting growth. As told by the domestic consumption figure, it kept dropping from less than 40% to somewhere around 35% for the past few years while accordingly but interestingly consumption of US increasing from around 65% to 71%, and there is not too much improvement to be seen in the foreseeable future.
In a word, it has been a vicious cycle for developing countries to rely on the external demand to drive its growth because it is not only a model depending too much on others’ unstable demand rather than its intrinsic growth, but also at the same time crowding out domestic demands if the distribution system is not fair enough, as the case of China. When the cyclical downturn hit its external parties unavoidably from time to time, the economy is going to suffer, maybe even worse than its importing counterparts simply because the structure of demand can easily be adjusted to the extent of disposal income, while production side does not have the luxury of this flexibility.
One more thing, while political issue is not a good topic to talk, please allow me to make two points here regarding implications of a the non-democratic system in China.
1. In a non-democratic world, resources are more dedicated to investment driven growth model rather than a intrinsic consumption driven one. Simply because it is not the priority there to please the voters, but to show more performance so as to get more political tractions.
2. In a non-democratic world, the legitimacy of the political power is coming from the front of the growth of the society as a whole, not necessarily from the real benefit of the welfare of the individual.
So even though a lot of people, some for the wishful thinking that after this crisis China is going to walk out relatively less scathed and some for the performance driven pressure, are rushing into China now as told by the big out performance of both A Share market and HSCEI index to either World MSCI Index or S&P 500 in the US, the real danger lies in the mismatch of the post-stimulus demand situation and the continuing-deleveraging western household sector then. Because the US consumers are now thriving to get its foot on the ground of taking its saving rate back to the long term normal, rather than anything else; And if history is any indication, this takes long to achieve. So don’t be misled by the cheer there now in China but be really careful on your bets if you are going to make it big. However, it is not the case to say that it is not good to take a ride of this run, even it is a run of the irrational excuberance.
