essays by: jacques attali mohamed el-erian• kishore … · 2011. 3. 28. · companies, and...

COMPANIES, ANDCONSUMERS, THECRITICAL QUESTIONIN THE COMINGYEAR IS THIS:

YOUR DEBT?

Albania Lek 950 France €6.50 Kuwait 60 1.90 Norway NOr 55.00 S. Africa R 47.954 1 Austria €6.50 Germany €6.50 Latvia 56.95 Oman DII 2.40 Spain €6.50

Bahrain 013 2.30 Gibraltar £3.95 Lebanon 118000 Poland (incLtax) P1610.50 Sweden S6r 58.00Belgium €6.50 Greece €6.90 Lithuania $6.95 Portugal €6.50 Switzerland CHF 18.50Bulgaria DCL 6.00 Hungary Ft. 1800.00 Luxembourg €6.56 Qatar flIt 24.00 Syria SYP 250.00Croatia ON 32.08 Iceland NOR 525.00 Malta €6.56 Romania $6.95 Turkey TI 6.50Cyprus €6.00 Israel NIS 25.00 Mauritius Its 95.06 Russia $6.95 UAE Oh 24.00Czech Republic £26217.00 Italy €6.96 Montenegro DIN 350 S. Arabia SR 24.00 United Kingdom £3.05Denmark DOr 45.00 Jordan JO 4.30 Morocco OH 60.06 Serbia DIN 350Egypt E€ 21.00 Kazakhstan $6.95 Netherlands €6.50 Slovakia €6.50Finland €6.50 Kenya Shs 450 Nigeria N 450.00 Slovenia €5.00

SPECIAY. EDITION • ISSUES 2011--- -

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ESSAYS BY: JACQUES ATTALI • MOHAMED EL-ERIAN• KISHORE MAHBUBANI . STEPHEN ROACH JOSEPH STIGLITZ

HE ::EY TO1

FOR COUNTRIES,

CAN YOU HANDLE

WhatTHE SWISSDid RightBY STEFAN THEIL

The Swiss faced one of theglobe’s worst financial-sector blowups.Now they’re setting the gold standardfor how to regulate their banks.During the financial panic of 2008,

the Swiss had more reason than mostto be frightened. The country’s banks,dominated by Credit Suisse and UBS,held assets worth an incredible 680 percent of Switzerland’s GDP (comparedwith U.S. commercial banks’ assets of70 percent of GDP). No one knew howmany of the Swiss holdings were toxic.What everyone knew was that thesebanks were far too big for tiny Switzerland to bail out in any full-blownbanking crisis. Capital flight wouldcrush the Swiss franc and the country’s economy right along with it.There were scary parallels to Iceland,another small nation with an independentcurrency and outsize global banks.After a severe blowout, Iceland is nowin a deep recession and on life supportfrom the IMF.Yet today, little Switzerland is a

rock in the global tempest. The francis one of the world’s strongest reservecurrencies, and both Credit Suisseand UBS are among the globe’s mostsoundly capitalized big banks. Capital is flooding into the country and,yes, back into Swiss banks. It’s a far

cry from the U.S., where the FederalReserve is still pumping money intoa shaky banking and mortgage sectorthat shows few signs of healing. OrGermany, another epic victim of theglobal financial crisis, where politicians fight phantom speculators andeach month seems to bring fresh newsof previously undisclosed toxic-assetlosses. And unlike many of the countries sharing the euro, there was neverany worry that Switzerland would notbe able to pay back its debts.What did the Swiss do right? For one,

the country’s regulators and centralbankwere faster and tougher than most.During the lull in the summer before thecollapse of Lehman Brothers in September 2008, the Swiss were hard at workon a plan to deal with troubled assets atUBS, the worst of Switzerland’s problem banks—with a balance sheet morethan four times the size of the entireSwiss economy. When disaster struck,the central bank swiftly nationalizedpart of UBS’s assets and recapitalizedthe rest. That’s unlike authorities elsewhere in Europe or Washington, whowaited until the last minute to stitchtogether messy bailouts that left manyproblems to linger.Second, the Swiss decided early

on that tighter reins on their banks

wouldn’t just protect taxpayers fromfuture crises and bailouts, but wouldultimately be good for the banks’ ownbusiness as well. With trust in theglobal financial system only slowly reemerging, the perception that Swissbanks have to adhere to much tougherrules—and are therefore sounder—helps win the trust of Switzerland’smost important customers: the globalwealthy who let Swiss bankers managetheir fortunes.In just about every area, the Swiss

are stricter. New plans pushed forward by the Swiss National Bank’sambitious 47-year-old chief, Philipp

18 NEWSWEEK SPECIAL ISSUE

Hildebrand, will require UBS andCredit Suisse each to hold 19 percentof their total assets in capital to coverpotential losses—almost three timesthe new global standard of 7 percent that will be phased in by 2019.Swiss banks are also required to holdmore cash to prevent bank runs, andin 2009 were among the first to follow new guidelines regulating executive pay and bonuses—widely seen asan incentive to take excessive risks.Above all, Hildebrand has sworn thatnever again should taxpayers be heldhostage to banks that are “too big tofail.” To that effect, regulators have

proposed new rules that would forcebanks to divide their business amongseparate units that could be liquidatedin a crisis without sinking the mothership—something that banks like CreditSuisse are already beginning to implement. Here, too, Switzerland is farahead of the pack.You’d think Hildebrand would be

getting more credit for safeguardingSwiss banking’s future. Instead, theSwiss business press has accused himof being internationally isolated. TheInstitute of International Finance, anorganization that represents the world’slargest banks, has repeatedly warned

against individual countries “overreacting” to the financial crisis. Somecountries worry that tough, Swiss-style rules will put their own banks ata disadvantage; for some of the weakest banks in Germany or the UnitedKingdom, new requirements to raisecapital might require yet another infusion of taxpayer funds. Now that thecrisis is starting to recede into memory, the pressure to regulate mayweaken. Yet if the fast return to stability of the country’s banks, economy, and currency is any lesson, theworld could do worse than followSwitzerland’s lead.

