Friday, 20 August 2010


1. Setting The Scene...

In the immediate aftermath of the global financial crisis even the deepest market fundamentalists embraced the core Keynesian insight that when in deep recession, monetary policy will be ineffective and fiscal stimulus is required. They have now abandoned that view as calls for fiscal austerity abound regardless of the increasingly fragile nature of the global recovery.

While economists and policy-makers debate the short and medium-term remedies to the crisis, there is an incredibly surprising and under-discussed consensus emerging for the longer run....and that's that the United States and East Asia (notably China) have to change the ‘structures’ of their economies.

The US has to stop over-consuming on credit and actually produce things for export again. East Asian nations have to slow down their over-reliance on exports and increase domestic consumption. Another way of putting it: the key actors in the world economy need to undergo structural change.
2. But...How Did We Get Here in The First Place?

Between 1983-90 (the Reagan era) the TOTAL US DEBT (that means households, businesses big and small, government local/state/federal) grew from US $5 trillion to US $10 trillion. It took the US more than 200 years to get to US $5 trillion so the increase of an equal amount in 7 years it's rather significant!! More on this later...

3. Reaganomics...Enter Supply Side Economics

Reaganomics was based on supply side economics and his four pillars of economic policy were to:

1.Reduce government spending,
2.Reduce income and capital gains marginal tax rates,
3.Reduce government regulation
4.Control the money supply to reduce inflation.

Ronald Reagan's economic concept was that if you cut taxes you would increase Federal revenues since economic activity would increase. The increase in economic activity would bring with it increased Federal tax revenues. In other words the tax cut would be self liquidating and self paying since any lost revenues for the moment would almost immediately be made up by increased revenues in the future. It didn't cost anything, therefore, to lower taxes and the economy would be stimulated to new heights.

Ronald Reagan's principles were influenced by the Laffer Curve The curve suggests that, as taxes increase from low levels, tax revenue collected by the government also increases. It also shows that tax rates increasing after a certain point (Equilibrium Point) would cause people not to work as hard or not at all, thereby reducing tax revenue. Eventually, if tax rates reached 100% (the far right of the curve), then all people would choose not to work because everything they earned would go to the government.

In 1981, Reagan significantly reduced the maximum tax rate, which affected the very wealthy, and lowered the top marginal tax rate from 70% to 50%; in 1986 he further reduced the rate to 28%!

As a result of all this, the budget deficit and federal debt increased considerably: debt grew from 33.3% of GDP in 1980 to 51.9% at the end of 1988 and the deficit increased from 2.7% in 1980 to more than double in 1983, when it reached 6%; in 1984, 1985 and 1986 it was around 5%.

In order to cover new federal budget deficits, the United States borrowed heavily both domestically and abroad, raising the national debt from $1 trillion to $3 trillion, and the United States moved from being the world's largest international creditor to the world's largest debtor nation.

The federal government debt when Ronald Reagan took office was about US $1 trillion. That included in it all the debt run up for the Revolutionary war, the Spanish-American war, the Civil war, World War I, World War II, the Korean war, the Vietnam war and all the Social wars of the 1930's and subsequent years. In other words it took the United States from 1776 until 1980 or more than 200 years to accumulate a national debt of $1 1988 the debt increased to US $3 trillion!

4. Starving the Beast...

If government cuts taxes, but not spending, it still gets the money from somewhere—either by borrowing or inflating. Either method robs the productive sector. Cutting taxes is easy. Cutting spending is hard.

As Professor Laffer himself explained: 'It’s hard to win on spending. People love getting government benefits and they hate paying for them.' Reagan's mantra was the need to 'starve the beast' strategy has been a key tenet of Republican philosophy since Ronald Reagan. The idea was basically that sympathetic politicians should engage in a game of bait-and-switch. Rather than proposing unpopular spending cuts, Republicans would push through popular tax cuts, with the deliberate intention of worsening the government's fiscal position. Spending cuts could then be sold as a necessity rather than a choice, the only way to eliminate an unsustainable budget deficit.

Along with the fundamental concept of allowing the American people to spend more of their hard earned dollars themselves, the goal of tax cuts and lower taxes has been a way of keeping a runaway government in check. The problem is that, in practice, the starve the beast concept has rested on a flawed assumption – namely that a reduction in tax revenue would inevitably lead Congress and the White House to cut government spending. Clearly, that hasn’t happened.

Instead we've seen continued increases in both the size of government and its  mind-boggling numbers!!

5. Understanding US National Debt...BIGGER THAN YOU THINK

Public Debt represents money owed to those (people, businesses and foreign governments) holding government securities such as Treasury bills and bonds.
Total Debt includes intra-governmental debt, which includes amounts owed to the Social Security Trust Funds and Civil Service Retirement Funds.

The debt to the Penny and Who Holds It is a daily review of total amount of public debt outstanding offered by TreasuryDirect, a division of the U.S. Department of the Treasury Bureau of the Public Debt. The mission of Public Debt is to borrow the money needed to operate the federal government and to account for the resulting debt and it's done via a variety of savings and investment products.

As of 18.08.10 the Total Debt amounts to US $13.4 trillion, of which Public Debt amounts to US $8.8 trillion (65%) and Intragovernmental Debt amounts to US $4.6 trillion (35%).

