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Asia and the Meltdown of American Finance

The meltdown of American finance has closed the destination of much of Asia's economies that usually hum with industries for export. Without a plan to replace the region's reflexive reliance on exports to the United States with another economic driver, Asia too will be drawn into the economic and political maelstrom that now engulfs the American economy. Whether Asia's economies can chart a new course will determine their ability to ride out the present storm.

GLOBAL ECONOMIC CRISISEconomic & Political Weekly EPW november 15, 200825Asia and the Meltdown of American FinanceR Taggart MurphyThis is an expanded version of an article that appeared inThe Brief, a magazine of the British Chamber of Commerce, Bangkok, Thailand, October 2008. It was first published inJapan Focus at R Taggart Murphy (, a former investment banker, is on the faculty of the MBA Program in International Business at the University of Tsukuba’s Tokyo campus. The meltdown of American finance has closed the destination of much of Asia’s economies that usually hum with industries for export. Without a plan to replace the region’s reflexive reliance on exports to the United States with another economic driver, Asia too will be drawn into the economic and political maelstrom that now engulfs the American economy. Whether Asia’s economies can chart a new course will determine their ability to ride out the present storm.Schadenfreude is not a very nice emotion. Theodore Adorno once defined it as “unanticipated delight in the suffering of another”. But asking Asia’s business and governing elites to repress shivers of pleasure at the melt-down of the American financial system is probably demanding more than flesh and blood can bear. After all, it was only a short decade ago that officials of the Inter-national Monetary Fund (IMF) were rush-ing about the region insisting that govern-ments allow banks to fail, markets to clear, and currencies to fall. Political turmoil, collapsing living standards, the wipe-out of middle class savings: this was the price Asia must pay for its defiance of neo- classical economic orthodoxy, for its “crony capitalism”, for its hubris in imag-ining that governments could proactively shape a country’s industrial structure or engage in – heaven help us – planning.Believing they had no choice, much of Asia – beginning with Thailand and fol-lowed by Indonesia and South Korea – did what the IMF said. But it was clear even at the time that theIMF was acting largely at the behest of theUS Treasury. Any doubts on this point were eliminated when treas-ury officials jumped to squelch efforts led by Japan’s Ministry of Finance to experi-ment with an alternative, Asia-funded, route out of the crisis of those days.So the boardrooms and finance minis-tries of Seoul, Bangkok, Jakarta and Kuala Lumpur are no doubt filled with a fair degree of grim amusement at the spectacle of the politicians, pundits and academics of Washington and Chicago thrashing about in their attempts to justify the vast amounts of money shovelled at their cronies on Wall Street. Particularly when this money will have to be borrowed from the very people who a decade ago were being pooh-poohed for their “opaque” banking systems, their “incestuous” government-business relations, absence of their transparent financial reporting, good corporate governance, or accountable executives and regulators.But the glee in seeing the United States (US) hoisted by its own petard must surely be mixed with a good deal of apprehen-sion. Not only because Asia cannot escape this crisis unmarked. But because the crisis could conceivably force Asia’s elites to engage in the open political discussion they have largely avoided until this point – discussions about the kinds of economies they expect to shape in the wake of the American debacle, dialogues that carry with them all kinds of risks.The economic and financial dangers to Asia of the crisis need not detain us long for they are obvious. The region’s stock markets are caught in the global down-draft. Asia’s financial institutions are just as closely linked as those in every other part of the world to Lehman Brothers, American International Group (AIG), Merrill Lynch and their devil’s spawn of credit default swaps and “toxic waste” assets. We have already seen bank runs in Hong Kong and widespread layoffs by some of the regions’ leading financial institutions. We are likely to see more of these before the crisis plays itself out.The US appears headed into a recession that may be as bad as anything that country has faced since the 1930s. That in itself will spell trouble for a region that directly or in-directly relies on the US as the final engine of demand. Japan last month, for example, ran its first trade deficit since 1982, some-thing that is widely attributed to falling de-mand from the US. But while this is all generally understood and prudent business and financial leaders in the region are already battening down the proverbial hatches, there is more going on here than simply the shrinking of the re-gion’s most important external market. For what we are seeing strikes at the heart of the entire process by which the region transformed itself over the past 50 years.Endless Flood To be sure, Asia had little to do with the shoddy “subprime” mortgages, the elabo-rate slicing and dicing of rotten credits, the heads-I-win, tails-you-lose ethos on
