Moving China Up To The Next Level

By ANDY XIE

When China's GDP surpassed Japan's in the second quarter of 2010, the international media gave this milestone considerable coverage. But with natural disasters, environmental problems and the property bubble to cover, the domestic media hasn't given it as much attention.

Perhaps it is because China has over ten times as many people as Japan which puts China's per capita income at less than one tenth of Japan's - hardly something to celebrate. Nevertheless, it is useful to look back at how far China has come, study the risks it faces in the future, and, if the country can overcome the existing challenges, explore how much further it can go in the next decade.

China's economy took off in 2002 and since then nominal GDP has grown at 18.5%, and exports in dollars at 21.7% (I have extrapolated the economic performance for the remaining months of 2010). The nominal GDP has increased 2.9 times, and exports 3.8 times in USD and 2.9 times in RMB. Japan had a similar performance in the 1960's, Korea and Taiwan in the 1980's, but they are much smaller. In terms of scale, what China has done is unprecedented.
When growth is sustained over many years, with the miracle of compounding there is a huge long-term impact. Twenty years ago China and India had about the same value in GDP, yet this year China's GDP is roughly four times that of India.

Reform and opening up, China's policy center over the past three decades, has undoubtedly been the most important factor. China is now the largest exporter in the world. Having virtually no exports three decades ago and almost none even two decades ago, the country's exports have risen 5.2 times over the last decade. 'Being the workshop of the world' is the most important part of China's economy today. Without China's export success China's economy wouldn't be nearly where it is today.

Joining the WTO made a critical difference to the country's export success, giving multinational companies (MNCs) the confidence to base significant production in China. As China's domestic market grows, it gives MNCs another strong reason to keep production in China. No other country can offer economies of scale that combine selling locally and exporting abroad with low production costs.

However China no longer offers the lowest production cost. The labor cost in Bangladesh is merely one-fourth of China's. Indonesia's labor cost was twice as high as China's before 1997 and is now comparable to China's and rising at a much slower rate. Industries that do not require the supply chain to be nearby may exit China - for example the shoe and garment industries - but most others will stay since relocation is not an easy solution. Many manufacturers will simply pass their higher costs on to consumers and MNCs may just have to accept lower profit margins.

Infrastructure development has been a competitive advantage for China, and is the result of the government's ability to mobilize resources. Land and credit are usually constraints on infrastructure development in most other countries, but state ownership of land and banks has allowed China to develop large infrastructure projects while also benefiting from economies of scale.

The national expressway system is a good example of this. Only an interconnected system of such a large size can deliver economic benefits due to the so-called 'network effect'. In a dozen years China has completed over 60,000 km of expressways and another 30,000 km are under construction. The expressway system has made the national population more mobile, integrated villages and small cities into the national economy, and sharply decreased logistics costs.

The development of ports and industrial parks has encouraged OEM industries (original equipment manufacturers) to locate in China. Together with the highway system, this made it possible for China to become the largest export country in the world.

China was also early to embrace the Internet - and this laid the foundation for China to be part of and benefit from the global economy. In addition, China's large and productive labor force has contributed more than any other factor to China's growth. Until five years ago the nominal wage had been stagnant in nominal dollar terms for over a decade, even though labor productivity had been increasing at nearly 10% per annum and total factor productivity at over 4%. The increase in productivity of Chinese labor meant declining prices for western consumers, rising profits for MNCs, and rising tax revenues for the Chinese government. This saw more MNCs coming to China for production, and Chinese local governments in China continue to invest in infrastructure to attract them.

China's rapid growth has also coincided with a weak dollar. The dollar index peaked in 2002 and has declined by one third since. The dollar's weakness is due to globalization and technology, a result of driving liquidity into emerging economies, particularly China's. Though the tendency is to blame a crisis on slow growth, actually crises always seem to follow periods of high growth in emerging economies. It is the problems that are allowed to accumulate during the high growth period that cause both the crisis and subsequent slow growth. Nothing hides problems like high growth so policymakers tend to try and sustain it for as long as possible in the hopes they can outgrow the problems. But history teaches us that this is usually not possible. The longer the growth lasts, the more intractable the problems become.

