It is common knowledge that the revival of the US and the Western economies and indeed of China has been based on a massive stimulus by the government. Put another way, what the US has done is substitute private borrowing for public borrowing. The hope is that as the private sector revives, public debt will come down.
But what if debt, private or public, is an essential ingredient for growth in the US economy? That’s the thesis put forth by Robert Brenner, a professor of history at the University of California at Los Angeles.
Brenner says that the onset of competition from low-cost, export-oriented economies in Asia, starting from Japan to Taiwan, South Korea, the South-East Asian tigers and now China led to the creation of chronic overcapacity in a host of industries, which in turn resulted in declining profits.
R. Taggart-Murphy, professor of International Business at Tokyo’s Tsukuba University, writes: “Japan had, from the mid-1950s on, deliberately staked its prosperity on the construction of excess global capacity in a series of key industries beginning with textiles and marching up the value-added chain from shipbuilding and steel through machine tools, a wide range of consumer durables, and capital equipment, as well as a host of important upstream components. Japan did not launch industries. Rather, it targeted markets that were already served by existing capacity in other countries. Japanese companies built their own capacity to capture these markets and, then, backed by patient financing and enjoying the advantage of an undervalued currency with predictable labour costs and meticulous attention to quality control, flooded global markets with “torrential rain-type exports” to quote a Japanese government term. The result was to destroy profitability in these industries…”.
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China’s strategy, after Deng Xiaoping’s visit to Japan in 1978, was a determined emulation of the Japanese approach.
Brenner’s calculations show that the US non-financial corporate profit rate during 2001-07 was the lowest for any decade since 1949, except for 1980-90 when it was marginally lower. He says that in spite of low profitability, the huge oligopolies at the heart of the world economy were reluctant to cede market share to their rivals, preferring instead to cut costs and innovating. Cutting costs depressed real wages.
But how could the US economy cope with the resulting lack of effective demand? In his article titled, What is good for Goldman Sachs is good for America: The origins of the current crisis, Brenner writes that there were two solutions: the old Keynesian one of public deficits and a relatively more novel one of facilitating massive borrowing by households.
What did the US do to ensure that growth continued? From the late 1960s and 1970s, it tried Keynesian stimulus. Even in the 1980s, despite President Ronald Reagan’s conservative rhetoric, fiscal deficits soared in the US. After the Plaza Accord of 1985, the dollar was effectively devalued, leading to growth in US manufacturing.
But Brenner says that the successive waves of new low-cost economies entering the global market led to a zero-sum game, in which the newer players edged out the older ones. In the 1990s, with the entry of the South-East Asian tigers and with a low dollar, the economies of both Japan and Germany went into a tailspin. The US had to agree to the reverse Plaza accord in 1995 to bail out its allies. But with a stronger dollar hobbling its already high-cost manufacturing sector, what could be the new driver of growth in the US?
Brenner says the US policymakers took a leaf out of Japan’s book. After the Plaza Accord, faced with a rising yen that puts the brakes on its earlier policy of export-led growth, “the Bank of Japan radically reduced interest rates, and saw to it that banks and brokerages channelled the resulting flood of easy credit to stock and land markets. The historic run-ups of equity and land prices that ensued during the second half of the decade provided the increase in paper wealth that was required to enable both corporations and households to step up their borrowing, raise investment and consumption, and keep the economy expanding”.
Brenner believes that the US policymakers decided to adopt the Japanese model after the reverse Plaza Accord. That is how the celebrated “Greenspan put”—the belief that whenever the stock market tumbled, the Federal Reserve chairman would reduce interest rates to support the market—came into being. You could call it asset market Keynesianism—relying on easy credit to pump up asset values and using the inflated assets as collateral for another round of borrowing.
At the heart of Brenner’s thesis lies the belief that bubbles are a necessary means of propping up the US economy at a time when it has clearly lost its competitive edge. If you deflate a bubble, there is no alternative but to create another one. So, according to Doug Noland, senior portfolio manager of the Federated Prudent Bear Fund, after the collapse of the Wall Street and mortgage finance bubble, the year 2009 “marked the full-fledged emergence of the Global Government Finance Bubble.”
Emerging market bulls will be enthused by his view that “2009 marked the onset of China’s ‘terminal phase’ of Credit Bubble excess. The China Bubble is enormous and it is historic. It’s poised to make Japan’s late-80s Bubble era appear rather petite—and to perhaps even rival the scope of the US Credit Bubble”.
And if China bubbles, can India be far behind?
Manas Chakravarty takes a weekly look at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org