NEWSWEEK.COM 19

How to CureAMERICA’SIll EconomyBY KATIE BAKER

How can a country escape from crippling debt? This

question—once considered the purview of struggling devel

oping nations—now weighs heavily on the world’s advanced

economies as they slowly recover from the global financial cri

sis. Unfortunately, there’s little agreement as to the best way

forward: European governments such as Germany and Britain

are pushing government austerity slashing spending andrais

ing taxes despite widespread voter discontent. Japan’sleaders

are waffling between promises to cut budgets and yet more

state spending to try to jump-start growth. Meanwhile, nations

like Greece and Spain are looking to China to buy theirgovern

ment bonds and state assets in the hopes that Asia’sgrowth

engine will prop up their limping economies.

Nowhere is the question more relevant yet more contested than

in the U.S. The midterm elections, in which public anger over the

economy swept Republicans into Congress, have thrown doubt

on whether America’s leaders can come to a consensus on the def

icit and on President Obama’s calls for further stimulus spending.

The issue is a critical one for America’s future. To answer it,

NEWSWEEK asked two leading economists to weighin: Nobel

Prize winner Joseph Stiglitz argues that the U.S. needsto spend

its way to health; Morgan Stanley’s Stephen Roach comes down

on the other side of the coin, advising government tofocus on

belt tightening. But regardless of their differences, bothwriters

urge that America’s debt must shrink, and soon—not only for the

country’s sake but also for that of the entire global economy.


Special Advertising Feature I

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bid for investors’ attention—and winning it. Tianjin Economic-

Technological Development Area (TEDA)—set 128 km. southeast

of Beijing, between Tianjin, China’s sixth largest city, and the Bohai

Gulf—is the nation’s largest economic development zone andits most successful. Not long after TEDA was established in 1984,

China’s long-time leader, Deng Xiaoping, predicted that it would

have “a promising future.” Today, that promise is being fulfilled.

High Tech HubThe companies that have already set up shop atTEDA—Toyota,Samsung, Motorola, Novo Nordisk, Tinghsin and many others—

form a virtual who’s who of leading-edge multinationals.

International heavy-hitters—some 5,000 of them, with a total

investment value of $57 billion—come from a wide range

of sectors, including electronics and telecommunications,

automotive, biomedical, machinery manufacturing, new energy

and new materials, petrochemicals and food and beverages.

What draws them: TEDA’s impressive roster of resources, including

a wide range of state-of-the-art incubators and accelerators.

The Tianjin University Science Park, for instance, is a major high

tech incubator, home to research projects like the National Nano

Base and National Computer Virus Emergency Response Center.

The TEDA Service Outsourcing Park houses China’s Super-

computer Center and its largest Internet firm, Tencent Digital.

The Tianjin International Joint Academy of Biotechnology and

Medicine is working to speed up the lab-to-pharmacy process

for biomedicine and the life sciences. And the Hi-tech Promotion

Center provides a multifunction accelerator for other high-end

R&D projects.

Another benefit:The city ofTianjin,

with its 25 universitiesand over 140 research

institutes, as well as its 10million citizens—a labor pool

that’s as sophisticated and moreaffordable than those of Shanghai,

Guangzhou and Beijing.TEDA’s innovativeUniversity Town draws from Tianjin’s intellectual

resources, creating an atmosphere where new ideas are nurtured.

In addition, TEDA offers a variety of industrial parks where those

ideas become reality. What’s more, TEDA is also the site of an

increasing number of major international meetings, such as the

World Economic Forum’s Second Annual Meeting of the New

Champions (a.k.a. the “Summer Davos”).

World-class Logistics & LifestyleTEDA boasts other world-class resources, as well. Logistics and

supply-chain management are made easy, thanks to over 10

highways and transportation systems, including the two-year-

old Beijing-Tianjin Inter-city High-speed Train, which cuts travel

time between the two cities to about 30 minutes. Tianjin Binhai

International Airport and Tianjin Port provide convenient options

for air and water transport. And a local export-processing zone

and bonded logistics park offer a wealth of essential business

services.

TEDA has also created a beautifully designed, eco-friendly

community that meets every need for those who live and work

there. On Third Avenue residents will find everything fromfinancial-services entities like the TEDA Investment Service Center

and Binhai Financial Street to the TEDA Library and the TEDA

International Cardiovascular Hospital. The TEDA Promenade is

home to Binhai International Convention & Exhibition Center, the

TEDA Soccer Stadium, shopping malls, restaurants and pubs. An

18-hole golf course, botanical gardens and other green amenities

can be found on Nanhai Road. And smartly planned residential

blocks offer a comfortable home to residents from over 30countries and regions.

On the horizon for TEDA: A new financial-services area with

luxury hotels, malls and office towers, including the CTF Binhai

Center, North China’s tallest skyscraper. And as TEDA launches

into its next quarter-century, there’s much more to come. As the

chairman oftheTEDA Administrative Commission, He Shushan,

said earlier this year, TEDA will “seize opportunities, engage in

innovation, create a better investment environment, offer better

services, grasp the initiative of development and draw a grander

blueprint at a new stage’ That’s a promise—one that TEDA is

bound to fulfill, brilliantly.

TEDA :APromise FulfilledIn the heart of the planet’s fastest-growing economy is one of the world’s smartest

development zones: Tianjin Economic-Technological Development Area.

TEDAI

Beautifully designed, ecu-friendly TEDA Financial Street

For more information about TEDA, go to http:f/www.teda.gov.cn.

