Comparisons to the Great Depression and to other nasty past downturns (Panic of 1873, anyone?) are coming fast and furious these days.
But one thing that continues to surprise me is the frequency with which the US in 2007-2008 is being compared to the US of 1929-1930. I’ve mentioned in passing that China is in the position that the US occupied in the late 1920s: a massive manufacturer that was generating large trade surpluses, to the point where the imbalance was destablizing (under a gold standard, the US was sucking the metal out of its trade partners; the modern analogy is China’s massive foreign exchange reserves). And as the US was the epicenter of the Great Depression, we cannot be certain of the trajectory of this economic crisis until we have a sense of how bad things are getting in China and how good its policy responses are.
Reader Michael has been e-mailing me from time to time with not-pretty sightings on China’s responses to the downturn. This post from Michael Pettis tells us that China appears to be trying to keep its exports up, which is eerily parallel to what the US did in the Great Depression.
He finds other supporters of a view we presented earlier (and that attracted lots of jeers), that the Chinese are planning not to let the RMB rise, in fact to have it fall slightly against the dollar. Again, if you are a student of the Great Depression. trashing one’s currency was key to getting back on track to growth. The US economy did not start to recover in a meaningful way until it went off the gold standard, which lead to a 40% fall in the currency’s value. So China is planning to block the course to what is needed most: an end to destablizing global imbalances (not that we didn’t happily go along when they appeared to beneficial in the short term, mind you, but we need to find an end game).
From Michael Pettis. There are three must read paragraphs I have put in boldface. I am kicking myself for not having connected these particular dots, but it is also distressing that no one other than Pettis has:
Most people believe that the official urban employment rate significantly understates real urban unemployment, and although I have hear that real unemployment is as high as 10-11%, I have seen nothing very credible on the issue. I assume unemployment is higher but I don’t really know what it is.
If unemployment is rising, however, it does mean that there will be serious pressure to do whatever it takes to support employment growth. One thing that I am worried about (and this was the subject of the “longish writing commitment” I mentioned above) is that it puts pressure on the government to engineer measures to expand export growth. For example I suspect that the fight over whether or not to continue appreciating, and even depreciate, the RMB is intense. Two days ago Bloomberg had a piece that said the following:
The yuan fell as policy makers focus on supporting exporters amid signs the world’s fourth-largest economy is slowing because of global financial turmoil…”We expect the dollar to move higher versus the yuan as the focus shifts decisively to growth,” said Thomas Harr, a senior foreign exchange strategist with Standard Chartered Plc in Singapore. “But not a massive move though, probably up to close to 7 in the first half” of next year, he said. The currency traded at 6.8270 per dollar in Shanghai as of 9:45 a.m., compared with 6.8269 yesterday, according to the China Foreign Exchange Trade System.
Perhaps more importantly, Xinhua said in an article on Monday that:
China’s Ministry of Finance announced on Monday a list of 3,770 items involved in the third export tax rebate increase this year. The items include labor-intensive, mechanical and electrical products. New export tax rebate rates on these items were also announced. The change take effect Dec. 1….
Export subsidies, depreciating RMB – all of this might seem to make sense if you look at China as divorced from the global balance of payments system…
But if you think of China’s role within the global balance of payments, it seems to me that this is little more that a form of Smoot-Hawley-with-Chinese-characteristics. Global demand is slowing, just as it did in the 1930s, and China as the leading source of global overcapacity is trying to address its global demand problem by shifting the burden abroad.
In that light I should mention a recent exchange… Reference was made to a recent Washington Post OpEd piece by the British historian Niall Ferguson….:
Ferguson is probably right to compare the 2008 G20 with the failed 1933 London conference, but the problems with this account, I think, is that he has the US playing the same role in the 1930s as today. But the positions are very different.
In the 1930 it was the US who had huge overcapacity which it exported abroad (via huge trade surpluses) and it was Europeans who were over-consuming, financed by capital exports from the US. When the credit crunch came it was unreasonable, as Keynes argued bitterly, to expect the rest of the world to continue demanding US goods, especially since the financing of their consumption had been interrupted. Since US production significantly exceeded US consumption (with the balance consisting of course of the trade surplus), the need for demand creation most logically rested in the US.
