By Richard Alford, a former economist at the New York Fed. Since them, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.
The need to address and prevent future large global economic and financial imbalances is back on center stage, but it seems as if policymakers are unwilling to formulate a plan, let alone take action to prevent the imbalances from returning. This was made clear at the recent G20 meeting in Pittsburgh and a in a subsequent Bernanke speech.
The G20 Addresses Economic Rebalancing
What was achieved at the G20 meeting in Pittsburgh to help restore global economic balance? The short answer: nothing of any substance as reflected in the conspicuous absent of any mention of two subjects, i.e. currency adjustments and protectionism.
The US imbalances addressed in the statement include a savings shortfall and an excess of imports relative to exports. The stated objective was correcting these imbalances while achieving three goals: full employment, low inflation and a stable currency.
The expressed G20 vision is that policy-induced growth of demand abroad will allow the US to achieve both full employment and external balance. The vision represents a significant change in the publicly stated causes of the US trade imbalance. Until recently, the US had argued that the trade imbalance was the result of the unwillingness of China and others to let their currencies appreciate, as well as excess savings abroad. On the other hand, much of the rest of the world argued that the trade imbalance was the result of insufficient savings in the US and not the exchange rate. Now all agree that if demand is stimulated everywhere, including the US, imbalances will disappear without changes in exchange rates. However, given the trade rows in the past one cannot help but wonder if the continuing desire to promote domestic employment will stand in the way of rebalancing, even with increased global demand. Witness the ongoing US-China trade friction and the Opel kerfuffle.
The absence of any call for currency adjustments or condemnation of protectionist tendencies suggests that the leaders at the G 20 meeting were unable to agree on how to address the imbalances and decided instead to pat themselves on the back for the jury-rigged efforts to support financial institutions and fiscal stimulus measures that had already been adopted.
Bernanke Addresses the Global Imbalances
In a recent speech Bernanke said:
To achieve more balanced and durable economic growth and to reduce the risks of financial instability, we must avoid ever-increasing and unsustainable imbalances in trade and capital flows. External imbalances have already narrowed substantially as a consequence of the crisis, as reduced income and wealth and tighter credit have led households in the United States and other advanced industrial countries to save more and spend less, including on imported goods. Together with lower oil prices and reduced business investment, these changes in behavior have lowered the U.S. current account deficit from about 5 percent of GDP in 2008 to less than 3 percent in the second quarter of this year.
…As the global economy recovers and trade volumes rebound, however, global imbalances may reassert themselves. As national leaders have emphasized in recent meetings of the G-20, policymakers around the world must guard against such an outcome. We understand, at least in principle, how to do this. The United States must increase its national saving rate. Although we should deploy, as best we can, tools to increase private saving, the most effective way to accomplish this goal is by establishing a sustainable fiscal trajectory, anchored by a clear commitment to substantially reduce federal deficits over time. For their part, to achieve balanced and sustainable growth, the authorities in surplus countries, including most Asian economies, must act to narrow the gap between saving and investment and to raise domestic demand. In large part, such actions should focus on boosting consumption.
Bernanke makes no mention of exchange rate adjustment, but there is an acknowledgement of the need to increase the US savings rate or the imbalances will grow again. What does this recent talk suggest for the US contribution to global rebalancing and the rebalancing itself?
One, currency adjustments appear to have been ruled out. The G20 didn’t mention them. Bernanke didn’t mention them. The Administration “policy” seems to a mix of the “strong Dollar is in the US interest” mantra and a wink-wink-nudge-nudge policy of benign neglect. Between the perceived need to regain some international competitiveness on the one hand, and the fear that a Dollar depreciation would to weakened demand for Treasuries and higher interest rates on the other, US Dollar policy seems destined to remain non-existent. Internationally, Trichet is already complaining about the strong Euro and other countries appear willing to take steps to prevent any further appreciation of their currencies.
While currency adjustments were never sufficient by themselves to end global balance, it is difficult to see a successful rebalancing without some currency adjustment. The absence of any agreement to promote currency realignments does not bode well for global rebalancing.
Two, given that currency-driven adjustments have been ruled out. There is no operational plan to prevent the US external imbalances from growing again as soon as US growth resumes. While Bernanke acknowledges the need to raise the US savings rate, he again asserts that monetary policy should not have any role in promoting an increase in the saving rate. Bernanke believes that given it is better to have fiscal policy promote public savings rather than have the Fed or the fiscal authorities take steps to increase private savings.
However, does anyone believe that the President and Congress or any future President and Congress will permit external imbalances to drive tax or spending policies? Looking at the forecasted US fiscal deficits, does the word ‘austerity’ spring to mind? This is not the first time Bernanke presented an argument predicated on a very questionable assumption. In November of 2002, he gave a speech which included the following:
A particularly important protective factor in the current environment is the strength of our financial system: Despite the adverse shocks of the past year, our banking system remains healthy and well-regulated, and firm and household balance sheets are for the most part in good shape.
In light of recent history, the reference to a “well-regulated” banking system is telling. He was surprised in 2007. Had he verify the state of regulation in 2002? Did he re-verified in the midst of all the talk of financial bubbles? Will the Fed now set policy based on the premise that the President and Congress are about to embark on a campaign of fiscal austerity? Will he be willing to adjust monetary policy if large US external imbalances return and fiscal policy does not promote an increase in the savings rate? Bernanke continues to say no, although the Fed was quite happy to promote consumption/discourage savings post 2001.
Both the G20 version of rebalancing and the Bernanke version of rebalancing are decidedly deficient. There is nothing in the current or promised policy mix which suggests anything other than a return to unsustainable global imbalances that are incompatible with stable, crisis-free growth. Do US policymakers truly believe that they fulfill their obligation to the American people by assuming that policymakers in other counties will pursue policies so that the US can avoid the costs of adjustment?