Wednesday, January 7, 2009

Asia Needs To 'Wake Up'; US To Be 'Top Dog' in 2009; 'Smoot-Hawley' Redux?

'Buy USA' Push May See America Slip From Free Trade Church

By Ambrose Evans-Pritchard | 7 January 2009

The new wave of radical Democrats sweeping into Capitol Hill are insisting on a "Buy American" clause in the $750bn (£503bn) fiscal package being prepared by President-Elect Barack Obama. The $17bn bail-out of General Motors and Chrysler last month was already a step across the Rubicon towards a protectionist industrial policy, even if that was not the motive. The EU is exploring a World Trade Organisation complaint over "illegal state aid." But the latest 'Buy American' move is much more explicit.

"This is quite dangerous," said Peter Sutherland, chairman of Goldman Sachs International and a former director-general of the General Agreement on Tariffs and Trade (GATT). "The US is the key to keeping a one-world trading system. There is always the tendency to go for protectionism in a recession, and this is the worst one I've ever seen."

Hans Redeker, currency chief at BNP Paribas, says the US risks setting off a collapse in discipline across the world. "The US has a leading role, so this could set off a huge response in other countries," he said. "There is already talk of a €100bn (£91bn) fund in Germany to 'save its industry' from being sold off 'cheap'."

French president Nicolas Sarkozy has proposed a "strategic investment fund" to fend off "predators"— a euphemism for sovereign wealth funds from Asia and Russia— hoping to snap up France's crown jewels. "We will intervene massively whenever a strategic enterprise needs our money," he said. Nationalist measures are becoming ever more brazen in the emerging markets. Indonesia is resorting to special "licences" to choke off imports. Russia has reacted to the collapse in oil prices by imposing tariffs of 30% on cars and 15% on farm machinery. India and Vietnam have imposed duties on steel.

Pascal Lamy, the WTO chief, is so worried he has taken to displaying portraits of Willis C. Hawley and Reed Smoot at his Green Room in Geneva, evoking the arch-villains of the Smoot-Hawley Tariff Act that set off the trade wars of the Great Depression. The Act was forced upon a disgusted President Herbert Hoover in June 1930. This is the pattern in democracies. Lawmakers— with a constituency base— are the first to push for protection.

The question today is whether Mr Obama will try to stop it. His top advisers— Larry Summers, Tim Geithner, Peter Orszag— are free-traders with a global outlook. But Mr Obama himself dabbled in protectionism during the campaign. It is not clear how much political capital he will risk by threatening a trade veto within days of taking office. So far his team has been evasive, saying it is "reviewing the Buy American proposal".

"In the mind of Congress, almost anything that targets China is now considered fair game," said Professor Gary Hufbauer, from Washington's Institute of International Economics. Mr Obama shares the irritation with Beijing. "China must change its currency practices. Because it pegs its currency at an artificially low rate, China is running massive current account surpluses. This is not good for US firms and workers, not good for the world," he said in October.

China's actions since then seem designed to test his mettle. Beijing is holding down the yuan again, even though China now has a surplus of $40bn a month. "My guess is that there is a fierce debate within the Obama team," said Prof Hufbauer. "This could be very serious. The US can do what it wants under government procurement rules. Unfortunately the rest of the world is going to notice: they'll get their own lawyers to find ways of doing the same thing," he said.

"I am hopeful this move to protectionism will be slower to take hold than in the 1930s, but it is a race against time. If the sun doesn't start to come up on the economy and we're still grinding along in mid-2010, then I'll be worried," he said.

For the great exporters— China, Japan, Germany— a trade war would be a crippling blow to industry. For the great importers— the US, UK, Southern Europe— it could set off a bond meltdown as capital flows from Asia dry up. The two sides are bound together by imbalances. It is hard to see who can "win" if discipline breaks down.


US Will Emerge As Undisputed Top Dog In 2009

By Ambrose Evans-Pritchard | 7 January 2009

Interest rates near zero across the G10 bloc will prevent a replay of the Great Depression, but they will not pull us quickly out of the doldrums, writes Ambrose Evans-Pritchard, in a semi-serious look at 2009. America will reemerge as undisputed top dog, the only one with real demographic, scientific, and strategic depth.