Yves here. Note the Chinese have a problem that probably did not obtain in the US during the Depression: a huge disparity in living standards between the exporter and importers. Remember, there was still a great deal of international labor mobility in the early 20th century, and that helped dampen wage differentials between countries. Presumably, many of the goods the US exported in the 1920s would have been the sort that US consumers would buy. By contrast. a lot of the goods made for export to the US would not appeal to the mass market in China. I do not know how specialized manufacturing is and how hard it would be to reorient production for the domestic market. But American like to overconsume in quantity as well as type (when I lived in Australia, I was struck by how much smaller their closets are than ours. It was refreshing, in a way).
Back to Pettis:
As we all know, in spite of FDR’s Keynesian reputation (he wasn’t) the US not only failed to expand fiscally as much as it needed to but it actually tried to use trade restrictions to protect its overcapacity problem and “export” its lack of demand to the rest of the world. That didn’t work, and when world trade collapsed the US had to bear the full adjustment cost of the gap between production and consumption, and it did so in the most difficult possible way, by contracting production.
Today it is China who is exporting overcapacity and it is the US who is consuming too much, fed by Chinese financing. With the collapse of bank intermediation US households and businesses are cutting consumption and raising savings. This is a necessary adjustment. Calling on the US government to engage in massive fiscal expansion to replace lost private demand is crazy. It means that we should continue the current game that has led us into so much trouble, but instead of having US over-consumption and rising debt at the private level we must have it at the public level.
If Keynes were around today he would probably make the same point he did over 60 years ago. Demand must be created by the current account surplus countries, which have, to date, relied on net exports to protect themselves from the consequence of their overcapacity. They must force demand up quickly in order to close the gap, and since expecting private consumption to rise quickly enough is unrealistic, it has to be public consumption – a large fiscal deficit.
Just as the US stupidly tried to increase its ability to dump capacity abroad by creating import restrictions (which has the effect of further expanding domestic production), China seems to be hoping for the same thing by increasing export rebates and slowing the currency appreciation (there is even increasing talk of depreciation).
This can’t work for long. The world has excess production and there is a need for the US to reduce its demand and increase its savings. The only proper place for new demand to originate is, once again as in the 1930s, from current account surplus countries. They should be engaged in demand creation, not supply creation. If they continue trying to export their way out of a slowdown, there will almost certainly be a trade war, as in the 1930s, and the full force of the adjustment will be borne by the current account surplus countries, again as in the 1930s. Remember that back then the current account deficit countries, like Germany after 1932, found it relatively easy to limit the impact of the crisis by forcing balanced trade — which has the effect of increasing demand (domestic) and reducing supply (foreign).
It is amazing to me that people like Ferguson, who have been arguing correctly for years that US consumed too much and saved too little, are now terrified of the necessary adjustment, and are arguing that it should be stopped and even reversed. The process cannot be stopped – US savings are too low and will rise one way or the other. The global imbalance between production and consumption must grow because US and European consumption must decline, and if we cannot find a new source of demand, there will have to be a contraction in production. In an open world, the contraction will be paid for by everybody more or less equally, with those aggressively pursuing export growth getting off relatively lightly and the rest doing worse. In a closed world most of the cost will be borne by the countries with overcapacity.
If Asian countries continue to try to boost exports it is not hard to see why this could easily lead to trade barriers.
China needs to resolve this problem by expanding fiscally, not by stimulating exports. The US in the same position sixty years ago tried to do the same thing China is doing (half-hearted fiscal stimulus and more interfering with trade in order to alter the terms in its favor), with disastrous consequences mainly for itself. Instead of looking for and dreading Smoot-Hawley in US or European policy-making, we really need to worry about an Asian Smoot-Hawley.
Remember that there is no difference in this case between restricting imports and subsidizing exports and, by the way, currency depreciation does both.
Yves again. Ahem, there is a wee bit that Pettis fails to mention in the supposedly “easy” adjustment of the trade deficit countries like Germany, France, and England defaulted on their debts. The handwriting is on the wall.