The US economy size is measured by its GDP, and the 2010 forecast is around US $14.6 trillion...which means the TOTAL DEBT of US $13.4 trillion (92%) is nearly the size of the whole economy...and a recent report from IMF indicates that TOTAL DEBT will surpass GDP by 2012!!  

The scary thing is though...the FEDERAL GOVERNMENT TOTAL DEBT is not the TOTAL US DEBT (meaning households, businesses big and small, government local/state/federal)...that's the one that remember grew from US $5 trillion to US $10 trillion under Reagan...that number is now...US $57 TRILLION!!..AND STILL CLIMBING

The Chinese View...Cheng Siwei, Vice-Chairman, China's Standing Committee (2009)

'The US spends tomorrow's money today.That's why we have this financial crisis. We Chinese spend today's money tomorrow.'

 to be continued...It's The Economy Stupid!

Tuesday, 17 August 2010

China's Call for One World Currency...

1. IMF's Special Drawing Rights

On the 23.03.09 Zhou Xiaochuan, Governor of the People’s Bank of China, delivered a speech , published on the central bank’s website and unusually was released both in English and Chinese, emphasising China’s dissatisfaction with the global primacy of the dollar. This was a clear muscle-flexing move with the assertiveness that China now possesses as the 'clear winner' of the global economic crisis.

Mr Zhou Xiaochuan's indicated in this speech...I quote 'The outbreak of the current crisis and its spillover in the world have confronted us with a long-existing but still unanswered question,i.e., what kind of international reserve currency do we need to secure global financial stability and facilitate world economic growth, which was one of the purposes for establishing the IMF? There were various institutional arrangements in an attempt to find a solution, including the Silver Standard, the Gold Standard, the Gold Exchange Standard and the Bretton Woods system. The above question, however, as the ongoing financial crisis demonstrates, is far from being solved, and has become even more severe due to the inherent weaknesses of the current international monetary system.'...unquote

He continued...'the desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.'

Beijing indicated that the dollar’s role could eventually be taken over by the IMF’s so-called Special Drawing Right (SDR), a quasi-currency that was created in 1969. Mr Zhou argued that the SDR has the potential to act as a 'super-sovereign' reserve currency, spanning national jurisdictions. In turn, he suggested that this could not only eliminate the risks associated with paper fiat currencies, such as the dollar and pound – which are backed only by the credit of the issuing country, rather than by gold – but would make it possible to manage global liquidity and imbalances more effectively.
He said: 'The role of the SDR has not been put into full play due to the limitations on its allocation and the scope of its uses. However, it serves as the light in the tunnel for the reform of the international monetary system.'

Mr Zhou suggested a shift by which the SDR could form the anchor of a new global exchange-rate system, replacing the former Bretton Woods system of fixed but adjustable exchange rates, which collapsed in 1971. Since then, most large Western economies have had floating currencies, while nations such as China have managed their exchange rate, creating incompatibilities blamed for stoking up the damaging imbalances.

'When a country’s currency is no longer used as the yardstick of global trade, and as the benchmark for other currencies, the exchange-rate policy of that country would be far more effective in adjusting economic imbalances,' Mr Zhou said.

The IMF's SDR, although denominated in US dollars, has a nominal value derived from a basket of currencies. This basket is composed of Japanese Yen (11%), US Dollars (44%), British Pounds (11%) and Euros (34%), and the proportion each of these four currencies contribute to the nominal value of a SDR, which is reevaluated every five years. For the period of 2006-2010, one SDR is the sum of 0.6320 US Dollars, 0.4100 euro, 18.4 Japanese yen and 0.0903 pound sterling.

Due to varying exchange rates, the relative value of each currency varies continuously and thus the value of the SDR fluctuates. The IMF fixes daily the value of one SDR in terms of US dollars based on the exchange rates of the constituent currencies. The latest US dollar valuation of the SDR is always available from the International Monetary Fund web site.

2. Gathering Strength of Voices in China Against US dollar as a Reserve in China

Recently, Yu Yongding (left), member of the state-backed Chinese Academy of Social Sciences and former central bank adviser indicated that U.S. Treasuries fail to provide safety or liquidity when it comes to managing China’s US $2.45 trillion foreign-exchange reserves.
China is unable to sell the securities in a 'big way' and a 'scary trajectory' of budget deficits and a growing supply of U.S. dollars put their value at risk, he said.
The State Administration of Foreign Exchange, which manages the nation’s reserves, said last month that U.S. government debt has the benefits of 'relatively good' safety, liquidity, low trading costs and market capacity. China’s holdings of Treasuries, the largest outside of the U.S., totaled  US $867.7 billion at the end of May, down from US $900.2 billion in April and a recordUS  $939.9 billion in July 2009.

To help cool demand for the securities, China needs to curb the growth of its foreign reserves by intervening less in the currency market, Yu said. The People’s Bank of China said June 19 it would let the yuan float with reference to a basket of currencies, ending a two-year-old dollar peg.

The yuan has since appreciated 0.8% to 6.773 per dollar and analysts predict the currency will end the year at 6.67, based on the median estimate. China limits appreciation by buying dollars, fueling its demand for Treasuries.

'China has to depend more on demand and supply in the foreign exchange market for the determination of the yuan exchange rate,' Yu wrote. 'Only God knows how much of the value that China has stored in the U.S. government securities will be left in the future when China needs to run down its reserves.'

