If the patient is sick with pneumonia, treating him for an ulcer isn't going to do much good.
In fact, the patient is likely to get worse and die, even though the disease that killed him was certainly treatable.
I'm afraid we're going to do exactly that in the current global financial crisis. The treatments that the doctors -- from the Federal Reserve's Ben Bernanke to Rep. Barney Frank, D-Mass., to Sen. Charles "Let them commit suicide" Grassley, R-Iowa -- have proposed don't even vaguely address the right disease.
The disease isn't greed. That's always with us on Wall Street.
It isn't a failure of regulation -- that certainly didn't help -- but regulation in the modern financial world is like trying to prevent a dam collapse by sticking a finger in the dike.
It's not even the cupidity and stupidity of many of our elected representatives -- although, God knows, as I showed in this column, that sure didn't help.
The disease goes much, much deeper. The world's circulatory system simply isn't up to the big challenge of the 20th and 21st centuries: how to circulate immense quantities of money, more than the world has ever had in circulation before, from accumulating countries such as China and Saudi Arabia back to the spending countries of the United States, Europe and Japan.
The result is the financial equivalent of cardiac arrest.
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Follow the money -- to China
Let me use the examples of China and the United States to illustrate the problem that has brought the financial system to its knees.China's foreign-exchange reserves now exceed $2 trillion. In 2007, before the global economy went into a nose dive, China's trade surplus hit $262 billion. That was up 47% from 2006. Every month an increasing part of the world's cash wound up in China.
In that same year, the United States ran a trade deficit of $709 billion. Oil and oil products accounted for $293 billion of that deficit, according to the U.S. Bureau of Economic Analysis. Consumer goods accounted for $328 billion of the deficit, and a good part of that went to China.
In a healthy world, the surpluses don't sit in one place until all the world's wealth winds up in one spot and the rest of the world collapses. It gets recirculated. Here are three ways that can happen over time:
- The currency of a surplus country will, all things being equal, rise in value, while that of a deficit country will sink. Over time that reduces the deficit as the surplus country's exports get more expensive and the deficit country's exports get cheaper.
- A deficit country's standard of living declines as its citizens spend less, and a rise in the standard of living occurs in the surplus country. The residents of the deficit country spend less, leading to a drop in their deficit, and the residents of the surplus country spend more, leading to a drop in their surplus.
- A happy ending: The residents of the deficit country could work harder and more productively. They could invent new products so desired by the rest of the world that the deficit would shrink.
Some of the mechanisms operate quickly. An official at a government or commercial bank in Beijing -- or Moscow or Riyadh, Saudi Arabia -- can decide to take some of that surplus and buy U.S. Treasury bonds or stock in General Motors (GM, news, msgs) or real estate in Manhattan. That keeps money circulating in the global economy and prevents its buildup in one or several parts of the globe.
This quick "solution" has one problem: It's really no solution at all. The cash does indeed get recirculated, but each time it does the deficit country winds up writing more in IOUs, and the surplus company winds up holding more IOUs. It's really just a holding action until the long-term mechanisms can redress the balance.
Fast and unfortunate
Unfortunately, despite their inherent inadequacies, the quick solutions often are left to hold the fort for a distressingly long time. And that's exactly what happened in the run-up to the global financial meltdown that began in 2007.Globalization -- and the integration and rise of the world's developing economies -- have been taking place at a breakneck pace. Who would have believed 20 years ago that China would become the world's third-largest economy in 2008? Or that so many jobs and, in some cases, whole industries would essentially be shipped from the developed world to countries with low labor costs?
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Is it time to chase stocks?Last week the Federal Reserve said it would buy $300 billion in Treasurys, sending stocks higher. It was a nice boost to stock prices, Jim Jubak says, but investors need to remember that we’re still in a bear market. (March 23)
Meanwhile, the longer-term solutions have yet to kick in:
- Developing economies have been slow to let their citizens spend their growing wealth. Government decisions to provide only a pittance, if any, of a pension at retirement, restrictions on land rights that prevent farmers from selling their land, and moves to market-based, for-fee education and health care systems have all depressed spending. If you know the future is completely up to you, you put as much as you can under the mattress.
- Developed economies have been slow and, in some cases, actively delusional about addressing the limits of their wealth. Japan, the European Union countries and the United States all offer unsustainably high retirement and health care benefits, for example. The Bush administration's calls to expand the percentage of Americans who own their own homes in a period of stagnant family incomes made political but not financial sense.
- Developing economies have remained wedded to controlled currency exchange rates that slowed the appreciation of their currencies against those of their trading partners. The lessons of the Asian currency crisis of 1997, which nearly bankrupted export-based economies that hadn't put enough in the bank, led to an almost obsessive drive to build up reserves.
For all these reasons and more, the world came to rely more and more on short-term solutions. And as the period that short-term solutions were called upon to fix stretched out further and further, it put increasing strain on the short-term system itself.
Continued: Make-believe safety
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