Sunday, May 30, 2010


I've heard people compare the 1980's to this past decade. Ok, maybe Lady Gaga is a techno-pop version of Madonna circa 1988 when she pranced around wearing those cone tits. And true, conspicuous consumption became the reigning zeitgeist just as it had when the sitcoms, excuse me, TV dramas like Dallas and Dynasty were cultural epitomes. Up until recently, everybody was making a lot of money, and greed was cool again. Instead of corporate raiders like Gordon Gecko, we've witnessed the rise of the Hedge Fund Man, whose basic value system isn't that much different from Gecko's.

Both decades did begin and end with recessions. Both the end recessions had as their root causes a real estate bust that lead to a banking crisis (remember the Savings and Loans?). Although the late 80's/early 90's downturn was not nearly as severe as the 2008 Great Recession, both economic lapses caused Americans to feel much less secure about the standing and role of the US in the world. A sort of fin de siecle gloom descended over the end of the 80's as well as the end of the 00's. Both the late 80's and 2010 were filled with much talk that hailed or mourned the decline of the US, with left wingers doing the hailing and conservatives the mourning.

Of course one nation's descent presupposes another nation's ascent. Back in the 80's the nation on the ascent was Japan. The sun certainly seemed to be rising over Japan back then. People like Lester Thurow and Paul Kennedy declared that the Japanese would be the world's greatest economic power by 2010, supplanting the US; and the only way the US could even stay in the race would be to put the economy in the capable hands of Washington politicians/bureaucrats and smart people like Lester Thurow and Paul Kennedy. Japan did indeed seem formidable at the time, with a booming economy driven by exports, a genius for manufacturing and the best educated and motivated work force in the world. America's insecurity vis-a-vis Japan was aggravated by the insatiable appetite Japanese seemed to have for American trophy properties. They were buying up Rockefeller Center and Pebble Beach and just about anything worth buying in between. Goofy numbers were bandied about, like how the square mile around the Japanese Royal Palace was worth more than all the real estate in LA. The Japanese were on their way to taking over the world not with ships, planes and tanks as during WWII, but with economic superiority. The Nikkei moved above 36,000. Hirohito was having his revenge.

But suddenly all that changed, reversed. Japan fell into a slump in the late 80's that persists in some respects even today. Japan's economic decline has sowed a deflation that won't reflate away despite massive government deficit spending which has take public debt to 200% of GDP. Notwithstanding two or three recessions, including the Mother of All Recessions, over the past two decades the US is still the great economic power, without a close second. We managed to get through a couple of busts and still initiate the age of the Internet. We have the most productive work force in the world. We continue to dominate in Nobel Prize winners. Manufacturing has taken a hit over the past 20 years, but US manufacturing is still 67% higher than it was in 1967, inflation adjusted. Be prepared to be shocked, but the US is still number one in terms of manufacturing output.

Why were people like Thurow and Kennedy so wrong? Americans are acutely conscious of the US's place in the world and therefore insecure about any challenges to its top ranking in terms of the economy, military, global leadership. We're always looking over our shoulder to see who's gaining. Consequently, we emphasize a potential rival's strengths without taking due consideration of its weaknesses. With hindsight, we now see that Japan had glaring weaknesses that would hinder it's move to the top, i.e. a dysfunctional political system; incestuous "horizontal" relationships between industrial companies and banks; a deep and culturally ingrained inability to recognize problems, like bad loans, leaving "zombie" banks to haunt the economic landscape; flatline growth in population due to an innate zenophobia; a housing market so unsophisticated financially that the average Japanese has to save a lifetime in order to buy a home, which leads to high savings and low consumption. The sun rises, but it also sets, even over the exporting juggernaut, Japan.

One could take all the headlines from the late 80's trumpeting the triumph of Japan and insert China for Japan and get similar headlines today touting the rise of China as the successor to the US as the world's great power. Just like Japan, China is a manufacturing, exporting dynamo. Thanks to its ability to harness its teeming, billion plus population to the yoke of low wage manufacturing, China has become the place to make things. And with a currency, the yuan, artificially cheapened through government actions and relatively open trade borders in the US and Europe, China has managed to create enormous reserves of dollars and euros. China is more than happy to lend some of those reserves back to the USA, the country from whence most of those reserves were generated.