'The U.S. government has strong incentives to reduce its real burden of debt through inflation and dollar devaluation,' he said. 'Whichever way it is, the yuan-recorded market value of Treasuries will fall, causing huge capital losses to China’s central bank.'

The Sliding Dollar

The dollar has weakened against all 16 major currencies monitored by Bloomberg in the past month, sliding 5.4 percent versus the euro and 4.7 percent against the pound. The Dollar Index, which the ICE futures exchange uses to track the greenback against the currencies of six major U.S. trading partners, is headed for its lowest close since April 15.

Premier Wen Jiabao in March urged the U.S. to take 'concrete steps' to reassure investors about the safety of dollar assets after President Barack Obama stepped up spending to help end a recession. The White House predicts the U.S. budget deficit will hit a record $1.47 trillion this year, about 10 percent of gross domestic product.

An 'appropriate' policy for China would be to allocate its reserves with reference to the weightings of Special Drawing Rights, a unit of account of the International Monetary Fund, Yu said in May. China bought a net 735.2 billion yen ($8.3 billion) of Japanese bonds in May, doubling purchases for this year.

Sunday, 15 August 2010

China Economic Situation Today & Going Forward...Part II

1. China's Huge Trade Surpluses vis-a-vis US Huge Trade Deficits. The Role of the IMF...Fairness in Currency Exchange Rates

The International Monetary Fund (IMF) is the world's central organisation for international monetary cooperation. It is an organisation in which almost all countries in the world work together to promote the common good.

The IMF's primary purpose is to ensure the stability of the international monetary system—the system of exchange rates and international payments that enables countries (and their citizens) to buy goods and services from each other. This is essential for sustainable economic growth and rising living standards.

The IMF was conceived in July 1944, when representatives of 45 governments meeting in the town of Bretton Woods, New Hampshire, in the northeastern United States, agreed on a framework for international economic cooperation on a post-World War II economic environment. They believed that such a framework was necessary to avoid a repetition of the disastrous economic policies that had contributed to the Great Depression of the 1930s.

During the 19302s attempts by countries to shore up their failing economies—by limiting imports, devaluing their currencies to compete against each other for export markets, and curtailing their citizens' freedom to buy goods abroad and to hold foreign exchange—proved to be self-defeating. World trade declined sharply, and employment and living standards plummeted in many countries.

Seeking to restore order to international monetary relations, the IMF's founders charged the new institution with overseeing the international monetary system to ensure exchange rate stability and encouraging member countries to eliminate exchange restrictions that hindered trade. The IMF came into existence in December 1945, when its first 29 member countries signed its Articles of Agreement. Since then, the IMF has adapted itself as often as needed to keep up with the expansion of its membership of 187 countries as of July 2010 (if we consider that there 192 member countries of the United means that the world as a whole has agreed to be governed by the IMF) and changes in the world economy.

The IMF under Article IV - Obligations Regarding Exchange Arrangements and in Section 1. General obligations of members point (iii) clearly defines that...I quote 'avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members'

One of the main issues regarding the imbalances of 'China's Huge Trade Surpluses' vis-a-vis 'US Huge Trade Deficits' is related to the perception that China (an IMF member) is manipulating its currency in a sort of 'Beggar-Thy-Neighbour Policy' of currency manipulation.

Paul Krugman's in his New York Times column has brought this issue to the forefront in a recent short and very convincing article entitled 'Chinese Rumbles'.

2. Beggar-thy-neighbour predatory currency manipulation?

It has long been recognized that the global financial structure — built as it is around the dollar as the world’s reserve currency — has a fundamental design flaw that makes it inherently unstable. The problem was first identified back in the early 1960s by the Belgian-American economist Robert Triffin, in 'Gold and the Dollar Crisis.'
Such policies attempt to remedy the economic problems in one country by means which tend to worsen the problems of other countries.

The term was originally devised to characterise policies of trying to cure domestic depression and unemployment by shifting effective demand away from imports onto domestically produced goods, either through tariffs and quotas on imports, or by competitive devaluation. The policy can be associated with mercantilism and the resultant barriers to pan-national single markets.

An obvious example, is the use of tariff barriers. A country may place tariff on imports to help promote local domestic industry. This may help local unemployment, but, be at the expense of the other country's export sector. Another example is the manipulation of exchange rates...keeping them artifically low in order to help exports.

That's the key argument here as the US is very critical of China's low exchange rate. The US argues that it increases Chinese growth at the expense of a US trade deficit.

There is one problem though with Paul Krugman's and the US government 'simple and clear argument'...and that's related to the US $ being the de-facto 'world reserve currency'.

A reserve currency, or anchor currency, is a currency which is held in significant quantities by many governments and institutions as part of their foreign exchange reserves. It also tends to be the international pricing currency for products traded on a global market, and commodities such as oil, gold, etc.

This permits the issuing country to purchase the commodities at a marginally lower rate than other nations, which must exchange their currencies with each purchase and pay a transaction cost. For major currencies, this transaction cost is negligible with respect to the price of the commodity. It also permits the government issuing the currency to borrow money at a better rate, as there will always be a larger market for that currency than others.

3. The 'Triffin Dilemma'

Writing about Europe’s accumulation of dollars, he argued that the system carried the seeds of its own destruction. Foreigners could acquire dollars only if the United States ran current account deficits — that is, spent more than it earned. But lending money to someone who lives beyond his means has obvious dangers, and the same is true of countries.