Central banks will do whatever it takes to combat debt deflation. Even Frankfurt will join the rush to print money, buying every form of debt from mortgages to corporate bonds. The Fed will follow the Bank of Japan in propping up stock markets. Puritans will grumble, but the surprise will be how it long takes for this stimulus to gain traction. We will once more learn the term "pushing on a string".

Western societies will feel the first shivers of raw fear as people twig that the authorities are not in control. Iceland's winter will set an awful example. Job losses will reach 1m a month in the US at the point of peak pain. Economists know this is a late-cycle effect— darkest before dawn— but the public will see it otherwise. This will be the phase that shakes society.

The geopolitical landscape will look different. Cohesive states with a rule of law and old democracies— the Anglosphere, Holland, France, Scandies— will muddle through. They will start to enjoy a political premium in investor psychology, despite horrendous debts.

Obama's America will shine. The country will reemerge as undisputed top dog, the only one with real demographic, scientific, and strategic depth. As first into the crisis, it will be the first to hit bottom. Those expecting the dollar to collapse will have to wait.

The damage to core Europe will take longer, but run deeper. Belgium will face a break-up scare. Markets will test highdebt states as they try to roll over bonds— €200bn (£191bn) for Italy and €40bn for Greece. Spain's corporate debts will turn bad.

Germany's economy will contract by 3% as exports collapse, and the delayed effects of the strong euro and tight money feed through. Germany's Angela Merkel's Left-Right coalition will be haunted by its failure to tackle the crisis earlier. The neo-Marxist Linke party and the hard-Right will muscle in. The country will start to look ungovernable. This will at least divert attention from the Club Med mess, making a North-South split in the eurozone less likely. After sterling's sudden death, the euro will face slow death. The pair will rediscover their 'accustomed level'.

Authoritarian regimes will fare badly. Those that depend on perma-boom to hold power will fray. Repression will escalate in China as an inflammatory cocktail of migrant workers and jobless graduates vent their anger in riots. Massive fiscal spending will buy time.

The Kremlin will not have that option. Oil at $40 (£28) a barrel will expose the insolvency of the Russian state, forcing spending cuts. Anti-Kremlin marches will evolve into a simmering rebellion, setting off pitched battles with police.

Analysts will be shocked by the ferocity of the downturn across Asia, where the strategy of export-led growth will be called into question. It will become clearer that Asia's boom has been a leveraged play on the West, and leverage works both ways. Some Pacific tigers will try to resist the dénouement by holding down currencies. Such beggar-thy-neighbour policies will lead to tit for tat responses. The US and Europe will finally tire of holding the ring for free trade. The WTO will look ever more like the League of Nations.

By late 2009, the massive monetary and fiscal stimulus will feed through. Angst will start to switch from deflation back to the risk of incipient inflation. Equities, oil, and gold will rally. Bonds will falter, and then crash.

At that point it will become clear that reflation is just as dangerous as deflation in a world of debt. We will find that there is no way out. But that, perhaps, can wait until 2010.


Asia Needs To Fully Wake Up To The Scale Of The West's Economic Crisis
Asia Is Not Going To Rescue The World Economy.

By Ambrose Evans-Pritchard | 7 January 2009

The news from Japan, China, and the Pacific tigers has moved from awful to calamitous since the global industrial system snapped in October. A raw reality is being laid bare. The mercantilist export model of the East is proving dangerously geared to the debt-driven excesses of the West. As we go down, they go down too. Some are going down even harder.

Japan's industrial output contracted by 16.2% in November, year-on-year. "For an economy which lives from the prowess of its industrial exports, this is simply earthquake," said Edward Hugh from Japan Economy Watch. Japanese exports fell 26.7%. Real wages fell by 3.1%, the seventh monthly fall. Taken together, the figures are worse than anything during Japan's "Lost Decade". They have the ring of 1931.

