Martin Wolf, the associate editor and chief economics commentator at the Financial Times, is one of the world's most influential financial journalists. He's an associate member of the governing body of Nuffield College at the University of Oxford; an honorary fellow of Corpus Christi College at Oxford; an honorary fellow at the Oxford Institute for Economic Policy (Oxonia); a special professor at the University of Nottingham; and a member of the board of governors for the Ben-Gurion University of the Negev in Israel. His column in FT, the U.K. counterpart of The Wall Street Journal, is available online and is almost always brilliant. In his latest book, Fixing Global Finance, Wolf clearly and concisely dissects the world economic crisis.
Gluck: The global meltdown that we're seeing-was the U.S. the main cause?
Wolf: This was caused by deep systemic failings in the world system. ... Over the last three decades, there's been an extraordinary expansion in credit. This led to an extraordinary amount of bad lending, as one would expect.
So this is an enormous credit bubble, and in the process a very large amount of bad debt has been created all over the place. The second thing that has happened over these 30 years is we tried to transfer capital-or some of this credit-to emerging economies. Every time that happened, we ended up with a huge financial crisis and ultimately, after the last and biggest of these waves of crises in '97-'98 in Asia, most emerging economies ... started to run very large current account surpluses. The capital they were receiving from the developed world came back out as foreign currency reserves, which were deposited in developed countries-particularly the U.S.-creating very low real interest rates in the U.S. and very large accumulations of liquidity in our banking system-further promoting, on a very large scale, the credit boom.
It's no doubt exacerbated by the fact that a large part of the credit that was supplied in the last few years was to households that could never pay it back. And it was obviously made worse by the fact that the instruments used to finance the credit bubble were very complicated securities that are distributed across the whole financial system of the world and nobody knows where they are, which has created vast uncertainty, and they're almost impossible to value. So there are clearly very important failures of regulation within the financial system which have also made the crisis worse than it would otherwise be. But I hold a view, at least at the moment, that we would have had a very severe correction in the economy even if that had not been the case because the credit bubble was going to burst at some stage.
Gluck: But you think that the real problem and solution may lie with China, which has accumulated these large foreign currency reserves. You argue that China must become a better borrower, right?
Wolf: Yes. It's very important that we do two things now: restructure the global stock of credit and debt (and in particular restructure the debt of households), and restructure the financial system so it's solvent. That's a task predominantly for the developed countries-particularly, obviously, the U.S. But beyond that, we have to get back to a different pattern of income and expenditure in the world, such that it doesn't rely so heavily on this massive borrowing by the household sectors of a relatively small number of developed countries, which are now maxed out. They just can't really be expected to borrow anymore. It's obvious that U.S. and U.K. households are going to save more. This is a very big deal because U.S. consumer demand alone is about 20% of world demand. It's equal to double China and India together. It's simple arithmetic. If we're going to sustain high levels of economic activity across the globe, then somebody else must offset this decline.
The longer-term solution is for those people who are saving too much to spend some more, and the obvious example of that is China, where consumption is actually only 30% of GDP as against more than 70% of the U.S. The question for the Chinese is: How can they go about this? In the short run, it's very, very hard because the structure of the economy is not easy for them to change.
Gluck: They need a more sophisticated financial system.
Wolf: They need several things. In the long run, first of all, they have to raise disposable incomes as a share of GDP. At the moment, household disposable income is only about 40% of GDP. You can't have a mass consumption society when disposable income is so small. The rest is corporate and government income and they have to transfer more income to households. That is actually a very big and complicated problem. Second, as you mentioned, the Chinese need a financial system. They've moved a long way in that direction, but must be better at extending credit to households. Third, the government needs to think of ways to promote more labor-intensive growth. The recent growth of China has been very dependent on massive investment and much of that has been very capital-intensive and hasn't been generating much jobs. That's one of the reasons why income growth has been so low for households despite the very rapid growth of the economy. They save about a third of their disposable income. In the short run, they have to do basically what the Americans do-spend more.