China's money supply has quadrupled in the last eight years, growing at 19% per annum, and if the off-balance sheet expansion of the financial institutions and underground financial activities are included, the money supply may have grown at 11% per annum. During the same period the nominal GDP has grown at 18.5% so if one compares the official GDP data and monetary data, it does not seem cause for concern, as the two are about the same. But there are two potential problems to consider: nominal GDP has been inflated by the property bubble, thus the rapid monetary growth is also probably a bubble; and real monetary growth is much higher.

China's electricity consumption grew at about 13% per annum between 2002-10. Historically China's real GDP has grown faster than electricity consumption - the ratio of electricity consumption increase to GDP increase is called elasticity and it was around 0.8 during the 1990s. Heavy industry has been leading the current growth boom, thus the economy has become more dependent on electricity for growth, so the elasticity should have increased and I suspect it wouldn't be more than one. Hence, it is reasonable to guess that China's real GDP has grown at 13% over the past eight years, which would put the GDP deflator - the broadest inflation gauge - at 4.5%

So far, inflation has mostly occurred in land and commodities. Land prices have increased on average by more than ten times since 2003, 30 times in some hot coastal cities, and more than 100 times in the most speculative areas. It is reasonable to believe that China's land price is highest among all the major economies today, even though China's average wage is one tenth that of developed countries.

Land price inflation has shown up in the nominal GDP through rising property sales of over 14% of GDP last year. Much of the investment has been due to the collateral value of land, with local governments borrowing enormous amounts of money (probably around 17% of the total bank lending) to fund or subsidize investment to create GDP. The loans are secured with land, so without high land prices such financing would be impossible. With fixed investment being driven by the government and close to half of GDP, it is easy to see how the land bubble has accounted for a large portion of the growth during the current cycle.

Recent manufacturing investment, for example, is due partly to high land prices. Local governments have been competing fiercely for manufacturing investment and many companies have learned how to extract enough benefits from local governments that they do not need to put up any equity capital for investment. They often ask for free land and use that as collateral for a bank loan. They then lease equipment from the manufacturers who have used the leasing contracts to obtain bank loans. This explains why so many companies have been able to continue expanding with a negative cash flow: expansion is critical to their survival as new investment brings in the cash they need to sustain themselves.

Profit drives investment, which in turn powers employment, and that then grows consumption. When profit is due to asset appreciation and not sustainable, it may lead to crisis. Large bubbles often occur during prolonged prosperity, when people stop paying attention to risk and there is excessive demand for risky assets, leading to an asset bubble that prolongs prosperity beyond the normal cycle.

Possibly half of China's bank lending is going into property-related businesses or local governments that are pledging land as collateral. While the current boom has catapulted China ahead of Japan to become the world's second-largest economy, we must remember the excesses in this cycle and the need for an adjustment as soon as possible. Nothing reveals the vulnerabilities more than the banking system's exposure to unsustainable economic activities that are dependent on land appreciation. China should proactively bring about the needed economic adjustment.

Andy Xie Is Spot On On China Property

By Andy Xie

The central government has unleashed another round of property tightening measures. This time it is focusing on mortgage lending terms: the mortgage interest discount for first-time homebuyers has been reduced; the discount for second-time homebuyers has been abolished and the down payment requirement raised to 40%; and the rate for third-time buyers is being left to the banks' discretion with down payments raised to 60%.



Predictably, sales volumes in both primary and secondary markets have collapsed. But no one is panicking, not even those who live off the property bubble. Why? Aren't they supposed to be terrified of the government's crackdown?

It seems we have seen this movie before. China has launched property-tightening measures several times but it relaxed them just when they began to bite. The bottom line is that local governments, and the central government through them, depend very much on property for revenue. The market doesn't believe the government will cut off the hand that feeds it.

Local governments and developers are sitting on massive liquidity that they raised last year through land and property sales and borrowings, taking advantage of the "anything goes" window during the stimulus period. They seem to believe that the central government will change its mind before they run out of liquidity. So they are comfortable waiting and not cutting prices.

Cutting prices doesn't make sense if the government is expected to loosen policy again soon. The current lending terms effectively keep second- and third-time homebuyers out of the market. To sell, developers must cut prices to levels affordable to the buyers of first homes, who have low incomes and little wealth. All the players will play by the new rules only if the central government proves its credibility by maintaining the tightening policy until local governments and developers run out of money.

Contrary to the policies' intent, local governments are readying for another round of property inflation. Local governments have been using bank loans to resettle residents, and resettlement costs have skyrocketed since those being moved need enough compensation to buy properties at today's prices. Unless property prices rise considerably, local governments will end up losing money, which they cannot afford to do.

