Obama's Deadly Cure for Global Crisis

By Michael Stutchbury

When Wall Street erupted six months ago, American voters swung behind Barack Obama as the best candidate for the crisis.

But with the US losing more than a half million jobs each month, Wall Street down a further 20 per cent since inauguration and American banks deep in trouble, he is making the crisis worse.

In a typically sweeping analysis last week, Paul Keating doubted whether Obama's $US787 billion ($1.2 trillion) budget stimulus would restore confidence in the US or world economy. And he sheeted home blame for the crisis not to Kevin Rudd's extreme capitalism, not to Alan Greenspan and not to greedy sub-prime bankers on Wall Street. These were simply accessories to the original culprits: the Clinton administration, the International Monetary Fund and Timothy Geithner, a 1990s mid-ranking US econocrat who has ended up as Obama's tax-avoiding Treasury Secretary.

The implication is that fixing the fundamental global imbalance behind the crisis requires American belt-tightening as part of what some call a "grand bargain" between the world's biggest debtor, the US, and its biggest creditor, China.

Under the bargain, Beijing would tap its $US2 trillion of foreign reserves to stoke domestic demand, build infrastructure and construct a social safety net underneath 1.3billion Chinese. Instead of drawing on Chinese savings to finance US consumption, Washington would rein in its budget deficits. China would let the yuan strengthen against the greenback, boosting Chinese purchasing power and helping American industry narrow the US trade deficit.

Global recovery would be driven by Chinese consumers and American net exports, so correcting the fundamental imbalance. The US would consume less but would save American jobs. The Chinese would export less but live better. But, rather than balance Beijing's $US586 billion budget stimulus with US belt-tightening, Obama has embarked on massive New Deal-style spending. Disguised as a recession cure, this will widen this year's US budget deficit to $US1.2 trillion or 12per cent of gross domestic product and lift net public debt to 60 per cent of GDP or $US13 trillion in a decade.

Even this requires rosy economic forecasts and a big run-down in defence spending. No wonder the confidence effects from Obama's fiscal stimulus "have not been great", Keating said. "Is American default on the cards? If not, who is going to buy the bonds?"

The Chinese, of course, says Obama's Secretary of State Hillary Clinton, who last month told Beijing it was in China's interest to keep the US economy afloat. That's Bill Clinton's line, too. Yet, while the Clintons want the Chinese to stockpile more US bonds, Geithner wants Beijing to stop "manipulating" a weak currency that threatens American jobs. That is, the US wants it both ways.

That's too much for Keating, who blames the crisis on Bill Clinton's failure to exploit the end of the Cold War by reshaping the global economy's post-World War II institutional architecture. Instead, Clinton "declared victory and walked off the field". The US spent the '90s in self-celebration, happy to "vacuum up the savings of the world" as its spoils. Washington's only use for Beijing was "to turn up to bond tenders".

Keating told a Lowy Institute forum last week that Gordon Brown and Obama must use next month's Group of 20 London summit to pave the way politically for the grand bargain. Obama must defy his own advisers to entrench the G20, the child of the 1997 East Asian financial crisis, as the successor to the Group of Seven big industrialised nations that formed during '70s stagflation but that excludes China. And the G20 must replace the Washington-run and trans-Atlantic-dominated IMF as the official funder of emerging economies hit by external crises. Stuck in the 1947 Bretton Woods world, the Benelux countries have more IMF voting rights than China.

Calls by Brown, Rudd and others to pump more capital into the IMF "would be a huge mistake", Keating said. The IMF had been "making a mess of things for 20 years and the greatest mess was East Asia". When the hot money sucked into booming East Asia during '90s globalisation was sucked back out, the IMF should have diagnosed a fitful exodus of capital that called for bridge financing. Instead the IMF prescribed the tough medicine usually reserved for structural balance of payments crises. Geithner was the "Treasury line officer" who wrote the punishing IMF program for Keating's valued Southeast Asian partner, Suharto, and the country in which Obama lived as a boy.

"It takes a gigantic fool to mess that up," Keating said. Geithner's then superior and now Obama's chief White House economic counsel, Larry Summers, had a shouting match with Peter Costello over Australia's push to redraw the IMF's Indonesia program. Brown was IMF committee chairman.

After that, no East Asian country, particularly China, would put its "head in the noose" of the IMF or the US Treasury, said Keating. To protect its sovereignty, Beijing built its huge defensive war chest of foreign reserves, financed by exports that otherwise would have lifted Chinese living standards.

But, as Chinese demand bid up the price of US government debt, interest rates fell and risk became cheap. Searching for higher yield, the American investment banks that built the 20th century's great industrial economy ended up lending to the lowest-value borrowers, tarting up sub-prime mortgages as investment grade bonds, inflating the US housing bubble and poisoning the global banking system. That's what money pushers do when money is so abundantly cheap, whether they're "greedy Dick Fuld" of Lehman Brothers or Citibank's "hopeless Charles Prince".

Keating didn't draw this out but Obama's yes-we-can platform was built around ongoing Chinese credit. The crisis simply became a too-good-to-waste opportunity for the Obama Democrats to ratchet up government spending. Now they want the universal health insurance that Bill and Hillary couldn't deliver, but with no money to pay for it.

Obama last week compared Wall Street's rout with the statistical noise of daily political polling. It's more serious than that. What Keating described as Wall Street's "profound" wealth destruction may be forcing on the US a version of the belt-tightening that Geithner and Summers imposed on Indonesia a decade ago. That could add General Motors and Citibank to the scalps of Lehman and Merrill Lynch.

As the richest and most productive nation on earth, the US should be generating savings to invest in emerging economies, not being bankrolled by the savings of poor Chinese. The irony is that, rather than change, Obamanomics is resisting adjustment to China's ascent.