TheWayOut ofDEBT?Spend, Spend, Spend.BY JOSEPH E. STIGLITZ

Irnagine yourself as a business-person, able to borrow substantial sumsof money at a low, long-term interestrate, say 2.5 percent. You have a backlogof projects that you know will, on average, yield returns of 20 percent. Someprojects will do worse, some bettei andyou can never be sure which projectswill be the big winners. Yet you wouldbe foolish to pass up this opportunity.Even if you already have considerabledebt, borrowing for projects that willgenerate high returns will improve yourfinancial position.This is exactly the predicament in

which America finds itself today. Inthe U.S., the backlog of good projects isespecially large because the public sector has been starved of investments foryears. The high returns are not wishfulthinking: a few billion dollars to rebuildNew Orleans’s levees would have savedhundreds of billions. That these leveeswere needed is not a matter of 20/20hindsight: they have long been at the topof the list ofAmerica’s most urgent public projects. And it’s not just the country’s crumbling infrastructure; thinkof the returns on government researchprograms that led to the developmentof the Internet—an innovation that hastransformed the economy.Right now the U.S. economy has mas

sive excess capacity in the private sector.Millions are working part time becausethere is insufficient demand for theirservices, while millions more are unem

ployed. Plants and equipment are sitting idle. It is a sign of a malfunctioningeconomy when there are idle resourcesand unmet needs, but that is exactly thesituation confronting America today.The financial crisis taught us that

markets, by themselves, may be neitherself-correcting nor efficient. So, too, theprivate sector’s restorative powers are,at best, weak. Indeed, they may not beworking at all: all the excess capacityin the economy puts downward pressure on wages and prices, and if deflation emerges, it will make the process of’reducing America’s huge indebtednessall the more difficult.Even free marketers have come to

accept government intervention throughmonetary policy. But the U.S. FederalReserve has shown greater skill in getting the economy into a mess than pull-

ing it out. Lower interest rates have notreignited investment and are notlikely to do so, given the continuedweakness of the banking system andexcess economic capacity. The flood ofliquidity isn’t going into new lendingin the U.S. economy. Rather, it is looking for the safest and highest returns,and finding those in emerging markets,where it wreaks havoc by creating newbubbles and pushing up their currencies. The pumping of cheap money intothe economy by central banks is unlikelyto restore the U.S. and other Westerneconomies to health. hether this pumppriming works in more normal times isdebatable; that it hasn’t been workingnow should be self-evident.What is required is more spend

ing on high-return investments. Public investment spending will increase


GDP—and tax revenues—in both theshort term and the long. For the U.S., itdoesn’t take a very high return to makesure that the long-term national debt isreduced. Assuming that 20 percent ofany growth in GDP goes to the government in taxes, a return of only 5 percenton investment is more than enough topay the current cost of interest. Manyprojects will, of course, yield muchhigher returns, paying for themselvesin just a few years. The increasinglylikely alternative is that the UnitedStates remains mired in a Japanese-style malaise with excess capacity for anumber of years.To be sure, not every project will

yield high returns, and critics willpoint to failures. But not every oil wellis a gusher; most, in fact, are dry holes.Successful investments, like the Inter-

net, more than make up for the failures.Keep in mind, too, that the private andpublic sectors both make mistakes;witness the massive misallocation ofresources engineered by our financialsector in the run-up to the crisis. Onaverage, in the past, government spending has yielded far higher than requiredto pay hack what is borrowed.The benefits of spending may be

even higher. If individuals are rational(an admittedly questionable assumption considering the behavior that ledus into the crisis), they will realize thatthe economic dynamism unleashed bypublic investments will raise futureincomes and tax revenues, and knowingthis, they will feel more confident andraise their consumption today. In short,there may be a large “multiplier” effectof spending.

WORK WANTEDA JOB FAIRIN NEW YORK.

The cost of not spending is evenhigher. If the economy remains stuckin high unemployment for years, workers will lose their skills. Human capitalwill be destroyed. The economy’s potenHal growth will be impaired. There is aserious risk that the American economywill enter a “new normal” with anunemployment rate markedly higherthan the 4 to 5 percent that was normalin the past. In short, not spending themoney will mean terrible waste—as theeconomy operates below its potential,and as we waste our resources away.And this in turn will mean that government budget and debt projections basedon a return to the old normal will looklike rosy scenarios.Naturally, we shouldn’t evaluate the

benefits solely in terms of the impact onpublic debt. Government has a responsibility to maintain the economy asclose to full employment as possible.Unemployment numbers are statistics,but behind every number is a family,whose dreams—for their retirement, forthe education of their children, for theirfuture—are being dashed, replacedwith mounting anxieties: Will they losetheir home? What happens if they getsick? Will they be able to afford the education that their children deserve? Howwill they pay for the nursing care of anaging parent?This, then, is the ultimate irony: by

increasing America’s indebtedness now,and spending the money on high-returninvestments, we will be both increasingsociety’s well-being now and reducingour long-term national debt. We canhave our proverbial cake and eat it too.

5TJGLITZ Ls a professor at columbiaUniversity, a Nobel laureate in economics,and the author ofFreefall: America, FreeMarkets, and the Sinking of the WorldEconomy.

