Full Text

The Economic Quicksands of Globalization

The World Is Curved: Hidden Dangers to the Global Economy
By David M. Smick
Portfolio, 305pp. $26.95

Reviewed by Martin Walker

Future historians will likely look back on the year 2001 as pivotal, not for the usual date of 9/11, but rather for an event three days later when China joined the World Trade Organization. From that moment, China's exports and trade surpluses began to soar, with consequent imbalances between Chinese surpluses and U.S. debt; between American consumption and Chinese exports. This dynamic sharply accelerated the extraordinary interdependency of the global economy.

One important aspect of this is that China's exports are not quite what they seem. Wholly or partly foreign-owned companies in China employ only three percent of the workforce (25 million people), but deliver over 55 percent of exports and 80 percent of export growth, as well as producing 22 percent of China's GDP and 41 percent of GDP growth. China's exports are thus Western corporate profits; our companies are exporting, via China, to ourselves, in a virtuous circle of interdependent trade.

When the U.S. housing bubble burst and the credit crunch arrived, the consequent fall in American consumption hit China hard. So mutually dependent have we all become on the global trading system, that its interruption has provoked what we should probably start considering our generation's own "Great Depression."

So far, the world's stock markets have lost $33 trillion of their nominal value at their peak and the world's property owners have seen another $16 trillion erode from the peak values of commercial and residential real estate. Altogether, we have seen wealth destruction the equivalent of one year's GDP of planet earth. When we ask where the money has gone, the only answer is that much of it was phantom wealth, based on paper gains. And yet, hundreds of millions of individuals built dreams and tens of millions of companies built business plans on the basis of that phantom wealth. The psychological shock of the apparent disappearance of the savings of the world's middle classes is posing a severe threat to what David Smick's book calls "the imperfect good of globalization."

Smick may be best known as the editor-publisher of the magazine, International Economy, but he also runs a high-level consulting firm. He began on Capitol Hill as chief of staff to Congressman Jack Kemp - a free market conservative. In 1980, he worked on the Reagan campaign and subsequently launched a highly successful series of conferences on international finance with participants of the caliber of Alan Greenspan, Nigel Lawson and Jean-Claude Trichet.

He began writing The World is Curved before the "bubble" burst, after reading The World is Flat - Tom Friedman's now distinctly dated paean to globalization. It did not seem flat to Smick, whose own experience of international finance was "an endless, dangerously twisting and turning road with abrupt steep valleys and risky mountainous climbs. We can't see ahead. We are always being surprised and that's why the world has become such a dangerous place." And that also explains Smick's title, why he sees the world as curved, with frighteningly limited sight lines.

Smick's book was apparently written in the summer of 2008 after the Bear Sterns collapse, but before the Lehman Brothers bankruptcy in October, which threatened systematic meltdown. Because of this, his book makes only one passing reference to Obama and predates the massive stimulus packages and the collapse of Asian exports, as well as the Eastern European crisis that is testing European solidarity. Even from his mid-2008 perspective, Smick clearly saw the dangers looming. So his diagnosis may still apply that:

The world today appears to be moving away from the model of globalization and unfettered free markets of recent decades toward something more reminiscent of the 19th century model of globalization - a new, more mercantilist era of backroom rivalries, deal-making and tensions based on ambitious national political agendas and capital shifts controlled by governments ... The innocent, well-meaning G7 policy coordination by democratically oriented industrialized nations, what little there was of it, is dying fast. The so-called Anglo-Saxon world of free capital markets is under siege. The upshot is that the potential for disruption in the entire global financial market is growing exponentially.

In particular, he calls China "the next bubble to burst," noting acidly "Chinese state-run banks make the Japanese banks look like amateurs in the art of hiding non-performing loans."

The immediate dangers are as much political as economic. The first is the threat of a retreat to protectionism, driven by domestic pressures on national leaders. "Today's protectionist tweaking can easily become tomorrow's trade and commodity war, resulting in a new, frightening era of even scarcer liquidity," Smick warns. The second is what he calls "coming disagreements over climate warming issues between Asia and the West" sharpening trade tensions. The third is the eroding effectiveness of the central banks, as economies fail to respond to the usual tools of cutting interest rates and boosting the money supply.

In each of these three areas, the argument for close policy coordination between Europe and the U.S. is overwhelming. Between them, these two behemoths account for half of global GDP and on climate change, free trade and central banking, no real progress can be made without their agreement.

Smick's chapter on "The Incredible Shrinking Central Banks" points out that the usual rules no longer seem to apply. In the year following the summer of 2007, when U.S. expectations of inflation rose from 3.2 percent to 5.2 percent, long-term bond yields dropped by 1.5 percent. In theory, this should not happen because bond yields are expected to rise to compensate investors for future inflation. But it did, because of the vast inflows of money into the dollar as China, Russia, Japan and the oil-exporters bought U.S. Treasury bonds. So Smick's explanation makes sense when he suggests that "U.S. long-term interest rates may to an extent have become a captive of global financial forces." The implication that Americans no longer control their own interest rate-policy should be a sobering one for U.S. politicians.

Smick was writing before Chairman Ben Bernanke embarked on his heroic expansion of the role of the Federal Reserve, accepting unprecedentedly risky collateral to expand the Fed's asset sheet from $700 billion last September to over two trillion dollars today. Bernanke's Fed single-handedly revived the collapsed commercial paper market, and his bold leadership stands in stark contrast to the wretched performance of the unlamented Treasury Secretary Hank Paulsen. Bernanke's role buttresses Smick's urging that "like never before, a courageous body of policy leaders needs to step forward with an effective agenda to avoid disaster." President Obama's stimulus package and budget would seem to fit the bill, so long as China and the other leading nations in the G7 and G20 maintain their cooperation and their commitment to the liberal trading system.

There is one lesson from the past that Smick, along with most other commentators, seems to have missed. In warning that we need to avoid experiencing something like Japan's "lost decade," we have forgotten Japan's key achievement in that grim time. Even as Japan's land and stock values lost some $15 trillion in value, the government's commitment to deficit spending ensured that Japan's GDP never fell. This cost Japan over four trillion dollars and boosted its debt to 170 percent of GDP, but it was worth it. A sustained fall in GDP, which is what now threatens the global economy, would be far worse not only in economic but in human terms. The International Labor Organization is currently predicting that 50 million jobs will be lost this year, a dreadful human cost raising the specter of a lost generation of young people coming into a hollow labor market.

What Japan went through in the 1990s is the same grim experience that the United States and much of the rest of the world are suffering now: a recession driven by a deficit in demand. Richard Koo, chief economist for Nomura Research Institute, calls it "a balance-sheet recession" - meaning that consumers and companies, as we go into the recession, have such high debt levels that their overwhelming priority, even when they get stimulus funds, is to pay down their debts rather than consume or invest. As a result, their savings pile up in the banks because nobody wants to borrow. Demand for goods and services collapses and economic activity stalls. The lesson from Japan is that the only way out is for government to spend and spend and spend to keep the economy moving - until the debts are paid off and people start to borrow and invest again.

The global economy is about to be hit by a tidal wave of over two trillion dollars in deficit spending. China is committing $586 billion, European countries are pumping in another $600 billion, and the U.S. has not only the $800 billion stimulus package, but even more from the Obama budget. Will it work in lifting all boats? It should, provided that a) it can be sustained long enough for the banking problem to be fixed; b) that there are no more shocks and c) that governments do not resort to protectionism. Those are daunting conditions and there is no Plan B. If the "stimulus shock" fails, Smick's next book could well be titled How the World Imploded.