Resettlements played an important role in supporting demand for property last year. The overwhelming majority of end-user purchases probably came from resettled residents who used their compensation money for a down payment. Resettlement compensation is the biggest transfer of wealth from the government to the household sector since the privatization of public housing at low prices a decade ago. It is probably the most important government action supporting today's economy.



The positive elements of resettlement compensation come with two major negatives. First, it is using a form of leverage to support demand. Local governments borrow to pay the compensation packages, using the land as collateral. The resettled residents use the compensation as down payment for mortgage borrowing; so government debt becomes equity for mortgage debt. There is no real equity in the financing chain.

Second, the high compensation costs, though beneficial to the resettled residents, make local governments a player in further inflating property prices. China's economic policies have been favorable to the low-income class in the past few years through rural subsidies, agricultural land reform, and price controls for necessities. The resettlement policy is another element in the push to help them, but the costs are being borne by the middle class, whose most important expenditures — property, cars and education — are highly inflated. Indeed, China's property and car prices are among the highest in the world in absolute terms, and by far the highest relative to income. Unless policies change dramatically, the middle class squeeze will only get worse.

China's property market is a massive bubble. The stock of residential properties, developers' inventories, and land that local governments have pledged to banks may exceed by three times the gross domestic product. Rental yields in most cities are too low to cover depreciation costs. In major cities, the price-to-income ratio, a measure of housing affordability, is routinely above 20, which means that it would take an average mainlander 20 years to buy the average property using their total income. The bubble can still continue because China's banking system has plenty of liquidity – thanks partly to hot money and because local governments have many levers to channel bank liquidity into the market. But the longer the bubble lasts, the more damage it will do to the economy.

The stability of a modern society depends on its middle class being in the majority and content with its situation. The high land-price policy is a form of tax on the middle class, which will slow its growth. China may become a country with a small group of the super-rich, a vast lower class with no property, and a small middle class. Such a social structure would not be good for long-term stability.

The key to a sensible property policy is to reform the fiscal structure. First, government spending, mostly in fixed investment, should be curtailed. China doesn't need to build everything at once. Last year, the sum of government fiscal revenues, central and local government borrowings, and expenditures by state-owned enterprises probably exceeded half of the GDP. Could the government sector spend so much efficiently? Shrinking the government sector should be a top priority for the nation's future.

Second, the government sector still owns assets worth more than the entire GDP. The government should give it to the people to expand the middle class – a move that would support consumption, incomes and tax revenue. Shrinking the government and giving wealth to the people are the policies necessary to make growth balanced and sustainable. The rapid expansion of the government sector only increases its need for revenue and the incentive to inflate the property bubble. Without credible government reforms, property tightening is not credible.

One more point to note is that most of the bears assume Beijing will be sitting around doing nothing. Please note that bank lending by Chinese banks fell 43 per cent in the first quarter from a year earlier as the government winds down its stimulus and tries to cool a credit boom while keeping its recovery on track, central bank data showed on Monday.

Banks lent 2.6 trillion yuan (S$529.7 billion) in the January-March quarter, the People's Bank of China said on its Web site. That compared with 4.6 trillion yuan in loans in the first quarter of 2009 as banks ramped up loans for construction and other projects as part of a 4 trillion yuan stimulus. The figures indicated the central bank's efforts to prevent runaway lending and restore financial discipline in China's state-owned banking industry might finally be taking hold, lessening the need to raise interest rates to curb inflation.

The tightening on lending reflects worries that many of the loans issued in the past year or more may go sour and that easy credit is fueling wasteful investments. On Sunday, the chairman of the China Banking Regulatory Commission, Liu Mingkang, announced an aggressive plan to assess the safety of loans made to financing entities set up by local governments to invest in real estate, infrastructure and other projects.

Andy Xie On Market Rally & The Fed

Many people like Andy Xie, including me. Singapore liked him so much that they wanted him away from the country as much as possible so that they can miss him more. Andy Xie, former Morgan Stanley economist and current board member of Rosetta Stone Advisors shares some thoughts on the stock market rally and the Fed.

Regardless of what investors or speculators say to justify their punting, the real driving force is the return of animal spirit. After living in fear for more than a year, they just couldn't sit around any longer. So they decided to inch back. The resulting market appreciation emboldened more people. All sorts of theories began to surface to justify the market trend. Now that the rising trend has been around for three months globally and seven months in China, even the most timid have been unable to resist. They're jumping in, in droves.