NEWSWEEK.COM 23

Throwing Off theSHACKLESOf DebtBY STEPHEN S. ROACH

VJhen America’s credit bubbleburst in the summer of 2007, the country’s overindebted citizens quickly foundthemselves in serious trouble. Savingsrates were at historically low levels; thejob market started shrinking; and U.S.households saw their net worth plummet by more than 20 percent.Three years later, American consum

ers are finally starting to climb out of thedark abyss of the global financial crisis:they’re cutting back on spending, paying down debt, and rebuilding the nesteggs that were severely depleted during the past decade’s era of excess. Butthe process of deleveraging—increasing assets and winding down debt—hasonly just begun. U.S. household debtis still an astonishing 120 percent ofdisposable personal income. Althoughthat’s down about 10 points from therecord high in 2007, it’s still sharplyabove the average of 75 percent in the1980s and ‘90S.Equally disturbing is the fact that

unwinding the crisis has involved anenormous transfer of America’s private-sector indebtedness into the publicsector. The Bush and Obama administrations deployed outsize budget deficitsto arrest the recession, and later to tryand spur a vigorous economic recovery. As a result, at the end of 2010 U.S.federal government debt stood at 62 percent of GDP—up from just 36 percentin pre-crisis 2007. The CongressionalBudget Office estimates that if current

economic policies continue, federaldebt could soar to 90 percent of GDPby 2020. America’s federal finances arenow in rarefied territory seen onlyduring World War II and its immediateaftermath.What this means for the U.S. as a

whole is that there really has beenno deleveraging at all—only a shift inthe mix of public and private debt. Amodest drop in household debt hasbeen swamped by mounting government red ink. This shows up veryclearly in America’s overall savingsrate. The country’s combined savingamong individuals, business, andgovernment—the net national savingsrate—actually dipped into negative territory in 2008 and fell further, to minus2.3 percent of national income, in 2009.Never before in modern history hasthe world’s leading economic powersuffered such a profound shortfall indomestic savings. Put simply, the average American is still in a very insecureposition.

Now the United States has to turnto the rest of the world to fill its savings void, importing surplus savingsfrom abroad. This has led to a massivedeficit in America’s current account—the broadest measure of a country’sfinancial imbalance with the rest of theworld—and to an outsize trade deficitwith 90 countries in 2009. These massive deficits, unsurprisingly, have alsobeen weakening the dollar. Since its2002 peak, the dollar is now down 24percent against an average ofAmerica’strading partners’ currencies.All this puts great pressure on the

world’s leading surplus savers—China,Japan, and Germany—to continue subsidizing ever-mounting U.S. debt. Withthe so-called currency wars now heating up in an anemic global recovery,and Washington threatening trade

sanctions on China, foreign lendersmay start getting nervous about sending their surplus savings to the UnitedStates at the same very low rates theyhave been content with in recentyears. To the extent that this leads toa sharper drop in the dollar or higherinterest rates on U.S. debt, Americacould suddenly find itself in a seriousfunding squeeze.Meanwhile, out-of-control govern -

ment deficits remain a clear and present danger at home. The Europeans—especially the Germans and the British—have drawn a line in the sand ondeficit reduction, making it an essential ingredient in their strategies toraise long-term economic growth. Inthe U.S., though, no such consensus onbelt-tightening exists—rather, Americais still betting that deficit spending will


eventually create the economic growththat enables the public sector to pay offdebt. If the U.S. is right, all will be wellin the end. If it’s wrong, the government’s current debt will haunt America’s future generations.To make matters worse, U.S. mone

tary policy has left the country in a deephole. With its main interest rate at zero,the Federal Reserve has no more ammunition, and is now deploying unconventional tools of money creation that werelast used—unsuccessfully—by the Bankof Japan in its struggle to cope with thenation’s two “lost decades.” The practical effect of these policies is to pushalready-low interest rates even lower,making it artificially cheap for bothpublic and private debtors to continueto service America’s massive overhangof debt.

The problem is that these tacticsmake debtors dangerously vulnerableto a sudden and unexpected rise inrates. What’s more, such subsidizedrelief is hardly a panacea for an overlyindebted society. In fact, it could wellsow the seeds of new excesses—suchas another round of asset and creditbubbles or, at some point, even an outbreak of inflation.As challenging as the financial crisis

was, trying to manage the recovery isturning out to be far more vexing. Inlate 2008 and early 2009, there waswidespread agreement on the steps necessary to stop the global economy’s freefall. Massive fiscal and monetary policywas the right medicine at that time. Butwhat worked to shore up crisis-tornmarkets then may not be the recipe fora sustainable recovery now.

Nowhere are these doubts more relevant than in the United States. If allWashington can do is to continue playing a shell game—in effect, swappingprivate-sector debt for public-sectordebt—there can be no sustainablerecovery. Eventuall both the American government and the Americanpeople will need to stop borrowingand start saving again. Unlike the easymoney that got us into this problem,a lasting cure won’t come cheaply.Deleveraging is a painful, but entirelynecessary, part of that process. Ourchildren expect—and deserve—nothing less.

ROACH, a member of the faculty ofTale University, is also nonexecutivechairman ofMorgan Stanley Asiaand author ofThe Next Asia.

NEWSWEEK.COM 25

Companies HaveCASH HOARDSBut Nowhere to SpendBY R. M. SCHNEIDERMAN AND AZRIEL JAMES RELPH

The recession 1as beenover in most countries for more thana year now, and as economists continueto decipher how and why this downturn differed from others, an interesting anomaly has emerged. Whilenations like the United States, GreatBritain, and Japan are saddled withdebt, companies in the U.S. and Europehave more than $1.5 trillion sittingon their respective balance sheets. Innormal times, this abundance of cashwould be good for the economy, as companies would invest, expand capacity,and create jobs. And indeed, over thenext year, analysts say there may bea slight uptick in spending as cash-heavy firms turn to mergers andacquisitions, dividend payments, capital expenditures, and a variety of job-creating investments, particularly inhigh-growth countries such as China,India, and Brazil.But what’s also new this time around is

the extreme caution firms have retainedabout spending, even as the recoverycontinues to unfold. In the U.S. in particular, where demand is low and uncertainty over taxes and access to creditcontinues to loom large, firms are simplysitting on piles of cash. “Companies were

caught in a near-death experience,” saysRuchir Sharma, the head of emerging-markets equity at Morgan Stanley. “Theyare overcompensating... because theywere caught short in the crisis.” Untilthat perception changes, bloated corporate coffers may become the new normal.As a consequence, so too may higherunemployment and slower growth.Even before the recession began, com

