When in Doubt, Blame the Asians

by Tim Swanson

In a rush to explain the current economic conundrums facing the United States, an increasingly popular rationale is to shield policy makers and collectively blame Asia's huge rate of savings and large productive capacity.

For instance, former Treasury Secretary Henry Paulson thinks that global trade imbalances with Asia pushed interest rates down and drove "investors towards riskier assets."

Brad Setser of the Council on Foreign Relations believes that Americans borrowed too much and Asians saved and lent too much to Americans — that Asian money consequently flooded the US economy and drove down interest rates.

Michael Pettis, an American finance professor in China, suggests that China overproduces and underconsumes, an imbalance that ultimately recycled large amounts of savings back into the US housing and securities markets, creating an unsustainable bubble.

However, the main problem with the explanations provided by Paulson and the burgeoning establishment line is that none of the Asian countries sits on the Federal Reserve board, the prime instigator of this effervescent predicament. And as influential as the China or Japan lobbies are seen to be by many, neither country sets the federal-funds rate or conducts open-market operations.

Who's Who

Americans at the Federal Reserve alone are responsible for setting interest rates. And stoked in part by the financial specter of Mexico and other external phantoms beginning in July of 1995, Chairman Greenspan began a series of rollercoaster rate cuts — and temporary increases — culminating in a perversely low 1% rate in mid-2003.[1] This, along with expanding the monetary base — provided by the Fed and coordinated with other central banks — arguably spurred speculative malinvestment globally in areas such as technology and, later, real estate.[2]

Beginning in 2002, the Bush administration began a protracted campaign of deficit spending to fund wars and welfare. In addition, government-sponsored housing agencies (GSEs), including Fannie Mae, Freddie Mac, Ginnie Mae, and the FHLBs, enacted a series of loose-lending standards — in part to comply with the Community Reinvestment Act — and consequently guaranteed and accumulated trillions of dollars in what are now viewed as deleteriously risky mortgage-backed securities.[3][4]

In establishment terms, these are the "known knowns."

Some other "knowns" that are undisputable: Americans ran the housing GSEs; Americans occupied the Bush administration; and, to the best of our knowledge, Alan Greenspan is an American. And while many of these decision makers may be immigrants, none of them was then simultaneously an executive member of the CCP, LDP, GNP, KMT, or PAP.[5]

Finger Pointing up the Chain of Command

The above exercise reveals those who are responsible for enacting particular legislation and executing specific policies.

At no point did Asian savers force Fannie Mae to reduce down payments on houses or reduce mortgage rates. At no point did Asian savers force American banks to allow consumers to use their home equity as ATM machines. At no point did Asian savers force the Bush administration to run deficits to pay for foreign wars and domestic welfare. At no point did Asian savers force government-sanctioned ratings agencies to rubber stamp risk assessments. And at no point did Asian savers force Alan Greenspan to lower interest rates.[6]

Neither the US government nor its federally controlled housing agencies had to spend the money it received from Asia. In fact, they could have refused the money altogether. No means no, right?

In addition, the government could have paid off its obligations and maintained a balanced budget. Instead it spent it all and continued borrowing. As a consequence, it is pure balderdash to insinuate that the uptick in Asian savings somehow coerced the House Committee on Ways and Means to appropriate billions in extra liabilities. No one in Asia pointed chopsticks, bamboo, or a gun at Larry Summers, Paul O'Neall, Dennis Hastert, Bill Thomas or American consumers and told them to spend the money.

True enough, Asian countries produced relatively cheap goods that Americans wanted to buy, but it was the Federal Reserve alone that created the "cheap" money that was then lent to Americans who in turn bought products from China.

In fact, the only "hot" money in the global system was that created by the Federal Reserve. Every dollar that the Chinese and Japanese used to buy US Treasury bonds originated from the Federal Reserve. And as much as they would have liked to do it, no evidence has surfaced to suggest that China, Japan, South Korea, or any other Asian country was involved with counterfeiting money. That responsibility is left solely with the Federal Reserve's own printing press.

The Politically Incorrect Narrative

As illustrated by Robert Murphy, the most recent bubble began in 2001, when the Fed dramatically increased the money supply, temporarily making American banks and financial institutions artificially wealthier (i.e., they received funds first). These firms, in turn, lent to American consumers at extraordinarily low rates. Americans, believing they were rich, spent the money on products made in places such as Asia. Asians, for various reasons, saved more than they spent. And, looking to diversify and participate in the global economy, many Asians parked their earned savings in purportedly safe assets.

It so happens that the US Treasury during this time was trying to fund large deficit spending and sold large amounts of bonds — which are dubiously rated AAA.[7] Similarly, in an attempt to satisfy congressionally mandated universal homeownership goals, GSEs such as Fannie Mae loosened home-financing standards for millions of Americans and sought financing on the international credit markets — and also held a dubiously AAA-rated bond.[8] As a consequence, a substantial portion of the Asian savings was used to purchase these seemingly safe bonds.[9]

So to review, the "imbalance" did not start because of too much savings in Asia but rather because of a huge expansion of credit by the Federal Reserve and imprudent welfare handouts by the federal government.

Stop Being So Productive

As noted above, professor Michael Pettis thinks China has a chronic problem with overproduction and he is right in one respect: American consumers purchased too much from China. He correctly notes that, around 1998, Americans stopped saving and "diverted a rising share of their income to consumption." Pettis then constructs a framework in which self-serving fiscal policies of China and America became self-reinforcing and ultimately led to unsustainable growth.

This phenomenon eventually peaked — in housing prices in 2006, in stock prices in 2007, in corporate-bonds prices in 2008, and arguably in sovereign-bond prices in 2009–10.[10][11]

But instead of connecting the dots to the only institution capable of expanding the credit supply — the Federal Reserve — Pettis seeks a bilateral, politically crafted solution that does not involve the abolition (or even admonishment) of the Fed. This is the same Fed that did not see a housing bubble coming.

And by insisting that it was overzealous Manchurians concocting trade policies in smoke-filled rooms of the Forbidden City, American policy makers are setting up future generations for a monetary disaster.[12]

Three years from now, the American political class will be begging for Asian savings, but it is unlikely that many Asians will be interested in coming to their rescue[13] — in part because they were unfairly blamed for a phenomenon they did not create and in part because they see how the political class will spen