Is
the United States at long last getting serious about
global imbalances, or are we risking currency wars
that can end in unmitigated disaster for all? No one
knows, though tension is on the rise with China. This
much is certain: any advantage from a lower currency
is a zero-sum gain for the world economy as a whole.
At best, it is about how to distribute the pie, not
about growing it.
Until recently, many economists were not sure if global
imbalances were something to be worried about at all.
If markets always worked efficiently as most economists
had accepted as an article of faith before the crisis,
there had to be a rational explanation as to why these
imbalances were, if not a blessing in disguise, at
least, an innocuous outcome. Clearly capital was flowing
into the United States from the rest of the world
for a reason. Maybe it was the benefits of the deep,
highly liquid, and efficient U.S. financial markets
the foreigners were taking advantage of, or perhaps
they were simply trying to invest in the bright future
that was awaiting the United States because of its
superior productivity growth.
Some even argued that the imbalances were simply an
illusion created by poor accounting, a result of the
failure to capture the true value of the financial
services the United States was "exporting"
to the rest of the world. These were the optimists,
the true believers in the wisdom of the market, who
did not think much, if anything, had to be done.
Then there were the pessimists who feared that foreign
demand for U.S. financial assets would sooner or later
fall short of what was needed to finance the rapidly
growing current account deficit. They differed on
how imminent the danger was and on what shape a hard
landing would take, but, invariably, a run on the
dollar and prohibitively high interest rates were
the opening acts in their list of possible bad scenarios.
They all agreed that sooner or later the United States
would need to save more and that it would help if
China stopped manipulating the value of its currency.
Unsurprisingly, the more optimistic arguments began
to wear thin as early as the bursting of the dotcom
bubble, only to die out completely after the financial
crisis. The argument that the U.S. stock market boom
in the late 1990s reflected booming productivity growth,
and thus rational expectations about a much higher
level of future income in the United States, was hard
to maintain even after the dotcom debacle but yet
managed to survive until after the financial crisis.
Likewise, the argument that the surge in house prices
reflected improvement in their quality-the redone
kitchens with Italian marble countertops, etc.-quietly
petered out only after the real estate bubble burst.
But the financial crisis has raised questions for
the pessimists as well. Most notably, the crisis was
not triggered by a run on the dollar caused by a disorderly
unravelling of global imbalances as many had feared,
but instead by problems that had to do with the market
provision of liquidity within the financial system
itself. For instance, it was hard to discern a direct
connection between the purchase of toxic U.S. mortgage-backed
assets by foreign banks which transmitted the crisis
to Europe in its decisive initial phase and the financing
of the U.S. current account deficit. It hardly seemed
to be the case that the crisis would have been prevented
had the major players undertook a coordinated timely
policy intervention targeting global imbalances.
Despite these questions, the pessimists' basic understanding
of global imbalances appears to have survived the
crisis intact to become the conventional view today.
The following are its basic tenets:
- imbalances are the ultimate cause of the crisis;
- they are the result of overspending mainly in
the United States and exacerbated by the undervalued
currencies of East Asian surplus countries;
- one way or another spending has to fall in deficit
countries and rise in surplus countries; and,
- taking steps to enhance exchange rate flexibility
would help to achieve that end.
None of this is new, of course, but one addition
that is missing above has been the emphasis on the
importance of financial regulation. Previously, overspending
used to be blamed on government budget deficits, but
after the crisis another culprit emerged: the failure
of financial regulation to detect and prevent frothing
credit growth which made it possible for households
to over-consume.
Imbalances versus Recovery
Now that the finance bill has passed, the Obama administration
and the U.S. Congress seem to be turning their attention
to the surplus countries' role in global imbalances.
If only China would let the renminbi appreciate, they
seem to be thinking, China would save less and the
United States would save more, causing global imbalances
to shrink. Of course, the pain that would imply is
often ignored. Cutting down global imbalances today
would require cutting down demand in the United States
in the midst of an anaemic recovery, which is clearly
counterproductive.
