LOSING CONTROL (18 page)

These arguments assume that income losses are only temporary and that people are therefore able to ‘bounce back’ from temporary setbacks.
The growth in incomes of the rich and the increases in the
prices of staples as emerging economies catch up with the developed world suggest, however, that income inequality is increasing not just because the volatility of income is increasing through a person’s lifetime but, also, because we are in the midst of some major secular trends that, so far, have either been ignored by policymakers or have proved difficult to control.

Indeed, the easiest way to mask the problem of modest income gains for large swathes of the population has been to encourage a culture of debt dependency.
Why worry if income growth is not particularly strong when consumer spending can be fuelled through the exorbitant use of plastic?
It’s easy to keep the masses happy in the short term through big increases in debt.
If, however, GDP growth does not easily translate into household income growth – as has been the case for the vast majority of the US population – the short-term fix will lead to long-term problems.
Even if, in a world of low nominal interest rates, debt is easy to service, the truth of the matter is that, eventually, the outstanding debt will have to be repaid (or, alternatively, the debtor will have to default).
Repayment is much more difficult if income gains are depressed or if, as discussed in Chapter 4, wealth gains turn out to be transitory.

Longer term, the education route appears to be attractive, but I cannot help feel there are immense limitations.
We’re back to the population numbers game.
As already noted, US evidence suggests that graduates are not getting their rewards for increases in productivity in recent years.
In the UK, the picture is, so far, more encouraging.
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Yet, for all the additional investment that might be made in education in the US, the UK and elsewhere, the likelihood is that, in the international jobs market, increased competition will be coming from Chinese and Indian graduates who are willing to work for
wages significantly lower than those now being paid to the educated elites in the developed world.

The rise of the emerging world is coinciding with the ageing of societies in the developed world.
The implications of this will be discussed more fully in Chapter 8.
For the purposes of this chapter, the important point is that, with the baby-boomer generation heading into retirement, vulnerability to sustained increases in food and energy prices will increase: living on unearned income in a world of secular price increases may not be much fun.
Policymakers in developed countries already worry about the cost of ageing societies – through the provision of pensions and medical support – but they may also have to give consideration to the costs associated with a growing Malthusian constraint.

And then there’s the potential for a political backlash.
There may be a rising global economic tide, but Jack Kennedy’s hopes are in danger of being washed away.
Not everyone’s boats are being lifted and those who feel vulnerable are becoming easy prey for populist politicians who, in turn, will attempt to turn the debate towards protectionism, nationalism and blatant xenophobia.
Even mainstream politicians find the temptation to pander to the worst instincts of society overwhelming, as the quote from Gordon Brown at the beginning of this chapter highlights.
In May 2009, President Obama, newly installed in the White House, offered similar sentiments: ‘It’s a tax code that says you should pay lower taxes if you create a job in Bangalore, India, than if you create one in Buffalo, New York.’
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For those in the developed world who wish to carry on consuming regardless of the constraints on their incomes, there is another way.
Harold Macmillan, Britain’s Conservative prime minister in the late 1950s and early 1960s, launched a now famous assault on Margaret Thatcher’s Conservatives in the 1980s, when he likened the privatization policies at that time to ‘selling the family silver’.

If the developed world is not ready for the income-redistribution implications of the rise of the emerging economies, an easy short-term solution is to sell Western assets to those who have the money to buy them.
The money raised could be used to carry on consuming, at least for a while, even as the ownership and control of capital heads elsewhere.
This is the subject of my next chapter.
Many people in the West have forgotten about the importance of state capitalism as a source of their economic success.
Emerging nations have not.
The philosophies of the British East India Company are beginning to return, but, this time, they’re being embraced by the emerging world.
This is economics at its most political.

Globalization creates winners and losers.
The benefits and costs of globalization are randomly distributed by the market’s invisible hand across and within sovereign states.
State capitalism, arguably, can be seen as an attempt to overrule this process.
It offers a chance to exert government control over resources that might otherwise be lost through market forces to higher bidders elsewhere.
State capitalism can be used to ensure resources are either retained for domestic consumption or used as bargaining chips in the exertion of global economic and political power.
Whether to guard against income inequality or to pursue geopolitical objectives, almost all governments have an incentive to override the market.
Capital is then owned and controlled not by millions of investors keen to maximize profits but, instead, by a limited number of governments and state agencies keen to maximize their political clout.

