China and the Global Financial Crisis

By
Henry C.K. Liu

This article appeared in AToL in two parts as
Denial as theStorm Gathered (Dec.5, 2008) and as
Beijing Holds Key to Prosperity (Dec.6. 2008)
 
  
 
China’s response to the current global financial crisis is predicated on the reality of the international situation and the separate responses of other major economies around the world.
 
US Denial as the Storm Gathered
 
It took more than a year for US President George W Bush, in whose country the decades-long credit joyride finally imploded in August 2007, to belatedly acknowledge that the financial crisis resulting from decades of US monetary indulgence and fiscal irresponsibility is not merely a passing shower needed to deflate the latest debt bubble in the housing sector of the US economy. The credit turmoil turned out to be a catastrophic global financial perfect storm of unprecedented dimension that will cause serious structural damage to all market economies around the world. It may even spell the end of the cowboy finance capitalism of past two decades in which risks are socialized and gains privatized with debt manipulated to act as phantom capital and high returns on pension funds of workers paid for with permanent loss of employment and regressively low wages for those still working.
 
Snake Oil Theory of Big Market, Small Government
 
For decades, aggressive globalization and wholesale deregulation of finance have been propagated by flawed US ideology of faith-based capitalistic free market fundamentalism and of the alleged merits of government nonintervention in markets. The snake-oil slogan of “big market and small government” has been promoted around the world as a win-win neo-liberal miracle good for all trade participating economies and regurgitated tirelessly by neo-comprador economies such as that of Hong Kong. Ironically, free market Hong Kong finds it necessary to turn to socialist China for government bailouts whenever its free market slows, while it continues to mindlessly boast the superiority of its free market regime. Hong Kong’s infatuation with US propaganda notwithstanding, the fact is that US ideological imperialism on free market fundamentalism allowed the financial crisis that began in the US in August 2007 to quickly lead to interconnected market failure in advanced, emerging and developing economies alike the world over.
 
Predatory Dollar Hegemony
 
The exporting economies have been lured into shipping real wealth to the US in exchange for US debt denominated in fiat dollars which cannot be spent in their own domestic economy without monetary penalty and which then must be returned to the US as capital to finance US sovereign debt.  The adverse effects of this predatory monetary regime, known as dollar hegemony, differ on economies at different stages of development. But one common effect can be observed clearly: the helpless working poor in all trading economies around the world, who had no voice in economic, trade and monetary policymaking, did not benefit throughout the phantom boom phase from trade globalization and are now suffering the most in these days of reckoning when the boom bust.
 
Primrose Garden of Poison Reed
 
US neoliberal trade globalization, having promised a primrose garden of economic growth, has instead led the global economy into a jungle of poison reed, resulting in the worst financial disaster in a century, setting the whole world ablaze with a financial firestorm. This unhappy fate was finally acknowledged as having been policy-induced by Alan Greenspan, the former Chairman of the US Federal Reserve who was largely responsible for the monetary indulgence that had caused this hundred-year financial perfect storm. Greenspan confessed before Congress that his trust on transnational finance institutions for self-regulation as a survival instinct had been misplaced, leading him to a flawed policy in support of anarchical financial deregulation and permissive risk management.
 
Still, Greenspan left unmentioned his equally misplaced faith in central bank ability to mitigate the adverse effect of burst bubbles by creating larger sequential bubbles with more liquidity. The Federal Reserve under Greenspan repeatedly created money faster than the global economy could profitably absorb, creating serial bubbles denominated in fiat dollars. Greenspan insisted that it was not possible, nor desirable, to identify an economic bubble in the making as he was inflating it with easy money, lest economic growth should be prematurely cut short. It was a perfect example of the rule that intoxication begins when a drinker becomes unable to know its time to stop drinking.
 
On a more fundamental level, politically independent central banking under Greenspan, instead of being a market-stabilizing force, has become part of the destabilizing causes of recurring economic bubbles. The Hong Kong Monetary Authority (HKMA), the self-styled central bank notwithstanding the peg of the Hong Kong dollar to the US dollar at a fixed rate of 7.8 to 1, thus rendered itself to the status of a monetary policy subsidiary of the US Federal Reserve. When the US Fed eases monetary stance, HKMA must also ease to sustain the currency peg. Thus Hong Kong has been exposed to a contagious bubble from the US bubble. HKMA Chief Executive Joseph Yam has for decades held up Greenspan as his policy guru, tirelessly declaring himself publicly without shame as a faithful disciple of the Wizard of Bubbleland.  Greenspan has confessed publicly his policy blunder. The people of Hong Kong, now suffering the pains of the Greenspan virus, have yet to hear from the self-important Mr. Yam to whom the people of Hong Kong pay an obscenely high salary, 7 times that of Greenspan as Chairman of the Fed, making him the highest paid central banker in the world even though he performs no substantive central banking duites, overseeing one of the smallest monetary regimes in the world.
 
Fiat Dollar Liquidity Destroys Wealth
 
This US-induced global financial disaster that now threatens to keep the world in deep economic depression for another decade and more is essentially the product of US ideologically-based policy and practices. While substantial damage has already been irreversibly done to the world economy by the collapse of economic bubbles caused by a liquidity flood, particularly to confidence in the market system, the US rescue strategy has been to keep the debt bubble from bursting with indiscriminate injection of liquidity. Until the US monetary policymakers realize that excess liquidity denominated in fiat dollars cannot create wealth, but rather it destroys wealth, the debt-infested US economy will not begin to recover.
 
Further damage to the global economy cannot be averted without a fundamental change in US policy that has been exploiting its predatory monetary hegemony. This dollar hegemony grows out of a fiat dollar that has allowed the US to finance its decades-long current account deficit with a compulsory compensatory capital account surplus, sucking wealth from the exporting emerging economies to the US to keep it as the world’s richest economy that consistently consumes more than it produces with the help of debt denominated in fiat dollars that the US could print at will.
 
The Arson of the Global Financial Storm Asking the Burning World for Help
 
Now, in the face of a global firestorm of debt that the US has single-handedly created with its flawed ideology and dysfunctional monetary and trade policies, the international community is being asked to coordinate and followed still misguided US ideology-constraint bailout measures to help the US deal with a global problem of its own making. Yet the solution lies only in fundamental reform of US policy.
 
The venue for this audacity is the White House Summit on Financial Markets and the World Economy of November 15, 2008, called by a lame duck president whose office would last only 8 more weeks beyond the Summit, inviting the attendance of leaders of the G-20 countries, the United Nations, the World Bank, the International Monetary Fund, the Financial Stability Forum and other international agencies.  The members of the G20 are: Argentina, Australia, Brazil, Britain, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United States, and the European Union. The G20 countries combined produce 90 percent of global gross domestic product (GDP), account for 80 percent of world trade, and are home to two-thirds of the world’s population. Also attending the G20 summit are the managing director of the International Monetary Fund (IMF), the president of the World Bank, the secretary-general of the United Nations and the chairman of the Financial Stability Forum. The Summit is billed as the first of a series of follow-up summits to deal with the urgent and complex crisis.
 