Thus, the American deficits necessary to supply dollars to the world for international transactions simultaneously undermined confidence in the currency. It was only a matter of time, Triffin predicted, before the system would be hit by a crisis — which it duly happened in 1971 when President Nixon ended the dollar’s convertibility into gold.

Whereas Triffin had been primarily concerned about the European accumulation of dollars, the spotlight is now on Asia. In the wake of the 1997 financial crisis there, countries in East Asia set out to build up war chests of dollars as insurance against domestic banking runs or downturns in the global economy. At about the same time, China embarked on a program of export-led growth, engineered by keeping its currency artificially low.

The Main Point of Triffin's Dilemma is...

The use of a national currency as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the US balance of payments, specifically the current account.

The dilemma is reflected in that:

  • In order to meet the world demand for the reserve currency dollars must flow out of US, but

  • In order to maintain a stable value of the US $, dollars must flow into the US, but

  • Both can't happen at the same time.
This relationship forces most of the governments into a strict budgetary discipline. Too large a budget deficit and you will end up with inflation as well as a large external account deficit. Currency reserves are finite and eventually you need to cut back on your external deficit as well as budget deficit to balance your accounts.

4. The US 'Free Lunch'...time is running out?
There is one exception. If your external account can be funded by simply printing more money, you can keep on spending indefinitely as long as the world is willing to accept your currency as good money. Large trade deficit? Simply print more dollars and pay it off. Large budget deficit? Issue more treasuries that will be bought by your suppliers with the dollars you gave them. This cycle suited everyone, especially the US.

The real gain for the US in this arrangement comes from the fact that as an issuer of currency of the world, it can create wealth at the expense of everyone else...IN A NUTSHELL THE US 'FREE LUNCH'  It has been done before, particularly in the medieval economies when public finances in the current sense of the phrase did not exist, Princes had to borrow and repay debts like everyone else; except that they had the right to issue currency. Adam Smith pointed this out more than 200 years ago in Wealth of Nations:

…the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had been contained in their coins… By means of those operations, the princes and sovereign states… were enabled, in appearance, to pay their debts and fulfill their engagements with a smaller quantity of silver… their creditors were really defrauded of a part of what was due to them.

This applies to the world even today. In the short term, an abundant supply of dollars does not seem to have any impact. But in the longer run, people are defrauded as true value of the currency falls on a continuous basis. In fact, if you measure the value of dollar against a more enduring store of value, precious and base metals, the dollar has been debased quite drastically over past few years. It has also taken a lot of other currencies down with it, ensuring that the loss of real wealth is not limited to dollar alone.

The 'world reserve' status of the US dollar created a demand for it, but through this, it also created a glut of Treasury bond holdings in foreign central banks, and an unserviceable national debt in the US. The combination of removing the dollar from the gold standard (President Nixon in 1971) in tandem with gaining world reserve advantage allowed the US government (along with central bankers) to create the most precarious illusory fiat currency in history.

Could this process continue indefinitely? It's possible, but only if the demand for dollars continues to rise annually. As long as people want dollars in greater and greater amounts, the US could simply continue to expand its debt...well into infinity and beyond!...but what happens if demand for the dollar falls, or disappears entirely? The massive liabilities the US has already accrued will no longer have the crutch of perpetual Treasury investment. The US would no longer receive the busloads of foreign capital needed to continue functioning. The system the US has staked its future would just disintegrate.

Anyone who uses common sense would easily conclude that it is highly unreasonable if not outlandish to expect that other countries will continue to pump more and more money every year into what's a very unstable system. Eventually, every undisciplined debtor hits a state of critical mass; a point at which he runs out of options in extending his ability to outrun bankruptcy.

We are seeing this right now in the U.S., most prominently in municipal debt in states such as California and Illinois. These are not just 'local problems'...the growing insolvency in states is a direct reflection of the growing insolvency in the Federal Government.

Enter IMF's SDRs- The Chinese Proposal to the 'Triffin Dilemma' be continued

Tuesday, 10 August 2010

China Economic Situation Today & Going Forward...Part I

1. The Onset of the Financial Crisis & The Chinese Economic Model

The financial crisis of 2007 to the present is a crisis that was triggered by a liquidity shortfall in the United States banking system caused by the overvaluation of assets. The immediate cause or trigger of the crisis was the bursting of the United States housing bubble which peaked in approximately 2005–2006. Already-rising default rates on 'subprime' and adjustable rate mortgages (ARM) began to increase quickly thereafter.

Low interest rates and large inflows of foreign funds created easy credit conditions for a number of years prior to the crisis, fueling a housing construction boom and encouraging debt-financed consumption. The combination of easy credit and money inflow contributed to the United States housing bubble. Loans of various types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed an unprecedented debt load.

As part of the housing and credit booms, the number of financial agreements called mortgage-backed securities (MBS) and collateralised debt obligations (CDO), which derived their value from mortgage payments and housing prices, greatly increased. Such financial innovation enabled institutions and investors around the world to invest in the U.S. housing market. As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime MBS reported significant losses...and the rest is history Lehman Brothers, AIG, Merrill Lynch, Fannie Mae & Freddie Mac, RBS, Lloyds, HBOS, etc, etc.