All the major sovereign players in the world economy are involved in the game today.
One of the more visible signs of state capitalism is the emergence of sovereign wealth funds, a response to the large imbalances that have arisen in the global economy since the 1980s.
Countries running balance of payments current-account surpluses have built up huge holdings of foreign assets that need to be invested somewhere.
As we saw in Chapter 4, some of these assets are held in the form of foreign-exchange reserves, typically invested in a very narrow range of government and quasi-government paper.
As these reserves have multiplied, however, the desire to diversify into a wider range of assets has increased enormously.
To diversify in this way, more and more nations have resorted to the creation of sovereign wealth funds.
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While sovereign wealth funds have undoubtedly received the lion’s share of media attention, the rise in state capitalism is not just a question of the ownership of assets, whether through sovereign wealth funds or other investment vehicles.
State capitalism is ultimately a story about economic nationalism and global power politics, especially when it comes to energy, food and logistics.
The increased gravitational pull of the emerging nations is having a huge impact on relative prices across goods, labour and capital markets.
The redistributional consequences of these price changes provide an increasingly strong incentive for governments to intervene in an attempt to bypass or distort the market.

The increased economic clout of sovereign states partly reflects the global savings glut we first came across in Chapter 4.
If the emerging economies carry on saving more than they’re spending and countries in the developed world – at least the US and the UK – carry on borrowing more than they’re earning, there are huge implications
for ownership of almost every conceivable asset, from bonds to stocks and from companies to residential real estate.

For every year the US runs a balance of payments current-account deficit – implying an inflow of capital – it increases its liabilities to the rest of the world.
For every year the emerging economies run balance of payments current-account surpluses – implying the need to invest abroad – they increase their holdings of foreign assets.
Logically, should the US run a current-account deficit for ever, all US assets would be sold off to foreign investors.
There would no longer be a USA Inc.

Already, the US is by far the world’s biggest debtor nation.
Despite all this borrowing, however, US interest rates have, for the most part, been remarkably low.
As debts to the rest of the world have risen, so interest rates have declined.
The reason is simple: it’s not so much that the US has deliberately set out to borrow too much.
Instead, people in the emerging economies are collectively saving excessively.

They’re saving for all sorts of sensible reasons.
They don’t have the credit markets that fuel consumer spending in the developed world.
If an American wants to buy a car, he can do so today merely by borrowing against projected future income.
If a Chinese citizen wants to buy a car, the chances are he’ll have to save for many years.
Nor do the people in emerging nations have the social-insurance safety nets available in the West, an innovation stemming from the economic crises of the 1930s.
If the state won’t look after you during periods of sickness or unemployment, you’ll have to make the savings yourself.
People living in emerging economies don’t have the easy access to education enjoyed in the developed world.
Despite the millions now going to university in China, India, Brazil and elsewhere, tertiary education is still very much a luxury that requires a lot of scrimping and saving.
And, following the late 1990s Asian crisis, which is seen by many to be a response to excessive emerging-country borrowing, policymakers in the emerging world concluded
that saving more and borrowing less was a good idea, at least from the perspective of delivering greater short-term economic stability.
No longer did they want to be dependent on ‘hot money’ inflows from the developed world that could turn tail at any moment.

The dynamics of this process are potentially explosive.
An easy way to think about this is to consider a two-country world, involving just the US and China.
Imagine that the US economy expands at a rate of around 5 per cent per year, split between 3 per cent of volume gains and 2 per cent of inflation.
China, meanwhile, expands at a rate of 12 per cent per year, split between 8 per cent of volume gains and 4 per cent of inflation.
For the sake of simplicity, there is no exchange rate: both countries use dollars.
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Assume, also, that the US has a very well-developed domestic capital market while China’s is rudimentary at best.
In particular, whereas US citizens can easily borrow on the back of future incomes, Chinese citizens cannot.

Imagine, also, that Chinese excess savings (in other words, the current-account surplus) are a fixed proportion of the value of Chinese national income.
This is not a particularly far-fetched assumption: the vast majority of G7 countries found themselves with high household savings rates during the 1950s and 1960s, before the advent of financial deregulation.
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With this assumption, it’s easy enough to show that the US current-account deficit has to get bigger and bigger over time.

In my two-country model, the Chinese and US current-account positions must cancel each other out (there are only two countries, so there is no trade with the UK, Germany or Mars because these additional countries and planets don’t exist).
If Chinese excess savings are a fixed proportion of Chinese national income, and Chinese national income is rising more quickly than US national
income, it must follow that Chinese excess savings are rising as a share of US national income.
But as Chinese excess savings must equal US excess borrowing, it follows that US excess borrowing must be rising as a share of US national income.
In other words, a combination of strong Chinese growth and a stubbornly high saving ratio will inevitably deliver a rising US current-account deficit as a share of US national income.
And, if Americans need to be persuaded to borrow (and often they appear not to require too much persuasion), the most obvious influence is likely to be the impact of Chinese excess saving on US interest rates, which end up lower than would otherwise have been the case.
Meanwhile, as this process continues, so China’s holdings of US assets climb as a share of US national income and, hence, America’s liabilities to China climb as a share of US national income.