panies had been stockpiling cash fordecades. Researchers from the University ofArizona and Ohio State Universityfound that the average cash-to-assetsratio for industrial firms in the U.S. roseby 129 percent from 1980 to 2004. The2008 recession, with its massive liquidityshock, compounded this ongoing phenomenon and sent tremors through themarket. Firms shed workers, increasedproductivity, slowed production, andreduced inventories—everything necessary to improve their balance sheets,which become flush with cash.The recession ended in the summer

of 2009, yet many firms have continuedto stockpile greenbacks due to continued uncertainty over the economy,taxes, and regulation. As of November,Microsoft alone had $43 billion on hand.Meanwhile, unemployment remains

at close to 10 percent, and consumerdemand—once the engine that drove alarge percentage of the economy—hassputtered. “Companies want to ensurethey have contingency,” says MarkSpelman, the global head of strategyfor Accenture. “Even industrial firmsare concerned about capital markets[and are] using cash to hedge againstrisk,” says Thomas Bates, a professor offinance at Arizona State.The recession—and subsequent sov

ereign debt crisis in Greece—has ledEuropean firms to hoard cash as well.From 2008 to 2009, the corporate savingrate in the euro zone went up by 4 percent. Among the biggest cash hoarderswere firms in Great Britain, where government debt has been a major concern.Even Germany, which weathered therecession far better than its continentalcounterparts and seems to have its fiscalhouse in order, saw the net savings rateof its companies increase.Over the next year, however, there

will likely be a slight increase in spending, as consumer confidence grows andbanks become more willing to lend.But analysts say it’s not likely to besubstantial enough to result in amajor uptick in new jobs. In the vast


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majority of cases, firms will increasedividends or upgrade their technological systems and equipment, whichin some cases will replace humanworkers. “Machines are cheaper thanpeople,” says David Wyss, an economist at Standard & Poor’s. In somesectors, such as technology, wherethe mountains of cash are the largest, many expect to see an increase inmerger-and-acquisition activity, yetthat too tends to reduce rather thanincrease employment—at least in theshort term.Even when corporate coffers do

result in job growth, most of it is likelyto take place overseas, particularly inemerging markets. The major reason:better growth prospects. Countries likeBrazil, India, and China came out of therecession largely unscathed. They allhave GDP growth rates well above thatof the United States and Europe. Theyhave younger demographics, an emerging middle class and consumers whoare not saddled with debt. “A lot ofcompanies are actually hiring,” says JamesManyika, the director of the McKinseyGlobal Institute. “Quite often ... it’sjust ... not here [in the U.S.].”For American firms at least, taxes are

another reason to start putting more oftheir business overseas. Companies inthe S&P 500 Index make more than 40percent of their profits abroad, according to the Investment Company Institute. And between 25 to 6o percent ofall their cash is currently held outsidethe U.S. Firms that choose to repatriatetheir money would be subject to taxes,and America has the second-highestcorporate tax rate in the world. “It may

actually be cheaper for these companies to tap the domestic credit marketsthan to draw on their offshore profits,” writes John Bilardello, the head ofglobal ratings at Standard & Poor’s, ina recent note.None of this is to say that job creation

will grind to a halt or that the U.S. and

Biggest Cash PilesIE ‘ ---nw’ rrJohnson&Johnson •

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euro zone will lose their competitiveedge; it’s simply a question of extent.The U.S. economy, for instance, added151,000 thousand jobs in October, andis expected to grow at a rate of roughly2 percent on the year. Meanwhile,growth from emerging markets—whilefar from a massive, job-creating catalyst—is still likely to benefit developedcountries and a subset of domesticworkers; the latest technological gadgets may be assembled in China, butthey are still designed in Silicon Valley,their marketing plans are still drawn

up in New York or London, and that’snot likely to change.Nevertheless, anyone waiting for

a return of the full employment andgo-go growth of the 1990s will likelybe disappointed. “I don’t think you cancriticize consumers for not spending,”says Wyss, the S&P economist. “We

SRAPHIC BY STANFORD KAY STUDIO

were living way beyond our means.” Asconsumers and governments becomeincreasingly forced to live within them,analysts say companies will find it hardto justify massive investment; in thewake of the recession, they’ve learnedhow to do more with less. And thatcould mean a self-perpetuating cycleof fewer jobs added, weak consumerspending, and a less robust economyin both the United States and Europe.As Manyika, the McKinsey director,puts it: “We maybe stuck with sluggishgrowth until it feels normal.”

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IInsideTHE MINDOf the CEOBY JOSEPH FULLER

If youre looking to the world’slarge and profitable companies to pullthe West out of the downturn by investing and creating jobs, you bad better look elsewhere. Their hesitancy toinvest is palpable and measured in thetremendous unspent cash reservesbuilding up on corporate balance sheets.But none of the usual explanations—the slack capacity still in the economy,

¶ uncertainty over future regulation andtaxes, or the “new normal” world of lowgrowth—account for the pervasiveness

f ofnoninvesting.

There is a more fundamental andpotentially more far-reaching forceat work: today’s CEOs have beenshellshocked by crisis. It is not just theworld that’s uncertain, it’s the managerial class itself that has lost confidencein its ability to make decisions in aworld shaped by volatility and shock.

