So whose fault was this crisis? China’s or America’s?
Standard Chartered poses the question and comes to the enlightened conclusion that it was probably a crisis largely of the USA’s making, most likely due to the overextended period of low interest rates between 2002-2006.
While that’s hardly a radical view – or even a new one - the report does make a number of interesting observations, including the fact that while US consumption is contracting, it’s hardly making an impact on the trade account deficit just yet.
Note the following chart showing to what extent the US external account is not rebalancing:
As Standard Chartered puts it:
US consumption is now contracting, putting an end to the enormous demand for China?s manufactured goods and Middle East oil. However, while this has caused the US non-oil trade account deficit to move back towards balance, the overall trade account remains in deficit. In other words, as Chart 8 shows, the US external account is not rebalancing.
Meanwhile, China’s appetite to fund short-term US debt is not abating either. For example, Standard Chartered sees a marked shift of Chinese buying towards the front-end of the US Treasury curve and a clear shift away from agency and long-term Treasury paper.
But, they add, if the fault lies anywhere with China, it’s in the country’s relentless foreign currency intervention:
The semi-fixed exchange rate and the PBoC?s daily intervention in the FX markets encouraged exports, and thus the expansion of China?s external imbalances, from 2004. Without rehashing the old debate about the currency, we believe more could have been done.
On the US side, as well as keeping rates too low for too long – StanChart says policymakers were wrong to overlook house prices in their gauge of inflation (our emphasis):
The problem was that most folk (including the Fed) were looking at the prices of goods and services, not houses. House prices peaked in July 2006, as Chart 6 shows. US monetary policy explicitly did not take this into account, which now looks like an error of judgement. Sub-prime lending peaked during 2005-07. China?s imbalances grew large only in 2007-08, probably further fuelling the bubble once it had inflated. The liquidity from emerging markets, which was recycled back into the bond markets, probably prevented US monetary conditions from responding to the short-term rate hikes, as shown in Chart 7.
The ramifications of the global financial crisis plus all of the above has, according to Standard Chartered, clearly put pressure on the underlying system holding the two economies together – that being Bretton Woods 2 (the US-dollar global currency reserve system).
But while Bretton woods may be morphing, the bank reassures the system has not collapsed (just yet). That said, they add:
The simultaneous slump in global demand we are currently experiencing makes rebalancing difficult. The BW II system also increases the risks of protectionism if surplus countries continue to encourage exports.
And back to who is to blame…
…the US is clearly the origin of this crisis. A low US policy rate environment allowed a US asset bubble to develop, and US financial markets were oriented towards amplifying the risks that this created. In sum, we agree with President-elect Barack Obama, who in his recent speech about the economy said that this was „a crisis largely of our own making?.
Related links :
And now for the Asian domestic bond collapse – FT Alphaville
Is the East heading into the red? – FT Alphaville