Blame game will not make crisis easier to resolve
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A headline in the People's Daily last week blasted outgoing United States Secretary of the Treasury Henry Paulson for playing the blame game. According to the article, Mr Paulson had claimed that a failure to address the rise of emerging markets and the resulting trade-related imbalances was partly to blame for the global financial crisis. This follows Federal Reserve chairman Ben Bernanke's long-standing argument about the Asian savings glut, which was also lambasted in the article.
As the financial crisis deepens, threatening to become a trade crisis, the eagerness of policymakers around the world to blame foreigners is escalating. Europe is engaged in a shouting match between Germany on the one hand and Britain, France and Italy on the other over the same trade-related issue. Given the nastiness of the European debate, it would be surprising if the global debate were a polite one.
Many mainland analysts and policymakers are livid at the claim mainland policies played a role in the massive global financial distortions. The fact is that several countries, dominated by China, engineered policies whose result was the decade-long accumulation of foreign currency reserves at a rate never before seen in history. This could not help but affect the global financial system.
It is often forgotten that the world is tied together in a series of relationships that include all trade- and investment-related money flows, and these relationships are intertwined. When several Asian countries, after the trauma of the 1997 crisis, put into place policies aimed at generating massive trade surpluses and in the process accumulated historically unprecedented hoards of foreign currency reserves, two things necessarily followed.
First, other countries would have to run correspondingly large trade deficits. Second, the trade surpluses would have to be recycled to the trade deficit countries, and the way they were recycled would determine the size of the deficit.
If this recycling had occurred in the form of private capital flows, it might have been widely spread into a variety of assets around the world, and the distribution of trade deficits would have been equally widely spread. But the recycling was more than 100 per cent accounted for by reserve accumulation (which sharply exceeded trade surpluses), and so the distribution of the imbalances was determined almost exclusively by Asian central banks.
US and European central banks should have been much more vociferous about the payments imbalances and should have enacted monetary measures to counteract Asian currency policies, but they so enjoyed the benefits of low interest rates and cheap goods, that they permitted, and perhaps even encouraged, domestic financial imbalances to get out of hand. Nonetheless, however one chooses to assign primary blame, the fiscal decisions of Asian countries combined with the investment decisions of their central banks were key determinants in the structure of the resulting global imbalances. This cannot possibly be a controversial proposition to anyone who understands the basics of the global balance of payments.
There is no question that US and European monetary policies were at least as deeply flawed as Asian monetary policies in creating the conditions for the massive global credit bubble. There is plenty of blame to share regardless of how one wants to apportion it.
Normally this blame game would be deplorable, but not worth much more than a shrug of the shoulders. The world hardly needs further lessons on our tendency to blame others for our problems. But this time things are different. The global balance of payments is undergoing a sharp adjustment in which countries that exported demand - the trade-deficit countries - are being forced to increase savings and cut consumption. Every time this has happened in previous cases in history, the cost of the adjustment turned out to be much worse for the trade-surplus countries than for the trade-deficit countries. Think of the US in the 1930s, for example, or Japan in the 1990s.
If acrimony leads to a sharp reduction in international trade - and it is in the short-term interest of trade-deficit countries that it does - once again the worst impact will be on those countries that have exported overcapacity and relied on the import of global demand, that is, the trade-surplus countries. This means that for many of these countries the effect of the global crisis could be far worse than anyone has imagined.
It is best for the world, and especially for Asian countries with large trade surpluses, that the global adjustment be smooth and gradual - possibly spread out over four to five years rather than the one year in which it seems to be happening. This will require a clear understanding of the causes of the global imbalances and real statesmanship on the part of US, European, Japanese and Chinese policymakers, who must co-ordinate policies to minimise the disruptive cost to China.
So far, evidence of statesmanship is lacking. This, again, is consistent with historical precedent, but if things don't change, the crisis will get much worse before it gets better.
Michael Pettis is professor of finance at Peking University