Used to making bold, aggressive decisions in the years of fast growth andeasy credit, many executives today findthat the business instincts that propelled them in their careers are no longer a reliable compass for their actions.Think, as an analogy, of the peoplewho lived through America’s GreatDepression and remained thrifty andrisk-averse for the rest of their lives.We have likely entered a long-lastingshift to more careful and conservativebusiness leadership in the West, onemarked by a new ethos of caution thatcould have profound and possibly neg

ative effects on the economy for manyyears to come.Consider the past decade. It opened

with the bursting of the dotcombubble and the destruction of $ trillion in equity value in the U.S. alone.Then, 9/11 heralded the emergenceof a chronic terrorist threat. A risingtide of uncertainty—including geopolitical turmoil, economic volatility, andturbulence in commodity prices andexchange rates—marked the decadeeven before the financial crisis of 2008.The years since then were the coup degrace for business confidence.The new mindset is visible along

multiple dimensions. Executives aremuch more likely to defer decisions orsettle for small, incremental improvement in their companies’ performance.Many large corporations are marshaling cash because they are anxious overthe availability of financing. Othersare using their cash to shore up theircompany pension schemes, again asa protection against future financialrisk. This propensity to hold cash anduse it to hedge against risks will likelyboth undermine companies’ returnsand cause them to hesitate in the faceof opportunity.For the shellshocked CEO, the bur

den of proof for any investment ishigher. We are still seeing companiesmaking acquisitions, for example, butthe typical deal today might be Oracle’s November 2010 purchase of software maker ATG for $1 billion. It wasa small expansion in a familiar marketwhere Oracle’s risk stays within wellknown bounds.What other kinds of investments are

NEWSWEEK.COM 43

left that carry limited risk? A logicaldecision, particularly for a cash-richWestern company, would be to makea major acquisition in a big emergingmarket. But in China, the regime doesnot look kindly on foreign majorityownership of a large local company. ForIndia, most Western companies lackthe expertise needed to operate there.Russia, for most companies, is an incalculable risk. In the new era of caution,the risks of pursuing a position in unfamiliar markets have grown in parallelwith the hostility of governments toacquisitions or investment by foreigners in an ever-lengthening list of “strategic sectors.” Favored companies willbe those with long-established, viableoperations in markets like China, India,

Many executives no

business instincts.

and Brazil, as well as those with thetype of rich intellectual property thatthose economies will increasingly seek.Latecomers and dabblers will find therisks too high.If the “new normal” begets an endur

ing ethos of caution among the mana

gerial class, it will have profoundimplications for economic recoveryand national policy. If establishedenterprises remain reluctant investors,governments will have to enact policies specifically designed to spur entrepreneurship and support for smallerenterprises. Countries that embraceentrepreneurship culturally and havelarge and diverse sources of risk capitalwill prosper.Countries where established compa

nies dominate economic activity andtop graduates eschew job opportunities at entrepreneurial firms in favorof the prestige and safety of “nationalchampions” will slip further behind.Countries hoping to be the beneficiaries of the next wave of foreign directinvestment targeted at countries withlow labor costs, like Vietnam, or burgeoning local markets, like SaudiArabia, may find themselves disappointed, as Western companies arenow less willing to take risks. Thosewho benefited from the investmentboom of the past 20 years may enjoyextended prosperity.Companies will cast off their con

servatism only when they accept thatthe standards they used to assessopportunities and evaluate risk inthe past are no longer appropriate. The“new normal” has changed the natureof opportunities, not proscribed them.The greatest opportunity may cometo those whose competitors are stillstuck in their paralysis. As always,the marketplace will ultimately rewardthose who stare down their fear and act.

FULLER is the cofounder ofMonitor Group.

INCALCULABLEMOSCOW’S RISKYENVIRONMENT

It is not just the worldthat’s uncertain, it’s themanageriaL cLass itself.

longer trust their own


HowAsia’sBINGE SHOPPERSWill Help theWestBY OWEN MATTHEWS AND ALEXANDRA A. SENO

LOOk at global economics from amoral point of view, and it’s a story ofvirtue rewarded. Growth in the West,fueled by easy credit and consumption,collapsed in the 2008 financial crisis.Growth in the East, by contrast, fueledby saving and production, has heldsteady. But look more carefully, and thereality is that Asia’s legendary cultureof saving, while not quite a myth, is fastdeclining in many places.The culture of Western-style con

sumer credit is spreading rapidly acrossemerging markets, nowhere faster thanin Asia. It turns out that many ofthe habits of Asia’s burgeoning middle classes,living in increasingly affluent cities,aren’t all that different from those of theirpeers in the West. With the help ofbankseager to expand their business, tens ofmillions of consumers all across theemerging markets are picking up homemortgages, credit cards, and auto loans.For every village grandmother living frugally and putting aside some of the family money, there is at least a grandchild(or three) living in a city, striving to keep

up with the evolving consumer needs ina fast-changing Asian city. It is a generation that has discovered the pleasures of“spending before they earn,” abetted byeasy plastic money, says Hong Kong CityUniversity economist Li Kui-wai.So much for centuries-old taboos on

debt. When easy credit is offered, it isusually taken, regardless of traditionsor values, says Carmen Reinhart, a University ofMaryland economist. In SouthKorea, all it took was a bout of financial-sector deregulation since 2008 for private debt to snowball to 150 percent ofannual disposable income, a numberthat would make even some Westernnations blush. Malaysia, another Asiantiger economy whose leaders have oftenlectured the West about Asian values ofthrift, even has its own festering creditcrisis. The Southeast Asian nation hasone of the region’s highest levels of personal credit, now at ‘‘ percent of GDP.‘While more than half that debt is fromhome mortgages and car loans, the substantial rest is credit-card debt and otherconsumer finance. In Hong Kong, the

average outstanding credit-card balanceis now higher than in Western Europe.Binge shopping beyond one’s means iscertainly no Western prerogative.If all that doesn’t sound familiar, how

about this: the Bank of International Settlements warned as early as 2008 that thegrowing credit boom in Asia and otheremerging markets poses “new risks tofinancial stability.” Eventually, BIS economists Ma Guonan and Tae Soo Kangwarn, excessive indebtedness will leadto rising credit cost, contracting credit,instability in the financial system, anddamages to the broader economy.But as long as they can avoid that out

come, all this shopping and spending—even if it’s on credit—is very good newsfor the global economy. Instead of tryingto boost their sagging exports, Asiansneed to grow their own consumption inorder to balance their economic growthand help get the West out of its slumpand back into a buying mood. China, forinstance, the locomotive for all of Asia’sgrowth, urgently needs to raise its consumption share of GDP; that’s the only


