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Summit in Santiago

Published by The Straits Times, Singapore on 2004-11-09

WHEN President George W. Bush of the United States turns up in Santiago, Chile for the 12th annual summit of the Asia Pacific Cooperation forum (APEC) in a few days, he will certainly be felicitated on his re-election last week. He will certainly get a chance to practice his fluent Spanish with his hosts, who share his dedication to the free market and open trade. And he will certainly be lauded for his renewed commitment to eradicating terrorism around the world.

But APEC leaders are meeting in Santiago merely to backslap with Mr Bush. He will most certainly need to engage the 20 other leaders of the forum in a collective seance about the financing of the growing US deficit, estimated to exceed US$500 billion this year. The Asians, in particular, are certain to raise the question of their lending to the world's most powerful economy - lending that's likely to make the global economy even more imbalanced in the months ahead.

"In short, this is not going to be yet another photo-op summit," Mr Brad Setser, of the Global Economic Governance Programme at University College, Oxford, told The Straits Times yesterday from Washington. "Extricating the US from its dependence on Asian financing to make up for a lack of domestic American demand, and Asia from its dependence on an already too-indebted American consumer will be an extremely difficult challenge."

The other issues that may make Mr Bush's Santiago sojourn somewhat less than fun-filled concern the falling US dollar and whether China - whose economic growth is again showing signs of resurgence - is inevitably headed for a hard landing. The convergence of these economic issues are certain to affect Mr Bush's political agenda for his second term: definitively win the war in Iraq, partially privatize Social Security, and not raise taxes while spending more on defence and on combatting global terrorism.

To carry out his agenda, President needs to borrow large sums - as cheaply as possible, of course - and only Asian central banks have been lending to the US on Mr Bush's optimistic terms. Says Mr Setser, the former Acting Director of the US Treasury's Office of International Monetary and Financial Policy: "Mr Bush needs that lending - Asian central bank financing of the US budget deficit - to carry out his second term agenda. Mr Bush wants the current pattern of Asia lending to the US and financing both US budget deficits and the purchases of Asian goods to continue."

That's bound to be worrisome for the other APEC leaders gathering in Santiago especially because - notwithstanding China's frenetic attempts to rise from Number Four to Number Two in the world's economic pantheon - the US, with an economy of US$11 trillion, remains the world's most powerful engine for economic growth. As the old saw goes, if the US catches a cold, it's Asian economies - and others, too, of course - that suffer from the resulting fever.

But APEC's membership makes it the world's most powerful grouping of nations, accounting for nearly 3 billion people, or almost half of the global population of 6.2 billion; a combined gross domestic product of US$20 trillion, or more than half of the world's GDP; and 47 percent of world trade, which was US$10 trillion in 2003, and is expected to grow by 8.5 percent in 2004. The organisation's "three pillars" are: liberalization of commerce and investment; the facilitation of commerce and investment, and economic and technical cooperation, according to Mr Heng Swee Keat, Permanent Secretary of Singapore's Ministry of Trade and Industry, and the country's main liaison with APEC, which maintains a small secretariat here.

In the first decade after APEC's founding in 1989 as a chat club for leaders, the Asia-Pacific region generated nearly 70 percent of global economic growth, making it, as Mr Mike Moran of Standard Chartered Bank in Hong Kong put it yesterday, "the most economically dynamic region in the world."

That's why, for example, economists like him and Mr Manu Bhaskaran, the Singapore-based partner of the Centennial Group in Washington, worry about the fast pace of credit expansion in the China, the large and likely growing portfolio bad loans in the Chinese banking system, and property bubbles in some parts of China. Moreover, for Asia to sustain its current expansion, it will have to learn to depend less on the US consumer, and rely more on the demand generated by Asia's own growth dynamic.

The growth dynamic - averaging around 6 percent annually - is bound to be affected even more in the months ahead by Asia's continued need for imported oil, and especially by the rapidly rising needs of China's manufacturing sector. Asia's oil imports are generally a larger share of Asian economies than, say, the US or the European economies. Its dependence on the US consumer market also affects Asia's growth dynamic, since more than 70 percent of the region's exports are consumed by Americans.

If oil prices were to spike upward because of a supply interruption - for example, if something were to happen with Iran - and that spike triggered a slowdown in the US, Asia would get hit on both ends - by higher oil prices and a shrinking market for its exports, according to various economists interviewed by The Straits Times over the weekend.

That's why Mr Bush is likely to be questioned seriously in his private chats with fellow APEC leaders about how the US plans to deal with its deficits - which the Bush Administration until now has not viewed as a particularly thorny problem.

Typically, fiscal deficits are financed through foreign borrowing. In 2003, according to the Bank of International Settlements, global reserves increased by US$500 billion, and Japan and emerging Asia - including India - accounted for US$465 billion of this increase (US$200 billion from Japan, US$265 billion from emerging Asia). Of that, US$441 billion was invested in dollar assets.