The International Monetary Fund estimated that large U.S. and European banks lost more than US $1 trillion on toxic assets and from bad loans from January 2007 to September 2009. These losses are expected to top $2.8 trillion from 2007-10. U.S. banks losses were forecast to hit US $1.2 trillion and European bank losses will reach US $1.6 trillion.

A good example of what banks went through can be seen below, in terms of the loss of of Market Capitalisation of major banks prior to the outset of the crisis (in Q2 2007) and at January 20th 2009....

Not surprisingly the financial crisis precipitated a global recession. There was an immediate breakdown of the system of international financial intermediation, which had been smoothly transferring China’s unprecedented surpluses to cover the unprecedented current payments deficits of the United States...suddenly some of the long-term questions about the sustainability of China’s early twenty-first-century growth strategy demanded immediate answers.

  • Could China replace export-oriented growth with similarly strong growth focused on opportunities in the domestic market?

  • Could China expand expenditure enough and quickly enough if developments in the international economy prevented the accommodation of China’s huge and growing external surpluses?
2. China's Emergence as a Major Player Post-Economic Crisis

The superb Beijing Summer Olympic games in August 2008 and the very impressive show of power presented on the 60th anniversary celebration of the People's Republic of China on October 1, 2009 were major events held in the midst of the global financial crisis that clearly announced the arrival of China into the world stage and a sign to the troubled western economies that a strong and assertive China was moving forward towards the top spot.

The media started talking of a world dominated not by G-7, but by G-2 consisting of the US and China. The credit crisis has certainly pushed China from behind America’s shadow into a central position on the world stage...

3. IMF's endorsement of China's Economic Performance

In a recent report (29.07.10) from the International Monetary Fund (IMF) the Chinese government is praised for skillful response to the global financial crisis.

In an interview, the Fund’s lead economist on China, Nigel Chalk, said that despite the global slump, the country’s economy had posted an impressive performance. He explains, they clearly understood that the downturn of the global economy would greatly affect China, and you saw a response that involved a large fiscal package to stimulate the economy. It also involved a quite significant amount of monetary stimulus.

All of these things kind of work together, they’re all very helpful in supporting the economy in the face of this very large external shock. And you see that in the outturn for 2009. During that year you had more than 4% of GDP drag on the economy from the decline of exports. Nevertheless the economy grew overall by more than 9%, which is quite an impressive achievement. Our assessment is a large part of that was driven by the public sector stimulus.

The IMF said China’s 'quick, determined, and effective policy response' meant it was now spearheading the global recovery.

There is no argument in regards to the scale of China’s achievement, which can now be viewed over three decades, is extraordinary by any standard! It has industrialised at roughly three times the pace that the West did. What took 100 years in Europe has taken one generation in China. And in handling this massive transformation, what is really striking is the absence of large-scale violence.

It is true that China is a dictatorship...but so were many Western countries when they industrialising their economies, and they had much more mass violence. Other East Asian countries have made this journey, but none has the size and scale to alter the world in the same way China is doing...

The net effect is that we have the rise onto the world stage of a new great power and one with massive potential for further growth along all dimensions. Of course, nothing can be taken for granted. China does have a restless middle class, persecuted minorities, border disputes, and the challenge of moving up the economic ladder, all within the context of a one-party system.

Friday, 6 August 2010

Why China Succeeded & The Soviet Union failed at Implementing Reform? Part II

4. Deng Xiaoping...'Socialism with Chinese Characteristics'

Deng Xiaoping was the leader of China from 1978 (two years after Mao's death) until his death in February 1997. He was the last of the great revolutionary leaders of China and a Time Man of the Year twice (see below). The Person of the Year (formerly Man of the changed in 1999 in an effort to be more inclusive) is an annual issue (tradition started in 1927) of the prestigious US current affairs magazine Time that features and profiles a person, couple, group, idea, place, or machine that 'for better or for worse, ...has done the most to influence the events of the year.'

                       1978                                                                                        1985

Interestingly...Mikhail Gorbachev was also Man of the Year twice! In 1987 and 1989 (where he was also considered Man of the Decade).

                       1987                                                                                         1989

These are excellent examples that put into context the seismic changes that both leaders were trying to implement in their respectives countries...which in the end resulted in very different outcomes for both. As Alexis de Tocqueville wrote in his treatise on the French Revolution, 'The most perilous moment for a bad government is when it seeks to mend its ways. Only consummate statecraft can enable a king to save his throne when, after a long spell of oppressive rule, he sets to improving the lot of his subjects.'...chaos rides in on rising expectations.

A tough, abrasive, resilient, with many political comebacks (Deng was purged from the Communist Party three times: in 1933 as a mid-level party official; in 1966 during the Cultural Revolution; and in 1976 during a dispute with the Gang of Four, who called Deng a 'counterrevolutionary') Deng was 74 years old when he embarked on his Deng Xiaoping Theory whose social and economic philosophy is an attempt to merge a 'market economic model' with a 'socialist political system'. This became known as 'socialism with Chinese characteristics.'

In the Chinese spirit of balance between yin and yang, Deng's attempt was not only on a monumental scale, but also it was aimed at blending seemingly irreconcilable elements: state ownership and private property, central planning and competitive markets, political dictatorship and limited economic and cultural freedom. Indeed, it was almost, as it so often seems to skeptics in both the Western and Marxist worlds, an attempt to combine Communism and Capitalism.