When the least informed and most credulous get into the market, the market is usually peaking. A rising economy and growing income produces more funds to fuel the market. But the global economy is now stuck with years of slow growth. Strong economic growth won't follow the current stock market surge. This is a bear market rally. People who jump in now will lose big.
The dollar index-DXY has fallen 10 percent from the March level, even though the U.S. trade deficit has declined substantially. It reflects the market's expectations that the Fed's monetary policy will lead to inflation and a dollar crash. The cause of dollar weakness is the outflow of U.S. money, in my view. It is the primary cause of a surge in emerging markets and commodities. Most U.S. analysts think the dollar's weakness is due to foreigners buying less of it. This is probably incorrect.

The dollar's weakness can limit Fed policy options. It heightens inflation risks; a weak dollar imports inflation and, more importantly, increases inflation expectations, which can be self-fulfilling in today's environment. The Fed has released and committed US$ 12 trillion (83 percent of GDP) for bailing out the financial system. This massive overhang in money supply could cause hyperinflation if not withdrawn in time. So far, the market is still giving the Fed the benefit of the doubt, believing it will indeed withdraw the money. Dollar weakness reflects the market's wavering confidence in the Fed. If the wavering continues, it could lead to a dollar collapse and make inflation self-fulfilling.

The Fed may have to change its stance, even using token gestures, to assure the market it won't release too much money. For example, signaling rate hikes would soothe the market. But the economy is still in terrible shape; unemployment may surpass 10 percent this year. Any suggestion of hiking interest rates would dampen growth expectations. The Fed is caught between a rock and a hard place.

Andy Xie On Current Global Crisis

Andy Xie (the economist who got into trouble with Singapore government) is still one of the top economists in Asia by any measure. Pleasantly surprised with his discerning views and solutions on the current global crisis. Good piece.

By Andy Xie, Caijing guest economist and board member of Rosetta Stone Advisors Limited
From Caijing Magazine

Policymakers around the world have not shown an understanding of the current crisis. It is the end of a two-decade long bubble. It is the end of the asset-based economy. It is the end of productivity dividends from IT revolution and globalization. Perhaps one tenth of the income in the global economy was from bubble activities and is permanently lost. The income will shift elsewhere. The resulting demand is different. The supply side has to change to meet a different mix of demand in the post bubble economy. If governments don’t understand, the world may suffer a lost decade ahead. No, it is not Japan in the 1990s. It is Japan of the 1990s plus inflation, i.e. stagflation.

Stock markets around the world have fallen close to or below the lows of November 2008. Concerns over bank bailout uncertainty and deepening recession drove the decline that reversed the 20 percent bounce from the lows of November 2008. The delays in releasing details by the U.S. Treasury on its bank bailout plan led to suspicions that it didn’t know what to do yet. The exposure of European banks to Eastern Europe caused concerns over their solvency. If big global banks remain mired in bad assets, credit system won’t function normally, and the global recession has no hope to end soon.

On the economic front, the news is grim: Japan’s GDP contracted by 3.3 percent, the euro zone by 1.5 percent, and the U.S. by 1 percent in the last quarter of 2008. The U.S. fared better because it piled up inventories, which could lead to a worse situation later. The global economy probably contracted by 2 percent in the last quarter of 2008 from the previous quarter, the worst decline since the World War II. The first quarter of 2009 won’t be better. January trade data for East Asian economies already casts a dark shadow over the quarter. All the data are portraying a global economy burgeoning on collapse.

Three forces are behind this. First, the collapse of Lehman Brothers triggered a sharp increase in credit cost. Its impact was similar to increasing interest rate by 3 to 5 percent by all the central banks together. To cope with high cost of capital every business has been running down inventory, which is the cheapest way to raise funds. In commodity industries, inventory unwinding has been dramatic. Most commodity users kept inventories high for fear of price increase and speculation. When commodity prices reversed, they were stuck with a depreciating asset and had to run it down as quickly as possible. I suspect that this force accounts for half of the economic contraction at present.

