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Asia’s Century: The American Credit Crisis & the Re-emergence of China and India!

Dr. Julian E. Gaspar, Executive DirectorCenter for International Business Studies, &Clinical Professor of International FinanceMays Business SchoolTexas A&M UniversityCollege Station, Texas

STRATEGIC ISSUES FACING ASIA

The American Credit Crisis – What Really Happened?Understanding the Causes & Consequences

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U.S. Structural Imbalances: Living Beyond Our Means

U.S. private consumption binge (driven on credit) reached an all time highCorrespondingly, U.S. personal savings (as a percentage of disposable income) was low (~0%)Excessive leveraging by U.S. hedge funds, private equity firms, investment banks and corporationsLax underwriting & credit rating standards, followed with massive debt (mortgage, credit card, autos, etc.) securitization. Prolonged “deregulation” initiated in 1980 during the Regan Administration under the disguise of encouraging financial sector “innovation” eventually led to the creation of a fragile financial system that was almost like a house of cards.

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U.S. Structural Imbalances: Fiscal & Current Accounts

U.S. budget deficit under the Bush Administration was alarmingly large caused by a combination of ill-conceived tax cuts on the revenue side and the “wages of war” on the spending sideMassive spending, hence imports, contributed to unsustainable levels of current account deficits --in U.S. balance of paymentsThe need to finance the twin imbalances (deficits) above has led to serious dependence on foreign savings (from Asia in particular)In summary, U.S. consumers, corporate America, and the federal government were all binging on credit and living beyond their means for a very long time. But, other countries (e.g., China, Japan, Taiwan, Germany, Saudi Arabia and other oil-rich Middle Eastern countries) were willing to finance such behavior

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Financial Sector Shortcomings: Inadequate Regulations

Deregulation of financial sector that began under the Regan Administration (Greenspan Fed) accelerated during the Clinton and Bush administrations with the repeal of Glass-Steagall ActGreenspan Fed’s prolonged loose monetary policy since the implosion of the dotcom bubble in 2000 increased the availability of cheap credit that encouraged excessive, non-transparent, and lax attitude toward risk taking [hedging?] by financial institutionsExcess liquidity also compounded speculation (in the real estate and commodity markets), encouraged lax lending policies, increased leveraging, securitization (of US subprime mortgage loans sold domestically and abroad to banks, investors, and hedge funds), and unregulated growth of credit default swapsConsequently, inflationary pressures led to rising interest rates, resetting of adjustable interest rates mortgages, increased foreclosures, bursting of the housing bubble, CDS market, and start of the credit crisis

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American Economy at Risk

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68

70

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1960 1970 1980 1990 2000 2010 2020

U.S. CONSUMPTION BINGE

U.S. Personal Consumption Expenditure: % of GDP 1960-2010

6

7

0.0

2000.0

4000.0

6000.0

8000.0

0000.0

2000.0

U.S. Euro Zone(16)

Japan India China

Scale Matters ($ Billions)

Private Consumption 2008

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

U.S. Euro Zone(17)

Japan India China

70.6

57.5 58.6 57.2

30.4

Consumption Share of GDP

Source:World Bank, World Development Indicators, 2011, Structure of Demand.

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Wages of War Tax cuts and military spending (for operations in Iraq and Afghanistan), bailouts and stimulus packages have increased the federal deficit.

U.S. Budget Surplus / Deficit($ Billions and % of GDP)

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10

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The Dollar has Fallen most against the Euro...