The agenda set by the US for the Summit was for world leaders to exchange views on three “important” issues: (1) to assess the progress made by the international community in response to the current financial crisis; (2) to discuss the causes of the financial crisis; (3) to discuss issues such as the regulatory norms and institutional reform in international finance and try to reach consensus on some principles.
 
The key issue of the basic flaw in neoliberal market fundamentalism was not on the agenda. World leaders were not asked to deliberate on new alternative economic orders to save the world from US-created impending financial disaster, but to “coordinate” with US efforts to validate flawed US ideology and to save predatory finance market capitalism based on it.
 
To drive home the point, President Bush gave a speech on The Financial Markets and World Economy at Manhattan Institute in New York City on November 13, two days before the White House Summit, in which he claimed:

The leaders attending this weekend’s meeting agree on a clear purpose — to address the current crisis, and to lay the foundation for reforms that will help prevent a similar crisis in the future. We also agree that this undertaking is too large to be accomplished in a single session. The issues are too complex, the problem is too significant to try to solve, or to come up with reasonable recommendations in just one meeting. So this summit will be the first of a series of meetings.

It will focus on five key objectives: understanding the causes of the global crisis, reviewing the effectiveness of our responses thus far, developing principles for reforming our financial and regulatory systems, launching a specific action plan to implement those principles, and reaffirming our conviction that free market principles offer the surest path to lasting prosperity.

First, we’re working toward a common understanding of the causes behind the global crisis. Different countries will naturally bring different perspectives, but there are some points on which we can all agree:
Over the past decade, the world experienced a period of strong economic growth. Nations accumulated huge amounts of savings, and looked for safe places to invest them. Because of our attractive political, legal, and entrepreneurial climates, the United States and other developed nations received a large share of that money.


It is a gigantic stretch of self deception to claim that the leaders attending the Summit agree on anything besides agreeing to meet. Attendance cannot be misrepresented as supportive of biased US views. The fact is that many in the world think that the idea of a global savings glut is a myth. The US is receiving a large capital account surplus only because of dollar hegemony, a geopolitically-constructed peculiarity through which critical commodities, the most notable being oil, are denominated in fiat dollars, not backed by gold or other species since President Nixon took the dollar off gold in 1971. This financial crisis is US sourced that has spread to the rest of the world.
 
The recycling of petro-dollars into other dollar assets is the price the US has extracted from oil-producing countries for US tolerance for the oil-exporting cartel since 1973. After that, everyone accepts dollars because dollars can buy oil, and every economy needs oil. Dollar hegemony separates the trade value of every currency from direct connection to the productivity of the issuing economy to link it directly to the size of dollar reserves held by the issuing central bank.
 
These dollar reserves held by foreign central banks by definition must be reinvested in dollar assets. Dollar hegemony enables the US to own indirectly but essentially the entire global economy by requiring its wealth to be denominated in fiat dollars that the US can print at will with little monetary penalty. Much of the world is suffering from shortage of capital while non-dollar economies are prevented from financing their domestic development with sovereign credit and had to rely excessively on export for dollars. There is no savings glut, only a dollar glut released by a wayward US central bank addicted to monetary laxative.

World trade is now a game in which the US produces at will fiat dollars of uncertain exchange value and zero intrinsic value, and the rest of the world produces goods and services that fiat dollars can buy at “market prices” quoted in dollars.
 
Blaming the Victims for the Crime
 
President Bush continued with his self-absolving explanation of the global financial crisis:

The massive inflow of foreign capital, combined with low interest rates, produced a period of easy credit. And that easy credit especially affected the housing market. Flush with cash, many lenders issued mortgages and many borrowers could not afford them. Financial institutions then purchased these loans, packaged them together, and converted them into complex securities designed to yield large returns. These securities were then purchased by investors and financial institutions in the United States and Europe and elsewhere — often with little analysis of their true underlying value.

The financial crisis was ignited when booming housing markets began to decline. As home values dropped, many borrowers defaulted on their mortgages, and institutions holding securities backed by those mortgages suffered serious losses. Because of outdated regulatory structures and poor risk management practices, many financial institutions in America and Europe were too highly leveraged. When capital ran short, many faced severe financial jeopardy. This led to high-profile failures of financial institutions in America and Europe, led to contractions and widespread anxiety — all of which contributed to sharp declines in the equity markets.

These developments have placed a heavy burden on hardworking people around the world. Stock market drops have eroded the value of retirement accounts and pension funds. The tightening of credit has made it harder for families to borrow money for cars or home improvements or education of the children. Businesses have found it harder to get loans to expand their operations and create jobs. Many nations have suffered job losses, and have serious concerns about the worsening economy. Developing nations have been hit hard as nervous investors have withdrawn their capital.

Notwithstanding President Bush’s attempt to blame the victims for the crime, the easy credit was not caused by massive inflow of foreign capital. It was the other way around. The massive inflow of foreign-owned capital denominated in dollars was caused by easy credit which grew out of monetary indulgence on the part of the US central bank which alone can issue dollars. This monetary indulgence enabled the US to sustain a current account deficit with a capital account surplus of recycled dollars. The US has been consuming more that it produces through recurring trade and fiscal deficits made possible by dollar hegemony, sucking up wealth form its trade partners who are not in any position to increase domestic consumption because real wealth has been exported to the US in return for fiat dollars that cannot be used in the domestic economy without causing inflation.
 
The reason homeowners defaulted on their mortgages en mass was not merely because home prices dropped, but because these mortgages were made on inflated home prices pushed up by the debt bubble to levels way above what could reasonably be supported by owner income. This is known generally as subprime lending. This was the problem of income disparity created by neoliberal free trade which depressed wages in all economies around the world through cross-border wage arbitrage. Sublime lending also permitted no-down-payment mortgages which gave borrowers incentive to default when home prices fell below the value of the outstanding mortgage.
 
Market-Oriented Leader Resorts to Nationalization
 
President Bush said with a straight face about his ideological surrender:

We are faced with the prospect of a global meltdown. And so we’ve responded with bold measures. I’m a market-oriented guy, but not when I'm faced with the prospect of a global meltdown. At Saturday’s [November 15] summit, we’re going to review the effectiveness of our actions.

Here in the United States, we have taken unprecedented steps to boost liquidity, recapitalize financial institutions, guarantee most new debt issued by insured banks, and prevent the disorderly collapse of large, interconnected enterprises. These were historic actions taken necessary to make — necessary so that the economy would not melt down and affect millions of our fellow citizens.