Economic & Political Weekly EPW november 15, 200827GLOBAL ECONOMIC CRISIStools of Keynesian demand management to keep the country from sliding back into Depression. (Among these tools was the deliberate promotion of home ownership through special classes of financial institu-tions led by Freddie Mac and Fannie Mae.) Meanwhile, abroad, the US through such measures as the Marshall Plan and the aid to Occupied Japan, essentially offered to finance on very easy terms the transfer of production capacity to war-devastated na-tions. And then agreed to accept the ex-ports manufactured thereby without re-ciprocal demands for imports of American products. The notion that places like Ja-pan could ever pose a serious economic threat toUS industry did not occur to any-one on either side of the Pacific. What Washington cared about was that Japan and western Europe not follow China and Poland into what was seen then as Mos-cow’s orbit.Export-led GrowthBut the Keynesian synthesis that so elec-trified economists and policymakers of the time in theUS seemed to have little relevance to the challenges faced by an Asia emerging from colonialism and war. Keynes had addressed himself to the prob-lems of a highly developed economy find-ing itself stuck in a trough of structural unemployment and idle production capac-ity; in 1946, Japan and Korea did not have production capacity to idle. Instead, there were two alternative models of develop-ment on offer. One was the Marxist- Leninist; the other went under the rubric of import substitution or dependency the-ory – ie, that the goal of development ought to be the freeing of a country from dependence on foreign financing and imported capital equipment. Both called for state-directed capital accumulation and autarkic development, although the latter did allow for market mechanisms to function at the local level. Both boasted an extensive theoretical literature. In Asia, China would be the champion of the former, India of the latter.Japan, however, did something dif-ferent. With theUS able and willing to provide the wherewithal to rebuild its economy (albeit at the price of aligning its foreign policy with Washington’s and ensuring that leftists were kept away from the levers of power), Japan chose to engi-neer an economic structure that focused on the rapid accumulation of dollars so that it could buy the capital equipment it needed. This meant the deliberate chan-nelling of scarce domestic savings into the building of externally competitive export industries. It is here that we see the origins of the east Asian model of export-led growth. The distinction between this and the import substitution model then being championed by India’s Jawaharlal Nehru may appear a semantic one in that both called for the development of domestic industry behind protectionist walls. But they differed crucially in their stance towards the existing global financial order. India sought to eliminate its dependence on that order; Japan to accu-mulate sufficient dollars so that it could exploit that order for its own domestic needs. Largely for geopolitical reasons, the architect and provider of that order – the US – was perfectly willing and even happy to see Japan use it to cement post-war recovery and join the ranks of the developed nations.I wrote above that Japan “chose” its post-war path of development, but this is not quite correct. It happened not, as in Beijing or New Delhi, through any con-scious choice of an overarching theoreti-cal model, but because the pressures and opportunities of the time made it seem in-evitable to Japan’s decision-makers. The war years had left Tokyo with an intact institutional apparatus that could be used to channel scarce financing into targeted industries – it was easy enough to redirect the flows from munitions makers to pro-mising export industries. With the fortui-tous (for Japan) outbreak of the Korean War, theUS suddenly began placing large orders for Japanese goods needed to equip its military. Thus, through a process more akin to biological evolution than conscious political choice, Japan found itself in a niche that functioned well-nigh perfectly for the country in the economic ecology of the era. That niche involved rapid devel-opment of internationally competitive ex-port industries whose production could be sold into what seemed an almost infinite US market.The results exceeded anyone’s expecta-tions. Between 1955 when the final elements of the post-war Japanese system were put into place and 1969 when its growth began to alter the global economic ecology which had fostered it, Japan boasted the highest growth rates that had ever been recorded by any economy in human history. But the circumstances of its birth – its coming into being without any real debate on the matter or generally accepted theoretical foundation – lie at the root of what is happening today.Accumulating Dollar ReservesThe late 1960s provided the first evidence that things could not keep on going as they had without adjustment. The rigid inter-national financial architecture of the time, labelled the Bretton Woods system for the small New Hampshire resort town where it had been hammered out in 1944, could not accommodate the emergence of Japan’s export surpluses – joined to a lesser extent by those of West Germany – and their mirror images, the first substantial trade deficits run by the US for a century or more. Attempts to rework the formal arrangements of the Bretton Woods system collapsed in the political chaos surrounding the Watergate scandals and the American defeat in Vietnam. The world economy limped through the rest of the 1970s until Paul Volcker’s Federal Reserve did what it took to halt the infla-tion that threatened to destroy the dollar as a store of value. Japan’s tremendous vote of confidence in Volcker – snapping up US dollar securities – permitted the rebuilding of the organising principle of the Bretton Woods system: the dollar’s central role in the international financial system. But instead of Bretton Wood’s formal arrangements that required theUS to back the dollar by gold, while other participants maintained fixed exchange rates with the dollar, the new system was predicated purely on the willingness and ability of non-US dollar holders to continue to accumulate and hold stores of dollars. Meanwhile, Japan’s 25-year sprint from devastation to the front ranks of the world’s industrial powers provided an overwhelming example to the region. Korea, Taiwan and Malaysia all pro-actively adopted the Japanese emphasis on export-led growth with concomitant suppres-sion of domestic demand, undervalued
