By Steven Pearlstein
Friday, February 20, 2009
For the past two years, Asians and Europeans have tended to view their own financial and economic problems as largely imported from the United States. The impacts on their own economies, they reasoned smugly, would be modest and short-lived.
Turns out they were wrong.
Over the past two weeks, the bottom has fallen out of Asia's export economy while Europe has come face to face with a financial crisis that is as bad as ours and will probably become even worse without the kind of unified response that individual countries have so far resisted.
And what does that mean for us? Nothing good. It means that our downturn will be longer and deeper than many had hoped and that we can't rely as much on export growth to pull us out of the ditch.
Basically, there are two stories to tell here about the sudden downturn in the global economy.
The easiest to understand is the collapse of industrial production in East Asia, where the supply chain starts in places like Taiwan and Vietnam and moves through places like China and Japan before cars, shoes, computers and flat-panel TVs arrive at stores in the United States, Western Europe and everywhere else.
According to Barry Eichengreen, an economist at the University of California at Berkeley, the 40 percent decline in Taiwan's industrial production at the end of last year was the "canary in the coal mine" of Team Asia's formidable export machine. At about the same time, Japan's exports fell 35 percent, Korea's 17 percent, and China's fourth-quarter gross domestic product was essentially flat -- no economic growth at all.
As did a number of other economists, Eichengreen told me he'd never seen declines this fast and this steep, even during the Asian economic crisis when he was working at the International Monetary Fund's war room here in Washington. It all reflects not only the sharp pullback in discretionary consumer spending around the world but also an equally sharp pullback in the flow of foreign investment that was used to build factories and shopping centers and has been an important driver of growth in the region.
Demand for Asian exports will pick up again before too long, but it will be a long time before they reach the levels attained at the height of the bubble economy. And it will be longer still before foreigners will be eager to invest in expanding capacity again.
Ideally, Asians would respond to this challenge by reducing their heavy reliance on exports and foreign investment and reorienting their economy more toward domestic consumption. But as Raghuram Rajan of the University of Chicago points out, that's not as simple as it sounds.
For starters, the things Asians might want to consume aren't necessarily the things they produce to export, so production would need to be reoriented and workers retrained and redeployed. And to replace the foreign investment, these economies would need to develop financial institutions that can raise and invest risk capital, which right now they don't really have. Most significantly, Asian governments would have to create safety-net programs like Social Security so people don't save so much and spend so little.
In short, the Asian downturn is probably manageable, particularly now that the Chinese government has responded with a massive stimulus package. But it will take time for the region to make the necessary adjustments to get the region humming again.
The second story concerns Eastern Europe. Since the fall of communism, these countries have developed remarkably quickly on the strength of their industrial exports, mostly to Western Europe. And like the Asian tigers, they benefited from direct investment and credit by multinational companies and Western banks.
Unlike the Asians, however, Eastern Europeans didn't save a lot of the money they earned from exports. After years of living under communism, they were eager to catch up to Western European living standards. So they spent their earnings -- and then some -- borrowing heavily in foreign currencies to finance the accoutrements of middle-class life. They also wanted more and better government services, some of which were also financed through government borrowing.
Now, with Western Europe in recession, demand for Eastern European exports has suddenly dried up, and even the companies with orders to fill find it impossible to get the working capital they need. As in Asia, plants are closing, unemployment is rising and stock prices are nose-diving.
What is different from Asia, however, is that the exchange rates of local currencies have also plunged, which means the cost of paying back all those loans denominated in foreign currencies has suddenly become 20, 30, even 40 percent more expensive. Not only are households and companies defaulting, but a number of countries are also in jeopardy of defaulting on their sovereign debt.
As we've all learned, this isn't just a borrower's problem. It's also a problem for the lenders -- in this case, major banks in Western Europe that, collectively, have about $1.6 trillion in outstanding loans to Eastern Europe. What makes the situation particularly fragile is that many of these highly leveraged European banks don't have a financial cushion against losses of this scale.
In big countries such as France and Germany, the government can probably afford to step in and recapitalize troubled banks, much as the U.S. government has done with Citigroup. But in smaller countries with big banking sectors -- Austria, Italy, Ireland, Belgium, Sweden and the Netherlands -- the exposure to troubled loans is a sizable percentage of GDP. In those cases, any government rescue would cripple the economy, as it has in Iceland.
Economist Ken Rogoff of Harvard University sums up the European situation this way: Because Eastern Europe moved too quickly to try to raise its living standards to converge with those of the West, it is now the living standards of the West that are about to converge with those of the East.
The obvious solution is for European nations to pull together, with each contributing to a TARP-like program to rescue systemically important banks. And as finance ministers from Eastern Europe recommended recently, the European Union should set up a facility to rescue countries in danger of defaulting and taking the common currency down with them.
But this is Europe, so you won't be surprised to learn that things seem to be moving in the opposite direction. Leading politicians in Western Europe have vowed they will not ask their taxpayers to bail out other countries or their banks. And other countries are threatening to follow the lead of France, which last week threw a financial lifeline to Peugeot and Renault on condition they make their job cuts somewhere else.
Meanwhile, European banks are said to be quietly pulling capital out of their subsidiaries across the continent and bringing it home.
If allowed to continue, this kind of financial protectionism will set the European economic project back a generation and suck all of Europe into a deep recession. That would be bad news for Team USA.
Steven Pearlstein is moderator of a new Web site, On Leadership, at http://washingtonpost.com. He can be reached at pearlsteins@washpost.com.
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