The “market-oriented guy” is forced to temporarily change his orientation toward massive government intervention in the market until the prospect of a global meltdown is averted. Since August 2007, the “unprecedented steps” the US has taken have so far failed to stabilize market seizure, price volatility and loss of confidence. Equity market value has fallen over 50%. Major financial institutions had to be nationalized or allowed to go bankrupt. Financial sectors in all market economies are moving closer toward total collapse by the day.
 
Once the floodgate of government intervention is open, the ailing US auto sector, in steady decline for several decades, takes advantage of the financial crisis to clamor for government bailout, demanded to be treated on par with distressed financial institutions in their access to more easy money from the government, on the basis of “too big to fail”. Besides the auto sector, every other sector of the economy is waiting in line for Federal government help, as are state and local governments.
 
Market Capitalism Continues to Fail After Massive Government Bailout
 
Market capitalism is failing in every respect and in every corner of the economy even after the US pumped trillions of liquidity into the financial system, both by creating more fiat money and taking on more sovereign debt. Unemployment has reached above 10 million and still rising; with large firms announcing plans to each lay off ten of thousands more. The Federal government is reportedly prepared to provide more than $7.76 trillion, about half of current US annual GDP, which US taxpayers must repay in the future, to keep badly managed institutions form failing. The latest measure announced was to guarantee $306 billion of Citigroup debt.

Total US debt, defined as the sum of all recognized debt of federal, state & local governments, international, private households, business and domestic financial sectors, including federal debt to trust funds - but excludes the huge contingent liabilities of social security, government pensions, Medicare and other government off-budget items, stands at $53 trillion in November 30, 2008. According to the Bank of International Settlement, the total outstanding notional amount of over-the-counter derivative contract was $683.7 trillion as of June 2008, with gross market value of $20.4 trillion. Of this total notional amount, 66% are interest rate contracts, 10% are credit default swaps (CDS), 9% are foreign exchange contracts, 2% are commodity contracts, 1% are equity contracts, and 12% are other. OTC derivatives are largely subject to counterparty risk, as the validity of a contract depends on the counterparty solvency and operational ability to honor its obligations. Against this volume of exposure, $7 trillion is additional obligation if interest rate were to shift 1% on a notional value of $700 trillion. 

As of November 26, 2008, the US has committed or expended, without the benefit of an overall strategy, lurching from emergency to emergency, the following public funds to rescue with little success the collapsing finance sector:

From the Federal Reserve:
(TAF) Term Auction Credit - $900 billion allocated; $415.3 billion expended.
Discount Window Lending - $140 billion
Banks (other loans primary credit) - $93 billion
Investment Banks (other loans primary dealer and other broker-dealer credit) - $47 billion
Loans to buy ABCP (other loans asset-backed commercial paper money market mutual fund liquidity facility) - $66 billion
AIG (allocated minus Treasury’s $40 billion) - $112.5 billion; $87.4 billion expended
Bear Stearns (initial loan to support JPMorgan takeover) - $29.5 billion; $27 billion expended
(TSLF) Term Securities Lending Facility - $225 billion; $200.5 billion expended
Swap Lines (dollars provided by Federal Reserve to foreign central banks) - $602 billion
(MMIFF) Money Market Investor Funding Facility - $540 billion
(CPFF) Commercial Paper Funding Facility *upper limit from Reuters - $1.8 trillion; $271 billion expended
(TALF) Term Asset-Backed Securities Loan Facility - $200 billion
(GSE) Government Sponsored Enterprises and
(MBS) mortgage-backed securities Program - $600 billion
From the Treasury:
(TARP) Treasury Asset Relief Program - $700 billion; $330 billion expended
Exchange Stabilization Fund to guarantee principal in money market mutual funds - $50 billion
Treasury direct purchases of MBS since September - $26.5 billion
Citigroup (Treasury+FDIC guarantees) - $238.5 billion
From the FDIC:
Guarantees for Banks - $1.9 trillion
From Other Sources:
Automakers - $25 billion; $25 billion more pending
Consumer credit - $50 billion (out of TARP)
(FHA) Federal Housing Administration - $300 billion
Fannie Mae/Freddie Mac Nationalization - $350 billion
Grand Total: $7.362 trillion
 
A government plan to sop up hundreds of billions of mortgage securities spurred a bond rally that yanked 30-year home loan rates down half a percentage point to about 5.5 percent in the final week of November.  The supply of unsold homes is near record highs. Buyers fearing job loss, or betting on even greater bargains, are unlikely to commit now to one of their biggest investments. Private sector employers cut 250,000 jobs in November, the most in seven years and the latest sign of recession fallout. US unemployment rate is expected to rise to 6.8% in November after setting a 14-year high of 6.5% the prior month.
 
Government Help Not Going to People in Need
 
After committing over $7 trillion into the finance sector, the market continued to fail and the economy heading downward. If just $2 trillion of the $7 trillion the government has so far committed for the financial sector were to be channeled directly to the unemployed, each worker would receive $200,000 (the equivalent of 4 years at average wages) to tie them over their jobless phase to kick start the economy. The same amount would support for one whole year 40 million middle-income families with an annual income of $50,000. If government funds were directed towards people rather than institutions, consumer demand will revive immediately and companies will sell again to make profits. The recession will end within 18 months.
 
But alas, the measures taken by the US government thus far were all designed to save the financial system and its institutions from the penalty of excessive risk rather than to help the economy and its people from the pains of recession. The net result of this top-down approach would be to punish the economy with a lost decade while feeding the cancer of a dysfunction financial system held together by unsustainable debt.
 
Still, the market-oriented US leader felt the need to adhere ideologically only to a top-down solution. The priority must be to save the dysfunctional financial system and its wayward institutions, while the public must wait for the presumed trickling down benefits, if any. And a decade-long depression will be the result. The 2010s may well be the lost decade for the US economy and its trading partners as the 1990s were for Japan. The leaders of the G20 have a collective responsibility to face the reality of the crisis to save the world economy from total collapse instead of meekly following misguided US rescue measures of adding more liquidity to a crisis created by excess liquidity.
 
The Farce of International Coordination
 
President Bush then reported the “good news” of international coordination:    

In Europe, governments are also purchasing equity in banks and providing government guarantees for loans. In Asia, nations like China and Japan and South Korea have lowered interest rates and have launched significant economic stimulus plans. In the Middle East, nations like Kuwait and the UAE have guaranteed deposits and opened up new government lending to banks.

In addition, nations around the world have taken unprecedented joint measures. Last month, a number of central banks carried out a coordinated interest rate cut. The Federal Reserve is extending needed liquidity to central banks around the world. The IMF and World Bank are working to ensure that developing nations can weather this crisis.