The end game for this story, with particular emphasis on the US dollar’s reserve currency status, will be explored more fully in Chapter 9.
For now, I want to focus on one particular aspect of the story.
If China’s rapid growth and excess savings imply that, over time, China owns a greater and greater proportion of US assets, which particular assets will the Chinese choose to hold and which assets will the Americans let them hold?
More generally, if we’re living in a world where people in the emerging economies are unable or unwilling to focus purely on domestic investment opportunities, how do things change as a result of their investment in assets which, hitherto, have been seen to be irredeemably American, British or German?

Until now, the vast majority of the surplus savings held by the emerging markets have been invested in foreign-exchange reserves, mostly US dollar government paper.
The rising demand for this
paper keeps the price high and, hence, the interest rate unusually low.
The advantage for emerging-market investors is primarily that US Treasuries are liquid.
In other words, with lots of people in the market, Treasuries can be bought and sold very easily.
There are also disadvantages.
Because interest rates are low, returns are low.
With the supply of Treasuries ultimately controlled by the US authorities, there’s always the danger that supply will increase very rapidly, driving prices lower, perhaps as a result of a large increase in the budget deficit.
And with Treasuries priced in dollars, a big increase in the supply of dollars, leading to surging US inflation or a collapse in the dollar’s value against other currencies (or perhaps both), would leave emerging investors nursing potentially big losses in domestic currency terms.
Treasuries may be liquid, then, but they are not necessarily safe.

Given this, policymakers in emerging economies have three options.
First, they can carry on buying Treasuries, while recognizing that the safety of their investments is not guaranteed, at least in their own currencies.
Second, they can choose not to acquire foreign assets, a decision that would require a sustained reduction in their current-account surpluses over many years, primarily through the encouragement of a higher level of domestic consumption and investment.
Third, they can choose to diversify their holdings of foreign assets out of Treasuries and into something else.

The first of these options would leave US long-term interest rates unusually low and would, in all likelihood, contribute to further instability of the kind associated with the global credit crunch that kicked off in 2007.

The second option is not likely to be achieved overnight.
Indeed, any attempt to do so would probably end in disaster.
One mechanism by which smaller current-account surpluses and hence lower capital outflows could be achieved is to allow a surplus country’s currency to appreciate rapidly; but, as we observed in Chapter 4, Japan’s
experience with currency appreciation has not been particularly successful: Japan’s surplus has increased, not decreased.
Another mechanism might be to cut domestic interest rates rapidly to boost domestic spending, but that might threaten a repeat of Japan’s experience in the late 1980s, when a domestic boom driven by remarkably low interest rates was partly responsible for the decades of stagnation that then followed.
A more sensible mechanism – the only one that has a realistic chance of working – is for lasting reforms to reduce domestic saving (or increase domestic borrowing).
That will take a long time.
After all, only after half a century of development in social-security systems and credit markets did Western economies deliver lower levels of household saving and higher levels of debt against a background of incomes per capita far higher than those in the emerging world.
Short cuts have been tried before, but, for the most part, they have failed, collapsing under the weight of balance of payments crises or inflation.

The third option, diversification, therefore has significant attractions, at least until there’s a radical change in domestic savings beha-viour within emerging economies.
Diversification implies, at the very least, a change in ownership; but it may also imply a change in control.
We are back to political economy.
Is the West happy to allow investors from emerging economies to cherry-pick their favourite trophy assets?
If not, who decides which assets can and cannot be purchased?
And is there a difference between ownership and control?

A canny investor might not be unduly concerned about ownership alone: what matters is the ability to buy assets at a low price and sell them at a high price, not who owns the assets.
Under the heroically unrealistic assumption that all investors in the developed world are
canny while those in the emerging world are naive, ownership might turn out to be completely irrelevant.
The developed world could carry on borrowing cheaply from the emerging world, using the money raised to buy emerging assets on the cheap, the sort of beha-viour banks indulge in on a daily basis.
Alternatively, the developed world could offload some unwanted domestic assets at ludicrously inflated prices to the emerging innocents, who might be too interested in ‘trophy assets’ to recognize they’re being swindled.
Over time, this approach would leave the market value of assets owned by developed market investors in the emerging world rising rapidly, while the value of assets held in the developed world by emerging investors might be in decline.