Economists often talk from both sides of their mouth
to deal with the problem: raising spending is advisable
in the short run to revive growth when in a slump,
but needs to be curtailed in the long run when growth
is restored. The trouble is that the short-run fix
takes us further away from the long-run target, without
any clear idea how we are to go from the former to
the latter. For instance, during the thick of the
crisis, there has been a significant reduction in
the size of global imbalances along with a drastic,
steep contraction in world trade. Yet, with the partial
revival of trade since the recovery, global imbalances
have begun to widen again. Does it then follow that
the world is farther from a solution to its structural
ills today than when it was at the bottom of its slump?
Arguably, the conventional view offers little policy
guidance for here and now.
It is possible that the conventional view also fails
at a deeper level, for it assumes a world that no
longer exists. It implicitly presupposes an international
economy consisting of distinct national economies
with their own separate systems of financial intermediation
that are tied to each other mainly through trade.
In other words, it assumes a world where financial
assets are traded to move the goods; a world where
central banks control credit growth; a world where
the current account rules the roost. None of this
of course is consistent with the increasingly transnational
world we now inhabit. The expansion of cross-border
financial transactions began to outstrip the expansion
of goods trade as early as the 1970s, but their increase
with the rapid acceleration of financial globalization
since the 1990s has simply been spectacular. In this
new world, it is misleading to assume that the asset
trade is still auxiliary to the goods trade.
All of this suggests another way of looking at global
imbalances which can give a very different understanding
of the nature of the problem we face. Think of Bernanke's
"savings-glut" thesis-and, ignore its frequent
Pollyanna-ish use. It basically says that the U.S.
credit boom that led to overconsumption, and thus
the ballooning trade deficits, was in turn caused
by money flowing into the United States from the rest
of the world through its capital account. In other
words, it was ultimately the capital inflow that fuelled
the credit expansion and brought long-term interest
rates down, making it possible for U.S. households
to overspend and thereby be the engine of world growth.
Note that in this view what needs to be done to restore
world growth is not as obvious as in the conventional
view. Here, the overspending in the United States,
along with the trade deficit it gave rise to, appear
as a "solution" to a deeper problem involving
excessive savings in the global economy. Thus, one
could even say that the real estate boom in the United
States was perversely functional in creating a source
of demand that forestalled the deflationary effect
of excess savings for as long as possible. In other
words, the trouble was not with global imbalances
per se, but the unsustainable way they were being
recycled and what they were used to finance.
Because U.S. households and banks continue to face
an ongoing threat of insolvency, personal saving has
been rising markedly since the crisis. The adverse
effect of this on aggregate demand has so far been
partially offset by a sharp increase in public spending
(or dis-saving). Now that recovery is supposedly well
underway, the conventional view calls for cutting
public dis-saving so that the U.S. trade deficit can
be reduced. Yet, that is a recipe for disaster-it
risks much higher levels of unemployment than what
we have now. It also aims at returning to a world
as it was before globalization, which probably cannot
be achieved if at all without first going through
a global slump comparable only to the Great Depression
in its length and depth.
There is Another Way
Yet soldiering on with more public stimulus to "jump-start"
the economy that only widens the twin deficits is
not really a viable option either. Even if the fears
about a sovereign debt crisis in the U.S. are wildly
overblown, the fear is real and will impair the effectiveness
of continued use of public stimulus. As is often the
case, fear is rarely overcome by arguing that it is
unjustified. More importantly, it is futile to jump-start
U.S. overconsumption to lead the world economy out
of its doldrums. Even if it works in the short run
it simply will not be sustainable.
What other alternative is there if we don't bite the
bullet and shrink our economy, deglobalizing in the
process if need be?
The alternative is to ask how the problem of global
excess savings can be addressed in the first place.
In other words, what if anything can take the place
of U.S. overspending in offsetting the deflationary
effect of global excess savings today? Once the question
is posed thus, the real policy challenge today can,
for instance, be defined as figuring out how to put
to use the U.S. financial system to recycle large
dollar reserves abroad to finance development in poor
countries, which will benefit everyone including the
rich. The corollary of that is also the question of
how to restore the system of global financial intermediation
on sound footing rather than getting rid of it.
* This article appeared in Policy
Innovations on 13 October, 2010 at
http://www.policyinnovations.org/ideas/commentary/data/000202
It is licensed under a Creative
Commons License.
October
14, 2010.
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