If you ever want to start a fight in a room full of economists, just ask them if it was China that caused the credit crisis.
Ask them if the root problem was really too much borrowing in the United States, or whether it was actually Beijing’s economic policies that were to blame for the whole mess by encouraging too much saving in China.
At first the question might sound absurd. After all, for the past two years a stream of august commentators have told us how the crisis was caused by over-leverage in the US, where reckless subprime borrowers were pushed to over-extend themselves by greedy bankers, abetted by ineffectual regulators and a negligent central bank.
But there is an alternative explanation.
According to this view the real culprit was Chinese government policy, and especially Beijing’s policy of keeping the yuan undervalued to boost exports.
Maintaining an undervalued currency, argue the minority, led to financial repression in China, causing a massive excess of saving.
The result was China’s huge accumulation of foreign reserves, most of which were recycled into the world’s largest financial market in the US in a flood of liquidity which inflated a credit bubble of truly enormous proportions.
You can tell that the cause of the crisis was excess saving rather than too much borrowing, argue China’s accusers.
If the cause was really over-borrowing, the extra demand for credit would have driven up market-determined long-term interest rates, and US bond yields would have risen.
On the other hand, if the trouble was too much saving, the excess supply of liquidity would have pushed long-term interest rates down and bond yields would have fallen.
As it is, the answer is clear: long-term interest rates have been on a declining trend for years, with the yield on the 10-year US Treasury note falling from 8 per cent in 1995, to 6 per cent in 2000, to 4 per cent in 2007, largely thanks to massive purchasing by the People’s Bank of China as Beijing has swelled its reserves.
That argument might hold up in a narrow economic sense, but a book entitled China and the Credit Crisis: The Emergence of a New World Order offers a more nuanced view.
Its author, Giles Chance, is well placed to weigh into the debate. Neither a China-basher, nor entirely a China-booster, Chance is a former World Bank staffer and fund manager with 20 years’ experience of doing business in and with China.
Now a visiting professor at Peking University’s Guanghua Business School, he examines in depth the role China played in inflating the credit bubble that preceded the bust, and looks at how Beijing is set to emerge from the downturn with its position on the world stage immeasurably strengthened.
On the question of blame, he finds Beijing not guilty. “China did not cause the credit crisis,” he writes, adding: “But without China the credit crisis could not have happened.”
Chance makes a strong argument that what really caused the crisis was the failure of Western central bankers to appreciate the game-changing impact on the world economy of China’s emergence as a great exporting power.
He describes China’s accession to the World Trade Organisation as a one-off supply shock to the global economy in which the rock-bottom wage costs and vast economies of scale of China’s export industries combined to bring down goods prices around the world, lowering inflation rates in the developed economies.
Politicians and central bankers in the West misread the signals, attributing the drop in inflation not to the influence of China but to the brilliance of their own economic policies.
For example, in a blazing display of hubris British Chancellor of the Exchequer, now Prime Minister, Gordon Brown, claimed to have vanquished the boom and bust business cycle, telling his October 2000 party conference: “It is not by accident, but by our actions, that we now have the lowest inflation for over 30 years.”
US policymakers got it wrong too. Interpreting falling inflation as the result of a deficiency in demand rather than a supply-side shock, they slashed interest rates in an attempt to stave off the threat of deflation.
“The monetary stimulus was unnecessary,” Chance writes, “and helped to create the disastrous real estate bubble at the heart of the crisis.”
Chance recognises the impact of Beijing’s policies in ramping up savings in China’s state-owned corporate sector, and of the importance of China’s reserve accumulation in holding down long-term interest rates in the developed world.
But he absolves Beijing of culpability for the credit crisis. “Attempts by Western bankers and politicians to blame the crisis on excess capital generated by Asian thrift sound like a driver blaming his car accident on the man who bought him a drink,” he writes.
It’s hard to disagree with his point, but that won’t stop economists fighting over the question for years to come.