None of these lip-service measures by other governments can be expected to have any significant impact on rescuing the US big domino if the US continues to follow a strategy of adding more liquidity to a crisis of liquidity trap which occurs when the nominal interest rate approaches zero, and the central bank is unable to stimulate the economy with conventional monetary measures. In a liquidity trap, market participants forego higher returns on physical or financial investments to flee to short-term cash accounts, exacerbating an economic downturn and leading to deflation.
 
Helicopter Money Rains only on Distressed Institutions, not Distressed people
 
Fed Chairman Ben Bernanke subscribes to Milton Friedman’s prescription for a liquidity trap by bypassing financial intermediaries to give money directly to consumers or businesses, invoking the imagery of dropping money from helicopters. In essence, it is form of inflation targeting to reverse deflation. Helicopter money can only be dropped covertly to avoid ideological conflict and only to institutions deemed too big to fail. To inject liquidity into a distressed financial system, central banks during a financial crisis sometimes buy gold at above market prices or buying preferred shares and convertible bonds as hidden money to distressed firms.
 
Chairman Bernanke in a speech to business leaders in Austin, Texas on December 1, hinted on the possibility of further central bank relief for a stubbornly sagging economy with the purchase of Treasury notes and bonds to bring down long-term rates. Bernanke’s comments immediately stirred further buying of longer-term Treasury bonds, pushing the yield of benchmark10-year Treasury notes, already at a 31 year low, to 2.719%. The National Bureau of Economic Research announced on the same day that the US has entered a recession since December 2007, a year ago, already longer than all recessions since WWII. A long downturn is projected by many forecasters. The DJIA dropped 680 points, or 7.7%, to 8,149.09, the 12th biggest one-day percentage drop and fourth sharpest point loss since the DJIA was launched in 1869. The fall interrupted a five-day rally of 1,277 points, or 17%, caused previously by the announcement of a new $200 billion program to buy consumer debt and small business loans by Treasury and the Fed. Treasury Secretary Henry Paulson announced that the Treasury has committed all but $20 billion of the first $350 billion Congress has authorized for Troubled Asset Relief Program (TARP).
 
Inflation Targeting instead of Income Targeting
 
Inflation targeting does not work if economic turmoil is caused by the bursting of a debt bubble created by monetary inflation, which could only be cured by allowing the bubble burst to liquidate the misallocated investment made during the bubble boom. The debt bubble burst has left the US with a national insolvency problem of insufficient income to support bloated asset price levels. US ideology of market fixation normally limits the solution to come only from market corrections. However, when market correction causes systemic market failure, market ideology is cast aside to make room for practical emergency measures to revive a market system hit by cardiac arrest.
 
Still, under this market ideology, government assistance is not allowed to be applied directly to distressed individuals who are innocent victims of a dysfunctional debt regime to help them increase their income to transition to a new viable financial regime in a new economic system. It can only be applied to distress institutions deemed too big to fail. Yet nationalization of insolvent private institutions facing weak demand so that they can continue to survive massive losses in a market economy will only bankrupt the entire nation, bringing down all citizens with it.
 
What the US economy needs in this crisis is not inflation targeting but income targeting. Let’s hope the new Obama administration has the sense to implement immediately a massive income policy when it hits the ground running on January 20, 2009.
 
The Case of Japan
 
Japan, whose financial system has been in continuous recession for more than a decade, is ironically relatively sheltered from the current credit squeeze. It has come under US and EU pressure to try to stimulate domestic demand through government spending. Kaoru Yosano, Japan’s minister for economic policy, attacked calls for higher public spending, saying Japan could not afford to add to its gross public debt, already about 180% of national output, the highest in the advanced world. The government is hard pressed to find many worthy targets for stimulus funding. The only possible option is faster expansion of the national Shinkansen high-speed rail network.
 
Mr. Yosano urged more spending on unemployment benefit, saying the government could mitigate the social effects of recession by, for example, doubling to a year the period that benefits could be paid. Japan had learnt that deficit spending was dangerous leading to uncontrollable inflation. Japan could not be a locomotive for the global economy besides bolder emergency fiscal measures and try to stimulate personal consumption in the medium term. Japan’s economy is unlikely to respond to a planned fiscal stimulus but will have to endure higher unemployment and possibly a return to deflation and shrinking output, according to Yosano.
 
Mr. Yosano painted a gloomy economic picture, saying that companies were preparing to cut thousands of non-permanent jobs at the end of 2008 when fixed-term contracts expired. Japan’s labor market had become very fluid, with more than a third of workers in non-regular employment. As a result, the jobless rate, which peaked at 5.5% in the previous recession, could rise more steeply from its present 4.1%. Mr Yosano, a fiscal hawk, played down the likely impact of a planned Y5,000 billion ($52.3 billion) package, saying that most of it was credit guarantees rather than genuine new money.
 
Germany and Russia Accuse the US of Cheap Money Cure
 
German Chancellor Angela Merkel, normally a faithful US ally and a converted free market conservative who grew up in socialist German Democratic Republic, joined Russian President Dmitry Medvedev to accuse the US and other suddenly-interventionist neoliberal governments of making more “cheap money” a central tool of their financial rescue strategy, thus planting the seeds of another greater financial crisis in five years, repeating the Greenspan approach of creating another bigger bubble to cushion a bursting bubble. “Excessively cheap money in the US was a driver of today’s crisis,” Merkel told the German parliament. “I am deeply concerned about whether we are now reinforcing this trend through measures being adopted in the US and elsewhere and whether we could find ourselves in five years facing the exact same crisis.”
 
The chancellor defended her government’s modest fiscal stimulus of €12 billion over the next two years – as a “measured and proportional response . . . tailored to the situation”. Ms Merkel’s comments came as the European Union proposed a €200 billion economic stimulus plan aimed at avoiding a deeper recession through tax cutting and infrastructure spending plans. The proposals envisage the 27 states in the EU contributing €170 billion with the European Commission and the European Investment Bank providing the remaining €30 billion, partly through accelerated fiscal spending programs. Doubts immediately surfaced as to whether its 27 member states would back the EU proposed measures.
 
Russia and France Call for New World Order
 
President Dmitry Medvedev of Russia, in a speech on October 10 at a conference at Evian hosted by French President Nicolas Sarkozy to discuss the international financial crisis, called on European leaders to create a new world order that would minimize the hegemonic role of the US, by asserting that the US was at the root of the global financial crisis. In order to end the “unipolar” model in which the world depended on failed US leadership, he proposed creating new financial systems to challenge the dominance of the International Monetary Fund and the World Trade Organization, both of which had been under Washington’s hegemonic control since the end of WWII.
 
Effect of EU Market Slowdown on China
 
An economic slowdown in Europe was a key factor behind a decision by the People’s Bank of China (PBoC), the central bank, to lower by 108 basis points its one-year lending and deposit rates that banks are allowed to charge, the biggest cut in a decade. The move reflected concern about a collapsed domestic housing market and declining export demand from both the US and the EU concurrently. China had hope that the EU economy would provide a counterbalance cushion for a US slowdown, as the EU market has recently surpassed the US market for Chinese exports.
 