way to compensate for the drop-off insales to the West. In fact, Chinese consumption as a percentage of GDP hasactually declined in the past decade, from46 percent in 2000 to 36 percent in 2009.And, says Peking University economicsprofessor Michael Pettis, “unless domestic consumption expands dramatically,China can continue growing rapidly onlyby increasing investment well beyondwhat is economically useful or by forcinglarger trade surpluses onto a reluctantworld.” So to rebalance the world economy, the question is not whether Asiansare spending too much, but whether theirspending is growing fast enough. So it’svery good news if they’re spending, and ifthey need credit to do it, fine.By Western standards, Asia’s cash

reserves are still massive. Ever since Asiaemerged from the economic uncertaintyof its last financial crisis in 1997, peopleand governments have been stashingaway large chunks oftheir incomes for theproverbial rainy day. Now China ranksas one of the world’s biggest savers, at anational rate of 38 percent of GDP. Indiaboasts about 35 percent ofGDP in savings.That’s nearly 10 times spendthrift America’s 3.9 percent. But these numbers, too,are deceiving. Dig a little deeper, and it’sthe bank accounts of export companies,rather than thrifty Chinese and Indianhouseholds, that account for the bulk ofthose holdings.Undaunted by the fallout of the 2008

credit crisis in the West, local and Western banks are doing their best to reversethis culture of thrift across emergingmarkets all over the world. And theyhave a point: unlike the stagnant West,emerging markets are growing, people’sincomes are rising, and credit is seenas an expression of confidence. Thebasic pattern across the world’s fastest-growing economies is that governments

are more focused on the fruits of credit-driven growth than on the dangers ofeasy credit. Malaysia is a prime example. In 1998 borrowing by individualsaccounted for only 25 percent of debt inthat country, while today the figure hasgrown to more than half, fueled in partby personal credit habits. In Turkey, too,the number of credit cards in circulationgrew from 15.7 million to 47.7 million,more than one per household, between2002 and 2009. In Russia, the volume ofconsumer credit has been growing by 1to 2 percent every month since last May,and now the country’s total consumercredit is $180 billion—2o percent ofGDP, and a 5.4 percent jump above theprevious year. “Credit is a positive tendency for Russia’s economy,” says IvanLebedev, vice president ofVTB24 Bank.Massive marketing campaigns are

helping to drive the boom. China Union-Pay, the biggest card issuer in the People’sRepublic, has been buying up advertisingbillboards across Hong Kong in a bid todouble the number ofcards in circulationthere from 3 million in early 2009 to more

than 6 million by the end of 2010. In Turkey, too, credit-card advertising dominates the urban landscape—and it works.Turks borrowed nearly $ioo billion in2009 on plastic, a staggering 7 percent ofGDP, at interest rates as high as 42 percent. Up to 15 percent of Asia’s household debt is now from credit cards. Thebottom line for emerging markets is that

Household Savings*as a percentage of disposable income15%

2011

—— 200710 —

___° ____

5—

0L

-5U.S. Japan Ger. France Italy U.K. Canada

JUNE 2010 SOURCE: DECO GRAPHICS El’ STANFORD KAY STUDIO


credit drives growth. Take Brazil, whichwas long famous for its misshapen socialpyramid: a huge underclass at the broadbase, a small elite at the pinnacle, and awafer-thin middle class in between. Butthanks in part to more widespread accessto credit, Brazil’s social geometry hasundergone a radical makeover over thepast decade. As the economy stabilized

Household Debtas a percentage of annual disposable income±

and then began to boom, some 27 millionpeople have climbed out of poverty since2000. By 2009 the middle class was officially the nation’s largest social class forthe first time in Brazil’s history Thosemillions of emerging consumers havegone to town with their pent-up demand,turning the heads of merchants, banks,and industries.Recent census data showed that 69 per

cent of the Brazilian middle class owntheir own homes; 22 percent are car owners; 89 percent have mobile phones; halfown computers (and fully percent ofthat number have broadband connections); and all have TVs. Much of thisacquisitive fever is nurtured by credit.Banks and credit agencies project that628 million credit cards will be issued bythe end of2010, an 11 percent increase over2009. Half of the new plastic (9 percent)is in the hands oflow-income and middle-class customers, and with the economyprojected to grow by 5 percent a year forthe next five years, the number of creditcards will likely double by 2020. Evenamong the 40 percent of Brazilians whostill have no bank accounts, many usecredit cards.It’s anybody’s guess how long the

emerging markets’ credit boom can goon. In Brazil, for instance, consumercredit has been growing by 17 percent ayear, and is expected to reach $360 billion in 2011. In a survey of 30 banks lastsummer, the Brazilian Banking Federation found retail credit growing ata 21 percent clip, nearly three times therate of the overall economy. It’s the samestory in Hong Kong, where the Prime-Credit analysis group reported in thesummer of 2010 that 70 percent of localcardholders had carried over the bulkof their balances—almost twice as manyas the average of supposedly profligate

U.S. debtors. Another 2010 study foundthat roughly 10 percent of South Koreans 15 or older were three months lateon personal debt payments. In August2010, India’s SKS Microfinance raisedS350 million in fresh capital—and itsstock crashed two months later whennews broke that it was having difficultycollecting on its microloans.Still, there are signs that Asia has

learned from past mistakes, includinga string of credit-issuer bankruptcies inTaiwan, Hong Kong, and South Koreabetween 2001 and 2005. Since then,some of the industry’s worst excesseshave been curbed. In some countries,credit rules have been tightened andcredit-card marketing has been regulated in an effort to control consumersplurging. Asian banks tend to betougher lenders than American ones—for example, they haven’t targetedpoor people with offers of “subprime”mortgages. Most card companies inAsia require relatively high minimumincomes, plus payment of at least loper-cent of the card’s balance each month,meaning that the average Asian consumer can’t even get a card.Before the 2008 crash, much of the

world believed that credit fuels healthyconsumption, and that governmentdebts would eventually be erased painlessly by sheer growth. The meltdownhas shattered many of those beliefs.So far, emerging-nation growth is stillstrong and savings are high. The question now is whether Asian banks andconsumers are courting disaster byimitating the practices that got the Westinto so much trouble.