2 comments:
How to start a fight in a room full of economists
Tom Holland
28 December 2009
If you ever want to start a fight in a room full of economists, just ask them if it was China that caused the credit crisis.
Ask them if the root problem was really too much borrowing in the United States, or whether it was actually Beijing’s economic policies that were to blame for the whole mess by encouraging too much saving in China.
At first the question might sound absurd. After all, for the past two years a stream of august commentators have told us how the crisis was caused by over-leverage in the US, where reckless subprime borrowers were pushed to over-extend themselves by greedy bankers, abetted by ineffectual regulators and a negligent central bank.
But there is an alternative explanation.
According to this view the real culprit was Chinese government policy, and especially Beijing’s policy of keeping the yuan undervalued to boost exports.
Maintaining an undervalued currency, argue the minority, led to financial repression in China, causing a massive excess of saving.
The result was China’s huge accumulation of foreign reserves, most of which were recycled into the world’s largest financial market in the US in a flood of liquidity which inflated a credit bubble of truly enormous proportions.
You can tell that the cause of the crisis was excess saving rather than too much borrowing, argue China’s accusers.
If the cause was really over-borrowing, the extra demand for credit would have driven up market-determined long-term interest rates, and US bond yields would have risen.
On the other hand, if the trouble was too much saving, the excess supply of liquidity would have pushed long-term interest rates down and bond yields would have fallen.
As it is, the answer is clear: long-term interest rates have been on a declining trend for years, with the yield on the 10-year US Treasury note falling from 8 per cent in 1995, to 6 per cent in 2000, to 4 per cent in 2007, largely thanks to massive purchasing by the People’s Bank of China as Beijing has swelled its reserves.
That argument might hold up in a narrow economic sense, but a book entitled China and the Credit Crisis: The Emergence of a New World Order offers a more nuanced view.
Its author, Giles Chance, is well placed to weigh into the debate. Neither a China-basher, nor entirely a China-booster, Chance is a former World Bank staffer and fund manager with 20 years’ experience of doing business in and with China.
Now a visiting professor at Peking University’s Guanghua Business School, he examines in depth the role China played in inflating the credit bubble that preceded the bust, and looks at how Beijing is set to emerge from the downturn with its position on the world stage immeasurably strengthened.
On the question of blame, he finds Beijing not guilty. “China did not cause the credit crisis,” he writes, adding: “But without China the credit crisis could not have happened.”
Chance makes a strong argument that what really caused the crisis was the failure of Western central bankers to appreciate the game-changing impact on the world economy of China’s emergence as a great exporting power.
He describes China’s accession to the World Trade Organisation as a one-off supply shock to the global economy in which the rock-bottom wage costs and vast economies of scale of China’s export industries combined to bring down goods prices around the world, lowering inflation rates in the developed economies.
Politicians and central bankers in the West misread the signals, attributing the drop in inflation not to the influence of China but to the brilliance of their own economic policies.
For example, in a blazing display of hubris British Chancellor of the Exchequer, now Prime Minister, Gordon Brown, claimed to have vanquished the boom and bust business cycle, telling his October 2000 party conference: “It is not by accident, but by our actions, that we now have the lowest inflation for over 30 years.”
US policymakers got it wrong too. Interpreting falling inflation as the result of a deficiency in demand rather than a supply-side shock, they slashed interest rates in an attempt to stave off the threat of deflation.
“The monetary stimulus was unnecessary,” Chance writes, “and helped to create the disastrous real estate bubble at the heart of the crisis.”
Chance recognises the impact of Beijing’s policies in ramping up savings in China’s state-owned corporate sector, and of the importance of China’s reserve accumulation in holding down long-term interest rates in the developed world.
But he absolves Beijing of culpability for the credit crisis. “Attempts by Western bankers and politicians to blame the crisis on excess capital generated by Asian thrift sound like a driver blaming his car accident on the man who bought him a drink,” he writes.
It’s hard to disagree with his point, but that won’t stop economists fighting over the question for years to come.
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