A master plan for China to bail out America
Arvind Subramanian
The financial rescue plan passed by the US Congress is viewed as flawed but
necessary to head off panic in financial markets and loss of confidence in the
economy. It seems a holding operation, a Plan C or D that might need
augmentation via a Plan A.
A vital component of a Plan A is likely to be additional money. For one thing,
there is suspicion that the amount of toxic assets is considerably greater than
the rescue plan provides for.
For another, more money may be required to address the problem in the housing
market by providing relief to subprime and marginal borrowers. And finally,
further fiscal stimulus could become necessary if recessionary forces take hold.
Where will this additional money - perhaps as much as another $500bn - come
from? The US taxpayer is wary. Joe Six-Pack has ponied up a lot already, and
done so with no great confidence that the money was for a worthwhile cause or
that it will be well spent.
Enter China. Ken Rogoff of Harvard cheekily characterised the vast Chinese
accumulation of US Treasury bonds over the past five years as the biggest
foreign assistance programme in history. Why not push that further? Here is a
thought experiment.
The Chinese government could offer to lend up to $500bn (from its current stock
of $1,800bn) to the US government for the rescue of its financial sector. Its
previous assistance - buying US bonds - was indirect and unconditional. Not so
in this case.
China's loan offer would be direct to the US government to be spent in the
current financial crisis. More important, it would come with strings attached.
Tied aid, the preferred mode of operation of western donors since the postwar
period, would now be embraced by China.
What would be the nature of the strings - or "conditionality" as the US
Treasury, a longtime practitioner of this art, has called it?
Conditionality as imposed by the World Bank and International Monetary Fund was
underpinned by an ideology that favoured markets and globalisation. But there
was also an assumption that either borrowing third world governments did not
understand their benefits or the reformers there needed a "spoonful of sugar"
to help overcome any internal opposition.
China would impose two conditions. First, it would declare that the offer of
money was conditional on the US government's adopting a particular approach to
rescuing the banks, namely to favour in the next round the use of government
money to recapitalise the banks.
Europe has been using this approach and evidence suggests it is the most
effective way of dealing with large-scale financial crises.
The US government - like third world governments in the past - has been unable
to adopt the most efficient course of action. This stems from an ideological
obsession against "socialising" banks or because inducement is necessary to
overcome any domestic opposition to it.
The second condition would relate to "social safety nets", which had become
standard embellishments to World Bank/IMF adjustment programmes. China would
stipulate that monies be devoted to cushioning the impact on vulnerable
homeowners, so that they would not be forced into forgoing the American dream
of home ownership.
Chinese conditionality on this front would achieve an outcome that several
economists on the left and right have argued for on grounds of fairness, and
also to address the fundamental problem in the housing market.
For China, this offer of help would have three virtues. First, it would be
riding to the rescue of a situation partly created by its own policies of
undervalued exchange rates, which led to lax global liquidity conditions.
Second, its economic interest would be served because successful US efforts at
rescuing its financial sector could help avert an economic downturn, protecting
China's exports, its growth engine.
Perhaps most important, it would seal China's status as a responsible
superpower willing to deploy its economic resources for the sake of protecting
the world economy.
And if the means for achieving that are by providing the current hegemon with
the largest aid package the world has ever seen with a healthy dose of sensible
conditionality, well, what could be more statesmanlike than that?
The writer is senior fellow, Peterson Institute for International Economics and
Center for Global Development, and senior research professor, Johns Hopkins
University
http://www.rediff.com/money/2008/oct/13bcrisis7.htm
A creaking door hangs long on its hinges
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