One of the best reflections out there on the Global Financial Crisis comes, unsurprisingly, from China. It is clear to anyone who has read the literature on the course of China’s economic development that the economic strategy and learning curve of China’s political class is quite formidible, and ironically immune to many of the ideological blinkers that hamper Western economics. Deng Xiaoping was the one who famously remarked that it doesn’t matter if the cat is white or black so long as it catches mice. This interview in the Atlantic with the American-educated Gao Xiqing, President of the Chinese Investment Corporation (which is heavily invested in the American economy) contains some of the most interesting insights into the Chinese view of the crisis I have seen, and many things which we ought to take to heart.
A Change of Thinking
Gao points to the skyrocketing leverage ratios of investment banks as evidence of a disturbing economic trend. “Thirty years ago, the leverage of the investment banks was like 4-to-1, 5-to-1. Today, it’s 30-to-1. This is not just a change of numbers. This is a change of fundamental thinking. People, especially Americans, started believing that they can live on other people’s money.”
As for financial derivatives- debt packaged for resale- he thinks this is an instance of collective irrationality for the economy. When called to give a presentation to the State Council under Premier Zhu Rongji, he explained derivatives using the metaphor of mirror images. You have a product with value, a book, and you sell that. Then you sell a mirror image of the book- the stock- in order to get money to make more books. Then you sell a mirror of that stock debt, and a mirror of the mirror of the mirror. Each individual product seems to make sense; collectively, the whole enterprise is inflationary.
A Broken Incentive System
Gao also sees a big problem with the compensation scheme for the financial sector: “People in this field have way too much money. And this is not right.” “It distorts the talents of the country,” since the allocation of compensation has the power to incentivise the expenditure of talent, in this case redirecting it from productive activities to ancillary activities. He cites friends of his who could have gone into productive scientific fields choosing finance or law instead, because they pay so much better. The result of this distortion of the country’s talent market is a whole culture of geniuses finding ever new and better ways to repackage debt into complicated financial products.
American power, he says, depends entirely on people telling the truth about the American system and the American ability to accept that truth and change in pragmatic ways. On the global level, America must accept responsibility for the system which supports it, and renegotiate that system. But, Gao warns, world confidence in that eventuality is waning.