‘Bigger the boom, bigger the bust: China is no exception to that rule’

(This interview with fund manager and economist Richard Duncan, was published in DNA edition dated December 28, 2009.)

The US economy is on ‘government life support’, but instead of spending trillions of dollars to prop up its ‘unviable’ economy and repeat Japan’s mistakes of the past 20 years, policymakers should overhaul the economy by investing $3 trillion in 21st century industries, reasons fund manager and economist Richard Duncan in his most recent book The Corruption of Capitalism: A strategy to rebalance the global economy and restore sustainable growth (reviewed here). In an interview to DNA Money’s Venky Vembu, Duncan also explains why he believes that China’s export-led economic boom of 20-plus years is at grave risk. Excerpts:

There’s been a revival in the US economy, and banks are returning their TARP funds and paying out big bonuses. Is America back in business?

The US economy is on government life support. In 2009, US GDP will contract probably 2%. Had it not been for the government spending through a 10% budget deficit, GDP would have contracted by 12%, perhaps more. And unemployment would have gone up to well above 20%. In other words, it would have been a replay of the Great Depression.

Next year too, the US economy will be completely dependent on government life support. As long as the government spends another $1.4 trillion, the economy will be just fine, but it cannot function in the absence of government support, and would collapse into a Great Depression. For years to come, the economy will have to be supported by massive government deficit spending.

Governments around the world responded to the economic collapse with massive public spending that Keynes would have approved of. What’s wrong with that?


Keynes’ masterpiece, The General Theory of Employment, Interest, and Money, was published in 1936, and it didn’t have any influence on how governments responded to the Great Depression. The Keynesian theory was never put to the test. Now that we’ve fallen back into a New Depression, it’s been tested. Governments implemented extreme Keynesian policies to prevent their economies from collapsing into a Depression. But because Keynes’ theories weren’t tested during his lifetime, he didn’t offer us any recommendations on how to get economies off the government life support. That’s the problem we’re confronting now. Governments are supporting the economy, and if they stop spending, the economy goes back into severe recession. We need to take Keynesian analysis further. Not only do we know that we must spend to support the economy when a very large credit bubble implodes, we now need to figure out how to use this government spending wisely so we can restructure the US economy and permanently resolve this crisis at its very core. At the core of the crisis is the fact that the US economy is not viable the way it’s currently structured. It makes very little that the rest of the world cannot buy much cheaper elsewhere.

So what’s the permanent solution?

The Congressional Budget Office projects the US budget deficit will be $7 trillion over the next 10 years. (Their assumptions are wildly optimistic.) Spending that money will support the economy just as massive Japanese government spending has supported the Japanese economy over the past 20 years. But Japan’s spending hasn’t fixed Japan’s problem. Japan stimulated the economy by building bridges to nowhere and really didn’t achieve anything. US policymakers should learn from Japan’s experience, recognise that they’re going to have to spend enormous amounts of money to support the economy and understand that it would be a disaster if they spend it in the same way that Japan did.

Instead of spending $10 trillion and getting nothing expect further deindustrialisation of the US over the next 10 years, US policymakers should invest an extra $3 trillion over that 10-year period in solar energy, genetic engineering and biotechnology and nanotechnology – the industries of the future. It would be possible to completely restructure the US economy so that it could make products that the rest of the world desperately wants, which they can’t buy anywhere else at any price. That would solve the crisis in the US economy.

How can the $3 trillion be raised – and is there political appetite for higher deficit spending?

The expansion of government debt in Japan to more than 200% of GDP demonstrates just how great a government’s capacity to borrow is. It’s true that Japan had the advantage of domestic savings, but the US too has other advantages.

But my bigger point is that the money is available. During the bubble years (the 1980s in Japan’s case, and the 1990s and most of this decade in America’s case) enormous amounts of profits were made. When the bubble bursts, that money realises that if it doesn’t shift from speculative ventures and become invested somewhere safe – like government bonds – it will be destroyed. So it’s the profit made during the bubble years that make it possible to finance very large deficits that are necessary to support the economy after the bubble pops.

That’s what we saw in Japan, and that’s what we will see in the US – and in China as well when China’s bubble pops.

In your book, you say China’s problem is worse than the US. Why’s that?

The first law of macroeconomics is, ‘If you don’t prevent the boom, you can’t prevent the bust.’ The second is, ‘The bigger the boom, the bigger the bust.’ Now that the Dubai bubble has popped, there’s only one exception to that rule over the past 250 years – China – but I don’t believe it will remain the exception much longer.

China responded to the American crisis with a massive, unprecedented stimulus and bank lending. It’s been useful, of course. It’s like China has drunk a quart of Red Bull: it gives you a very big jolt, and it makes you feel alert. But after a while, the effect will wear off, and China will have to drink two quarts of Red Bull – or accept the reality that the economy will slow very sharply and that much of the stimulus money will have been misallocated, given that China already has excessive capacity across industries.