Dollar exchange rate and indices (rebased)

0.00

0.30

0.60

0.90

1.20

70

80

90

100

110

120

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: International Financial Statistics, Yearbook 2011 ‐ IMF

Real Effective Exchange Rate

€/$

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... with no sign yet of reductions in global trade imbalances

-900.0

-700.0

-500.0

-300.0

-100.0

100.0

300.0

500.0

1995 1998 2001 2004 2007 2010

UK

Current Account Balances In Billions of Dollars

China

Germany

Japan

US

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United States:  Gross Federal Debt($ billion and % of GDP) 

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U.S. Gross Federal Debt by Administration($ Billions and % of GDP)

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The Credit Crisis and Corporate Bailouts

Concern over financial sector systemic risk and its impact on the real economyPublic outrage over financial sector’s privatized profit and socialized risk Introduction of prudent financial sector regulations and supervision (back to basics?): lending standards, leverage, securitization, corporate compensation, and proprietary tradingCorporate bail-outs: commercial banks, investment banks, insurance companies, and auto manufacturers? Too large to fail?Lessons for Emerging Market Economies: Financial sector liberalization should be gradual and well thought out with enforcement of prudent regulations that prevent excessive risk taking by financial institutions. Mimicking developed economies may not be appropriate nor will “open” financial systems be appropriate for emerging market economies in Asia.

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Consequences of overindulgence in the U.S.

Over dependence on foreign savings to maintain U.S. economic growthGradual move away from the dollar to euro, yuan and gold as choice international reservesPrivate capital will flow to emerging markets and propel growth Inflation potential and rising interest rates could lead to economic stagnation in the U.S.Income inequality in the U.S. is likely to continue risingAsia’s economies could emerge as strategic competitors to U.S. as our investment in higher education and health care deteriorate along with the shrinking size of the middle class.

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Capital is flooding into emerging markets…

Emerging market equities(rebased in local currencies, 2001=100)

…forcing countries with dollar pegsto increase reserves

International reserves rebased (2000=100)

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0%

10%

20%

30%

40%

50%

60%

70%

80%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

% U.S. Dollars

% Euros

Currency composition of developing countries’ reserves

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Income Distribution 

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Income Distribution  1990 ‐ 2006

28Financial Times: April 13, 2012

29Financial Times: April 13, 2012

Tax Loopholes: The High Cost of U.S. Tax Breaks

30The Economist, The high price of tax breaks,

April 28, 2012, p.32

What Next? Structural Adjustment Policies (Austerity)!

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APPRECIATING ASIA’S DIVERSITY

A. Political Systems

1. Authoritarian/Military Regimes

2. Benevolent Dictatorship

3. Communism

4. Democracy

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1. Closed Societies

2. Controlled Societies

3. Open Societies

APPRECIATING ASIA’S DIVERSITY B. Social Systems

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1. Buddhism

2. Christianity

3. Hinduism

4. Islam

5. Shintoism

APPRECIATING ASIA’S DIVERSITY

C. Religious/Cultural Spectrum

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APPRECIATING ASIA’S DIVERSITY

D. Economic Systems

1. Command Economic System

2. Free Enterprise System

3. Micro-managed Economic System

4. Transition Economic System & State Capitalism

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Pop. (m) GNI ($T) GNI (PPP$T)World 6775 59.2 71.8

Asia 3724 15.0 23.6Japan 128 4.9 4.3China 1331 4.9 9.2South Korea 49 1.0 1.3India 1155 1.4 3.8Indonesia 230 0.47 0.86Singapore 5 0.19 0.25Kazakhstan 16 0.11 0.16

United States 307 14.2 14.0

E. Demographics (2009)

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World’s Ten Largest Economies: US $ 2009Country GNI (billions) % of World

GNIPopulation (millions)

GNI per Capita ($)

United States 14,234 24.1 307 46,360

Japan 4,857 8.2 128 38,080

China 4,856 8.2 1,331 3,650

Germany 3,476 5.9 82 42,450

France 2,751 4.7 63 42,620

United Kingdom

2,558 4.3 62 41,370

Italy 2,115 3.6 60 35,110

Brazil 1,564 2.6 194 8,070

Spain 1,476 2.5 46 32,120

Canada 1,416 2.4 34 41,980

World 59,162 100 6,775 8,732

World’s Ten Largest Economies: PPP Basis

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World's Ten Largest Economies: Purchasing Power Parity (PPP) Basis* (US$2009)

