Friday, January 23, 2009

Financial Crisis Raises International Risks

Dongtian Mountain Hall, by Dong Yuan (c. 934-c. 962), a painter in the Southern Tang Kingdom of the Five Dynastics and Ten Kingdoms period. National Palace Museum, Taipei.

The downturn spawned by the US financial crisis is causing severe economic problems and the threat of social unrest in developing nations around the world.

China's Slowing Economy

We know that China's export sector is being hit hard, and according to the Bloomberg story Roubini, Edwards Predict Slump in S&P 500 on China, the downturn is severe. Economics guru Nouriel Roubini said that China is in recession despite government data showing 6.8 pct 4th-quarter growth rate. Societe Generale's global strategest Albert Edwards, investment strategist of Societe Generale, said rising unemployment among factory workers will fuel social unrest, threatening the Communist Party’s survival and increasing the risk authorities will devalue the yuan to boost exports.

Slower Growth to Continue

The Financial Times reports in China data to show slowest growth in decade that economists are lowering their estimates of 2009 Chinese economic growth. After adoption of an aggressive policy of fiscal stimulus and deep cuts in interest rates, "recent figures for credit and money supply growth have encouraged hopes among some economists that the stimulus efforts are beginning to gain traction". Not all economists are impressed. RBS and Morgan Stanley lowered estimates of 2009 growth to "below 6 percent". This compares to 13% in 2007 and would be the lowest GDP growth rate in 20 years.

US Deleveraging Hits Trade Partners Hard

There are good reasons to forecast a continued slowdown in China, as Paul Kedrosky argued in Watch out, world: Americans are saving again. He noted that the US savings rate rose to 2.8% in November from zero at the start of 2008, and further opined that the savings rate could rise to 4% at the end of 2009 and 7% by late 2010. Even if the savings rate held at 3%, the capital flows to US banks would be five times the total of China's current Treasury holdings. As Kedrosky says, "all that money has to come from somewhere", meaning from China and other US trading partners. His prediction: "It will be biggest story of 2009: How will rest of world restructure in face of US hell-bent on replenishing its bank accounts?"

China Already Faces Political Problems

Even without the pressures of the global financial crisis, China already has problems with social and political stability. The New York Times reported recently in China Sees Separatist Threats that China's cabinet, the State Council, issued a white paper saying that it sees threats from independence movements related to Taiwan, Tibet and the western desert region of Xinjiang.

Tension in US-China Relations

The US will have to steer a careful course with respect to trade, as shown by China's sharp response to recent comments by the new US Treasury Secretary, Timothy Geithner. Mr. Geithner wrote to a senate finance committee that "President Obama, backed by the conclusions of a broad range of economists, believes that China is manipulating its currency" and "President Obama has pledged as President to use aggressively all the diplomatic avenues open to him to seek change in China's currency practises." The chief economist at China Construction Bank, Hua Ercheng, responsed "I was very disappointed and surprised at the remarks. We are concerned about rising trade protectionism in the US."

Risk of Competitive Devaluations

There is always the risk that countries will try to protect domestic jobs by devaluing their currencies to make exports more competitive. In Alliance Bernstein's Asian Weeekly Insights, Anthony Chan reports Fear of Jobs Crisis Keeps Beijing Under Pressure to Depreciate RMB . Chan believes that the depreciation of the Renminbi against the dollar by about half a percent in the last two months signals a Chinese policy to move toward a weak currency, and that this policy is motivated by the need to create jobs:

With export growth falling off a cliff and the closure of small- and medium-sized factories becoming rampant along the export-dependent coastal regions, a strong exchange rate makes no sense from a political-economy perspective. China needs to create 10–15 million urban jobs each year to absorb the millions of rural workers migrating to the cities. Failure to do this would jeopardize social and political stability, and pose a serious challenge to the Communist Party’s one-party rule.

Widespread Unrest Predicted around the World

The Times warned recently that riots in Iceland, Latvia and Bulgaria are a sign of things to come. Speaking to a protest meeting in a Reykjavik cinema, Robert Wade of the London School of Economics warned that world was approaching new tipping point. He predicted large-scale social unrest starting in the period March-May 2009.

It will be caused by the rise of general awareness throughout Europe, America and Asia that hundreds of millions of people in rich and poor countries are experiencing rapidly falling consumption standards; that the crisis is getting worse not better; and that it has escaped the control of public authorities, national and international.

The article warns that Ukraine could be next because of its gas pricing deal with Moscow. Bulgaria has seen its worst riots since the fall of the Socialist government in 1997. Since the time of Wade's address, Iceland's government has fallen.