One of Deng's most famous quotes, dating back to the years before the Cultural Revolution, states that 'it doesn't matter whether a cat is white or black, as long as it catches mice.' In other words, he did not worry too much about whether a policy was capitalist or socialist as long as it improved the economy.

In December 1978 at the Third Plenum of the 11th Central Committee, Deng Xiaoping announced the official launch of the Four Modernisations, formally marking the beginning of the reform era. These were in the fields of agriculture, industry, national defense, science & technology. The Four Modernisations were designed to make China a great economic power by the early 21st century.

These reforms were a reversal of the Maoist policy of economic self-reliance. China decided to accelerate the modernisation process by stepping up the volume of foreign trade, especially the purchase of machinery from Japan and the West. By participating in such export-led growth, China was able to step up the Four Modernisations by attaining certain foreign funds, market, advanced technologies and management experiences, thus accelerating its economic development. Deng attracted foreign companies to a series of Special Economic Zones, where foreign investment and market liberalisation were encouraged.

5. Agriculture...The Basis of Chinese Success Story

The animating spirit of Deng's reforms was the liberation of the productive energies of the individual, a daring concept not just for a Marxist but for a Chinese (the concept of individualism has a negative connotation in Chinese society). He began, appropriately, with agriculture, which had been collectivised by Mao to a degree extreme even for the Communist world. The land was worked by communes that grew what the state directed and turned over all food produced to the state for distribution. Pay was based on a system of 'work points' that bore little relation to production: a peasant would accumulate a certain number of work points for planting rice seedlings, for example, but he or she would fare no better if the eventual crop was large than if it was small.

Deng's reforms abolished the communes and replaced them with a contract system. Though the state continued to own all land, it leased plots, mostly to individual families. Rent is paid by delivery of a set quantity of rice, wheat or whatever to the state at a fixed price. But once that obligation is met, families can grow anything else they wish and sell it in free markets for whatever price they can get (though the state determined limits on how much some prices could fluctuate).

Most of the first leases were for two or three years, but they were extended, usually for 15 years and as long as 30 years on grazing land. In 1985 a law established that made leases inheriterable. Peasants owned their draft animals, and those who prosper could buy machinery; ownership of tractors and machinery exploded.

Though the state retained the power to cancel a peasant family's lease and award it to someone else, that power was rarely exercised, therefore farm families started to regard the good earth as theirs and using it about the way they would if they owned it outright. Farmers were allowed, indeed encouraged, to build privately owned houses on their state-owned land....agriculture today in China is completely privatised. 

The results have been simply phenomenal...agricultural output increased by 8.2 percent a year, compared with 2.7% in the pre-reform period, despite a decrease in the area of land used. Food prices fell nearly 50%, while agricultural incomes rose.

A more fundamental transformation was the economy's growing adoption of cash crops instead of just growing rice and grain and increases in agricultural productivity allowed workers to be released for work in industry and services, while simultaneously increasing agricultural production. Trade in agriculture was also liberalised and China became an exporter of foodstuffs, a great contrast to its previous famines and shortages.

Private enterprise began as a king of offshoot of the agricultural reforms. Mao's 'people's communes,' for all their faults, at least guaranteed everyone in the rural economy a job of sorts. Deng and his lieutenants feared that breaking up the communes would cause masses of jobless peasants to descend on the cities, where there might be no work for them either. So beginning in the late 1970s, individual farmers and village collectives were permitted to start sideline businesses and keep any profits.

The first enterprises were connected with farming: a group of peasants would set up a roadside market to sell their crops and perhaps buy a truck to haul their own produce as well as, for a fee, food grown by other peasants. But private entrepreneurs and village collectives very quickly expanded to all kinds of other businesses—inns, restaurants, stores, tailor shops, beauty parlors and light manufacturing like assembly of TV sets—often in competition with government-owned businesses.

Some entrepreneurs even opened services in major cities to recruit maids and other household help for busy urban families. Businessmen could hire workers privately, a practice that conventional Marxists regarded as inherently exploitative. Legally, no private entrepreneur was supposed to employ more than 15 hired hands, but local Communist Party officials often ignored that limit.

6.The Shift from Heavy Industry to Consumer Goods Industry

The pre-reform system, that operated under what Mao had copied from Stalin, was that ministries in Peking assigned all raw materials and dictated all investments, told every factory manager what and how much to produce and where to sell it and at what price, set wages and assigned jobs, took all profits and subsidised any losses. As late as 1984, one factory manager in Shanghai said, he had a discretionary fund of only US$33 that he could spend without getting permission.

Early on, Deng's government began revising this system too. In 1979, it halted a Stalin-style Five-Year Plan that emphasized heavy industry, like steel mills, and redirected much investment into consumer goods: refrigerators, washing machines, TV sets.

In the main move towards market allocation, local municipalities and provinces were allowed to invest in industries that they considered most profitable, which encouraged investment in light manufacturing. Thus, Deng's reforms shifted China's development strategy to an emphasis on light industry and export-led growth. Light industrial output was vital for a developing country coming from a low capital base. With the short gestation period, low capital requirements, and high foreign-exchange export earnings, revenues generated by light manufacturing were able to be reinvested in more technologically-advanced production and further capital expenditures and investments.

7. Final Thoughts on Difference with the Soviet Union.

Deng's program of reform termed Gaige Kaifang (meaning Reforms and Openness) preceded the most popular and well-known Perestroika and Glasnost introduced by Mikhail Gorbachev who was in reality 'borrowing' those terms from the Chinese.