CountryPPP GNI** (billion US$)

% of World PPP GNI

Population (million)

PPP GNI/capita (US$)

United States 14,011 19.5 307 45,640China 9,170 12.8 1,331 6,890Japan 4,265 5.9 128 33,440India 3,786 5.3 1,155 3,280Germany 3,017 4.2 82 36,850Russia 2,599 3.6 142 18,330United Kingdom 2,217 3.1 62 35,860France 2,191 3.1 63 33,950Brazil 1,968 2.7 194 10,160Italy 1,919 2.7 60 31,870European Union (27) 15,590 21.7 497 31,368World Total 71,774 100 6,775 10,594

Source: The World Bank, World Development Indicators 2011, pp.10-12.

*PPP conversion factor is the number of units of a country's currency that is required to buy the same amount of goods and services in the domestic market that a U.S. dollar would buy in the United States.**GNI is the total value of goods and services produced by a country plus net receipts of employee compensation and property income from abroad.

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World's Ten Largest Economies: PPP Basis (US$2009)

Country

PPP GNI (billions) 2009

Real GNI Growth 2009-2020p.a. est.

PPP GNI(billions)2020

Population(millions)2009

Population Growth rate 2009-2020

Population(millions)2020

PPP GNI per Capita($)2009

PPP GNI per Capita($) 2020

1 United States 14,011 2.20% 17,800 307 0.9% 338.8 45,640 52,540 2 China 9,170 8.00% 21,381 1,331 0.6% 1421.5 6,890 15,041 3 Japan 4,265 1.50% 5,024 128 -0.3% 123.8 33,440 40,568 4 India 3,786 7.00% 7,969 1,155 1.3% 1331.3 3,280 5,986 5 Germany 3,017 2.00% 3,751 82 -0.3% 79.3 36,850 47,284 6 Russia 2,599 5.00% 4,445 142 -0.3% 137.4 18,330 32,356 7 U.K. 2,217 2.00% 2,757 62 0.5% 65.5 35,860 42,087 8 France 2,191 2.00% 2,724 63 0.3% 65.1 33,950 41,840 9 Brazil 1,968 5.00% 3,366 194 0.7% 209.5 10,160 16,069 10 Italy 1,919 2.00% 2,386 60 0.1% 60.7 31,870 39,332

European Union (27) 15,590 2.00% 19,384 497 0.30% 513.6 31,368 37,738

World TOTAL 71,774 2.70% 96,215 6,775 1.10% 7641.4 10,594 12,591

Source: The World Bank: World Development Indicators, 2011, pp. 10-12 and 36-38.

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Asia’s Challenge: Stability and Sustainable Growth

Will the fall out of the American credit crisis and European Union sovereign debt crisis continue to encourage economic reforms (privatization, governance, market liberalization, transparency and rule of law) in Asia?

Will Asia encourage domestic consumption, strengthen social programs and middle class growth or focus on savings and manipulating (weakening) currencies (like the Chinese yuan)?

Will long term political stability (move toward functioning democratic institutions) prevail?

What are the prospects for social unrest (caused by high unemployment, widening wealth gap between the rich and poor, lack of social safety net) and religious harmony?

What is the potential for regional conflicts?Will Asia (China, India, Japan, and South Korea) decouple from

the U.S. to create a multi-polar world?

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Quotes on China and IndiaRecalling how the Soviet Union changed, the Dalai Lama thinks for a moment how China is developing. “China is communist without communist ideology --only power,” he declares. “So logically, no future!” The “only future” for China is “democracy, rule of law, free press, religious freedom, free information. China’s future depends on these factors.” Wall Street Journal, Sep. 22-23, 07.

“China is a sleeping giant. Let her lie and sleep for when she awakens she will tremble the world” Napoleon Bonaparte

“(India) A billion people and it’s a democracy. Ain’t that something?” President George Bush (during 2000 presidential campaign)