Solution to global economic crisis lies a lot closer to home

PUBLISHED : Monday, 26 September, 2011, 12:00am
UPDATED : Monday, 26 September, 2011, 12:00am

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Officials at China's Ministry of Finance gave their counterparts in the United States and Europe a stern ticking off last Friday.

'We should urge major developed countries to maintain financial stability,' they said in a statement, calling on rich world governments to boost growth while reducing their budget deficits.

'Major developed countries should also properly handle the sovereign debt problem, and reduce the negative spillover impact resulting from their policies, and channel more global financial resources to developing countries,' they added for good measure.

That's quite a 'to-do' list: calm the markets, stimulate growth, balance your budgets, cut your debt, make sure the rest of us don't get hurt in the process, and - oh yes - give us poor folk more money.

Still, these days China's officials believe they are fully entitled to lecture their opposite numbers in the developed world.

With the US economy teetering on the brink of a double-dip recession, American policymakers seem to have run out of ideas for stimulating growth. At the same time, Europe's politicians are failing to get to grips with the continent's debt crisis, making sovereign defaults and the break-up of the euro ever more likely.

In contrast, Beijing successfully steered China's economy through 2009's global slump, maintaining near double-digit growth rates despite the collapse in world trade. With low levels of official debt, a record US$3 trillion in foreign reserves, and a rapidly expanding domestic market, Chinese officials clearly think they have devised a superior economic model.

No wonder they feel they have the right to deliver a sermon or two, especially with so many people now looking to China as the potential saviour of world economic growth.

But before anyone gets too preachy, it's worth remembering that although Chinese officials may think they now have the moral authority to reprimand crisis-hit policymakers in the West, a significant minority of economists believes Beijing's financial policies were largely to blame for causing the whole crisis in the first place.

According to this view, the root cause of the debt crises in both the US and Europe was a glut in the world's savings, much of it originating in China.

This isn't as batty as it sounds. After all, if one economy saves more than it can invest at home, then it has to lend out its surplus savings abroad. As a result, excess savings in one economy must be reflected by a build-up of debt in others.

And the years before the crisis saw an awful lot of excess saving, largely in China, but also in Japan, the Middle East and Germany.

That glut of spare money helped keep interest rates exceptionally low, fuelling a binge of unwise borrowing in the US as well in Europe's peripheral economies. The result was the debt crisis the developed world is still going through today.

The bad news is that nothing has changed. As the first chart below shows, the world's savings as a proportion of total economic output are back up to pre-crisis levels. And according to forecasts from the International Monetary Fund, they are set to go higher still.

Once again much of the surplus is coming from China. The second chart shows China's excess savings; how much of its income the economy saves each year above and beyond what it needs to fund its domestic investments. After hitting a record in 2008, the excess fell in 2009 as Beijing stepped up its investment programme. But with officials winding back their stimulus efforts, the surplus rose again last year to more than US$300 billion.

According to Charles Dumas at economics consultancy Lombard Street Research, this excess of savings represents a deficit of demand at home. Unless China and the other surplus savings countries implement policies to encourage domestic consumption, the shortfall of demand in the global economy will inevitably tip the world into a destructive episode of deflation.

For China, Dumas says, the easiest way to boost demand would be for Beijing to float the yuan, allowing it to appreciate to its fair value, which would greatly lift the purchasing power of Chinese consumers.

Unfortunately, that's not going to happen. Chinese policymakers are far too busy lecturing the US and Europe to look any closer to home for the causes of the world's economic problems.