An extraordinary confession

Soon after the speech (needs to be commented upon separately) of Ms. Janet Yellen, the Chairperson of the Federal Reserve Board, concluded at Jackson Hole, Wyoming, China’s official news agency Xinhua wrote an Edit imploring/beseeching/begging the Federal Reserve not to hike interest rates. Yes, from 0.25% to 0.50% will be too much for the world economy to bear. Well, it seems like it will be too much for the Chinese economy to bear.

The Editorial is actually an extraordinary confession of the extreme fragility of the Chinese economy. The emperor has really no clothes.

A friend wrote to me that China was extracting its pound of flesh for not selling US Treasury bonds from its reserves at the height of the global crisis in 2007-08, at the request of the Americans. May be, it is true and may be, it is not. If it is true and if America requested China not to sell any of its US Treasury holdings, it betrayed a profound lack of understanding of the extreme dependence of Asian economies, principally China, on the American consumer. China could not have sold US Treasury bonds without hurting itself very badly. America should have known that.

America’s lack of confidence is baffling. Joe Biden, American Vice-President apologised to the Turkish government last week. He has done so before -two years ago. His comments from two years ago were actually backed up by German Interior Ministry in its letter in response to queries raised by a political party in Germany.

In my archives, I found this letter that I had written to the ‘Financial Times’ in April 2005. I do not recall if it was published. Well, I do not recall if I even sent it to FT.

Here goes:

If the American Treasury Secretary goes down on his knees in gratefulness to his Asian financiers (Martin Wolf, FT April 20, 2005), he might well make eye contact with his Asian counterparts kneeling to thank the American consumer.

While the entire world finds it easy to castigate the US – there is plenty of merit in that – what is not easily appreciated is that Asian countries have no other source of growth except the American economy. In the last eight years, OECD growth was negative in just two years. Take America out and it becomes five.

After the Asian economic crisis, which was mainly due to funding domestic long-term real estate investment with foreign currency loans, Asian governments have abandoned investment spending. Malaysia undertook public investment spending post-crisis and it has reached the limits of fiscal policy. Thailand and Korea tried to reflate the consumer and the consequence is high consumer debt. American households have plenty of company in this part of the world too.

Hence, all attempts at domestic demand-led growth have been abandoned. Ever the China-admirer, Mr. Stephen Roach of Morgan Stanley admits that China lacks any meaningful domestic demand impulse. For an economy attracting around USD 50 billions of foreign direct investment, it ought to be running a substantial trade deficit. It is not.

While the substance of the American fiscal expansion and the reliance on rising home prices to finance consumption can be legitimately questioned, the discussion would both be incomplete and unfair without an equally scathing criticism of East Asian growth formula.

It is fairer to say that America and East Asia are in a fatal embrace which would end with much pain for both of them. There is no appetite for painful choices in either place. Nor do economists recommend deliberately inflicting pain as a policy option after Japan’s lost decade of the Nineties, partly brought about by a deliberate bubble-bursting effort by the Bank of Japan.

Hence, what well-meaning suggestions do not achieve, economic crises normally do. As Brad Setser says in his blog , there is risk in acting and there is risk in not acting. Therefore, the best thing for policymakers is to wait for crises to do the job. That is what they are doing – playing the waiting game.

I just searched for this letter on the Internet. No success. But, I did come across a detailed comment I had left on Brad Setser’s blog post on ‘Asia’s Savings Glut’ in May 2005. That is still worth reading. Here is the Brad Setser post and you can locate my comment (a long one) by searching for ‘Nageswaran’.

Simply put, America has nothing much to lose by returning the gaze. Others will blink first. They are more  vulnerable.

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