Excerpts From China International Business:
A Change Of Mindset
By Andy Xie
The biggest policy debate this year has thus far been when and how fast to exit from last year's stimulus policies. Last year, in a moment of panic over the global financial crisis, central banks and governments poured monetary and fiscal stimulus into the global economy. The side effects of these misguided policies are already showing up: asset speculation has engulfed the global financial market again and consumer price inflation is creeping up uncomfortably fast, especially in emerging economies. Despite the visible need for tightening, the consensus is demanding a slow and delayed exit. Japan's "early withdrawal" is touted as an example of what could happen otherwise.
Japan has experienced two decades of economic stagnation since the collapse of the infamous bubble it suffered in the 1980s. The most popular explanations are that Tokyo wasn't aggressive enough in stimulating the economy after the bubble burst, or that it withdrew its stimulus too early – or both. This line of thinking is popular among elite economists in the US, where it is rarely challenged. But few Japanese analysts buy it.
The Americans liken an economy in a slide to a car with a dead battery: it can be jump-started with a forceful enough push. But there's no sound logic behind such thinking. After a big bubble bursts, an economy suffers a terrible misalignment between supply and demand. Through high prices, a bubble diverts investment and labor to needed activities. It takes time for an economy to normalize. The bigger the bubble, the longer it takes to heal.
At the peak of Japan's bubble, the biggest in history, the excess value of its property and stock markets was more than five times its gross domestic product – more than the entire world's gross domestic product at that time. In comparison, the excess asset value in the US bubble was less than twice its GDP, or half the global GDP. So how is it possible to just stimulate an economy back to health after such a massive correction?
Japan has run up the national debt equal to 200% of GDP — the greatest Keynesian stimulus program in history — all in the name of stimulating the economy back to health. It has failed miserably. Japan's nominal GDP is about the same as when the stimulus began. Those who advocated the policy blame Japan's failure on either the stimulus being too small or not being sustained for long enough – that is, the dosage, not the medicine itself, was at fault.
The bankruptcy of Japan Airlines is a sobering reminder of what is still wrong with Japan. It stayed with unprofitable routes for years without its creditors or shareholders being able to do anything about it. And by making credit cheap and easy, the stimulus prolonged the airline's business model — actually, an anti-business model — for a long time. Zombie companies that have first claims to resources have trapped the Japanese economy in stagnation for decades.
US President Barack Obama has just announced a proposal to limit proprietary trading on Wall Street. This is his first major step to address the root cause of the crisis.
The crisis happened because financial professionals had incentives to bet other people's money in a game they could not lose.
Obama has not been well-advised. His so-called accomplishment — stabilizing the financial system — comes from throwing trillions of taxpayers' dollars at financial firms. He has behaved like a Wall Street trader: spending other people's money with no thought of consequences. Anyone can do that. Hopefully Obama has fundamentally changed his approach.
Reform, not stimulus, is the solution. Only by limiting financial speculation can the foundations be laid for a healthy recovery, and to prevent another crisis.
More insightful commentary by Andy Xie.
As Mr. Xie points out, after a bubble bursts, there is a large misalignment between supply and demand.
An example of this problem is that of the US housing boom and bust when close to 2 million houses were built annually fueled by speculation and low interest rates between 2001 and 2006, while household formation was only in the 1 to 1.3 million range annually.
- Massive supply overhang that will take years to work through as prices continue to collapse beyond the average 20% adjustment so far nationwide.
- Financial Institutions continue to hoard cash after massive bailout funds have been allocated from the public purse and added to the sovereign debt. One wonders if these zombie institutions will ever come back to life.
- To date only very small steps have been taken to address any of the moral hazard that is the root cause of the crisis. It seems that the political system is failing in this most critical area.
- If no real reform happens, the seeds of the next crisis are already planted, and waiting for the right conditions to sprout and spread their contagion.
As result, the market is unhealthy and is unable to determine true value for many types of goods and services.
With ultra-low interest rates, induced by the central planners at our central banks, it will be impossible for the proper, deflationary correction to take place to once again allow the market to function in a true manner of price discovery.