EU-China trade has increased dramatically after WTO accession in 2001, doubling between 2000 and 2005. Europe is now China’s largest export market and China is Europe’s largest source of imports. In 2007, EU goods exports to China were €71.6 billion and EU goods imports from China were €230.8 billion. Chinese export to the EU in 2007 was 23% of its world total of $1.3 trillion.
 
US Consumer Spending Falls
 
US consumer spending is facing sharp long-term decline in a downward spiral that could last several years. At its peak, before the credit crisis imploded in August 2007, US domestic consumption reached 72% of US GDP, which constituted more than 20% of world GDP. This was for a population of 300 million in a world of more than 6 billion people. By the end of 2008, US consumption can be expected to fall below 70% of GDP and can be expected to fall to 65% or less in future years if the economy fails to recover due to inflation targeting that keeps asset prices above the level supportable by personal income. In the third quarter of 2008, a fall in consumption to 70% of GDP subtracted 2.25 percentage points from GDP growth. This was the first quarter with a decrease in consumption spending since 1991.  A downward spiral has begun for the US economy.
 
Durable goods purchases in the US decreased most rapidly, by 14.1% in Q3, 2008. Spending decreased in all categories—motor vehicles, furniture and household equipment—with spending on motor vehicles seeing the largest drop. Spending on non-durable goods also decreased, with spending on food seeing the largest drop. The fall in house prices continued to depress new residential construction. The decline in residential investment subtracted 0.72 percentage points from GDP growth in Q3 of 2008. Consumption declined sharply as a falling percentage of GDP which also declined as a result.
 
China’s Countercyclical Market Response
 
In the face of falling consumer demand in EU and US markets for Chinese exports, China took countercyclical monetary and fiscal measures to try to moderate expected fall in its economic growth rate from double digits to as low as 6% in 2009, below the critical level of 8% needed to keep the economy on an even keel to provide jobs for the 20 million new workers who enter the labor force every year. China has instituted an all out effort to maintain an 8% growth rate. Surely such growth rate could not be sustained by export alone even when the global economy was robust. It can only be maintained with a policy to develop the domestic market. Because of an under funded social security safety net and an inadequate medical care insurance regime, Chinese consumers prudently save a large portion of their income. Consumer spending constitute only 35% of GDP, falling from 50% in the 1980s, compare to 72% in the US. Accordingly, it is reasonable to expect the stimulus package to reinforce China’s neglected social safety net. From that perspective, the CNY 4 trillion stimulus package, to be spent over a two year period, is grossly under funded unless high leverage is used.
 
G20 Meeting in Brazil
 
Five days before the White House Summit, finance ministers and central bank governors from the G20 major industrial and emerging economies closed their annual meeting in Sao Paulo on November 10, vowing in a joint statement that the G20 has “a critical role to play in ensuring global financial and economic stability.” The Group of 20 agreed that tax cuts and increased fiscal spending are necessary to avoid a global recession. However, the joint statement said “each country will take actions according to its own situation.”  The emerging BRIC (Brazil, Russia, India and China) nations asserted jointly that they, together with developing economies, must be given a bigger voice in supranational organizations, such as the IMF, the World Bank and the WTO.
 
China’s Monetary Response
 
On November 14, 2008, the PBoC new lending rate was lowered to 5.58% and the new deposit rate to 2.52%. The central bank had already cut the benchmark rate three times since September 16 and the benchmark deposit rate twice, by 0.27 percentage points each time. PBoC also reduced the percentage of assets that large banks must hold as reserves by 1 percentage point, and cut reserve requirement by 2 percentage points for smaller banks. To give banks an extra incentive to lend money instead of hoarding reserves, the central bank also lowered by 0.27 percentage points the interest rates that it pays banks for reserves deposited with it.
 
China announced a “stimulus package” of CNY 4 trillion ($586 billion) on November 14.  In its Five Year Plan spanning 2006-2010, the government earmarked CNY 5.1 trillion for spending on infrastructure projects. China must shift from low-value exports to high-value-added export and to redeploy manpower and investment toward production for the domestic market to reduce the economy’s excessive dependence of export. It must boost domestic investment financed by sovereign credit denominated in Rmb to balance overdependence on foreign direct investment which tends to concentrate in the export sector located in the costal provinces. More critically, China needs to stimulate domestic consumption by raising wages aggressively. This cannot be done as long as the economy is dominated by export sector which must compete with low wages.
 
It is imperative that the stimulus package be focused on combating the serious problem of migrant unemployment in the stalled export sector. Laid-off migrant workers should receive government assistance to return to their home villages to work in government-supported new enterprises that produce for the domestic market. The stimulus package should not be used to bail out failing foreign-owned export firms of labor-intensive, low-tech manufacturing that have been concentrated in the Pearl river delta near Hong Kong and the Yangtze river delta near Shanghai.
 
China must use the opportunity offered by the current global financial crisis to restructure and reorient its economy toward domestic development financed by sovereign credit denominated in Rmb, away from excessive dependence on export for fiat dollars to feed profit to foreign investment. This shift requires a period of strict capital and currency control until China is free from the effects of dollar hegemony which inhabit the application of sovereign credit for domestic development.  In this uncertain climate of international financial turmoil, China should refrain from further measures to move its currency towards free and full convertibility in the global currency markets. Appreciating the exchange value of the Rmb will only strengthen dollar hegemony while doing little to solve China’s problem of export dependency.
 
The amount of sovereign credit needed to develop the Chinese domestic economy will be enormous and much larger than China’s current $2 trillion foreign reserve. Any further move toward free and full convertibility of the Rmb will restrict China’s ability to finance its much needed domestic development with massive sovereign credit. Until foreign trade is reduced to around 35% of GDP, China will find it counterproductive to let the Rmb appreciate against other currencies. The domestic sector must accelerate its growth to reduce the current level of foreign trade from its 70% of GDP to around 30% of GDP, and to increase consumer spending to 70%. This means the domestic sector must grow at a rate double that of the export sector.
 
Four days after the G20 meting in Brazil, President Bush warned in New York a day before the Summit in Washington:

This crisis did not develop overnight, and it’s not going to be solved overnight. But our actions are having an impact. Credit markets are beginning to thaw. Businesses are gaining access to essential short-term financing. A measure of stability is returning to financial systems here at home and around the world. It’s going to require more time for these improvements to fully take hold, and there’s going to be difficult days ahead. But the United States and our partner are taking the right steps to get through this crisis.

It is true that the crisis took over two decades of flawed policy to develop. But surely the rescue cannot be allowed to take two decades to take effect.  The claim that US actions so far are having an impact on reviving the economy is misleading. The Congress is up in arms about the ineffective and misdirected measures taken thus far by the Bush administration which had asked and received a blank check of $700 billion to arrest the crisis. Yet the Bush administration remains unable to find ways to help the general public directly or even to force banks receiving billions of easy government money to lend to the needy public.
 