Economic & Political Weekly EPW november 15, 200829GLOBAL ECONOMIC CRISIScurrencies, and savings challenged into the development of internationally com-petitive industries. With the coming to power in 1977 of Deng Xiaoping and Bei-jing’s tacit adoption of the Japanese eco-nomic model, the transformation of the region was pretty much complete. Vietnam would arrive at the party in the late 1980s, and by the turn of the millennium, India would formally abandon Nehru’s legacy of import substitution to join in the scramble to build industries for export. Thus today virtually every economy in Asia – North Korea and Burma excepted – has an eco-nomy geared either to export finished goods or to supply other exporters in the region with components. But not only did most countries emulate Japan in making the highest national prio-rity the building of internationally com-petitive export industries, they followed Japan in accumulating reserves in dollars – a trend that accelerated after the crisis of a decade ago. Most countries in the region whether they had suffered badly in the crisis (Thailand; South Korea), or largely escaped the worst effects (Malaysia; China) resolved they would never again be in a position where emissaries from Washington – or anywhere else, for that matter – would be in a position to dictate their economic policies or how they ought to structure their banking systems. They redoubled their efforts to build impregna-ble fortresses of international reserves against the slings and arrows of future balance of payments crises. That effectively meant accumulating reserves inUS dollars. Aggregate two-way trade and investment flows between Europe and Asia are not large enough to permit the euro to circulate yet in suffi-cient quantities in the region to see the euro substitute for the dollar as the re-gion’s reserve currency, even if the region’s businesses were willing to switch from dollars to euros as their primary cross-border settlements currency. As for the yen, neither Japan nor China for separate reasons want to see the yen supplant the dollar in the region. China is not prepared to cede that kind of economic leadership to Japan, while the wrenching changes that the emergence of the yen as a major international currency would pose to the Japanese economic and political order insure that Tokyo will move to bring that about only when there is no alternative. (Idiscuss the reluctance of Japan to see the yen as an international currency in Murphy-From_a_Supporter_to_a_Challen-ger__Japan_s_Currency_Leadership_in_Dollar_Dominated_East_Asia_at_the_Brink_of_Financial_Collapse.)But when a country accumulates reserves in dollars, it is effectively leaving its export earnings inside the American banking sys-tem where they can be used, among other things, to finance the building of houses for people who do not earn enough to afford those houses. Seven figure salaries for gam-blers with other people’s money. Tax cuts enacted while spending soars on entitle-ment healthcare and wars of choice.Export-led Growth Doomed Thelatest surge of dollar holdings in Asia coming on top of a generation of dollar ac-cumulation in countries such as Japan and Korea coincided with the coming to power of the most fiscally irresponsible adminis-tration in American history. Not only did Asia’s dollar holdings make it possible for the George W Bush administration to rip open the sutures its predecessor had stitched up between America’s taxes and government spending, it facilitated a hor-rendous asset bubble in American housing while Alan Greenspan’s Federal Reserve watched idly from the sidelines.This is all over now. The mania – as manias always do – has ended. The core institutions of American finance are collapsing. The US is still – and will remain for some time to come – the world’s largest and most productive economy. But it can no longer act as the world’s engine of demand, no matter how many dollars Asia throws at it. For while those dollars may be “owned” by Asian central banks and busi-nesses, they reside inside a ruined financial system whose participants will not lend and no one can get credit. As the Japanese can explain from their own experience of the mid-1990s, you can pour all the money you want into tottering banks and brokers, but when they are paralysed by fear and will lend to no one but the government, demand dries up.The days of export-led growth for Asia are over (at least exports outside the region – intra-regional trade is another matter provided importers in the region can be found to equal exporters). As the Koreans and Thais can easily testify given their own recent traumas, the US cannot recover from the mess it is in without more savings – another way of saying less con-sumption. That in turn means theUS after 40 years of profligacy will have to export more than it imports. For that to happen, much of the production capacity that has been steadily transferred to Asia over the last 50 years will have to be repatriated back to the US so that Americans will have factories again where they can go to work to pay off the debts that their politicians and bankers so recklessly ran up. Other-wise, all those dollars Asia holds will quickly become worthless. What, after all, is a dollar other than a claim on the output of an American? The Americans will have to have the means to create that output if the dollar is to have any value.Meanwhile, what of Asia? How is Asia going to wean itself from its dependence on the US market? One lesson this