By Daniel J. Arbess
The recently concluded G-20 meetings in Korea were generally dismissed as a failure because participant nations could not establish a united approach to rebalancing global trade. But the fact that these nations are even talking about these issues at last may signal that the global narrative is finally set to move through a period of adjustment to a new and ultimately healthier track. Global consensus is very close to appreciating that the present model of global growth—a marriage of Western over-consumption of cheap Eastern product on credit, with the East’s continued over-dependence on selling and lending to the West—is no longer sustainable in a world where there is too much capacity and not enough demand and credit. We may look back at this moment as marking the start of an essential process of rebalancing leverage and consumption, and thereby coalescing around a more sustainable global growth trajectory.
The first stage in the discussion needs to be an improved understanding of how the world arrived at its present imbalanced track. Here’s how today’s model works: China works, builds and lends. The West borrows, buys and consumes. They drive 5-year urbanization and employment targets, generating low wages, long hours, high education standards, and 24/7 productivity. We have high-paid unions working 35-hour weeks; over-leveraged consumers defaulting on $10 billion a month in mortgage payments and paying off credit cards to buy themselves new iPads; and a democracy beholden to special interests, and apparently incapable of making complex policy choices until forced by crisis. Chinese consumption is 35% of GDP, and they save half of their disposable income and have no real government benefits. We consume twice as much, save a fraction, and rely on entitlements that add up to a multiple of our GDP.
This arrangement has worked for the past thirty years because it has given Western consumers more choices for less money, while at the same time fueling the industrialization of China and other emerging markets. Over the past decade, notably since China joined the WTO, the relationship evolved into a seemingly harmonious paradigm: “We will buy your inexpensive products if you buy our expensive bonds.”
But this relationship has recently seemed more like a marriage of unhealthy co-dependency. China has become the key enabler to irresponsible American consumers, even while it became ever more entrenched in financing our purchases of its products. It couldn’t last forever. The West’s consumers and governments are tapped out with too much debt to bear (as evidenced most recently by the debt crisis in Europe and growing doubts about the sustainability of debt levels in Japan, the UK and the United States), while China finds itself with too much capacity, too much savings, too much of our debt and not enough of its own consumption.
At the recent G-20 meetings, European leaders emphasized the importance of asserting fiscal discipline to restore economic confidence, while the United States focused on the need for higher consumption outside the United States. Both are necessary. The question is whether they will come about from here in a coordinated or unilateral fashion. On this front, the lack of consensus in Korea is concerning. European leaders are perfectly happy to see the Euro falling, because it helps European exports. But the Obama Administration is also calling on U.S. companies to double exports to offset declining domestic consumption at home. If every nation is looking to an export solution, who will buy?
A potentially un-coordinated currency devaluation risks triggering destructive beggar-thy-neighbor trade wars and protectionism. History shows this isn’t the way. Almost two years into the financial crisis, Central Bankers have so far avoided the temptations of protectionism, but nationalistic tendencies are reaching new heights and increasing the risk.
What is clear is that there will be no quick fixes here; no more big government-spend-us-back-to-status-quo band-aids. Real policy accomplishments and changes in consumer behavior are going to be required in both the East and West. We in the West need to consume less and borrow less, while our friends in the East need to consume more and lend less.
How? First, Euro-Dollar policies need to be stabilized to give companies on both sides of the Atlantic balanced access to each other’s markets. This requires talk about taking down tariffs rather than simply resisting the urge to put them up. Second, the United States and other Western governments need to reign in unaffordable entitlement programs to restore fiscal discipline, while China needs to move in the opposite direction and establish enough social benefits to stimulate its consumers to save less and consume more. As domestic consumption rises in Asia, the Yuan and other emerging currencies can be gradually re-valuated, leveling the playing field for both American and European consumers to fairly access China’s market.
There is every reason why the powerful twin forces of American innovation and emerging markets’ modernization should still drive the world forward in the coming decades, just as they have in the recent past. The necessary rebalancing of these powers seems at least to be reaching the agenda of the world’s economic leaders. It will take time, but we are finally on the right track.
Daniel J. Arbess is a partner of Perella Weinberg Partners and manages the Xerion investment strategy. He would like to thank Mike O’Rourke, chief strategist at BTIG, for his helpful input on this column.