Asia’s Economy:                                               

Challenge and Opportunity for the Obama Administration

by Terry Cooke (www,

February 2009

Terry Cooke is a Senior Fellow at FPRI and the principal director of GC3 Strategy, Inc., an international consultancy specializing in sustainability-related technologies and capital linkages between Asia and the U.S. Previously, Dr. Cooke was Director of Asian Partnership Development for the Geneva-based  World Economic Forum. He has advised the Lauder Institute on global business outreach as a member of the University of Pennsylvania’s Wharton School’s Department of Management.  Dr. Cooke was a career-member of the U.S. Senior Foreign Service, with postings in Taipei, Berlin, Tokyo and Shanghai. This Enote is one in a series concerning Asia policy for the new administration.

The Obama administration faces a changed world. As a precarious economy and a global economic crisis have risen to the top of the U.S. security threat list, Asia’s geopolitical significance is looming larger. In adapting economic policy towards Asia under these conditions, the new administration must also confront the loss of U.S. reputation and influence that the financial crisis has entailed. It must communicate the causes and consequences of the crisis to the public and address them in policy. It has to take responsibility for U.S. policy failures while maintaining firmness where required of our Asian partners and reaffirming the basis of our enduring engagement with the region.

For the first time since Asia’s modernization, both the West and Asia are together falling headlong towards economic stagnation and deflation. More than a half-century of interdependent growth is now over, as the U.S. and Asia find their economies roped together and sliding precipitously downward.

The current crisis has its origin in a quarter-century of global trade growth which, particularly across the Pacific, has far outstripped global output growth. With the World Bank anticipating a drop of 2.1 percent in world trade in 2009 following this unprecedented 27-year boom, the rapid expansion of international trade has given rise to imbalances that are now threatening the global system.

Early Signs

The earliest signs of the current financial crisis appeared in late 2007 in the U.S. subprime credit markets. At the outset, observers tended to see this problem as an American problem. Asia was reassured by the thought that its economies, following decades of strong regional growth, had effectively “decoupled” from Western markets. While Asian markets were, with the exception of Japan, smaller in absolute size than counterpart economies in the West, they had been enjoying steady and high growth rates and seemed to be developing strong intraregional demand. The region, so the thinking went, would be inoculated against any economic flu afflicting the West. This hope was bolstered by Asia’s experience coming through the 1997-98 Asian Financial Crisis.

But throughout 2008, it became increasingly clear that Asia would not be a safe haven in the spreading crisis. Some of Asia’s highly touted emerging economies now verge on being “submerged.” While a drop of projected output from high single-digits to low single-digits might seem good news compared with the negative growth projected for the U.S. and other advanced economies, the ability of Asian countries to withstand the social and political effects of slower growth is open to question. Taiwan’s exports were down 44 percent in January from the prior year. Korea is currently experiencing a bigger collapse in exports and a higher rate of capital flight than it did as the epicenter of the Asian Financial Crisis. The government of China has already announced that an estimated 20 million manufacturing jobs have been lost, with many more expected by late spring.

What Happened?

The root cause of instability has been an imbalance long embedded in the global trading system between a debt-leveraged structure of consumption in the Western economies and a savings-biased structure of export dependence among Asian economies. In recent years, this imbalance has reached unsustainable levels as a result of China’s quantum expansion of the vaunted Asian growth model.

After decades of unprecedented global peacetime growth, China’s quantum-level expansion of Asia’s traditional, export-led manufacturing model combined with other factors such as new demands on global supply from the rapidly growing middle-classes of China and India have tended to accentuate existing imbalances in the global system. In the resources realm, this disequilibrium took the shape of price spikes and commodity shortages for energy, food, minerals and other natural resources over recent years. From second quarter 2007 to second quarter 2008, the NYMEX price of oil doubled. In tandem, global food production, highly dependent on energy-intensive fertilization and dwindling agrable land, rose in price beyond the range of poor consumers. Political discussions of energy and food security took on new urgency, as did debate over how to combat climate change. In the area of global finance, rapid growth further amplified the basic disequilibrium between consumption-led growth in the West and export dependence among Asian economies. In China, the level of foreign exchange reserves resulting from its successful expansion of the export-led growth model rapidly eclipsed the level of surplus generated by Japan and Taiwan in earlier decades. Simultaneously, an upstart group of new sovereign wealth funds (SWFs) popped up to recycle the bonanza of petrodollars in the Middle East as well as foreign exchange surpluses in Asia resulting from booming exports to the West. China’s sovereign wealth vehicles, China Investment Corporation (CIC) and State Administration of Foreign Exchange (SAFE), began acting as new drivers of Beijing’s effort to draw in raw materials from around the world. In parallel to Beijing’s resource-attuned policies in Africa and other parts of the undeveloped world, China’s SWFs vetted acquisition of global resource companies in Australia and elsewhere in the developed and developing world. In the wake of the collapse of CNOOC’s bid for Unocal in 2005, Chinese SWFs were scrutinized with regard to the motivation for, and transparency of, their activities. In Washington, Congress increasingly preempted the executive branch’s public lead on these issues, fanning exaggerated fears in China of a supposed U.S. determination to block China’s rise.

Meanwhile, U.S. consumers kept piling on more debt to continue their splurge in the housing market and to absorb the flood of low-cost goods being churned out by Asian factories. To keep their export levels and employment in their factories high, China kept financing U.S. over-consumption through the recycling of its foreign exchange surpluses into purchases of U.S. Treasuries and other stable debt instruments.

While openly caustic about the United States’ biting the hand that feeds, Beijing has few other options for recycling its surpluses. Given the scale of the reserves being recycled, no other form of investment offers close to the capacity, liquidity, and relative safety of dollar-denominated Treasury issues. While there is ample blame to share on both sides, then Undersecretary of the Treasury Tim Adams put it best when he said in 2006, “You can’t have a situation where everyone complains about U.S. consumption and then drives their economic strategy to survive off that consumption.”

Under the Bush administration, China policy was mostly run through the Treasury Department and Hank Paulson’s Strategic Economic Dialogue (SED) process. For the U.S. side, the fulcrum of these negotiations was to wean Beijing away from a policy of fixing artificially low exchange rate for the yuan as a means to boost to China’s export industries. Since the first, grudging signs of China’s responsiveness to this negotiating push, the yuan did appreciate 21.5 percent against the dollar over the three-year period from mid-2005 to mid-2008. This level of appreciation was a step forward but is modest given the overall degree of bilateral and global structural imbalance. 

However, since the onset of the financial crisis, that movement has stalled. During the fifth, most recent SED meeting in Beijing in December 2008, the chair of the Chinese side, Wang Qishan , lectured the U.S. delegation on U.S. consumer profligacy. At the Davos World Economic Forum meeting in January 2009, Premier Wen Jia-bao broadened this critique, in unison with Russian Prime Minister Vladimir Putin, to a more general attack on the Western financial system. Despite these rhetorical flourishes and the stated fears from many quarters that the crisis might prompt China to reverse direction and devalue its currency, the yuan has held steady in recent months. In effect, Beijing is choosing to practice the Taoist art of wu wei (“do nothing”)  with its exchange rate policy while weathering the first bouts of financial turbulence and reckoning the direction of the new Obama administration.

In forming its economic policy, the Obama administration must find a means of breaking the sterile cycle of recrimination engendered by a narrow focus on exchange rate policy. Leading the world economy will require the U.S. to curb its own excesses and to offer a more compelling vision to encourage trade partners in Asia to move forward together as stakeholders in the global system. A renewed commitment to world trade can be a starting point.   (continued in next entry)