FT Alphaville spoke with Richard Duncan, partner at Blackhorse Asset Management and author of The Dollar Crisis on Tuesday, regarding his new book The Corruption of Capitalism. And while he is pretty pessimistic on the US, Duncan says there is a way out if policymakers make bold decisions.
But first some background. In the Dollar Crisis, published in 2003, Duncan explained how the collapse of the Bretton Woods system in 1973 was always going to lead to a global financial crisis due to the trade imbalances it encouraged and created. Based on the premise, Duncan successfully predicted the subprime problem, the downfall of government sponsored agencies as well as the banking crisis (and related bailouts) we’ve all — seven years on — come to know and love.
Simply put, according to Duncan, the breakdown of the gold standard allowed too much paper-money to be created in the US. This de facto funded the US deficit, which respectively fuelled a savings glut in Asia. That inevitably drove dollar inflows back into the US — which themselves, over the course of a four-decade period, fueled a global credit bubble of simply gargantuan proportion.
In Duncan’s words, the collapse of Bretton Woods represented the moment “capitalism became corrupted by government debt”. From that point on “US policymakers abandoned the core principles of economic orthodoxy: balanced government budgets and sound money”.
One chart reflecting the situation well according to the author is this one:
In Duncan’s eyes it clearly shows the breaking of the global financial system’s imbalanced back.
To his frustration, though, it’s not a point that’s been grasped by policymakers yet. Policy response if anything has been ill-fitting, meaning the world’s economy is on life support — at best. As he explained to FT Alphaville:
Last year the US economy shrank by 2.4 per cent. But the budget deficit was 10 per cent of GDP. Without that deficit spending, the economy would have shrunk by at least 12 per cent, i.e. -2 per cent plus -10 per cent. Even after that deficit spending, the unemployment rate is 10 per cent, interest rates are zero, and central banks around the world are printing enormous amounts of paper money to prevent economic collapse. This policy response is supporting the global economy but it has not even targeted the structural flaws responsible for the crisis.
The point being: the world’s largest economy and engine of global economic growth — the United States — is simply not a viable concern any more. As Duncan explained it:
The country is de-industrializing because wages in the US are up to 40 times higher than those in developing countries like China. Therefore, the United States makes very little that the rest of the world cannot buy somewhere else much more cheaply.
And so, like any troubled company, the US too must restructure itself if it is to remain operational, says Duncan. How it goes about it, though, will be crucial to its success. The best policy according to the author would be heavy government investment in so-called ‘future’ industries — everything from solar, biotech, nano-technology and so on. Trouble is, a move like that would take more government spending not less.
Duncan estimates some $3,000bn or so on top of the $10,000bn already estimated in deficit spending over the next 10 years would be needed to put the US back on top of the global industrial game in this way.
The worst-case scenario, meanwhile, would be America turning into Japan while it attempted to do just that. On the flip side, it’s from Japan’s experience that valuable lessons could also be drawn. As Duncan explained (our emphasis):
When Japan’s bubble popped in 1990, the Japanese government’s debt to GDP was 60 per cent. The Japanese economy has been on government life support since then and government debt to GDP is now more than 200 per cent.
During the bubble years of the 1980s, a great deal of profit was made in Japan. That money was available to finance the expansion of government debt after the bubble popped. If it had not invested in government bonds it would have been destroyed, because there are no viable investment opportunities in a post-bubble economy. So the private sector has financed the expansion of government debt in Japan, and it has done so on concessionary terms.
The 10-year Japanese government bond yield is only 1.3 per cent. Now that the US bubble has popped, the US government will also be able to greatly expand its debt. But the lesson the US must learn from Japan is not to waste that money building bridges to nowhere, but instead to use the money wisely to restructure the economy to restore its viability. This global crisis will not end until the United States restructures its economy and restores its long-term viability.
The consequences of a scenario where the US failed to respond effectively, meanwhile, would be grave indeed. Not only would the US slip into irreparable decline, according to the author, globalization would break down and export-oriented Asian economies could collapse.
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End of an era for Asia?
But if Duncan’s view here is bleak, it’s even bleaker on the China situation. As he stated:
…regardless of what happens in the US, China is facing a much more difficult future than is generally believed. Every boom busts. Every bubble pops. China will be no exception.
It is a serious mistake to believe China’s economy will continue to grow at 8 per cent or more for the next decade. That’s what people believed about Japan in 1989. Today, Japan’s economy is no larger than it was in 1993, if you don’t adjust for deflation. 2 per cent to 4 per cent annual GDP growth would be an excellent outcome for China over the decade, in light of the enormous capital misallocation that has occurred there over the past 10 years.
The economic crisis in the United States means Asia’s era of export-led growth is over. A protectionist backlash in the West will force China to substantially revalue the Yuan to avoid trade tariffs in the United States and Europe. Other Asian currencies will follow the Yuan higher. Finally, the direction of asset prices in Asia, and around the world, will be determined by the size and timing of successive rounds of government stimulus packages in the United States and within Asia. The global economy will remain on government life support for years to come.
So that’s pretty much bad news for Asia under every conceivable scenario.
And if gold bugs were hoping for a call back to the gold standard, we would have to disappoint.
Duncan’s view is that we’re now beyond a return to a gold-pegged system. The best we can hope for in terms of restricting future imbalances is regulatory reform focused on keeping credit creation at banks in check. As he summed up:
…we’re simply not in the garden of Eden scenario anymore.
For more on Duncan’s view click on the link below:
Related links:
Buyers, not savers, caused America’s deficit – FT
Villains and victims of global capital flows – FT