After the recession, a New World Order?

27 04 2009
<I>Fixing Global Finance: How to Curb Financial Crises in the 21st Century </> by Martin Wolf

Fixing Global Finance: How to Curb Financial Crises in the 21st Century, by Martin Wolf

Fixing Global Finance: How to Curb Financial Crises in the 21st Century, by Martin Wolf (published by Yale University Press)

Following the ‘credit crunch’ and now the full-blown recession, the big story of the twenty-first century is likely to be the shift in the balance of power between the indebted West and the credited East.  There are some writers on the economy who seem to understand better than others that politics should be seen as concentrated economics. Martin Wolf, associate editor of the Financial Times, is one such writer.

His FT column is a must-read for anyone who wants to understand what is happening in the current economic crisis. His latest book is about the problems of the world financial system and the events that led up to the current debacle. In it, Wolf explains both the underlying causes of the recession while also exposing the complex and potentially dangerous political consequences that have arisen as a result.

The central point in the book is that China is now playing a role in the world economy that no country has ever done before. China is ‘both the largest exporter of capital (as the United Kingdom was in the late nineteenth century) and the fastest growing emerging giant (the role played by the United States at that time)’.

China, along with other dynamic exporting nations, such as Japan, built up massive external surpluses of money in the period after 1997. The surpluses were based on the export of manufactured goods to mainly Western countries. By 2006, says Wolf, ‘The total Asian surplus was $511billion ($239billion for China, $170billion for Japan, and $102billion for the rest of Asia). The surplus of the oil exporters was another $396billion… But the US deficit was $857billion.’

So the US deficit was the equivalent of the total surplus of Asia and the oil-exporting countries. As a result, ‘The United States has in turn, been absorbing about 70 per cent of the surplus savings in the rest of the world, with the difference accounted for, not by increased investments, but by higher consumption and a lower rate of savings.’

Wolf is highly critical of the US for consuming rather than investing the massive amounts of imported capital, which ended up inflating the housing bubble and presaged the credit crunch. He sees the problem as one of underconsumption within China and other developing countries. He attributes the running up of huge external surpluses by China and others as a policy response to the Asian crisis of 1997/1998 when currencies collapsed and there were devastating consequences for the economies of some East Asian countries. He argues that ‘The lesson learned by many emerging economies – both those directly affected by the crises and those who have been onlookers – is not to tolerate current account deficits’.

So he sees the growth of external surpluses as a policy decision by developing countries. Others have argued that it is not as straightforward as that (1). China in particular would struggle to reinvest its huge surpluses internally because of the general underdevelopment of huge parts of the country (although its huge internal fiscal stimulus this year is trying to address that problem).

Wolf discusses why China and others have put huge sums of money into the US when the rate of return is so low. Given the problems China has in developing its own economy, the question really should be: what was the alternative, other than keeping the money under the bed? The nightmare scenario now for the Chinese is that the US inflates its way out of its debt, thus reducing the value of Chinese capital in the US.

So while we can understand from the Chinese point of view how we have got to where we are, from the US point of view the problem is completely different. The US and other Western countries, like the UK, have run up massive debts because, as Wolf points out ‘The high income countries have become importers of savings since their savings rates have fallen below their investment rates’.

Quite simply, we in the US and the UK have taken the savings from developing countries and consumed them, leaving ourselves in massive debt. The key question that comes out of this is how this imbalance in the world economy can be righted. As Wolf says: ‘A large-scale flow of capital from poor countries to the world’s richest nations is perverse.’

One consequence of the recession is that the international flow of capital has collapsed. It seems unlikely that, once the recession is over, the flows of capital from East to West will return in the same way. A rebalancing of some sort will have to take place. The West is unlikely to be able to resume its consumption of the savings glut from the rest of the world, certainly to the extent that it has in recent years. Western countries will have to find other ways to finance growth and consumption while we can assume that developing countries will shift their surpluses more towards the development of internal markets.

The rebalancing of the world’s economies will also, of necessity, affect the way the world is managed politically. Currently all of the world’s financial and political global institutions reflect the relative economic weight of countries 40 or 50 years ago. This will have to change. This is where it becomes politically challenging. As Roger Alton has pointed out:

‘The financial and economic crash of 2008, the worst in over 75 years, is a major geopolitical setback for the United States and Europe. Over the medium term, Washington and European governments will have neither the resources nor the economic credibility to play the role in global affairs that they otherwise would have played. These weaknesses will eventually be repaired, but in the interim, they will accelerate trends that are shifting the world’s centre of gravity away from the United States.’ (2)

As a result, some countries will lose power and influence and others will gain. Whether and how this can be managed is going to be the story of the first part of the twenty-first. Managing this shift in the middle of a recession is a huge political task, to which Wolf offers no solution except to argue for a restructuring of the International Monetary Fund. Nevertheless, he has written a fine account of the economic issues underlying the political problems facing the world today.

This book review was published by on 23 April 2009

(1) See Darling, it’s all about the global imbalances, by Stuart Simpson.

(2) The Great Crash, 2008: A Geopolitical Setback for the West, Foreign Affairs, January/February 2009




2 responses

27 04 2009

As someone pretty unhappy with my own United States these days and its new president’s feeling we can spend, spend, spend our way out of this crisis, I did like your pointing out that Wolf is “highly critical” of the US. This sounds like a very interesting book. I’ve been trying to keep up with economic news (kind of a necessity, really, as my investments go down…) and have found another great book to explain the economy in easy-to-understand language. It’s The 21st Century Economy – A Beginner’s Guide by Randy Charles Epping. It gives what I need: a basic understanding of global economics in today’s world, in an enjoyable, clear form. Much easier to read than that thick economics book from college!

28 04 2009

Incidentally there is an interesting website that is specifically dedicated to recession victims.It offers help and discusses all issues related to It’s worth a visit!

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