Prometheus 6

Hello, P6! Great job!

I'm trying to acquaint everyone with the concept of the CGD trap--which stands for currency, growth, debt. I've mentioned before in your comments section. It's explained here: "Market Discipline under Systemic Risk: Evidence from Bank Runs in Emerging Economies" (PDF), p. 8:

By December 1999, however, the Argentine economy was caught in a currency-growth-debt (CGD) trap. The currency was overvalued, growth was faltering, and the debt was hard to service [...] The macroeconomic stance deteriorated sharply in 2001. Doubts about the one-to-one peg to the dollar soared [...] At the same time, uncertainty about the debt component of the CGD trap grew as the government, instead of attempting an orderly debt reduction, postponed the impending crisis temporarily by absorbing the liquidity of banks and pension funds, rendering the banking system less liquid and more exposed to a government default. As financing sources run out, the threat of money printing became a growing concern, and ultimately a reality through the issuance of small denomination government bonds that differed from currency only formally. This, in turn, added to the misgivings about the margin to preserve the currency board. In the process, debt sustainability and bank solvency became intimately linked to the fate of the currency. The elements of this CGD trap (continued economic contraction, increasing default risk, and uncertainty about the exchange rate) reinforced each other. This led to a massive run on bank deposits.

My view is that this requires an international framework of capital controls. Admit the prospects for this seem grim at present. On the other hand, the wretched performance of countries that have remained clients of the OECD--Argentina, Brazil, Russia--is no shrugging matter anymore.

As to the essay "China Trades its way to power"--I'm not really impressed by the analysis. First, the authors are saying nothing new. Japan has a systematic policy of import substitution for the most developed economies, so it's unsurprising that it imports more from China than it does from the USA. Japanese industry doesn't compete with China--it's integrated with Taiwan and China in an elaborate sytem of capital flows and outsourcing.

American business managers and the financial press have been commenting on this since before the US balance of trade with Japan turned negative (in the late 1960's, IIRC). In other words, Shaplen & Laney's remarks are merely an echo of 40 years of NAM talking points. Their preferred policy response is to sharply reduce environmental regulations, worker health and safety, and slash taxes; also, end all remaining anti-trust activity. Drill in ANWR. So on.

The Chinese have been able to do this because they remained under authoritarian rule while transitioning to capitalism. Opportunities to spend are sharply restricted; savings is kept artificially high, possibly 40% of household income. The People's Liberation Army has traditionally been the manager and venture capitalist of last resort. Bottom line: strength of the state is everything; consumer welfare, nothing. The income gap between urban prefectures and rural ones, especially in the "west" (i.e., Sichuan, Shaanxi, Qinghai) is huge and growing; it could jeapardize the ability of the country to sustain centralized control.

I feel a little awkward because now, and for another decade, China is likely to perform impressively. I'm not excessively alarmed about the price of oil right now, although well-informed observers may disagree. But it's incorrect to assume that Japan is struggling now because it adopted a western model of economic growth; likewise South Korea or Taiwan. These countries adopted highly centralized growth models which have faltered as they hit their ceilings; China's is even more so.

So of course China will grow long enough to make me look like an idiot, and then hit the same sort of wall.

China, incidentally, is of no interest as a market to SE Asian countries.

But it's incorrect to assume that Japan is struggling now because it adopted a western model of economic growth; likewise South Korea or Taiwan. These countries adopted highly centralized growth models which have faltered as they hit their ceilings; China's is even more so.

So where's our ceiling? In my view, our economy is as centrally managed as theirs. European economics are compatible with US economics, which grew out of them. But they're not the same (or weren't).

But it's not just the assumption of an alien economy that does you in. It's the cultural imperialism that must come with it.

I have issues with the term "cultural imperialism." It occurs, but the phrase can be interpreted very broadly. Also, it implies a sort of nation-culture identity, as if cultural diffusion is a monstrosity if it crosses national boundaries.

The Japanese adopted European business institutions, modified them slightly (the Japanese kaisha has traditionally enjoyed much more sovereignty in the life of its employees than the Western firm), and adopted some American industrial policies (universities, patents). But even before the Tokugawa era (1613-1867), there were sogo, trading houses with affiliated lenders, that really formed the backbone of Japanese capitalism. Japan was not a passive recipient of capitalism; most of the zaibatsu that dominated pre-1945 economic life were founded by 1650, and employed management principles from the Shogunate. In contrast, Christianity never penetrated Japan significantly.

The ceiling is a financial matter; basically, the technocratic nature of Japanese capitalism means that at a certain point, creative destruction ends and the economy stagnates. There are a lot of ways to describe it, but basically economic systems require circulation, and if all the "fluid" accumulates in a single spot, the economy stops. The Chinese economy is accumulating US dollars, or dollar-denominated liabilities against other economies. How is it going to reverse course and start spending? There aren't assets in the hands of Chinese sufficient to buy domestic output.

Thinking. I need to be clear about why that doesn't convince me. Has a lot to do with the way Japanese people are reacting.

Well, one thing has to be pointed out: the institutions of the Japanese economy needed to adapt from the "captured capital" model* where they relied on monopoloid domestic markets and captive suppliers, to a global marketplace in which state policy has run its course, done all it can, and domestic consumption is maxed out.

So, after 1987, the Japanese economy relied on growth in exports for growth in its entire economy. This means if you need a growth rate of 6% to maintain the present level of unemployment, and domestic consumption is growing at 2%, then you need your trade surplus to grow much faster than 6%! And countries under a captured capital model do indeed need to grow faster than conventional economies in order to retain the same level of unemployment.

But, the Japanese financial system could no longer handle all these reserves the system was flooding it with. And the capital account surplus was a deflationary anchor on the economy. There were too few yen abroad to finance Japan's trade surplus, which was inevitable since Japan had been running a trade surplus for decades. The best companies--Yamaha, Toyota, and others--became MNCs, no longer reliant on Japan's industrial policy.

Since 1987, the Japanese economy has gradually turned around. But it's done so on an ad hoc basis, and while running colossal internal deficits--the LDP has been running deficits far larger than the USA's, measured as a share of GDP. The real question is now, how fast must Japan's economy grow to sustain the same level of unemployement? And how large a trade surplus does the country "need"?
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* "Captured capital"--industrial policy designed to use cartels to ensure certain desired industries develop. Because it is monopoloid, underemployment and deflation are dangers. So the state captures capital by making people save money in banks. The object is that, since there is general unemployment, you try to reduce unemployment in the labor market by flooding the capital market with cheap lendable funds. The main bank's job is to manage this flood so it doesn't go into consumer goods.