Before readers throw brickbats at me, I’m just acting as the messenger for two articles, one by Harvard’s Kenneth Rogoff, the other by the Financial Times’ Martin Wolf. Each points out that the US is taking a proportionately bigger hit than other big economies post crisis, particularly in terms of unemployment. And this is actually more than a bit perverse, since the normal course of action for a country in the position of the US (chronic current account deficits, high debt levels) is to depreciate the currency and/or increase import barriers, and renegotiate and restructure debt.
Both articles are of the view that the US public is going to lose patience with continued high unemployment, which amounts to exporting demand for the benefit of foreign manufacturers. Effectively, both contend it would behoove our trade partners to help solve this problem, because if they don’t, our response is likely to be unilateral and driven by politics rather than sound policy.
Rogoff at Project Syndicate (hat tip Mark Thoma) gives an overview:
G-20 leaders who scoff at the United States’ proposal for numerical trade-balance limits should know that they are playing with fire. The US is not making a demand as much as it is issuing a plea for help.
According to a recent joint report by the International Monetary Fund and the International Labor Organization, fully 25% of the rise in unemployment since 2007, totaling 30 million people worldwide, has occurred in the US. If this situation persists, as I have long warned it might, it will lay the foundations for huge global trade frictions. The voter anger expressed in the US mid-term elections could prove to be only the tip of the iceberg.
Protectionist trade measures, perhaps in the form of a stiff US tariff on Chinese imports, would be profoundly self-destructive, even absent the inevitable retaliatory measures. But make no mistake: the ground for populist economics is becoming more fertile by the day.
Some readers may scoff and say the US deserves to suffer; after all, the US made and sold toxic mortgage products all over the world. But the UK has a financial sector even larger relative to GDP than the US, and certainly no better behaved (London, not the US, was the home of the structured investment vehicle business, a an important piece of the mortgage machinery; as we discuss in ECONNED, bonus gaming by Eurobankg exploiting Basel II rules was another key component). Yet UK unemployment has been markedly lower than ours.
Similarly, the reflex of blaming US overconsumption is simplistic and misses how some of our trade partners gamed the international currency system. As Martin Wolf tells us:
First, today’s huge accumulations of foreign currency reserves are not a market phenomenon: they are the product of government decisions (see chart). They could be justified, initially, as a way of creating insurance against shocks. But these reserves have gone well beyond that, as the modest decline during the crisis of $470bn, or 6 per cent of the total, showed. Second, the repeated evidence that the world economy is unable to use large flows of surplus savings in a safe and effective way cannot be ignored. Finally, the world of today has massive excess capacity. That makes adjustment by deficit countries alone hugely undesirable, as Keynes would surely have argued.
Wolf’s third point is critically important. The US has operated as an engine of demand (which was partly fuelled by borrowing) that helped our trade partner keep their factories running and preserve employment. I doubt our failure to act to address this is due to altruistic concerns about raising the standards of living in China and Bangladesh; it no doubt instead is rooted in policies overly friendly to big corporations and financial firms (big banks like big international money flows; they produce a lot of opportunities to nick fees and suggest transactions). But the result was short term beneficial to exporting countries (arguably least so Germany, who has a fair number of high value added exports with no ready substitutes), but it put them in the position of being dependent on US demand.
Some have argued that China has changed from export dependence to investment dependence. But exports still constitute a meaningful proportion of GDP growth, and its investment spending is now less productive that that of the supposedly scelerotic US. So this model is reaching its limits.
Both Rogoff and Wolf contend that the US proposal to cap current account deficits is not a bad one; Wolf spends a fair portion of the piece discussing how the concept might be refined. I think the concept is fatally flawed by being voluntary (look how well the voluntary Kyoto accords have worked). And even though China has voiced general support for the idea of moving in that direction (which almost comes off as an enthusiastic embrace, compared to their usual vitriol), this could just as easily be a cynical maneuver to get the US demand that China let the renmnibi rise off the table. After all, any accord like this would take years to negotiate and still would have few to no teeth, giving China ample time to continue on its current path.
Rogoff did offer some concrete suggestion of measures exporters could take now to reduce trade imbalances with the US; they mainly take the form of ending abuses:
Still, even if other world leaders conclude that they cannot support numerical targets, they must recognize the pain that the US is suffering in the name of free trade. Somehow, they must find ways to help the US expand its exports. Fortunately, emerging markets have a great deal of scope for action.
India, Brazil, and China, for example, continue to exploit World Trade Organization rules that allow long phase-in periods for fully opening up their domestic markets to developed-country imports, even as their own exporters enjoy full access to rich-country markets. Lackluster enforcement of intellectual property rights exacerbates the problem considerably, hampering US exports of software and entertainment.
A determined effort by emerging-market countries that have external surpluses to expand imports from the US (and Europe) would do far more to address the global trade imbalances over the long run than changes to their exchange rates or fiscal policies. Emerging markets have simply become too big and too important to be allowed to play by their own set of trade rules. Their leaders must do more to tackle entrenched domestic interests and encourage foreign competition.
Yves here. The “free trade” mantra is a big part of the problem. As William Greider has pointed out, we do not have a system of free trade, but managed trade. Our counterparts have operated with clear objectives of preserving employment and running trade surpluses, and many have succeeded. If we try to emulate that model, or simply move to a balance, we created disruptive consequences for our trade partners. Some argue that the Fed’s QE2 is designed to tank the dollar and pressure our trade partners. The evidence strongly suggests that the Fed does not give much heed to the trade sector, but it also appears read to let the dollar fall as collateral damage, so the disruption abroad by QE2 is more likely to be seen as an unfortunate side effect than a primary objective.
Rogoff and Wolf both seek to preserve the current order by having the surplus countries exercise more restraint. Wolf sounds an optimistic note:
The role of the G20 is to give cover for the needed discussions between the incumbent and prospective superpowers. If China were to set itself the goal of raising demand and so eliminating its current account surpluses, ideally via higher consumption, the Chinese people would be better off and so would the rest of the world. The US should simultaneously commit itself to long-term fiscal consolidation.
Meanwhile, the role of the other heads of governments of the G20, in Korea next week, is to promote the necessary agreement. If they succeed, they will demonstrate one of the biggest benefits of multilateralism: it is a way to manage conflicts between the greatest powers.
Unfortunately, the lesson of the 1920s and the 1960s is that major incumbents tend to push international monetary arrangements to their breaking point, since domestic imperatives inevitably trump international ones. We can hope for better, but as a betting person, I’d plan for the worst.