The Bill From The China Shop
Charles Dumas and Diana Choyleva, Profile Books, 2006, 149 pages, £12.99.

Until relatively recently it was a given amongst most economists that the US balance of payments deficit was a) unsustainable, and b) the result of some combination of private and public sector profligacy. Moreover, since it was believed that this problem had been generated in the first place by US domestic excesses, the severest critics assumed that it was not only inevitable, but also entirely appropriate, that its resolution would ultimately involve a deep US recession. During the middle of 2004 a group of economists at Lombard Street Research began to offer an alternative explanation for the existence of global imbalances. They claimed that the US current account deficit together with the deficits of other Anglo-Saxon economies, were not primarily the result of these countries’ own policy failures, but rather a consequence of the excess savings and current account surpluses that were being generated elsewhere in the world. In March 2005 Ben Bernanke delivered his famous address to the Virginia Association of Economics, arguing much the same thing.

In this slim booklet one of the Lombard group, Charles Dumas, sets out the rationale behind their case, as well as suggesting that much of the economic and financial history of the past 10 years can be explained as a reaction to the emergence of an Asian savings glut. He argues that in the aftermath of the Chinese boom-bust of 1993-94, and the Asian crisis of 1997-98, China and the Asian Tiger economies toughened up what was already an essentially mercantilist approach to foreign trade. Given that this is an area where the natural propensity to save by the private sector is in any event very high, the result has been the generation of an Asian structural saving surplus. This in his view is the essence of the problem, although private sector structural surpluses associated with low population growth rates in Japan and North-Central Europe, together with cyclical surpluses in OPEC, Canada and Latin America, have not helped. In a world where global saving must equal global investment, where political constraints and institutional rigidities have limited profitable investment opportunities in China, India and Eastern Europe, and where since 2000 companies in the US, Japan and much of Europe have for various reasons been more concerned with restructuring than investment, the onus on avoiding continued global recession has been left primarily to the household and government sectors of the developed world. It has been their responses to what have been largely unavoidable shifts in fiscal and monetary policy that have led to the build up of the budget deficits, current account deficits and levels of personal debt that look so threatening to future economic stability. In essence, the counterpart of the chronic Asian savings surplus has been massive dis-saving elsewhere.

As Dumas points out, one of the consequences of the cheap money policies that have been evident since 2000 in much of the developed world has been a boom in house prices and a build up of personal debt. He could in fact have argued that the availability of cheap credit has produced a boom in the price of almost anything that the Chinese cannot produce, which includes not only real estate but art, stamps, fine wine and much else besides. Although he disputes the suggestion that there is a house price bubble, Dumas sees the sort of growth in personal debt that would be required in the future to sustain demand in the Western economies, during a continuing period of Asian savings surplus, as completely unrealistic. In any event Dumas believes that the amount of debt taken on by households and governments in the US, the UK and elsewhere already poses a severe threat to future prosperity. To underline this he employs a chapter on corporate Japan’s experience after the property and stock market bubble burst to illustrate the difficulties involved in paying back debt in a period of low inflation and mounting pension liabilities.

There is an alternative view which suggests that although the existence of large global structural imbalances carries with it relatively high risks, as long as policy makers respond reasonably rationally there is no reason why the imbalances should not be unwound without causing too much damage. As Asian and other Emerging economies feel less need to build up their reserves of foreign exchange, as exchange rates are allowed to float more freely, and as currency intervention finally manifests itself in the form of higher inflation rates in places like China, the very high trade deficits that exist in parts of the developed world will unwind. Dumas implies, however, that a shrinking of the Asian surplus would, with its associated increase in bond yields, almost certainly lead to a major cyclical downturn in US consumer spending given the existing level of household debt. For him the choices are either a near-term US recession, with the risk of both a breakdown in the existing global free trade arrangements and the break-up of EMU, or the continued build up of debt in the West, followed by economic blight as the additional problem of paying for the baby-boomers’ pensions unfolds.

Dumas places much of the blame for the instability in the global financial system on Chinese policy makers and in the final section of the book his colleague Diana Choyleva provides an insight into the functioning of the Chinese economy. She argues that although China may be the world’s emerging economic giant, its financial system is nevertheless hopelessly inadequate, with its largely-unreformed state banking system indulging in violent swings in lending to state-owned firms. The result has been economic boom-busts and a gross misallocation of resources. In this sense, therefore, the reluctance to allow the exchange rate to float is merely another illustration of the failure of what is still a Communist government to come to terms with free-market economics. There are, inevitably, parts of the argument with which one could take issue, but in general this is a provocative and informative explanation of the problem of imbalances. And whatever lies behind their existence, it does seem that unless we are quite lucky, the world may yet again be heading for a crisis that will have been precipitated by a central bank’s commitment to a fixed exchange rate.

Peter Lyon
Clay Finlay