WRT China turning towards commodity purchases as an alternative, I think that this may backfire. With demand being in such short supply local producers are sure to argue that state owned enterprises should not be in the procurement business for their respective countries. Especially ones where the products (resources) are frequently sold below market prices. Countries in which these assets are based can, with a swipe of a pen, change ownership requirements.

Thanks for your credible critics on conspiracy theory.More puzzling to me is that too many ppl on your blog worry too much on NPLs.I feel obliged to put forward a few points here.

To begin with,China has accumulated a massive amount of reserves during last several years.By taking hard-earned export dollars in and then recyclying it back to US,these reserves has led to liquidity expansion not only in China but also in US.

As both China and US are overwhelmed by ever-expanding liquidity,and too much liquidity leads to higher inflation and higher long-term interest rates which stifles long-term investment projects. To tackle this,I cannot put up any suggestion better(or less worse)than simply piling up more NPLs,which is just like setting fire to piles of paper money.

So we can see that unless the fundamental imbalance is not corrected,NPLs must go up.All good banking practice,which is summarized by Joseph Stiglitz as only lending money to those who don’t need money,can easily be overwhelmed by outside shocks.

So my point is,NPLs are not sth to worry about,but sth to live by under nowadays circumstances.I hope this point is not much too ironical….

I’m not a fan of “big bang” solutions. To resolve this crisis takes a thousand little solutions rather than one big solution. There are four big players, the US, EU, China, and the Middle East. The US can be the first among equals, but it’s not in a position to dictate or even lead.

Michael: I know I may be very contrarian here, but I actually see no hard evidence of a relative decline in US power.

US power has certainly declined in *relative* terms. China, the EU, and the Middle East certainly have far more say in the structure of the world now than they did in 2000. After the collapse of the Soviet Union, the US had this brief and unusual period in which it was the only major power in the world. That period has drawn to a close.

What’s more is that in the last two years, there has been a sharp collapse in American self-confidence because of the debacle in Iraq and now the financial crisis. This is a very different nation than it was in 2003 or even 2006. Part of the reason I think it is unwise to suggest that the US take a strong global leadership role to remake the world economic system is that the American people just don’t want this, and will react very badly if Obama starts using this rhetoric. Talking about reshaping the globe just sounds too much like Iraq.

The US certainly has the most wealth and institutional capacity by far of the the major global players. It also has the biggest problems, and these two cancel themselves out. The best way that the US can help the world is to fix its own banking system, since US banks are still at the core of the world financial system, and if the US banks aren’t fixed, then there is only a limited amount of things that other countries can do.

I do think that the US has a fine future. These troubles will pass. Part of the reason that I think the US has a very bright future is that among all of the nations of the world, the US has one of the most diverse and globalized populations, and in a multipolar, global world, being about to speak 200 languages is useful.

Micheal: I see no other country that is even close to taking a leadership position. I think that unless the US pushes for a new institutional framework, no one will.

As a practical matter, I don’t think we are in a position to push for a new institutional framework because no one really knows what that will look like.

I think for the next year, we are just going to be muddling through. Fixing the obvious problems, trying to deal with the less obvious ones. After all the dust settles, we can see what things look like and then formalize some of the systems.

In the current situation, I don’t see very much likelihood of increased trade protectionism, and the most important thing here is to preserve the WTO framework. I do see a lot of capital protectionism coming up.

Something that no one has mentioned yet is that if you see massive nationalizations of the banks, then the banks will be under pressure to loan domestically.

One final thing. It’s a bad idea to hope rather than plan. No one knows how long this downturn is going to be, and I hope (and rather suspect that it is happening) that someone in Beijing is doing “what if” stress testing to think about what happens if you have a long term contracting global economy.

One thing that is interesting in finance is when you hear the same story told by different people. I’ve heard it argued (and plausibly argued) that what got Japan in trouble was that a rigid, highly regulated system, but rather the fact that the Japanese government massively deregulated the system in the early 1980’s.

Looking long term, it is possible that a huge stimulus now will keep the demand and production within the Chinese domestic economy high even in the face of a fall in world demand. A healthy expanding economy will have fewer NPL’s than a sick shrinking economy.

Or maybe not…. My point is that it far from obvious that spending less now will reduce future NPL’s. A lot depends on how credit is allocated now.

Michael: If the US, China, and Europe try to fix their domestic economies without any concern about the impact of their policies on the rest of the world, the result will be horrible. By the way, this is one of the things that happened in the 1930s. It is hard to argue that policymakers then did the right thing.

I’m all for coordination and if there is something that country A is doing that is hurting country B, then this needs to be discussed.

However right now there are very few areas in which new policies taking in one country are adversely impact another. The two biggest potential problems are trade and capital protectionism. Trade protectionism can be handled through WTO. Capital protectionism is not going to be an issue if everyone has bad banks.

Seaturs, don’t overestimate the “meaning” of the impact of recent innovations on the financial system. First, this is not nearly the first time something like this has happened to the US. Financial innovation followed by financial collapse has been a pretty common event throughout US history, even before the Republic was established. Second, I believe the real culprit is excess monetary growth, not financial innovation. Even highly regulated, rigid systems with no innovation (think Japan in the 1980s) responds to massive liquidity growth by creating unsustainable bubbles.

OGT, see my response to Brad for a very brief set of proposals. Of course you are right that reforms in financing education could help, but I suspect that this falls in the very large category of good reforms that will only help in the medium term. And yes, three years from now when you read the 2009 edition of The World Ahead you will certainly find it amusing.

Grubby, I think the answer is a resounding “Yes.”

As for your last paragraph, I think you are completely wrong and one of my goals is to convince policymakers of how dangerous this kind of thinking is. If the US, China, and Europe try to fix their domestic economies without any concern about the impact of their policies on the rest of the world, the result will be horrible. By the way, this is one of the things that happened in the 1930s. It is hard to argue that policymakers then did the right thing.

Brad, the devil is in the details. There are a wide variety of policies that China can follow, but the proof must be in the trajectory of the trade accounts. I would focus on raising interest rates, raising minimum wages, liberalizing the financial system to divert more lending into services and consumption, greater spending on health and welfare, and a number of demand enhancing measures,. Most of these are things China is anyway desperate to do in the medium term, but it is too afraid to do in the short term because of the collapse in exports.

By the way it worries me that even a staunch internationalist like you is showing signs of weariness with China. This was also reflected in my meetings in Washington and with US and European policymakers I have met recently. Even China’s best friends are starting to get annoyed with China’s refusal to acknowledge its role in the imbalance, and this suggests a hardening of attitudes everywhere. I am deeply pessimistic about an orderly resolution of the global balance of payments crisis.