Capitalism Freezes in Worldwide Winter of Discontent

This was the headline of a Bloomberg article saying that, around the world, social strains are threatening the established political order, putting some countries’ very survival at risk. In past month, Nigerian rebels threatened renewed warfare against foreign oil producers, Russia sent riot police from Moscow to quell anti-tax protest in Siberia and China’s communist leadership warned of social agitation as 20th anniversary of Tiananmen Square massacre looms.

The article quoted Louis Michel, the European Union's development aid commissioner as saying that disillusionment and spillover effects of the global recession “are not only likely to spark existing conflicts in the world and fuel terrorism, but also jeopardize global security in general.” The effects threaten countries around the world, including: instability in Pakistan, a more aggressive if economically stricken Iran, a collapsing Somalia, civil disorder in copper-dependent Zambia, a strengthened, drug-financed insurgency in Colombia, a more warlike North Korea, and “blood and tears” in Pakistan.

Wednesday, January 7, 2009

Herodotus, Aeschylus, and the Financial Crisis

There was an interesting piece about Herodotus by Charlotte Higgins called The Rest Is History in The Guardian this past weekend. Her point seems to be that Herodotus is admirable because stories in his histories illustrate that no one can take good fortune for granted -- that events can suddenly turn happiness into tragedy for even the most secure of us.

That's not a bad point to make to readers during today's financial crisis, where fortune reversed for so many people who thought that their high-debt, easy-credit way of life would continue forever. Those people are now getting accustomed to a way of life based on thrift.

Let us hope that our society reorganizes to encourage savings and channel resources into investments for the future (like education, research, and productivity) rather than current consumption. No sign of that yet.

As for Herodotus, I prefer the message that Higgins conveyed a couple of days later in her blog with Herodotus: a historian for today. There she said:
His achievement was extraordinary – he was one of the wave of Ionian Greek intellectuals (from the Aegean coast of what is now Turkey) to present a rationalising view of the world that removed the gods from the limelight and put human actions centre-stage. In particular, he was the first to write an account of the historical causation of a set of world-changing events: the Persian wars of the 480s, in which, quite astonishingly, a frequently disunited, jittery coalition of Greek cities fended off conquest by what was then the most impressive world empire in existence.
Whatever errors and iffy gossip they might contain, The Histories were a milestone in the development of a sense of history as consisting of events explainable in terms of human action. And it is hard to beat the Persian Wars for importance in determining the future of Western civilization.

Some of my favorite tidbits about the first Persian War concern the playwright Aeschylus and his brother Kynaigeirus, both of whom fought in the Athenian contingent at the Battle of Marathon. After the Greeks routed the Persians with a double envelopment, Kynaigeirus died of wounds suffered when pursuing the fleeing Persians to their ships. Aeschylus was evidently proud of his participation in the battle, given the epitaph on his tombstone:
This tomb the dust of Aeschylus doth hide,
Euphorion's son and fruitful Gela's pride
How tried his valor, Marathon may tell
And long-haired Medes, who knew it all too well.
Among the plays of Aeschylus is The Persians, which is set during the second Persian War and includes as characters the ghost of King Darius, his son Xerxes, and his widow Queen Atossa. (It is the only surviving play from the set that Aeschylus wrote in winning the drama competition at the Dionysia in Athens in 472 BC.) A notable aspect of The Persians is that, in addition to celebrating Greek victory, it also portrays the Persians as understandable and even sympathetic human opponents, rather than merely as brutish invaders or effete Asians. It is worth considering how likely such humanity would be in our literature today if the Greeks had lost.

The Persians also gets us back to the current financial crisis. After news of the destruction of the Persian fleet at the Battle of Salamis arrives in Susa, the ghost of Darius appears and blames the debacle on his son's arrogance. (Aeschylus also fought at Salamis.) Arrogance leads to disaster in war, and it is also an essential ingredient in financial bubbles. When real incomes were falling, it was arrogant to think that lifestyles could be supported forever with neverending credit and mountains of debt.

Such is the stuff of bubbles. Now we have to recognize when the bubble stops deflating.

Friday, January 2, 2009

Financial Crisis and Social Conflict

Darfur refugee camp in Chad

The current financial crisis is resulting in extreme economic strains on countries around the world, and especially severe strains are being placed on developing nations. In China, the collapse of a large part of the export sector has led to massive unemployment and worries about the reintegration of workers returning to their former rural homes. Extremely poor and strife-prone nations like the Sudan appear to be vulnerable to even small increases in the general level of impoverishment. There are worries that as the financial crisis spreads, increases in poverty may stimulate civil conflict in many societies around the world.

