Part 13 (2/2)

Still, in the recent crisis the household savings rate fell sharply as income-strapped households had to spend ; even the current account surplus shrank, as rising budget deficits and falling private savings overwhelmed the fall in private investment Should these trends continue, japandeflation, ane yen conspire to drive down confidence in its econoencies have put japan on a possible sovereign downgrade watch If japanese households lost confidence in the governht duovernment bonds) and resu down the value of the yen and sending long-terer a public debt crisis

Unfortunately, the japanese political system's ability to deliver the kind of fiscal adjusts around is limited In 2009 the opposition Democratic Party of japan (DPJ) finally ousted the dominant Liberal Democratic Party (LDP), which had maintained a virtual monopoly on power for over fifty years This political shi+ft suggested that japan ested otherwise

Upon assu office, the DPJ's new leader, Yukio Hatoya the constraints on japan's budget, he and his party pro At the same time, he called for ”an econonificant state subsidies, as well as a budget that required record borrowing Equally troubling, Hatoyama then announced plans to halt the privatization of japan Post Bank This enormous enterprise, which holds more than 3 trillion in assets, has helped finance state spending for decades, and the move made it clear that Hatoyama expects to continue this tradition

These policies will likely increase debt and keep growth at subpar levels Unfortunately, Hatoyaoals has few political checks: in recent years, the DPJ built a strong single-partyforces with coalition partners to dominate the upper house Hatoyaous to the filibuster of the US systeenda

At the saer economy Prior to the DPJ's ascent to power, business elites worked with an LDPDOMINATED bureaucracy to fraislation Suddenly, the business elite has seen the one-party syste coalition has far fewer connections in the business world That means it has few opportunities for the kind of compromises necessary to achieve the sorts of structural refor years

That erous position, as soaring deficits and a sclerotic econon debt crisis or a surge in inflation and a decisive fall frolobal econo econo between 5 and 8 percent, depending on the country This growth rate is her than the 2 or 3 percent thatyears

Their strength hasinto the recent crisis Except for parts of central and eastern Europe, ee in the financial and household sectors that became the Achilles' heel ofendured financial crises in recent decades, these countries cleaned up their financial systems, followed sound fiscal policies, and insulated central banks froht better provide price stability

These strengths and lessons learned enabled the e economies to weather the crisis well They implemented effective rowth, setting therow at a healthy clip, should they stick with the market-oriented reforms and policies adopted before the crisis

That's the best-case scenario But we should keep a few caveats in mind First, these econo and financial ties to more advanced economies and cannot fully decouple from their problems An anemic recovery in the United States will inevitably act as a drag on even theeconomies include dozens of nations The BRICs-Brazil, Russia, India, and China-are the biggest of the bunch, and China is the undisputed king But China faces serious challenges While it has weathered the crisis, its all-too-effective response may set it up for problems in the medium term

For example, China has reacted to the crisis with state-directed credit growth State-owned banks have been told to provide massive amounts of credit and loans to state-owned enterprises in order to induce theoods, stockpile more commodities, and increase capacity Every province now induces banks to lend recklessly to state-owned enterprises in order to increase capacity in steel, ce, and other heavy industries But China already has a glut of capacity in these areas

Thanks to the boom in public and private investment, China now has an infrastructure that outstrips its level of develophith very few cars It also has a staggering increase in real estate developlut in corowth and urbanization will eventually make use of these i to outstrip the demand Unfortunately, some of these distortions are a function of the fact that land is not properly priced at a market rate; the state continues to control the supply

Sooing toward other, equally unproductive uses, including speculative, leveraged purchases of commodities, equities, and real estate This has the potential to beconificant doard correction in asset prices The authorities recognize this possibility, and rising prices in energy, food, and real estate have prompted theineering a soft landing

China occupies a paradoxical position in 2010 While stirowth back up into the 9 percent range, its economy still hasn't made the necessary shi+ft from an emphasis on exports to a reliance on private consumption Consumption in China remains stuck at a paltry 36 percent of GDP, compared with 70 percent of GDP in the United States There's certainly a happy medium between these numbers, but so far China hasn't done much to move toward it

Other proble years The country itself is growing at two different rates: coastal, urban areas that depend on exports are advancing more quickly than rural areas in the central and western parts Moreover, econoions has been pursued with a reckless disregard of the environures the landscape and causes significant health problems for millions of Chinese Finally, an authoritarian political systerowing restlessness of ethnic minorities, may also spell trouble down the line

The other es Coer rule of law, and greater protection of property rights But deovernments in India have slowed down necessary structural econoet deficits at the central and state levels, cutting inefficient govern the tax system

Other liberal reforms must be instituted as well Government intervention in the economy must be restrained; red tape and a bloated bureaucracy id and must be liberalized; so should trade and restrictions on foreign direct investement, as should investment in huress on these fronts, the risk re the gap between the Chinese hare and the Indian tortoise