The New York Federal Reserve Bank - the biggest of the US Fed's seven units - believes that this $441 billion is a better estimate of central bank financing of the US current account - the trade deficit - and the budget deficit than the more optimistic data published recently by the US department of commerce. If that is the case, foreign central bank reserves provided about 80 percent of the financing needed for the US 2003 current account deficit - and most of that came from Asia.

In the first half of 2004, Japan added US145 billion to its reserves, and emerging Asia added US$125 billion. If that had continued in the second half of the year, Japan and Emerging Asia would have provided a comparable amount of financing for the US current account deficit this year.

However, while emerging Asia is continuing to add to its reserves, though maybe at a slower pace than in the first half the year, Japan has stopped. If Japan continues to stay out of the dollar- currency market, that would imply Asian reserves accumulation of US$400 billion - US$250 billion from emerging Asia, roughly US$150 billion from Japan. That is a lot, but it is still less than the figure in 2003, which was US$465 billion), even though the United States current account deficit has grown.

"I think you can interpret the dollar's recent fall as evidence that there are not enough private investors willing to fund the US at current interest rates to make up for the end of dollar purchases from the Bank of Japan," said Oxford University's Mr Setser.

There are several reasons why the slowdown in Asian financing of the US deficit is troubling. Economists aver that if Asia ever stops building up its reserves at its current pace, or stops investing those reserves in the dollar, the US would be in for an unpleasant shock. Much higher interest rates would be needed to attract private flows of a comparable size, and those high interest rates would dramatically slow the US economy.

And without financing from Asian central banks, the US economy most certainly would have to contract, reducing the size of the current account deficit and the amount it needs to borrow - but ironically still pay more to attract sufficient financing to cover what would still be a large current account deficit. A $500 billion current account deficit in 2004 is not small by any means, but it would still be substantially smaller than the $700 billion or more current account deficit likely in 2005 if nothing changes.

President Bush will certainly be reminded in Santiago that while ending current US dependence on Asian central banks would be extremely costly if it happened suddenly, it also is not a long-term positive for the global or the US economy.

"The US consumes too much, produces too little and borrows too much," Mr Setser said. "In external terms, that means the US imports way, way more than it exports, and makes up the difference by borrowing from abroad."

There are times when borrowing from abroad to import more than you export makes sense - notably for a fast growing emerging economy that is attracting lots of foreign direct investment and has little external debt - for instance, a country with an external balance sheet like China, which has foreign trade surpluses in excess of US$550 billion, and rising.

However, the US external debt is no longer small - it will be close to 30 percent of GDP at the end of next month.

Aand with current account deficits of 5 percent or even 6 percent of GDP, the US is adding to its external debt at a very rapid clip. For an economy that does not export that much - in relation to its overall GDP or to its external debt - adding more external debt at this pace poses a real long-term danger.

That's why, as APEC leaders make preparations for their summit in Santiago, a growing number of economists worry that US demand for external financing may outstrip Asia's supply of financing - whether because of growing US demand, or reduced Asian supply or both. In the short run, this would be a major shock to the global economic system and to the US economy. But without important changes in both the US and Asia, the current process of Asia making up for a lack of domestic demand by financing the United States ever growing debt - and thus increasing US demand - will leave the global economy even more imbalanced than it already is.

Little wonder then that Mr Bush is eying for Asia to keep building up its reserves, and to keep investing those reserves in dollars. In between the banquets and photo-ops, rest assured that he would be conveying that message to his Asian counterparts.

APEC, after all, provides an important bridge between Asia and the Pacific. This 12th APEC Summit will also see several new leaders attending APEC for the first time. The summit provides a key platform for leaders to address trade and other global issues, and to agree on measures to promote the prosperity and stability of the Asia-Pacific region, according to Singapore's Mr Heng.

"APEC has been serving as a major motive force in advancing global trade liberalisation. With the Doha Development Agenda back on track, we hope this APEC Summit will help inject momentum for the global trade talks, in particular, through our work on trade facilitation and on building up a network of foreign trade agreements," he said.

In recent years, APEC has also responded swiftly to new global challenges, such as terrorism and SARS. "This year, we expect leaders to continue to discuss and further advance APEC's cooperation on counter-terrorism issues," Mr Heng added.

While Mr Bush's Santiago stay is therefore shaping up as more somber than the usually ebullient Texan would like, the host country is unlikely to allow US concerns to affect the festivities. After all, the summit will bring world attention to Chile, even if it's for two days only. Of Chile's 15 largest markets, seven are APEC economies, which buy 87 percent of the country's main exports, copper, wine, meat, fruits and coffee, with China devouring virtually all of Chile's copper and thus contributing to a global increase in commodity prices - and to Chile's trade surplus.

When the APEC Class of 2004 picture is taken, you will be able to identify quite easily Chile's President Ricardo Lagos Escobar, although he's not quite the global celebrity that Mr Bush or other participants like Russian President Vladimir Putin are. Mr Lagos will be the man wearing the biggest smile.

Pranay Gupte,
Senior Writer and Global-Affairs Columnist

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