History says 'Chimerica' heading for painful split

PUBLISHED : Monday, 21 September, 2009, 12:00am
UPDATED : Monday, 21 September, 2009, 12:00am

The greatest economic marriage in the world is on the rocks. Unfortunately, history teaches us that the separation is unlikely to be amicable. In 2007, Harvard University history professor Niall Ferguson coined the term 'Chimerica' to describe the interdependent relationship between China and America.

The two countries could be considered a single economy, he argued, with Chinese savings funding American consumption, which in turn powered the mainland's export-led growth.

'For a time it seemed like a marriage made in heaven,' he wrote in his 2008 book The Ascent of Money. 'But there was a catch. The more China was willing to lend to the United States, the more Americans were willing to borrow.'

The result was the leverage-fuelled binge which ultimately led to the subprime crisis and the subsequent global recession.

Now Ferguson warns that the Chimerica partnership is in danger of breaking up under the strain.

In Hong Kong to deliver today's keynote speech at the CLSA Investors' Forum, Ferguson argues that the economic pairing of China and the US is as fragile as any marriage in which one partner saves diligently while the other compulsively spends. When economic conditions deteriorate, tensions are bound to mount.

Even if divorce is not imminent, it does appear inevitable, he warns. With US consumer demand set to remain subdued as Americans repair their ravaged balance sheets, the Chimerica partnership is coming unravelled. The big question is whether the separation will be amicable, or whether divorce will end up impoverishing both partners.

The historical precedents are not encouraging.

If China cannot rely on external demand from the rich world to power its economic development, it will have to engineer a transition towards growth driven by domestic consumers. But that will be a long process lasting many years, during which Ferguson warns 'Chinese growth will be a lot slower than people think'.

Without rapid economic growth rates to maintain its legitimacy, Ferguson believes the Communist Party may take a leaf out of the history books. 'The one sure way the regime can preserve itself is by playing the nationalistic card,' he says.

Ferguson compares China today with Germany under the Kaiser, 100 years ago. Like China now, Germany then was rapidly emerging as an economic heavyweight, supported by first rate technological innovation and unmatched industrial strength.

But economic growth and social change were not matched by political development, leaving Germany with weak representative institutions and an anachronistic system of government. Unwilling to concede power the ruling elite sought to bolster its position through an aggressive foreign policy that led ultimately to its downfall at the end of the first world war.

'The lesson of history is that you cannot keep a political structure in place unchanged in the face of rapid economic development and the resulting social change,' Ferguson warns.

The break-up of the Chimerica relationship also carries severe implications for the US. With its fiscal deficit soaring and its debt-service burden mounting, 'the US is bumping up against the ceiling of what's credible', says Ferguson.

Historically, governments have sought to deal with heavy debts either through economic growth, which boosts revenues and reduces debt to gross domestic product ratios, or by inflating their way out of the problem, which reduces the real size of the burden.

For the US, neither route appears viable. With consumer demand depressed, a return to rapid growth looks like a distant prospect, while overcapacity is likely to keep a lid on inflation.

According to Ferguson, history suggests a third option. With excessive debt, slow growth and a sliding currency, the economic conditions the US finds itself in today are uncomfortably reminiscent of Britain's situation following the second world war.

If he's right, the result will be economic stagnation, a protracted decline in power and a retreat from the world stage in response to the unsustainable costs of overseas engagements.

Divorce could prove painful for both economies in the Chimerica union. Ferguson says the term was always intended as a pun on the word 'chimera', the mythical beast - part lion, part goat - which has come to stand for all fantastic and transitory illusions.

For the time being, however, he's keeping quiet about which partner history will judge to be the goat.