The US economy has been on a sharp decline since August 2007 with no bottom in sight.  The president’s reassuring remarks underscores his detachment from economic reality.  Thus far, every emergency action taken by the Federal Reserve and the Treasury without the framework of an overall strategy bought only fleeting reprieve in the stock market before it continues it steady fall. The DJIA can conceivably fall toward 4,000 before this crisis is over. All the measures urged by the US on its trade partners were focused on keeping the international financial system from imminent total meltdown. Long-range reform has yet to begin. And it cannot begin before a consensus is reach among trading nations on the true nature of the problem which may not surface before many more summits. The next summit is schedule in April 2009 when the US will be represented by President Obama and his new economic team.
 
Still, President Bush went on to call for long-range reforms to “establish principles for adapting our financial systems to the “realities of the 21st century marketplace”.  Yet what is needed is to reform the lethal “reality” of this failed market. Still, it is premature to talk about long-range reform when the full energy and resources of the government is needed to focus on putting out a raging fire emergency that threatens to destroy the entire financial system.
 
President Bush continues to assert the illusion that “history has shown that the greater threat to economic prosperity is not too little government involvement in the market, it is too much government involvement in the market,” to long applause from the New York audience of business executives. He cited the case of Fannie Mae and Freddie Mac as an example, notwithstanding that had these agencies remained government owned rather than privatized in 1968, their current problem with structured finance would not have surfaced. The president said: “There is a clear lesson: Our aim should not be more government — it should be smarter government.”
 
Yet this is a false alternative: smart government is always necessary, big or small. Anyway, Bush is leaving office with a major part of the financial sector nationalized for a period that may last decades before they can be privatized again. Private financial entrepreneurship has been put under emergency house arrest in the US. Investment banking has totally disappeared from the US financial landscape, with all investment banks turning themselves into regulated banks owned by bank holding entities in order to receive government bailout. The net effect of government bailout has been to keep private capital off the market.
 
While admitting that market failures are no longer deniable, and that “voices from the left and right are equating the free enterprise system with greed and exploitation and failure,” the president continues to argue that “the crisis was not a failure of the free market system. And the answer is not to try to reinvent that system.” He went on with a standard defense of market capitalism yet neglecting to address the problem that global financial market cannot be free without getting rid of currency hegemony.
 
Showing his ideological conceit, President Bush asserts that “free market capitalism is far more than economic theory. It is the engine of social mobility — the highway to the American Dream.” He cites technological inventions as evidence of his ideological fixation. It is true that the US socio-economic system has produced much that benefited mankind, yet inventions are not unique to US capitalism. Historically, inventions also were made under feudalism, communism and even fascism. President Bush concludes that “today, the success of the world’s largest economies comes from their embrace of free markets.”
 
By now, a case can be easily made with solid evidence that the failure of the world’s market economies comes from their incriminate embrace of unregulated free markets. Most Americans do not consider it part of the American Dream to allow executives of failed corporations to walk off with obscene bonuses when corporations under their management suffer billion in losses that lead to layoffs of ten of thousand of workers whose hard work had been wasted by mismanagement.
 
Brazilian President Luiz Inacio Lula da Silva said after the November 15 White House Summit he was gratified emerging countries like Brazil were be given a role in restructuring the global economy. He also said the G8 was no longer relevant in today’s globalized world. Indian Prime Minister Manmohan Singh said the crisis served as proof that countries which were excluded in the past must be included in the future. Mr Singh added that whatever economic model to be chosen to deal with the current international crisis, it would have to be genuinely multilateral and reflect the changes in the global economic reality.  It is clear that the emerging economic economies which have for years been demanding a greater say in international affairs, sense that the time has finally come to assert their just claim.
 
In the spirit of cooperation, Chinese President Hu Jintao accepted the US invitation and took an active part in the Summit-related activities in a constructive attitude, worked together with all the parties for the achievement of a pragmatic outcome, and to move the international community to deal with the global financial crisis in a timely, comprehensive and effective manner. Along with other leaders, President Hu attended the welcome banquet hosted by the US President George W Bush for the participating leaders on the evening of Nov. 14 at the White House; the summit discussions and the working lunch on November 15; and held bilateral meetings with the leaders of other countries.
 
While economic relation between China and the US is of great importance, it is still only one component of China-US relations in which China seeks a peaceful and constructive strategic partnership with the US on the basis of equality and mutual benefit. 
 
Acknowledging that the White House Summit will be critical for the future of the existing global economy, President Hu urged follow leaders: “When coping with the financial crisis, the international community should pay particular attention to the damage of the crisis on developing countries, especially the least developed countries (LDCs), and do all it can to minimize the damage.”
 
President Hu reaffirmed that China will deepen reform and open wider to the outside world, deliver steady and relatively fast economic growth, and play a constructive role in ensuring global economic stability. “Steady and relatively fast growth in China is in itself an important contribution to international financial stability and world economic growth," he noted, telling other participating leaders that “the Chinese government has adopted measures to boost economic development, including lowering the required bank reserve ratio, cutting the deposit and lending rates, and easing the corporate tax burdens.”  China has also introduce measures to subsidize and encourage consumer spending.
    
“As a responsible member of the international community, China has taken an active part in international cooperation to deal with the financial crisis and is playing a positive role in maintaining international financial stability and promoting development of the world economy. Stability of international financial markets and sustained development of the global economy are crucial to the wellbeing of all countries and people,” said President Hu, calling all to overcome difficulties through concerted efforts and to contribute to maintaining international financial stability and promoting global economic growth.
 
“The international financial crisis has now spread to the entire globe, from developed countries to emerging markets, and from the financial sector to the real economy. To effectively deal with the financial crisis, all countries should strengthen market confidence and intensify coordination and cooperation,” said President Hu.  To deal with the crisis, President Hu said major developed countries “should undertake their due responsibilities and obligations, implement macroeconomic policies that are conducive to economic and financial stability and growth both at home and internationally, take active steps to stabilize their own and the international financial markets and safeguard investors' interests. At the same time, all should enhance macroeconomic policy coordination, expand economic and financial information sharing, and deepen cooperation in international financial regulation so as to create necessary conditions for stability in both domestic and international markets.”
 
President Hu urged the international community to draw lessons from the ongoing financial crisis and through consultation undertake necessary reform of the international financial system. “Reform of the international financial system should aim at establishing a new international financial order that is fair, just, inclusive and orderly and fostering an institutional environment conducive to sound global economic development,” Hu said. He called for reform to be conducted in a comprehensive, balanced, incremental and result-oriented manner to seek a balance among the interests of all parties. All reform measures should “contribute to international financial stability and global economic growth as well as the wellbeing of people in all countries.”
 
