In his masterpiece, The World in Depression, Charles A. Kindleberger concludes the major cause of the Great Depression was a paralysis of leadership caused by the decline of the UK and the immaturity of the US. Neither was able to provide leadership and put themselves forward as the economy of last resort.
Kindelberger argues that during the 19th century, global growth was balanced by the UK’s decision to keep its economy open. When the home country boomed, capital flooded in to invest, but imports surged and offset the depletion of capital elsewhere. When the home country swooned, capital sought higher returns offshore, boosting growth elsewhere and therefore exports from the UK, softening the downturn. This mechanism prevented recessions from spiraling into depressions.
When the UK’s political and economic weight dramatically declined through the first 30 years of the 20th century so did this mechanism. And to make matters worse, when 1929 arrived the US was not ready to shoulder the burden of global leadership. When trouble came, it closed its trade borders. The globe was leaderless.
This analysis has two important points to make about our current situation. The first is that for the past couple of business cycles, the world has enjoyed a remarkably similar parallel in its macros settings. As the US boomed through the late nineties internet economy then again through its post-millennium housing bubble, capital flooded in, causing some to argue that the widening current account deficit was a result of a surplus of investment opportunities. In retrospect I think that’s been shown to be ‘new age’ thinking and all that was really happening was a credit bubble and over-consumption. Nonetheless, the result was an imports boom, which boosted the peripheral or emerging markets.
Then, as the US weakened, and monetary and fiscal policy was eased, capital flooded outwards to emerging markets, especially China.
The second point to draw from Kindleberger is that as US economic power declines and China rises, the world finds itself at a similar impasse in political leadership. It is clear that the US is no longer in a position to be the engine of global demand, the debt burden has simply surpassed it. Equally clearly, China is not yet of sufficient size, power or sophistication to lead the world into a new economic era through an open economy.
Making this worse is the uncomfortable realisation that unlike during the Great Depression, we are not seeing a transfer of power within a civilisation, which was difficult enough. This time its a power shift to a new civilisation. Such historic shifts tend to happen through crisis and conflict. Empires hold onto power, rising states seek to seize it. It is only ever clear in hindsight where this process of transfer is up to. Recent intemperate and confused statements from both China and the US about the yuan should be viewed in this light. From the FT:
China has warned that the US could plunge the global economy into a 1930s-like depression if it passes a bill that aims to punish Beijing for holding down the value of its currency.
With the Senate set to vote on Tuesday on legislation that would impose tariffs on imports from countries that manipulate their exchange rates, China has said that the consequences of such a move could be dire, leading to a trade war.
In a commentary just hours ahead of the vote, the official Xinhua news agency took the warnings a step further, saying the proposed legislation in the US was reminiscent of the Smoot-Hawley tariffs in 1930 that worsened the Great Depression.
Perhaps this rhetoric is aimed as much at domestic audiences – exporters etc – as it is the US. But it is worrying. In my view, the Kindelberger narrative for the Great Depression puts the onus on the rising power to avert a trade war. After all, the declining power can elect to take the pain for the greater good by ignoring its own demand shortfall but it pays a high price. The choice for the rising power is easier. It needs to rebalance its demand not slow growth completely. Moreover, the surplus country stands to lose most if the tariff war does begin.
Except, in the case of China, that doesn’t quite hold does it? The magnitude and political structure of the place makes it VERY difficult for them to accept any form of slowing growth.
I’d like to think that we can learn the lessons of the past. China has been appreciating the yuan but not at any great pace:
The mismatch is one of time as much as anything. China will only move slowly. With all domestic avenues for stimulus exhausted, and a Presidential election looming, the US needs to move quickly.
This is the last thing jittery global markets need.