On ascending to power in 1978, Deng ridiculed the Cultural Revolution slogan that held it was 'better to be poor under socialism than rich under capitalism.' The blunt, practical Deng offered instead: 'Poverty is not socialism.' Gorbachev observed and admired the changes that were taking place in China under Deng Xiaoping and they strongly influenced his own reform plans following his election as General Secretary of the Communist Party of the Soviet Union on the 13th of March 1985.

A nice and short synopsis (one to which I totally subscribe) on why China succeeded and the Soviet Union failed at implementing those critical reforms is given by Richard Evans, former British Ambassador to China and author of 'Deng Xiaoping and the Making of Modern China', he sees three secrets of success in China's drive to development that distinguish it from the failures of the former Soviet Union.
  1. China began by reforming agriculture rather than commerce or industry. This made food and raw materials for light industry plentiful and thereby created conditions conducive to change in the cities.
  2. China avoided hyperinflation and a rapid decline in living standards by removing price controls gradually, so that the consumer was not turned into an enemy of reform.
  3. Economic reforms preceded political reform, which improves the chances that a more open political order will survive once it does come about.
Another key issue, not mentioned by Evans but still of huge relevance, was the 'implementation type' of the reforms....i.e. the bottom-up approach of the Deng reforms vis-à-vis to the top-down approach of Gorbachev. Bottom-up reform cannot be resisted because it requires no negotiations, avoids confrontations, and it spreads like an unstoppable plague. Top-down reform can be killed easily by ridding the leadership of reformers or by high-level sabotage, however it was perceived 'easier', particularly in a totalitarian society, than securing support at grassroot level.

In China, there was a massive grassroots constituency which clearly understood the reform’s potential benefits. They acted quietly on their own, according to the Chinese saying, 'Do more but say less; do everything but say nothing.'

In a little over 30 years, Deng Xiaoping policies have allowed China to move from the peasant society it once was to an industrial superpower with a GDP second only to the United States. Since the beginning of Deng Xiaoping's reforms, China's GDP rose from some US $147.3 billion in 1978 (the size of the US economy in 1978 was US $2.3 trillion) when it was the 11th largest economy in the world to US $9.7 trillion in 2010 (with an annual average increase of 9.5 percent over that period) and 2nd largest economy in the world overtaking Japan this year, Yi Gang, China's chief currency regulator, mentioned the milestone during an interview with China Reform magazine, which was published on their website on the 31.07.10...see link below.

So China is now just behind the USA (the size of US economy in 2010 US $14.8 trillion)...and most analysts are now predicting that China's economy will be the world's #1 by 2020 or even earlier...

OK...China's path and results have been totally different  to those of the Soviet Union...but will it still collapse? to be continued

Thursday, 5 August 2010

Why China Succeeded & The Soviet Union Failed at Implementing Reforms? Part I

1. Setting the scene...Time for Reform

When historians look back on the twentieth century, they will note that the first three-quarters of the century were marked by extreme and violent revolutions on both the right and the left. They may be even more intrigued, however, by the fact that in the last quarter of the century, the governments established by those revolutions shifted to considerably more moderate positions and they did so in a non-violent manner.

The two most notable examples of this phenomenon were China and the Soviet Union, where Deng Xiaoping and Mikhail Gorbachev were engaged in trying to turn their countries away from what was called the 'Stalinist model', with its emphasis on heavy industry, centralised planning and authority, and political and cultural repression.

There were previous efforts to reform the Stalinist model, but what made the Deng and Gorbachev approach different was that they not only acknowledged the need to change, but also seeked to implement changes that challenged the vested interests of their own communist parties. Most of their colleagues, whether high officials or middle-level bureaucrats, seemed willing to recognise the shortcomings of the existing system, but they opposed with all their being its reforms, as the reforms threatened their existing status.

To understand what both leaders had to overcome, it is necessary to recollect what each found when he assumed power. In some ways their situations were similar...

Both countries began serious reform after the passing of a leader (or leadership) that abhorred reform. Deng Xiaoping and his allies succeeded Mao Zedong in 1978 after a brief power struggle with hardliners. Gorbachev succeeded the initial beneficiaries of Stalin’s purges of the 1930s, who rose quickly as young men to replace those who were executed.

At the time of Deng’s return to power at the Third Plenum of the 11th Central Committee of the Chinese Communist Party in December 1978, and Gorbachev’s selection as General Secretary of the Soviet Communist Party in March 1985, both were confronted with stagnant economies that were based on state ownership of the means of production, centralised planning and collectivisation of agriculture. Each man led one-party states that emphasised democratic centralism, meaning that all decisions and administrative appointments flowed from the top down.

2. The Soviet Union Case- Perestroika (Economic) & Glasnost (Political) Reforms...The  Beginning of the End of the Soviet Union

These were the 2 key areas of reforms that the seventh and last General Secretary of the Communist Party of the Soviet Union (serving from 1985 until 1991), and the last head of state of the USSR (serving from 1988 until its collapse in 1991) Mikhail Gorbachev introduced as ways of reviving the stagnant Soviet economy.

In 1985, he announced that the Soviet economy was stalled and that reorganisation was needed. Gorbachev proposed a 'vague programme of reforms', which was adopted at the April Plenum of the Central Committee.