To cope with the crisis, President Hu said efforts should be focused on three aspects:
 A) Effective measures should be adopted to prevent the further spreading of the crisis and help the market to regain confidence;
 B) Efforts should be made to minimize the adverse impact upon the real economy so as to avoid a global recession;
 C) Pushing ahead with the reform of international financial systems so as to avoid the recurrence of similar crises.
 
President Hu said that at present, “the global economy is stalling, instability and uncertainty are increasing, the situation is serious and complex. All countries should adjust their macroeconomic policies to stimulate economic growth through fiscal and monetary means and to control speculative opportunism in energy and food markets. The international community should reject all forms of trade and investment protectionism and to complete the Doha round negotiation.”
 
The Doha Development Round is the current trade-negotiation round of the World Trade Organization (WTO) which commenced in November 2001. Its objective is to lower trade barriers around the world to increase trade globally. As of 2008, talks have stalled over major issues of agriculture, industrial tariffs and not-tariff barriers, services, and trade remedies. The most significant differences are between developed nations led by the EU, the US and Japan and the major developing countries led and represented mainly by India, Brazil, China and South Africa. There is also considerable contention against and between the EU and the US over maintenance of agricultural subsidies that acts as trade barriers.
 
The negotiations collapsed on July 29 over issues of agricultural trade between the US, India, and China. In particular, there was insoluble disagreement between India and the United States over special safeguard mechanism (SSM), a measure designed to protect poor farmers by allowing countries to impose a special tariff on certain agricultural goods in the event of an import surge or price fall.    
   
President Hu said that to ensure international financial system reform to adhere to a comprehensive, balanced, progressive and effective approach, China proposes four key reform initiatives:
1) Strengthen international cooperation on supervision and regulation of financial markets to perfect the international supervisory and regulatory system, to establish a standardized code of conduct for rating agencies, increase global efforts to monitor capital flows, to expand supervision and monitor capacity and strengthening regulation over various financial institutions and intermediaries to improve transparency of financial markets and their products.  
2) Promote international financial architecture reform, decision-making level and creation process, elevate the representation and voice of developing countries in international financial organizations, speedily establish a world wide, especially for the major international finance centers an early warning system, improve internal control of international financial organizations to establish timely and high effect crisis rescue process to enhance the ability of international financial organizations to thoroughly discharge their responsibilities.    
3) Encourage regional financial cooperation to increase flexible mutual assistance ability, to strengthen regional financial infrastructure to fully facilitate the effectiveness of regional relief funding.
4) Improve international currency regime to steadily promote the steady diversification of the international monetary system to provide the common support of the stability of the international monetary system.
 
The four reform initiatives proposed by China broaden significantly the agenda proposed by the White House Summit, particularly its call for currency diversification in the international monetary system. A stable exchange rate is not only beneficial to trade, but it is also fundamentally critical to global financial stability.  Every financial crisis since the 1971 collapse of the Bretton Woods fixed exchange rate regime has been caused by exchange rate instability. Exchange rate policies cannot be substitutes for structural economic adjustments necessary for mutually beneficial trade between two economies. Nor can exchange rate policies be substitutes for sound domestic monetary or economic policy. Above all, the international monetary regime must be free from currency hegemony which distorts the cross-border flow of funds and restricts the use of sovereign credit for financing domestic development. 
 
Among the major currencies of the emerging economies, the Rmb (CNY) in 2008 has registered the largest appreciation against the US dollar (7.8%), in nominal effective terms (13.4%) and real effective terms (13.5%). By policy, CNY has risen almost 24% against the euro since this beginning of July. Over the same period the CNY has appreciated about 9% on a nominal effective exchange-rate basis.  In 2007,  the central bank raised interest rates six times and also increased banks' reserve requirement ratios 10 times, followed by another reserve requirement hike in January, 2008.  Meanwhile, successive interest rate cuts by the U.S. Federal Reserve to kick start the economy widened the China-US interest rate spread and helped weaken the US currency further. Yet, as a result of the effect on China's economy from the international financial crisis, the CNY on July 28, 2008 had the largest one-day fall from market forces since China cut the peg of the Rmb to the dollar in 2005.

The economic growth of Guangdong province north of Hong Kong has given it the biggest GDP among all of China’s provinces. This has been in larger measure due to the enormous growth of small and medium enterprises (SMEs) in the past three decades. These SMEs are mostly owned and operated by investors from Hong Kong and Taiwan. Although over three decade, these SMEs have themselves gone through several stages of metamorphosis, they are mostly still labor-intensive, high-pollution, export-oriented manufacturers prospering from outsourcing contracts from US and EU brands, with the largest portion of financial benefits going to foreign investor and US importers. The competitive advantages in China’s foreign trade have rested on two components: cheap labor cost and loose environmental regulations. These competitive advantages are in reality trade disadvantages for China. Foreign trade is further disadvantaged by its being denominated in fiat dollars of uncertain exchange value and zero intrinsic value.

As the Rmb appreciated in the recent years, and commodity prices skyrocketed, these labor intensive, high pollution, low-margin, short-term contract manufacturing business model have been struggling to survive on razor-thin margins. Government policy to encourage high-value added manufacturing, higher wages and benefits, tighter environmental regulations and improved workplace safety standards, and product safety inspection have made profitability increasingly elusive for SMEs unable to upgrade from sweatshop cottage industries to modern factories.  Large number of outmoded SME routinely went out of business to be replaced by more efficient firms at each stage of industrial metamorphose.

The international financial crisis that began in 2007 now threatens even the stronger and better managed SMEs, causing several to shut down abruptly, some failing to pay wages owed to workers. The Hong Kong Special Administrative Region which operates under market capitalism is putting pressure on the Central Government in Beijing to provide public assistance to Hong Kong- owned SMEs in the Peal River Delta.

While SMEs are recognized as an important component of economic growth, the leadership of Guangdong province has publicly rejected any government bail out of operationally obsolete SMEs. Their fate should be determined by market forces. The government, however, will ensure that the closing of obsolete SMEs do not lead to unfair treatment of displaced workers. Only SMEs that fit well in China development plan to upgrade its economy should receive government help. The Pearl River Delta will concentrate on high value-added, high-tech and services industries and create opportunities for a better grade of employment. The international financial crisis provides an opportunity and urgent imperative for Guangdong to accelerate its economic restructuring.

China needs to recognize that market capitalism with central banking is not the most effective or efficient system to achieve full employment with rising wages. China needs to adopt a full employment policy as a national objective. A socialist system must provide every able citizen who wants to work opportunity for work. China is still grossly underdeveloped economically. With so much to do to bring China into a modern nation, it is hard to imagine a country like China not faced with a labor shortage. China must create an economic system that puts full employment as a top priority, not allow itself to be trapped by neoliberal market fundamentalism of using unemployment to keep wages low to protect the value of money.
 