Second, faced with rising credit cost and declining demand, businesses around the world have cut their capital expenditure (capex) sharply. This force is most visible in the IT sector. Japan, Korea, and Taiwan are most exposed to it. Their exports have declined dramatically, much more than China’s, which has a broader mix. The tech heavy NASDAQ lost half of its value from its recent high in 2007, despite its terrible beating during the tech burst in 2000 to ’03 that saw the index down by 80 percent from the 2000 peak. Semiconductor makers were hit particularly hard. The Philadelphia Semiconductor Index is down 60 percent from its 2007 high. Many semiconductor companies on NASDAQ are trading at market capitalization below 10 percent of their sales revenue. I suspect that the suspension of capex is responsible for one fourth of the current economic contraction.

Lastly and the most obvious, the negative wealth effect from the evaporation of US$ 50 trillion paper wealth is cutting into consumption. The rule of thumb suggests that the negative wealth effect is about 5 percent. As two thirds of the global economy is consumption, ceteris paribus, the global economy can contract by 3 percent just due to this effect. Its impact is not all felt yet. Most consumers will adjust slowly.

The inventory cycle and reduced capex are temporary factors pulling down the global economy. At some point, inventories are sold, and capex is too low to cut. I suspect that inventory destocking will be completed in the first quarter of 2009, and that capex stabilizes in the third quarter. The global economy will probably show stability then. As fiscal stimulus kicks in around the word, we may see a significant bounce in the global economy in the second half of 2009. But stability or a stimulus-inspired bounce won’t lead to a sustainable recovery. Consumption weakness will haunt the global economy for a long time. The over-leveraged western consumer needs to pay down debt for years to come. Rising unemployment will make the problem worse. The western consumer – the driving force behind the global economy for the past decade – is down and out for good.

Governments must understand the lasting nature of the current downturn. The bursting of the credit bubble triggered the fall. The mismatch between income and demand could delay a sustainable recovery for years. During the bubble era income distribution became more and more skewered towards asset-based activities. For example, the profit share of financial activities among U.S.-listed companies quadrupled. Similar trends happened in many countries. The income for the workers in finance increased in a similar fashion. The bulging income from the financial sector was quite concentrated among a small group that spent money in luxuries and financial investment. This is the most important factor for rising concentration of income distribution around the world in the past decade.

The bursting of the bubble will destroy most income in financial activities. The amount lost could be one tenth of GDP. From limo drivers to luxury homebuilders, the compounding effect from the financial meltdown will leave unemployment across many industries and countries. The recovery becomes sustainable only when supply side is restructured to cater to a different demand mix. This process could take a long time to complete. But governments might prolong the downturn by making the wrong decisions. For example, governments around the world are engaging in fiscal stimulus. To some extent they are choosing winners, but if the ventures they back are way off what market would support, the stimulus would delay recovery. Stimulus is necessary in a severe downturn like now. It just needs to match the structural changes to come.

Let us think through the problem facing an unemployed banker and his ex-driver. The banker could splurge and hire a driver since he was making 20 times his driver’s wage. Of course, in addition, he was paying for his florist, tailor, maid, masseur, etc. On average, he spent 70 percent of his income on the equivalent of 15 people like his driver full time serving him and put 30 percent back in financial investment like in a hedge fund. Now, the ex-banker moves to Kansas City and becomes a high school teacher. His current income is the same as his ex-driver’s. He drives to work, cleans his own house, and forgoes massage. The economic problem is what happens next to the fifteen people who were serving him.

The banker’s income before came from asset market activities, essentially redistributing income to himself by manipulating asset prices. As he stops doing that, the cost for economic activities goes down by the amount equal to his income. But the people serving him have lost their income. The net result is that the economy contracts by the same amount as the banker’s income plus 15 unemployed people. In addition, the 15 unemployed people can’t spend. The multiplier effect magnifies the banker’s income contraction, possibly by a factor of two. The world looks worse off with a smaller economy and more unemployed.

When the government steps in to stimulate, it is essentially borrowing the equivalent of banker’s ex-income to spend. The purpose is to keep the 15 people employed. However, the government won’t spend on drivers, nannies or florists. The mismatch means the government can’t get the economy back with stimulus. It shouldn’t. The driver must find new customers. The banker is gone for good. What the government should try to do is stop the multiplier effect from the 15 people that the banker no longer hires. If these 15 people get unemployment, it could go a long way to mitigate the multiplier effect. The economy can come back when it is restructured so that the 15 people find new employment.