The fall-out in Japan has already shattered the authority of premier Taro Aso. His approval rating has dropped to 21%. The cabinet is in revolt. The world's second biggest economy no longer has a functioning government.

Credit Suisse warns that Japan could slide into deflation of -2% by the autumn. Since interest rates are already near zero, which means that real interest rates will rise as the slump deepens— the surest path to a liquidity trap. Kyohei Morita from Barclays Capital estimates that Japan's GDP shrank at an annual rate of 12.2% in the fourth quarter. "It's shocking," he says.

Singapore has already reported. Fourth-quarter GDP contracted at an 12.5% annual rate. Taiwan's exports fell 28% in November. Shipments to China dropped 45%. Korea's exports dropped 18% in November and 17% in December. "We are looking right in the face of an unprecedented regional depression," said Frank Veneroso, the investment guru.

"If there is one part of the global disaster that is not reflected in today's massacred markets it is this Asian debacle. The source of the collapse appears to be above all a contraction in China." One has to careful with Chinese figures. When I covered Latin America in the 1980s, veteran analysts watched electricity use to gauge economic growth since they could not trust official data. But, it is striking that China's power output fell 7% in November.

Asia has clearly failed to use the 'fat' years to break its dependency on the West. It has stuck doggedly to its export strategy— by holding down currencies, or by subtle policy biases against consumption. In China's case it has let the wage share of GDP drop from 52% to 40% since 1999, according to the World Bank.

The defenders of this dead-end strategy are now coming up with astonishing proposals to put off the day of reckoning. Akio Mikuni, head of Japan's credit agency Mikuni, has called for a "Marshall Plan" to bail out America by cancelling $980bn of US Treasury bonds held by the Japanese state. This debt jubilee does have the merit of creative thinking, but it is entirely designed to keep the old game going.

"US households won't have access to credit they have enjoyed in the past. Their demand for all products, including imports, will suffer unless something is done," he said. Let me be clear. I make no moral judgment on the "neo-Confucian" model, nor— heaven forbid— do I defend the 'debt depravity' of the West.

A stale debate simmers over whether the Great Bubble was caused by Anglo-Saxon and Club Med hedonism, or by an Asian "Savings Glut" spilling into global bond markets and fuelling asset booms, as Washington claims. It was obviously a mix. Two cultural systems interacted through globalisation, locking each other into a funereal dance. The point is that this experiment has now blown up. Whether or not we slam straight into a global depression depends on how we— East, West, all of us— handle this.

The top sources of net global demand as measured by current account deficits over the last 12 months have been the US ($697bn), Spain ($166bn), Italy ($71bn), France ($57bn), Australia ($57bn), Greece (53bn), Turkey ($47bn), and Britain ($46bn).

Most are tightening their belts drastically, and in the case of Britain the shift has been so swift that the arch-sinner may soon be in surplus. If they are draining world demand, then world demand is going to collapse unless others step into the breach. The surplus states— China ($378bn), Germany ($266bn) Japan ($176bn)— have not yet done so, which is why the global economy went off a cliff in October, November, and December. Beijing is planning a $600bn fiscal blitz.

But how much of that blitz is an unfunded wish-list sent to local party bosses? And, in any event, it will not kick in until the middle of the year, an eternity away. For now, China is dabbling with protectionism to gain time— a risky move for the top surplus country. It has let the yuan fall to the bottom of its band. Vietnam has devalued. Thailand and Taiwan are buying dollars.

Watching uneasily, the Asian Development Bank has warned against moves to "depreciate domestic currencies". Yet, anger is mounting in the West. Alstom chief Philippe Mellier has called for a boycott of 'Chinese trains'. "The Chinese market is gradually shutting down to let the Chinese companies prosper. There's no reciprocity any more," he told the Financial Times. Optimists say the collapse in oil prices will give Asia a shot in the arm.

Asian governments are still flush, with ample scope for fiscal rescues. Their central banks are sitting on $4.1 trillion of reserves. They have the means, perhaps, but do they have the will to act in time? Or do Beijing, Tokyo, Taipei, Kuala Lumpur,— and indeed Berlin— still cling to their assumption that others will spend for them?



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