, , , , , , , , , , , , ,

Since we’ve never had any contact, I can’t take any credit for Adair Turner’s outstanding new column that explodes lots of dangerous myths about China’s role in the world economy. Still, I feel entitled to be gratified that Turner, a former senior British finance official, has made many of the main points I’ve been laying out since my 2002 book The Race to the Bottom appeared.

One of Race‘s most important observations, in my opinion, concerned what you might call the real-economy roots of financial crises – in that case, the turmoil that convulsed East Asia and much of the rest of the developing world in the late 1990s. Whereas most analysts blamed the crisis almost entirely on lending and spending trends, largely in East Asia, that got way out of whack with economic fundamentals, I showed that these imbalances stemmed largely from trade trends and imbalances that became unsustainable.

China’s exports boomed so strongly, and Japan’s remained so robust, that even though the American market on which the entire region relied was growing nicely, newer trading powers like Indonesia, Korea, Malaysia, and Thailand got squeezed out. And since the world’s other high income regions (Western Europe and Japan) were following export-led strategies themselves, the new Asian exporters had nowhere else to go. Investors quickly began withdrawing credit that they’d extended in the assumption that these countries’ trade profits would keep growing indefinitely. And each plunged into a long and painful recession, and the fallout spread throughout the developing world.  China, however, escaped – mainly by quietly increasing various export subsidies and preserving its U.S. and global market share gains.  

When the 2007-08 financial crisis struck, I realized that a similar underlying dynamic was at work again, and I’ve been pleased that many of the world’s leading economists agree, even though they’re reluctant to blame trade imbalances in their highest profile statements. Largely as a result, U.S. leaders in particular remain clueless, and keep pushing new trade agreements likeliest to worsen trade imbalances again and set the stage for a repeat disaster.

So it was great to see Turner write that “the world market is simply not big enough to support high incomes for China’s 1.3 billion citizens,” and observe that “the flip side of China’s surplus [during the bubble decade] was huge credit-fueled deficits elsewhere, particularly in the US. When the credit bubble collapsed in 2008, China’s export markets suffered.”

And as I’ve also reported, Turner observes that “China’s current-account surplus has again soared. Though it seems significantly smaller than pre-crisis levels as a share of GDP – almost 4%, at the latest monthly rates, compared to 10% in 2007 – it has returned to its peak in absolute terms. And it is the absolute size of China’s external surplus that determines the impact on global demand. In short, China is back to where it started, with its growth dependent on export demand, which is now severely constrained by debt overhangs in advanced countries.”

The one area in which I disagree with Turner, unfortunately, is on what happens next. He expresses some optimism that China will solve the problem that countries with much smaller impacts on the global economy, like “Japan, South Korea, and Taiwan never had to face: how to boost domestic demand rapidly and sustainably.”

I fear that the incomes of the vast majority of Chinese remain way too low to achieve this goal. Moreover, it’s looking all too probable that Washington’s bipartisan trade liberalization obsession will let China – and the rest of the export-dependent world economy – off the hook and take the easy way out. If Congress approves President Obama’s new trade agenda, the Trans-Pacific Partnership in particular will open American markets much wider than foreign markets. And China will boost net exports either by devaluing its currency further, ramping up various trade-related subsidies, or some combination of the two. In fact, other than “When?”, the only major question I see outstanding about the resulting next crisis is “How big?”