The world will eventually be better off. The banker was just redistributing income to himself. The money would lead to more productivity if it could be directed to more productive people. It’s just that the process of adjustment could be long. The world has experienced an asset-based economy for two decades. It has led to extreme income distribution. In the last few years, large manufacturing companies like GE and GM came to depend on financial activities for profits. Their industrial activities were really used as a fund raising platform. In China manufacturing companies depended on property development or stock market speculation for profits. The profit margins from their main businesses kept dwindling. Reversing the trend of the past two decades would take a long time. If governments don’t understand and try to bring back the ‘good times’ of the past, it will prolong the adjustment, and the world may suffer a lost decade.

Japan suffered a lost decade characterized by stagnation, rising fiscal deficit, deflation, and strong yen. These characteristics were supported by Japan’s high savings rate and export competitiveness. The world as a whole could not replicate Japan’s experience. The U.S., for example, must borrow from foreigners to fund its budget deficit. Its currency is likely to be weak for years to come. As dollar is the currency for trade, capital flows and foreign exchange reserves, its weakness will lead to worldwide monetary expansion. The loose monetary condition will sooner or later lead to commodity speculation. The resulting inflation would lead to wage demand by organized labor, which opens up a channel between money supply and inflation. When I look at the government policies around the world, I fear for prolonged stagflation ahead.

While we need to worry about the long-term effectiveness of stimulus spending, the short-term effectiveness is not yet secure. With global banks still mired in toxic assets, they won’t be able to lend normally. If stimulus pushes up economic activities, businesses that want to invest to meet new demand may not get loans. In an upward virtuous cycle, rising demand leads to investment that leads to more jobs and more demand. Without a functioning banking system, this virtuous cycle is not possible. Instead, stimulus just perks up the economy temporarily.

The immediate task is to repair the banking system, especially in the U.S. The U.S. Treasury is promising overwhelming force now and details later. This may be a stalling tactic. The prices of big bank stocks and toxic assets already assume nationalization. The U.S. government is right to be concerned of the permanent damage to its financial system from nationalization. But to avoid it, the government has to grossly overvalue toxic assets. The U.S. taxpayers wouldn’t agree to throw taxpayers money at failed banks. If the U.S. doesn’t fix its banking system, the US$ 780 billion fiscal stimulus will be wasted.

The right approach is to nationalize these banks, separate the toxic assets into a different entity, and relist the healthy halves. The proceeds from selling down the healthy banks could be used to pay for absorbing the losses from disposing toxic assets. This is what China did to repair its banking system. It may be the only way out for the U.S.

Second, the West must contain the cost of its entitlement programs, beginning with healthcare in the U.S. If the U.S. doesn’t institute radical reforms to contain its healthcare cost, it will go bankrupt, possibly within a decade. If Europe doesn’t reform its pension and unemployment benefits, it will have to raise taxes or run bigger budget deficits permanently, and its economy would stagnate.

The biggest economic challenge among developed economies is aging, which leads to escalating pension cost and exponentially rising healthcare cost. While the wrong policies allowed the credit bubble to happen, the desire to defend an old lifestyle while social overhead grows higher was a major contributing factor. It allowed the western economies to delay the hard choices. The current system was set when aging was not a big challenge. The only viable course forward is to increase the retirement age and ration healthcare access.

Third, emerging economies must decrease export dependency. Export-led development usually reflects weaknesses in the political economy – the inability to efficiently turn savings into investment. The causes are usually lack of the rule of law and income and wealth concentration. Export orientation is to import the global system. From Japan a century ago to the Asian Tiger economies fifty years ago and China thirty years ago, the model has made fast development possible.

The problem with the model today is that it is crowded. Developing economies are already 30 percent of the global economy at current price and nearly half on a purchasing power basis. The export model cannot thrive for shortage of customers. Developing countries have to trade more with each other and develop domestic demand. But this would require painful reforms to their political economies. The key is property rights and income distribution. The two must go hand in hand. Lack of domestic demand tends to result from income concentration, which is due to uneven playing field in opportunities. Many developing countries, like South American and Southeast Asian countries, have stagnated in the past decade due to their inability to reform their political economies.

Bursting of the credit bubble is triggering the biggest recession since the World War II. Repairing the global economy requires complex and difficult reforms. Simple stimulus can’t bring back prosperity. While stock markets may improve in the second and third quarter, it is merely a bear market rally. When inflation concerns hit the market towards the end of 2009, stock markets could fall sharply again. Indeed, the ultimate bottom in the current cycle could happen in 2010.

p/s photos: Meisa Kuroki