Brazil's situation is different still It's a dynamic economy with plenty of natural resources, a sophisticated financial syste sector that couldtime But even in the best of all tirowth in the other BRICs topped 8 or even 10 percent-Brazilian growth lagged far behind at 4 percent

The Luiz Inacio Lula da Silva ad followed sound et deficit and an independent central bank coet growth above 6 percent, the next president will have to deal with unfunded pension liabilities; reduce govern and taxes that can badly warp econo; increase the skills of the labor force by investing in education and training; and improve and expand infrastructures via private and public partnershi+ps-all the while radually reduce income and wealth inequalities

The recent econo BRIC as a potential imposter The weakness of the Russian econoed banks and corporations-had been as prices After growing 8 percent in 2008, Russia's econo year

In effect, Russia's econoas-that fluctuates with the price of these commodities It needs to diversify, but that would require the privatization of state-owned enterprises, the liberalization of the economy, a reduction in the kind of red tape that hampers the creation of new firms, and a serious crackdown on the corruption that pery sector has to be liberalized Unfortunately, foreign investors reht eventually be expropriated or nationalized

Russia has plenty of other problems that should disqualify it fro infrastructure and a dysfunctional, corrupt political syste, and serious health problems-alcoholism, most obviously-have driven down life expectancy to worrisoest nuclear arsenal, and maintains a permanent seat on the UN Security Council, it is ”more sick than BRIC”

In fact, several other countries probably have a better clai some letters to the acrony South Korea in the BRIC-or BRICK-club South Korea is a sophisticated high-tech economic power: innovative, dynamic, and home to a skilled labor force Its only er that North Korea will collapse and inundate it with hungry refugees

Turkey too deserves to be included in the inner circle It has a robust banking sector, a thriving do population, a savvy entrepreneurial sector, and a co It has ties to Europe (NATO and European Union membershi+p candidacy), to the Middle East, and to Central Asia

Indonesia est Musli ly democratic politics, and an econolobal recession From the perspective of the United States, Indonesia presents a rather attractive alternative to Russia, which increasingly vies with Venezuela for leadershi+p of the ”A section

Indonesia has displayed resilience not only as an economy but also as a nation It has a reht cast doubt on its ability to make the transition to a world-class econoacy of a military dictatorshi+p and has recovered froh the Asian financial crisis in 1997, the tsunaence of radical Islae, Indonesia continues to move forward at an impressive rate

While Indonesia's per capita GDP remains low compared with that of other aspirants to BRIC status, it has remarkable potential It depends far less on exports than do its Asian peers (never mind Russia), and its markets in timber, paln invest stand against corruption and has raphic trends favor Indonesia, which, with 230 est country in the world by population, equivalent to Germany and Russia combined

The hype about the BRICs-or BIICs or BRICKs-reflects an iing- power A few years ago Lawrence Suration of China and India into the global econolobal labor force and the global nificant event in the last thousand years of human history, after the Italian Renaissance and the Industrial Revolution

How that plays out re econoes and will need to pursue very specific refore But in all likelihood, lobal econo years

A New Bubble?

Since March 2009 a range of risky global assets have undergone a massive rally Stock y and commodity prices started to cli ain their appetite for risk, investors have overnently up and the value of the dollar down

While this recovery in asset prices is driven in part by better economic and financial fundamentals, prices have shot up too fast too soon Why? The most obvious reason is that the central banks of the advanced economies have used superlow interest rates and quantitative easing to create a ”wall of liquidity” that has ed to surmount the ”wall of worry” left behind after the crisis And that's helping to fuel aelse is also fueling this global asset bubble: the carry trade in the dollar In a carry trade, investors borrow in one currency and invest it in places where it will yield a higher return Thanks to near-zero interest rates in the United States, investors can borrow dollars and sink them into any number of risky assets around the world As the prices of these assets go up, the investors make a tidy profit, which they can then use to pay back those borrowed dollars, which by this point have depreciated,it even easier to return the loan In practice, thatat zero percent interest rates; they're borrowing at negative interest rates, negative 10 or 20 percent, depending on how much the dollar depreciates In this climate, it's pretty easy to make a profit: 50 to 70 percent since March 2009

The Fed has inadvertently kept this gaoverne-backed securities, and the debt of Fannie Mae and Freddie Mac-the Fed has reduced volatility in the ,more and more investors into a bubble Theseinterest rates near zero, have made the world safe for the ”mother of all carry trades” and theweakness of the dollar has put central banks in Asia and Latin America in a difficult position If they fail to intervene in foreign exchange markets, their currencies will appreciate relative to the dollar,it even more attractive to borrow in dollars If they do intervene to prevent this appreciation, buying up foreign currencies like the dollar, the resulting foreign reserves can easily feed asset bubbles in these econolobal asset bubble that grows bigger by the day

Eventually the carry trade will unravel The Fed will end its progra some volatility to the markets; and at so indefinitely When it stabilizes, the cost of borrowing in dollars will no longer be negative; it will merely be close to zero That's bad news for anyone who has bet that the dollar will continue to decline, and it will force these speculators to suddenly retrench and ”cover their shorts”