China sceptics have for years now warned of a ‘coming collapse’, but they’ve been proved wrong. Why can’t China similarly keep its economy rolling?

A year from now, Chinese authorities will have to decide whether to force banks to increase their lending again by 30% of GDP. If they do, they’ll succeed in keeping the economy growing by 10% a year or whatever. But the longer they continue with that, the more certain will be the crash, and the harder the crash will be. The longer they carry on with this extraordinary stimulus, the harder their bubble will ultimately implode and potentially more serious the consequences for the Chinese people will be. Chinese leader would be wiser to accept reality, and prepare their people for much slower economic growth – say 2-4% a year – rather than promising 8% growth forever. If China can achieve 2-4% GDP growth a year for the next 10 years, that would be an excellent outcome.

The Chinese government has a low debt liability: only 20% of GDP. Doesn’t that give it headroom to prevent a collapse?

The low level of government debt will allow China to do what Japan did. When the bubble pops, the government will be able to borrow and spend. It will be able to stimulate the economy with large deficit spending programs. Japan took it from 60% of GDP to more than 200% of GDP. That’s the most hopeful thing China has going for it: that the government can take its debt up to 100% or even 200% of GDP. That will allow the government to avert a Great Depression. But if it forces banks to make more and more loans when there are no profitable lending opportunities, their banks will have to be bailed out. Bank bailouts can be expensive, and will cause the government’s debt to jump up quickly. It won’t take long under a banking crisis scenario for government debt to reach 100% of GDP; that would leave them less room for manoeuvre in terms of supporting the economy.

Isn’t China better positioned, financially and politically, than the US to invest in 21st century industries and take the lead?


China is becoming a leader in areas related to clean energy, but China’s problem is that it cannot consume what it produces because its workers don’t make enough money. And China has an unprecedented trade surplus with the rest of the world: this will be met with a protectionist backlash that will put a cap on China’s ability to export anymore anywhere. For China to transform its economy, it has to wean itself off its export-led growth strategy and develop its domestic sources of demand. But that’s very difficult: China’s economy is built for export, where its advantage has been its low-cost labour. But that also makes it impossible to create in a short period of time a consumer-led industrial society.


The US, on the other hand, has a trade deficit with everyone. Other countries couldn’t object to the US balancing its trade if it made something that other countries needed. That would remedy the global imbalances that are destabilising the world.

Also, the US economy is roughly 30% of global GDP. Only the US has the ability to finance the kind of investment programs I have in mind. $1 trillion each in three different industries is an enormous amount of money. It’s like the NASA space program, on a much larger scale and with much more at stake. China is still a small economy compared to the US.

China has pitched for an alternative to the US dollar as a reserve currency, but you say it should be careful what it wishes for.  Why?


The last thing China wants is an alternative reserve currency. If there were another reserve currency, it would mean that all international transactions would have to be denominated in that currency. It’s not clear what the new currency would be; let’s say it’s the IMF’s Special Drawing Rights (SDRs). The US cannot print SDRs the way it does dollars. It would have to pay for its imports with its limited supply of SDRs. Given its current trade deficit with China, it would be out of SDRs in three months, and it couldn’t buy anything more from China. China’s trade surplus would plunge about 75% within months, and China would go into an economic crisis on an unimaginable scale. China knows this. But its officials are making some noises to put pressure on the US to prevent it from pressuring China.

The reason the dollar is a reserve currency is that the US for many years had the largest trade deficit, which throws dollars off into the global economy. Until some other country comes along and has a giant trade deficit for a couple of decades, there’s no replacement for the dollar.

On India’s vulnerabilities
India has a trade deficit, and a very large capital account surplus. More than enough money comes into the country to finance the trade deficit. It ends up as a very large balance of payments surplus, which causes India’s foreign exchange reserves to rise. In one sense, India doesn’t have the kind of bubble that China has: China has been going gangbusters for 20 years. India’s problem is that all the capital inflow coming in has resulted in very rapid loan growth for many years in a row. That loan growth fuelled domestic consumption but also fed bubbles in the property sector and the stock market. India’s vulnerability would be exposed if a global economic crisis disrupts the flow of capital into the Indian economy. That would push interests rates back up, which would be very damaging for the credit boom, the expansion of mortgages and domestic consumption.

Related reading
China’s economy is dangerously addicted to cheap money‘:
Interview with Prof Patrick Chovanec
‘This is a very dangerous time for China’:
Interview with Dr Jim Walker
‘China’s biggest risk is that it doesn’t change its economic model’:
Interview with economist Stephen Roach
‘Much of China’s GDP vanishes into thin air’:
Interview with David Scissors
Why China needs to change:
Interview with Arthur Kroeber
‘China’s nuclear bomb is a dud’:
Interview with Michael Pettis


About Venky

Journalist, blogger, amused observer of worldly goings-on... More about me here.
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7 Responses to ‘Bigger the boom, bigger the bust: China is no exception to that rule’

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