What China must do in a Changing World Economy
 
With recurring capitalistic market crashes, the world is beginning to realize that market capitalism can destroy wealth as fast as it can create wealth. While keeping markets as an auxiliary mechanism for efficient allocation of resources, China must rely on central planning to direct investment in an orderly manner in sectors needed for national development, such as modernization of food production and distribution. It must rely on planning to direct investment towards physical and social infrastructure, in universal education and universal health care. These investments must be increased and accelerated with much higher target for each 5-year plan.
 
To do this China must develop more respect for and reliance on domestic indigenous talent and make more opportunities available to young people. Brain drain is the greatest loss China has suffered in the past century. In recent years, massive brain drain has plighted the Chinese finance sector. China must develop policies to stop further brain drain and to revert the flow of human resource back into China.
 
China must invest more on domestic development than on export, particularly on rural development. It must not look for growth through cross-border wage arbitrage by foreign capital. Wage income is the only reliable index of growth for any economy. Export-led growth is unsustainable for meeting the needs of an economy that comprise one fifth of the world’s population, particularly when export earning is denominated in fiat dollars that cannot be spent in China domestically. Modernization is not merely blindly copying the advanced economies. China must avoid excessive faith in market forces while taking care not to ignore them. It must set a framework in which market forces that create benefits for the community are encouraged and those that create costs to community are penalized.
 
At its root, China is an agricultural economy. Chinese leaders have depicted the new socialist countryside program as having higher productivity, improved livelihood of farming families, higher-degree civilization with greater socialist ethics, clean environment and democratic management in the 11th Five-Year Program (2006-2010) period, showing the resolve of China’s leadership to spread the fruits of reform to its rural areas, especially poor regions.
 
The Central Government allocated 13 billion yuan ($1.6 billion) in 2007 to its poverty reduction program, 13 times that in 1980 and 37.2% of which was earmarked for the autonomous regions of Inner Mongolia, Xinjiang, Ningxia, Guanxi and Tibet, and provinces with large ethnic populations, such as Guishou, Yunan and Qinghai. While this a good start, it is woefully inadequate. What is needed is 100 times the amount ($160 billion) every year until these regions reach self-sustaining prosperity. After all, a nation that holds close to $2 trillion in foreign exchange reserve, should not tolerate poverty anywhere within its borders.  
 
After more than 30 years of economic reform, the poverty rate in rural areas has dropped to less than 3%. But that still leaves 40 million poor due to China’s big (1.3 billion) population. China also has 26 million people who live in at subsistence level beyond the reach of the poverty reduction program. The Chinese government has turned more attention on its rural poor by reducing various taxes and promoting free universal compulsory education. The agricultural tax, which has had a history of 2600 years, was rescinded completely in 2006 and an increasing number of children in rural areas gained access to free compulsory education. China also has begun lower the price of medical services by reinstituting a rural cooperative medical service system. Still such a timid anti-poverty program for the world’s largest creditor nation is a glaring contradiction.  Yet this program is too timid allowing poverty to continue to be a drag on economic growth. 
 
China has since unveiled ambitious plans to help the 800 million people living in the countryside catch up economically with city dwellers. More rural investment and agricultural subsidies and improved social services are the main planks of a policy to create a “new socialist countryside”, which President Hu Jintao had declared as a national priority.
 
The new policy regards constructing a new socialist countryside an important historic task in the process of China’s modernization. “The only way to ensure sustainable development of the national economy and continuous expansion of domestic demand is to develop the rural economy and help farmers to become more affluent,” the policy asserts. It aims to modernize the countryside, which has fallen behind in China’s development in recent decades. From 2006 until 2010, the government promises sustained increases in farmers’ incomes, more industrial support for agriculture and faster development of public services. Yet current plans remain timid in relation to the size of the problem and must be redoubled to prevent rural poverty from emerging as a drag on national economic development.
 
Local governments have been warned that they will be held to account for ineffective administration and misallocation of precious resources on false symbol of prosperity. The new measures promise greater protection and improved democracy in rural areas, and local government bureaucracies will be streamlined to increase cost effectiveness. Instead of gauging progress by GDP growth, attention should be paid to income growth, particularly farm income growth. Income is all; without income, all else is mirage.
 
In part, the new socialist countryside policy is driven by concerns about China’s ability to sustain food self-sufficiency going forward as a global crisis of food is fast building. The past 25 years of rapid urbanization have seen much farmland turned into urbanized development zones, and more than 200 million farmers have migrated to the cities to serve export sector needs.
 
The new food policy proposes that China should remain “basically self-sufficient” in grain. It promises increased subsidies for farmers growing grain, as well as continued revenue “bonuses” for local governments in the grain belt, and says the government will continue setting minimum prices for grain purchases.
 
With more than 800 million people living in the countryside, the only way to ensure sustainable development of the national economy and continuous expansion of domestic demand is to develop the rural economy and help farmers to become more affluent than city dweller to reverse the migration trend. The program also stressed that construction of the new countryside should focus on practical development and involve democratic consultations. Most of all, ample farm credit must be provided by the central government to help poor rural region to kick start development.
 
Chinese agriculture is at a crossroads as the benefits of the agricultural changes first ushered in late 1978 have lost momentum. Grain production, which reached record levels in 1984, dropped suddenly in 1985 and is only now beginning to push above 1984 levels. The area under cultivation, already small compared with the population, is steadily declining as new housing, schools, factories and roads nibble away at rice paddies and wheat fields. State investment in agriculture has dropped precipitously over the last two decades.
 
China’s exposure to the international financial crisis is primarily a result of its high dependency on export, which in turn is the result of high dependency on financial market forces to allocate the use of capital, particularly foreign capital. Markets seldom direct resources where they are needed, only to where profit is easiest and highest. Market forces when unregulated and undirected always lead uneven and sometime undesirable development. Much of China economic dilemma today is the result of blind acceptance of the Hayekian efficacy of market forces. The reliance of a labor market to direct economic development is counterproductive. China needs to understand that labor is not a commodity but a national resource. The value of labor should not be allowed to be set by supply and demand in a labor market. It should be set by national policy around which markets are organized to fulfill it. This is the fundamental flaw of China economic reform for the past three decades.
 
China’s ability to rescue the stalled global economy through reform in trade is extremely limited. The best way for China to contribute to the stabilizing the world economy is to develop China’s domestic market and to increase the purchasing power of the population through a progressive income policy with full employment.  It fact, China needs to adopt a bottom up development strategy of direct assistance to people, the opposite of the US top-down development strategy of assistance to institutions. This means a strategy to set the increase of personal income and social benefits as goal around which the economic system is organized, rather than letting personal income and social benefits be the outcome of imported dysfunctional economic systems such as predatory neoliberal cowboy market capitalism.
 
December 3, 2008