WITH the United States' impending debt default dominating the airwaves, it's perhaps time to reflect as to how the country got itself into this dilemma.|
The US and China, like many other countries, reacted to the 2008 financial crisis in a similar way: pumping out enormous amounts of cash to stimulate their economies away from depression and back to prosperity.
That started an era of stimulus for China and the era of "quantitative easing" for the US. But how the cheap money injection has subsequently played out in China and the US is chalk and cheese.
Chased by the fear of recession in the wake of the 2008 financial crisis, the People's Bank of China slashed interest rates by 216 basis points over the last four months of that year. The central government approved a 4 trillion yuan fiscal stimulus plan (US$619 billion at current exchange rates) directed at bread and butter public infrastructure projects.
The stimulus effect was felt almost immediately. In early 2009, when the developed world was clocking negative growth, the World Bank revised China's growth forecast from 6.5 percent to 7.2 percent as the country was performing better than expected. By the end of 2009, Chinese GDP exceeded government forecasts to expand by 8.7 percent. Last year, the Chinese mainland's GDP surged 10.3 percent.
The good thing is that the cheap money polices cushioned the economy, the country's modernization sped up and the unemployment rate remained at around 4 percent - a flat trend since 2003.|
The bad thing is that China now sits with a major debt burden. In early June, China's National Audit Office stated that the country's local governments were US$1.6 trillion (10.7 trillion yuan) in debt.
Across the Pacific Ocean, the US government was already in debt from a spending spree after the IT bubble when its post-2008 crisis battle plan resorted to more cheap money.
To save its economy from depression and deflation, the US spent trillions of dollars on bank bail-outs and some counter-cyclical policies, then launched the so-called quantitative easing program.
In practice, it constitutes releasing money into the financial system through large-scale government bond and financial asset buying - with newly printed money.|
The first QE salvo was fired in late 2009 when the Fed spent US$1.7 trillion on treasuries and mortgage-backed securities through until March 2010. When that did not have the desired stimulant effect, QE II was launched and US$600 billion in bond-buying money flooded the financial markets up to June of 2011.
In total, the US total outlay for the bank bailouts plus the QE stimuli and other factors, range as high as 5 trillion dollars injected into the market - but not into the US economy, because the money either sat idle or left the country for greener pastures.
Although the US economy has shown some improvement, key US economic figures released on July 14 did not point at anything nearly as solid as China's. Unemployment rose to 9.2 percent in June from 9.1 percent in May, although jobless claims dipped slightly. Despite promising housing and retail sales data, economists' growth forecasts for the second and third quarters range from 1.5 percent to 3.1 percent.
The weak US economic data prompted Fed Chairman Ben Bernanke to reiterate that the central bank was prepared to buy more bonds if the economy appeared to be stalling. This essentially paves the way for a QE III program.
Professor Michael Hudson from the University of Missouri told Shanghai Daily that the QE II programme has had "no positive effect at all" and that the negative impact on foreign nations had been "worse than expected."
"The idea was supposed to be to get banks to lend more to small and medium-sized business. Instead, all the money has been sent abroad, mainly to the BRICS and Australia for interest-rate arbitrage and currency speculation. This has weakened the US dollar - and pumped more dollars into the world's central banks, China included," he said.
Soon after QE II's launch, Hudson said the Fed believed that rising debt levels could make the economy more solvent if US employment increased by producing more exports.
"The way to achieve this is presumably to depreciate the dollar - the kind of 'beggar-my-neighbor' policy that marked the 1930s. Devaluation will be achieved by flooding currency markets with dollars, providing the kind of opportunities that are heaven-sent for computerized currency trading, short selling and kindred financial options," he said.
"Such speculation is a zero-sum game. Someone must lose. If quantitative easing is to help US banks earn their way out of negative equity, by definition their gains must be at the expense of foreigners. This is what makes QE II a form of financial aggression."
The side-effects of QE, both inside and outside the US, have made it unpopular. And most importantly, its failure to stimulate solid growth - and government income - to pay back the US's massive, growing debt pile has created political trouble.
With less than a week to go before an August 2 debt default, the US Congress is still gridlocked over its best solution to avoid the default: raising the debt ceiling. Amid this uncertainty, global rating agency Moody's Investor Service put the US government's pristine AAA bond rating under review for a possible downgrade. This would have global repercussions, and fears of it have started shaking global financial markets and inspired calls from the IMF and world leaders for the US Congress to sort out their differences before it plunges the financial world into chaos - again.
Today, three years after the stimulus plans came into being, it's striking how different the respective plans have played out in China and the US as if, 80 years after the Great Depression, the roles have been reversed. China came out with its own New Deal, and the US came out with a No Deal.
New York Times columnist Thomas Friedman argues that through its policy decisions his generation has left an "incredible debt burden and constraints" on generations to come.
Chinese local governments have also borrowed into their children's savings, but have something to show for it - modern infrastructure that will benefit generations to come.
Superficially, one could argue that command-style governance systems have exposed capitalism's weakness. China has again showed how to rally up the economy to quickly drive through policies, while the fiercely capitalistic US is unable to push through relevant government policies and is unable to get banks to invest in its own economy. However, something deeper may be at play here.
Firstly, the world and economic relations have changed since the 1930s when a zero-sum dollar devaluation could still help the US emerge from the Great Depression. In the globalized world of mutually beneficial relations, a beggar-thy-neighbor approach could now potentially beggar thee too. Not to mention the global knock-on effect a debt default.
Secondly, some sort of "resources curse" has started eating at the US.
The resource curse theory refers to the paradox whereby resource-rich countries often end up being poorer than resource-poor countries, because the mining of precious resources tends to expose an economy to commodity price fluctuations and enriches the elite while impoverishing the masses.
The QE's abundant "cash commodity" flood props up the banking elite, spreads eastwards for arbitrage, artificially pushes up commodity prices and makes mining companies rich, while failing to filter through to the masses.
Thirdly, there is the addiction to quick fixes. The Fed, eyeing QE III, is like a person facing declining employment prospects who has maxed out two credit cards and is now thinking of applying for a third one to pay off the previous two's debts.
Finally, with time running out before the August 2 debt default, the Republicans have again delayed a Congress vote scheduled for yesterday over a how to reduce spending and raise taxes in return for the Democrats being allowed to raise the debt ceiling. Could it be that the US will have its first-ever debt default?
In Hollywood style, the debt ceiling will in all likelihood be raised just in time and August 2 may come and go without a default. But the longer term implications of raising the debt ceiling means the US will be allowed to pile on even more debt in the future and with slow growth the likelihood of paying off the debt is not good.
The problem at hand is structural, and QE III and debt ceiling quick fixes cannot solve it.
What needs to be addressed is the reason why the country is falling deeper into debt - it's too expensive to run an empire. It would mean stopping wars and revolutionizing industries and boosting the economy's cash-generating ability.
Maybe a default will be a good thing if only to serve as a wake-up call. But the way things are going now one's not sure if even that would wake Congress up from its bad dream.