With ANNA NEMTS OVA in Moscow,MAC MARGOLIS in Brazil, andWILLIAM UNDERHILL in London

123% 128

169

147

a

U.S. Japan Ger. France Italy U.K. Canada

SOURCE OECDtALL FIGURES ARE Q4 205R EXCEPT

U.S.=52 2010, JAPAN AND ITALY=O4 2008

NEWSWEEK.COM 57

CanANGLO-SAXONSReally Stop Spending?BY WILLIAM UNDERHILL

By rights, the careless consumers of the developed world should be ina chastened mood. After all, it was theirbinge spending on houses and consumergoods—fueled by credit and mortgagesfrom recklessly indulgent banks—thathelped bring the world to the brink offinancial disaster back in 2008. Americans and the British, in particular, weredone in by their free-spending ways. Foryears, Americans had been saving only2 or 3 percent of their income, comparedwith 10 percent or more in European andAsian countries. The British, in turn,amassed even larger amounts of personal debt. By 2008, average householddebt had reached 183 percent of annualdisposable income, the highest level ofany major economy.

So have the spendthrifts now seenthe error of their ways? Don’t be toosure. Initial signs were that a new frugality was taking hold. Overindebtedconsumers would have to pay off debtand rebuild their depleted savings, leading to a new era of thrift in the formerlyprofligate countries. Indeed, there hasbeen an upturn in savings in both Britain and America. The U.S. personal saving rate more than tripled from 2 percentin 2007 to 7 percent in the second quarter of 2009, before dropping back to 5.5percent, where it has hovered now for awhile. In Britain the rate is falling againand came down to a measly 3.2 percentin the second quarter of 2010.Another sign ofnew, thriftier habits is

the fact that many Americans are turn-

ing their backs on credit cards. At theheight of the credit bubble and housingboom in 2007, 87 percent of Americansused credit cards. That figure droppedto 56 percent in 2009 and was projectedto sink below 50 percent by the end of2010, according to a report by JavelinStrategy & Research. Meanwhile, moreand more cautious consumers are opting for prepaid debit cards, which don’taccumulate debt. Debit-card use hasskyrocketed, from a total transactionvolume of $32 billion in 2007 to $80 billion by the end of 2010, according to databy the Network Branded Prepaid CardAssociation.But look closer at these numbers, too,

and it seems old habits die hard. Yes,Americans have pared back their per-


-s j%

c

sonal debt. In the third quarter of 2010alone household debt fell $iio billion, oralmost 1 percent. The total has droppedmore than 6 percent since its peak in2008. But skeptics point out that muchofthe overall decline has come as a resultof home foreclosures and defaults oncredit-card debt, hardly an indicator ofimproved habits of personal finance.“I would love to be able to say that wehave learned lessons and will be thriftiergoing forward, but I don’t feel we have,”says Karen Dynan, an economist at theBrookings Institution in Washington.“That isn’t to say it can’t be true—but wejust don’t know at this point.” She alsosays that the statistics fail to show who,exactly, is doing the increased saving. InAmerica, more than in other developedcountries, it’s the richer households thatcan afford to save, while the poor getmired in debt.The truth may be that the spending

urge is hard to contain. Entire generations of consumers have grown up withthe idea of instant consumer gratification and the credit culture that comeswith it. The seemingly perpetual ascentof real-estate and stock prices in the longboom before the crisis created risingwealth without the hard work of having

to save. “People got used to accumulating wealth without doing much, andthat makes for habits that are hardto break,” says Dynan. Some even argue that there’s something in Americanor British culture that makes peopleforever spendthrift and happy to liveon debt. Jacques Monin, an author andcommentator, says that attitudes towarddebt are rooted in history and deep-seated national attitudes. “America is acountry built on taking risks,” he says.“France isn’t. There is a long traditionin France that you only spend what youhave in your \vallet, and ifyou have extramoney, you stow it away.”That kind of cultural explanation has

become popular, but it doesn’t go veryfar. Carmen Reinhart, a University ofMaryland economist who has studiedthe debt history ofmany different countries, says habits of spending, saving,and going into debt have little to dowith national traits. It’s not moral turpitude that breeds profligacy, she says, buteasy access to credit. Take the notorioushome-equity loan: a widespread practice among American families was toborrow against the market value of theirhomes to finance everyday purchases.Many of them are now deeply in debt as

the value of their homes has plunged.That practice is rare outside the UnitedStates. On mortgages, continental banksare much stricter, usually capping theamount that can be borrowed at 8percent of the value of the home, versus more than 100 percent at many U.S.banks. French banks won’t lend to awould-be homeowner if the monthlymortgage payment exceeds one third ofher monthly income.It’s loose controls in financial ser

vices—both by banks and by regulators—that inevitably lead to higherborrowing, says Reinhart: “The common feature of financial liberalizationeverywhere is that credit becomes morereadily available to households.” Savinghabits follow a similar logic. “People loveto make moral judgments, but in countries where there is less access to credit,consumers save more because they needthe money to buy the things that theywant,” says Steve Blitz, chief economistat ITG Research in New York. In otherwords, it’s not a return to sobriety andrectitude that will keep the credit-crazedout of the red. A tougher line on lendingjust might do the trick.

With JERRY GUO in New York

.-AP -

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NEWSWEEKCOM 59

essays by: jacques attali mohamed el-erian• kishore … · 2011. 3. 28. · companies, and...

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