crisis may finally have brought home is that genuine, long-term economic security and stability come not from lending money to distant foreigners to buy your stuff. And certainly not from games playing and speculation by would-be plutocrats. But rather from a large, economically secure middle class – a middle class with the means to purchase the output of a nation’s factories, farms, and service providers.Here is where we see the connection be-tween the meltdown of American finance and the political turmoil that has been wracking practically every country in the region. Each specific example has its own local causes and flavours: the struggle in Thailand over former prime minister Thaksin’s buy-rural-votes-populism; the political insurrection led by Anwar Ibrahim in Malaysia against the entrenched elite of the United Malays National Organisation; the seemingly all-out-of-proportion demonstrations in South Korea over beef imports; the palpable rage in China at the inability of the government to enforce safety standards in construc-tion and food provision; the challenge posed by Japan’s first serious, united opposition to a Liberal Democratic Party that has enjoyed some 50 years of nearly
november 15, 2008 EPW Economic & Political Weekly30GLOBAL ECONOMIC CRISISunbroken control of that country’s formal political institutions.But behind these varied struggles one can hear a common theme: a demand for accountable, responsible government that puts the interests of a rising middle class first. I wrote at the beginning of this piece that the political discussion necessary to restructure the region’s economies carries with it all kinds of risks. We can see those played out daily in the streets of Bangkok and Seoul or on-line behind the firewalls that Beijing builds in its attempts to contain and control discussion of China’s future. These struggles threaten the workings of the economy, and they provide a profound challenge to elites that are accustomed to effecting minor corrections behind closed cockpit doors to national trajectories that have long been taken for granted.But the meltdown of American finance has closed the destination of an economy humming with industries for export. Whether Asia’s economies can chart a new course will determine their ability to ride out the present storm.For a Revamp of the Global Financial Architecture South CentreThe South Centre calls for a revamp of the global financial architecture that will be an inclusive process and will take into account all the concerns of the developing countries.The South Centre ( is an intergovernmental policy think tank of developing countries. The financial crisis that originated in the United States (US) a year ago has become a global financial crisis unprecedented since the Great Depres-sion. Since mid-September financial mar-kets have collapsed and the world is enter-ing into possibly the worst recession of the post-second world war period. The credit freeze has severely hit devel-oping countries through increasing risk premia and a severe cut in financing, even of short-term commercial lending. Capital outflows from developing countries have generated a collapse of stock markets and exchange rates and a loss of reserves. Com-modity prices have plunged and export orders are being cut worldwide. Even deve-loping countries that were seen as relatively invulnerable to a recession in the industrial world are now feeling the strain. The financial crisis has shown how dys-functional the current international finan-cial architecture is to manage the global economy of today, with its myriad inter-connections through which financial tur-moil spreads across the world and with its revealed and significant regulatory deficit. In the 1980s, the debt crisis in Latin America, Africa and other parts of the developing world, and in the late 1990s the succession of the Asian, Russian and Latin American crises, had already revealed that something was deeply wrong with that architecture. The industrial world did not understand the need for serious rethinking of the governance of global finance. The fact that this time developed countries are at the centre of the storm may now lead them into action. The call by some of them to engage in a reform of the current governance and con-vene a Bretton Woods II Conference is, therefore, most welcome. The South Centre wants to join its voice in the call for revamping global finance, based on six lines of action: (1) The Process and Institutional Design That It Develops Must Be Inclusive: We welcome the initiative of industrial coun-tries but underscore that any discussion process must be inclusive, giving adequate voice to both industrial and developing countries, and to both large and small countries. The governance system that it designs must be based on representative institutions, not on any one ad hoc group-ing of countries, be it the G-7, a G-13 or a G-20. We call, in particular, for a deeper involvement of the United Nations (UN) in any reform process, as it is the most repre-sentative global institution. Indeed, the follow-up to the Conference on Financing for Development to be held in Doha, Qatar, in late November and early December is the best occasion to launch a participatory process leading to a reform of the global financial architecture, with the backing and close collaboration of the UN and the Bretton Woods institutions. This process should include a discussion of the voice and representation of developing coun-tries in international economic decision making and norm setting, as mandated by the Monterrey Consensus. So far the only reforms in this area were undertaken by the International Monetary Fund (IMF) and were extremely modest. (2) The Regulatory Deficit of Global Finance Must Be Corrected: The magni-tude of the current crisis is clearly

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