Perestroika poster...
'Don't Be Afraid of Work.'

Gorbachev's economic changes did not do much to restart the country's sluggish economy in the late 1980s. The reforms decentralized things to some extent, although price controls remained, as did the ruble's inconvertibility and most government controls over the means of production.

By 1990 the government had virtually lost control over economic conditions. Government spending increased sharply as an increasing number of unprofitable enterprises required state support and consumer price subsidies continued.

Tax revenues declined because republic and local governments withheld tax revenues from the central government under the growing spirit of regional autonomy. The elimination of central control over production decisions, especially in the consumer goods sector, led to the breakdown in traditional supply-demand relationships without contributing to the formation of new ones. Thus, instead of streamlining the system, Gorbachev's decentralisation caused new production bottlenecks.

He soon realised though that fixing the Soviet economy would be nearly impossible without also reforming the political and social structure of the Communist nation.

Glasnost poster...
'Be Bold, Comrade! Openness: Our Strength!'

While glasnost is associated with freedom of speech, the main goal of this policy was to make the country's management transparent and open to debate, thus circumventing the narrow circle of apparatchiks who previously exercised complete control of the economy.

Through reviewing the past or current mistakes being made, it was hoped that the Soviet people would back reforms such as perestroika. However, relaxation of censorship resulted in the Communist Party losing its grip on the media. Before long, much to the embarrassment of the authorities, the media began to expose severe social and economic problems which the Soviet government had long denied and covered up.

In Summary...

What Gorbachev did not realise was that by giving people complete freedom of expression, he was unwittingly unleashing emotions and political feelings that had been pent up for decades, and which proved to be extremely powerful when brought out into the open.

By the late 1980s, the Soviet government came under increased criticism and members of the Soviet population were more outspoken in their view as Gorbachev's policy of economic reform did not have the immediate results he had hoped for and had publicly predicted. Glasnost did indeed provide freedom of expression, far beyond what Gorbachev had intended, and changed citizens' views towards the government, which played a key role in the collapse of the Soviet Union.

3. The Chinese Case- From Mao Zedong's 'The Great Leap Forward' & 'Cultural Revolution' to Deng Xiaoping's 'Economic Reforms'

During the 1950s, Soviet-guided China followed the Soviet model of centralised economic development, emphasising heavy industry, and delegating consumer goods to secondary priority; however, by the late 1950s, Mao Zedong had developed different ideas for how China could directly advance to the communist stage of Socialism (per the Marxist denotation), through the mobilisation of China’s workers. These ideas progressed into the 'Great Leap Forward'.

The 'Great Leap Forward' of the People's Republic of China (PRC) was an economic and social plan used from 1958 to 1961 which ostensibly aimed to use China's vast population to rapidly transform the country from an agrarian economy into a modern communist society through the process of agriculturalisation, industrialisation, and collectivisation.

The 'Great Leap Forward' is considered as a major humanitarian and economic disaster, effectively a 'Great Leap Backward' that affected China in the years that followed. Industries went into turmoil because peasants were producing too much low-quality steel while other areas were neglected.

Furthermore, uneducated low-income farmers were poorly equipped and ill-trained to produce steel, partially relying on backyard furnaces to achieve the production targets set by local cadres. Meanwhile, essential farm tools were melted down for steel, reducing harvest sizes. This led to a decline in the production of most goods except substandard pig iron and steel. To make matters worse, in order to avoid punishment, local authorities frequently exaggerated production numbers, thus hiding and intensifying the problem for several years.

In the meantime, chaos in the collectives, bad weather, and exports of food necessary to secure hard currencies resulted in the Great Chinese Famine. The official toll of excess deaths recorded in China for the years of the Great Leap Forward is 14 million, but scholars have estimated the number of famine victims to be between 20 and 43 million.

On the other hand on May 16th 1966, Chairman Mao launched 'The Great Proletarian Cultural Revolution' or simply the 'Cultural Revolution' to stem what he perceived as the country's drift away from socialism and toward the 'restoration of capitalism'. The campaign, which was euphorically described at its inception by its progenitors as 'a great revolution that touches people to their very souls' and which inspired radical students across the world, was again another major catastrophe that created a nation-wide chaos and economic disarray and stagnation that only ended officially with Mao's death in 1976.  

The origins of the Cultural Revolution can be traced to the mid–1950s when Mao first became seriously concerned about the path that China's socialist transition had taken in the years since the CCP had come to power in 1949.

Mao concluded that the source of China's political retrogression lay in the false and self–serving view of many of his party colleagues that class struggle ceased under socialism. On the contrary, the chairman concluded, the struggle between proletarian and bourgeois ideologies took on new, insidious forms even after the landlord and capitalist classes had been eliminated. The principal targets of Mao's ire were, on the one hand, party and government officials who he felt had become a 'new class' divorced from the masses and, on the other, intellectuals who, in his view, were the repository of bourgeois and even feudal values.

The Cultural Revolution is now referred to in China as the 'decade of chaos' and is generally regarded as one of the bleakest periods in the country's modern history. The movement's ideals were betrayed at every turn by its destructive impulses. Hundreds of thousands, if not millions, of officials and intellectuals were physically and mentally persecuted. The much–vaunted initiatives that were to transform the nation often had disastrous consequences for China's education and cultural life. Economic development was disrupted by factional strife and misguided 'ultraleftist policies'.

Enter Deng be continued