With a 1.2 billion population and over $2 trillion in reserves, China certainly seems destined to be a great power, maybe even the greatest power two or three decades down the road. And with the US being the largest debtor nation in the world and owing so much money to China, some would say that we are already second rate. Isn't every lender in a superior position to its borrowers?

But are we once again overlooking weaknesses that a potential rival, in ths case China, must overcome to ever reach the level of dominance that the US currently has? People forget that over half China's population live in the countryside as barely subsistence farmers, peasants really. China must maintain a GDP growth rate of at least 8% to take care of the millions yearly moving from the farms to the cities. The possibility of social upheaval if such jobs aren't provided certainly must motivate China's leaders to keep the foot on the pedal and do whatever it takes to keep growing. Given the doomsday possibility of social revolution, manipulating the currency is a venial matter in the eyes of China's leaders.

Moreover, this peasant population provides very little in the way of domestic demand for goods relative to the export market. Like Japan, China's power comes from exports. Ironically, like Japan, that strength is also its weakness. China is so levered to demand abroad that a global slowdown could result in a wave of factory closing and massive job losses. China has been fortunate that most of Asia kept growing while the US and Europe were in the throes of recession. But even though the US is slowly crawling back, much of the world seems to be slipping back into a synchronized slowing. Maybe a serious slump causes unemployment in China to rise only few percentage points, but when you are talking about over a billion people, that's a huge number. Japan has been able to muddle through its deflation, but China can't afford to, given the less developed state of its economy and its gargantuan size. Japan also has a social safety net, while China, with all its wealth, doesn't.

Which raises a question: What is China doing with its 2 plus trillion in reserves? Why isn't it using that to develop local demand? Instead, some of those reserves are being used to purchase resources like oil, iron ore, cooper all across the globe, and some to buy dollars to keep the yuan cheap.

Besides the basic structural problems with China's economy, the same type of problems that kept Japan down, there is a even more fundamental reason why I think China will never be the great power that the US is. To attain the level of the US, China will have to become a technological innovator, be an incubator for companies like Intel, Microsoft, Apple. American technology is what propelled the US from being the last man standing after WWII to still the dominant global power 50 years later. Maybe centuries ago the Chinese were creative, innovative, technologically superior, but the only technology that the Chinese have today is what they stole or copied from the West, particularly the US.

But with such huge population producing waves of engineers and scientists and with such a hoard of funds, why can't China become a technological powerhouse?
The answer to that can be found in photo I saw on the front page of the Wall Street Journal showing the ten dudes who run the country. I forgot what they called themselves but they all looked almost like carbon copies of each other, with the glasses, blue suits, red ties. No matter how much economic freedom has been loosened in China the past twenty-five years, its is still politically and culturally repressed. It may not be Communist any longer, but it's still a totalitarian state. Tiannem Square massacre occurred only twenty years ago and guys of the same ilk are still running the show.

The recent spat about Google not willing to censor certain websites in China illustrates the point. How can a nation that is hellbent on controlling everything from the media to education, in short, the thoughts and expressions of its people, produce a Steve Jobs or a Bill Gates. Such a stifling, repressive milieu is not conducive to ingenuity and creativity, outside-the-box thinking. Mavericks don't make it in China; conformists do.

And so I don't buy the possibility that China one day will rule the world, at least China as it presently is, a mercantilist, totalitarian state. In fact, I wouldn't be surprised if China sometime over the next five years takes a serious fall, whether it's from some economic disaster, like an implosion of the bubble real estate market there (we've heard that one before), an out-of-control inflation that forces the monetary authorities to induce the Chinese version of the Great Recession. More likely is some eruption of the social distress that seems to be always burbling just beneath the surface there. Maybe the masses there who want the middle class standard of living that they see in Taiwan and South Korea (despite the past best efforts of the government to keep them from seeing), will finally lose patience and revolt. I've read reports that the wealthy in China are looking for other countries to move to in the case of such an event. Such class resentment is not surprising in a nation that for most of its modern history has been communist.

I am less confident that I used to be about the future of the US, given that we are currently speeding down the wrong track. It's amazing how forgetful we are, about the things that pulled us out of the last truly nasty recession, that of 1982. Lower taxes, less regulation, strong dollar, tight monetary policy; in other words, the exact opposite of all the things Obama is doing.

Notwithstanding my uncertainty regarding the future of the US, I am confident that we are not at the dawning of the Sino Century.

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