A slowdown in China is making the world economy wobble and will lead to declining trade, growth and returns to capital.
Soon after the fall of the Berlin Wall and the collapse of the Soviet Union, Francis Fukuyama published The End of History and the Last Man. He proclaimed: “The end point of mankind’s ideological evolution and the universalization of Western liberal democracy as the final form of human government.” Fukuyama was being a bit too Americano and just a touch premature in his prediction. The one thing we know from history is that trends toward universalization tend to trip up. Both fervent Catholicism and godless communism failed to convert everyone, despite their best efforts
After the end of the Cold War, new high priests emerged and their creed swept through the great universities of the planet. These priests were economists who assumed that human beings were rational, that they were highly informed and they made highly conscious and wise choices. Just as Catholics worship Jesus, economists swore by Jeremy Bentham, an Englishman who wanted the greatest good of the greatest number in his utilitarian philosophy. He proposed the Panopticon prison, which would “cost nothing to the nation.” One gaoler would be able to watch all inmates who would do menial labor and pay for their upkeep. The Panopticon was meant to be “a mill for grinding rogues honest,” and the government of William Pitt the Younger duly paid Bentham £2,000 for his splendid ideas.
When communism fell, people turned to markets for salvation. Milton Friedman, the favored priest of Ronald Reagan and Augusto Pinochet, became particularly influential. His prescription of privatization of collectively-owned assets such as the post office and national parks suddenly became respectable. In former communist countries, privatization was duly carried out. The relatives, friends and cronies of former party bosses bought state-owned assets for a fraction of their value and appropriated most of the wealth of the public. Friedman, a midget cheerleader in short skirts, approved. He crudely conflated capitalism with freedom, forgetting Adam Smith’s fine point that “moral sentiments” underpin markets.
Like Humpty Dumpty, the new world economy that was born in 1991 has taken a great fall. In the first six months of 2015, world trade has contracted at the fastest pace since 2009. In simple terms, it means the Americans are cutting down purchases of Chinese-made goods, the Brazilians are buying fewer Ferraris and the Chinese are quaffing smaller quantities of Burgundies. As The Economist points out, this is “the reversal of a trend where for decades the growth in global trade outstripped that of the world economy.”
This growth occurred because of three reasons. First, people wanted to consume more. People in formerly communist countries were besotted with better products from advanced economies such as cars, washing machines and cosmetics. Similarly, people in richer countries wanted more for less, be it chocolate or lingerie. Second, the new free market zeitgeist led to the birth of a global framework for trade in the form of the World Trade Organization that had been stalled for over four decades. Finally, capital chasing ever greater returns flocked to poorer countries where labor cost less. So, companies such as Nike and Apple shifted manufacturing to places like Vietnam and China. These reasons have now been exploited to the hilt, and world trade can no longer grow as in the recent past.
The biggest immediate shock to the world economy is now emanating from China. In August, manufacturing “fell to a six-and-a-half year low” and the stock market plumbed new depths this week. Since July, Chinese authorities have unwisely thrown the kitchen sink to prop up share prices. This has transferred wealth from the poor to the rich in exactly the same way as Hank Paulson’s bailout of US banks in 2008. Like Paulson, the Chinese authorities have panicked and most of their knee-jerk reactions are not working. Over investment, bad debts, corruption, pollution and extreme reliance on exports have been longstanding problems. Rulers of the Middle Kingdom cannot keep flogging an ailing horse that might die soon.
August 24 is being referred to as “Black Monday” because the Shanghai Composite Index fell by nearly 9%, its biggest one-day drop since 2007. China’s crash caused pandemonium in markets worldwide. Germany’s DAX fell by over 20%, Britain’s FTSE 100 lost more than $90 billion, Asian markets crashed and Wall Street buckled, with shares of General Electric dropping by more than 20% at one point. As this author has pointed out earlier, other economies are inextricably intertwined with China’s. If China buys less soybean and perfumes, then Brazil and France suffer. If Chinese factories start going out of business, then profits of US companies shrink. It is for this reason that market panic has spread faster than SARS. Currencies of emerging economies have slumped, commodity prices have crashed and oil prices are nearly back to the low levels of six years ago.
As a response, the People’s Bank of China cut its key lending rate to a record low of 4.6%. This follows the devaluation of the renminbi and the stock market bailout of two weeks ago. Other central banks are also pumping money into their economies and the world economy is now awash with cash. This excessive liquidity is leading to asset bubbles yet again. With stocks yo-yoing, capital is seeking a “safe haven” in bond markets, property markets and the US dollar. Yet bond market buyers of debt could do well to remember the Greek crisis. Economies of many countries will not grow dramatically and current levels of debt are unsustainable.
The debt restructuring deal that Ukraine agreed with its creditors proves this point. Bondholders agreed to write-off 20% of Ukraine’s $19 billion debt and give the country another four years for repayment. Prima facie, the deal looks decent. On closer inspection, just as in the case of the agreement with Greece, creditors have kicked the can further down the road and refused to confront brutal realities. Ukraine is in a mess. Conflict continues, inflation is nearly 60%, the dollar value of the gross domestic product (GDP) has fallen by 60% over the last two years and Ukraine is poorer than it was under the Soviet Union. Clearly, privatization of state assets without moral sentiments did not help. Similarly, repaying the International Monetary Fund over $4 billion before 2019 will not do Ukraine much good either.
In the coming years, trade, growth and returns to capital will decline. Citizens, politicians and even economists have to take cognizance of environmental damage, decreasing wages, increasing inequality, social conflict and declining democracy.
Perhaps things are not so bad. Of the 1.5 billion people with access to the Internet, more than a billion logged into Facebook on Black Monday. Elon Musk, Marc Andreessen and Mark Zuckerberg might lead us to Fukuyama’s end of history and Bentham’s utilitarian utopia yet.
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