The impact of a spike in poverty to civil conflict is addressed in a recent article, "Sudden impoverishment as a trigger of civil conflict" by Antonio Ciccone, of the Universitat Pompeu Fabra in Spain and CEPR Research Fellow. The analysis in the paper supports the hypothesis that that droughts in Sub-Saharan Africa that suddenly reduce income also raise the likelihood of civil conflict. The paper looks at data on 48 civil conflicts in Sub-Saharan Africa that started during the 1980-2006 period and concludes:

If civil conflict onset is partly driven by sudden impoverishment, conflict outbreak in Sub-Saharan Africa should be more likely following below-average rainfall years. I find this to be the case. This result, combined with the effect of rainfall on income, allows me to estimate the effect of sudden impoverishment on the probability of civil conflict onset. My estimates indicate that a negative 5% income shock raises the likelihood of civil conflict by 15 percentage points.

A Chinese migrant laborer returns to his home in Hefei, in the eastern Chinese province of Anhui, on Nov. 7, 2008, after being laid off from his job in Guangdong. Copyright © 2008, RFA. Used with the permission of Radio Free Asia, 2025 M St. NW, Suite 300, Washington DC 20036.

The economic downturn resulting from the present financial crisis is threatening workers around the world with a sudden the loss of their jobs. In China for example, the collapse of a large part of the export sector has led to massive unemployment and worries about the reintegration of workers returning to their former rural homes. Even official Chinese government press releases acknowledge that the job picture is "grim" and that labor unrest is a "top concern". In Factories Shut, China Workers Are Suffering the New York Times reported:

For decades, the steamy Pearl River Delta area of southern Guangdong Province served as a primary engine for China’s astounding economic growth. But an export slowdown that began earlier this year and that has been magnified by the global financial crisis of recent months is contributing to the shutdown of tens of thousands of small and mid-size factories here and in other coastal regions, forcing laborers to scramble for other jobs or return home to the countryside.

PLA Soldiers Enter Beijing (1949), Chinese Civil War

Fast-rising unemployment has led to an unusual series of strikes and protests, but the big impacts will occur in a reverse migration when factory workers return to their rural villages. Because factory closings are still underway in the once-booming urban centers, it is too early to have reliable estimates of how many of China’s 130 million migrant workers are heading back to their villages. However, the numbers are growing enough to raise the worry of social unrest, especially given that the recent past has raised expectations of economic progress.

Problems inside China may complicate international relations:

There has been speculation that the Chinese central bank would devalue the currency in an attempt to prop up economic activity. President-elect Barack Obama said in October that China must change its currency practices "because it pegs its currency at an artificially low rate." It is worrying that continuing economic woes will add pressure for China to do that. With many nations around the world being in the same recessionary boat, the temptations to engage in protectionism may eventually become too great for some country to resist -- setting off a round of competitive currency devalutations.

China isn't alone. The financial crisis is also forcing other major nations to raise protective trade barriers:

Boris Yeltsin, President of the Russian SFSR, standing on a tank in front of
the parliament to give an address opposing the August 1991 coup.

Ambrose Evans-Pritchard wrote an article that was published in The Telegraph with the catchy title Protectionist dominoes are beginning to tumble across the world. Russia is of course suffering financially because of the sharp decline in oil prices, and the international economic situation is adding to its woes. Now Russia is erecting trade barriers with import tariffs of 30% on cars, 15p% on farm kit, and 95% on poultry. Russia is not alone. "India and Vietnam have imposed steel tariffs. Indonesia is resorting to special "licenses" to choke off imports." As with China, Russia is facing internal unrest because of the economic crisis. The same article reported that there have already been labor protests in Russia because of a 13% fall in industrial output over the last five months. So far, there have been street protests in Moscow, St Petersburg, Kaliningrad, Vladivostok and Barnaul, and police crushed the "Dissent Marchers" in Moscow.

These initial protectionist actions are raising worries that the era of economic globalization may be coming to a close, and with unfortunate consequences. Not one to mince words, Evans-Pritchard concluded: "The last great era of globalisation peaked just before 1914. You know the rest of the story."

Australian infantry with gas masks, Ypres, 1917.

The age of globalization has not ended yet, but many more risks to the current economic regime could easily unfold during 2009. As the latest headines indicate, Israel Starts Gaza Ground Push in Bid to Halt Rockets, there are already enough potential sources of conflict in the world, without adding pressures from the financial crisis.