While we have enjoyed a period of relative calm after the 2007-2008 financial crisis, the improvement in economic conditions exists in parallel with growing geopolitical tensions. None of the causes of the crisis have been resolved. We still have global imbalances. We still have powerful, predatory, and unconstrained capital markets players firmly in control of the global debt markets, which are crucial to commerce. We still have the deflationary pressure of a massive increase in labor available to produce goods for advanced economies. And the major device that papered over those issues, the willingness of countries keen to maintain trade surpluses lending to creditor countries to support their consumption, is now under attack. Both borrower and creditors are concerned about debt levels and a new found religion of austerity is on the rise.
A common reaction is to see the savers as virtuous and thrifty and the borrowers as profligate, and to generalize from what happens at the household level, and simply view an heavily indebted economy as profligate. But these stereotypes are misleading. For instance, the EU version of this story is to characterize the Germans as tough frugal competitors and the Club Med countries as now having to pay the bill for living beyond their means. But as Martin Wolf explains, this simplistic picture is misleading:
Mr Wilhelm offers a disturbing paragraph: “The key to correcting imbalances in the eurozone and restoring fiscal stability lies in raising the competitiveness of Europe as a whole. The more countries with current account deficits are able to increase their competitiveness, the easier they will find it to decrease their public and foreign trade deficits. A less stability-oriented policy in Germany would damage the eurozone as a whole.”
I find it impossible to agree. What is fascinating about these remarks is that there is no mention of demand. Mr [Ulrich] Wilhelm is inviting everybody to join a zero-sum world of beggar-my-neighbour policies in which every country tries to grab market share from the rest. At a time of global weakness, this is a self-defeating recommendation for both the eurozone and the world.
More precisely, what Germany wants to see is a sharp cutback in fiscal deficits throughout the eurozone. With the fiscal deficit contracting and output weakening, the way out for each country would be via falling relative unit labour costs and higher net exports. If successful, this would shift each country’s economic weakness to other eurozone countries or, more likely, to the world, via a bigger eurozone net export surplus…..
I am saying Germany’s surpluses were made possible by other countries’ deficits, and so German stability by other countries’ instability. I am saying that part of Germany’s net exports were illusory, paid for by excessive borrowing, often financed by Germans. I am saying that if peripheral Europe is to improve its external accounts, either Germany must offset some part of this, or the current account of the eurozone itself must shift towards surplus, with adverse impacts on the fragile world economy.
In short, economic policy is about more than competitiveness. When the world is trying to struggle out of a deep recession, demand matters, too. As the world’s fourth-largest economy and the core of the eurozone, Germany has a role to play in rebalancing global demand. I appreciate that this is a difficult challenge. It must be met, all the same.
…there are a whole range of possible combinations of current account and domestic private sector financial balances which could be consistent with the 7% of GDP reduction in Spain’s fiscal deficit. But the simple yet still widely unrecognized reality is as follows: both the public sector and the domestic private sector cannot deleverage at the same time unless Spain produces a nearly unimaginable trade surplus – unimaginable especially since Spain will not be the only country in Europe trying to pull this transition off….
As it turns out, pursuing fiscal sustainability as it is currently defined will in all likelihood just lead many nations to further private sector debt destabilization. European economic growth will prove extremely difficult to achieve if the current fiscal “sustainability” plans are carried out. Realistically, policy makers are courting a situation in the region that will beget higher private debt defaults in the quest to reduce the risk of public debt defaults through fiscal retrenchment. European banks, which remain some of the most leveraged banks, will experience higher loan losses, and rating downgrades for banks will substitute for (or more likely accompany) rating downgrades for government debt. A fairly myopic version of fiscal sustainability will be bought at the price of a larger financial instability…
It is not out of the question that fiscal rectitude at this juncture could place the private sectors of a number of nations on a debt deflation path – the very outcome policy makers were frantically attempting to prevent but a year ago.
Yves here. The end game of lending too much money is creditor losses. The better path is to accept writedowns and restructurings, for the lenders to take their lumps. The record of past financial crises is clear on this matter. Even though it leads a larger initial economic downturn, its duration is comparatively short. Even though US policymakers refuse to listen, the Japanese are strongly of the view that their prolonged slump is mainly the result of the failure to write down bad loans and recapitalize its banks, rather than insufficient fiscal and monetary stimulus. And a deflationary spiral produces the same result, creditor losses, in this case via default, with more damage to the economy and higher costs of repairing the financial system.
But the fissure points are ultimately even greater than this gloomy account suggests. Ultimately, as Wolf points out, the Germans are demanding that the rest of the EU become more German, a lean, mean export machine. But all the big exporting contries want to hang onto their markets, while at the same time wanting their
export surpluses loans repaid. As Parenteau pointed out, the only way for that to work is for the current borrowers/importers to all become exporters. But it is collectively impossible for every nation to run a trade surplus. Stratfor describes the implications in an article “Obama’s Export Strategy” (no online version):
One of the leading reasons the world has been so stable is because the traditional merchant powers have had a deep market to sell into: the United States. Part of the peace accords and reconstruction of Japan included granting it full access to the U.S. market as well as full American protection of Japanese trade lines. Part of the peace accords and reconstruction of Germany included a similar arrangement. These arrangements proved so successful in containing Japanese and German imperial ambitions, revitalizing and enriching their economies, and giving them a powerful incentive to be part of the U.S. alliance structure that the pattern was repeated throughout Western Europe, in Taiwan and Korea, and to a lesser degree in Indonesia and elsewhere.
By granting these states privileged access to the American market — and not necessarily demanding American access to their markets in return — the United States created conditions extremely favorable for its allies’ economic development and prosperity. “All” it asked for in return was the right to determine military strategy, ultimately creating a global alliance network that served American interests. The United States traded some market share to turn adversaries into allies, both reducing the number of foes and intimidating the remainder by the sheer size of the U.S. alliance structure. As a result, some of the world’s most aggressive mercantile powers became placid. They no longer had to go to war for access to resources or markets.
This entire arrangement, however, rested on the basis that the United States generally did not use the full force of its state power in pursuit of its singular economic ends. The United States was content to buy others’ goods and run trade deficits to command the loyalty of its allies in security matters. The question with the Obama administration’s export strategy is whether it marks a change from this mode. To increase exports, one has to increase penetration into foreign economies, and a number of countries’ economies and social systems only work the way they do because they have taken shape with minimal outside pressure — i.e., minimal competition from the United States. This is not to say that many countries do not already perceive the U.S. presence as overbearing, but rather that the United States simply has not spent much energy in competing for foreign market share over the past half century. If it suddenly exerts itself in opening up the doors of trade around the world — and doubling U.S. exports would mean finding buyers for an additional $1.5 trillion dollars worth of goods — it will disrupt a lot of places.
We are not saying that the Obama administration’s export strategy is good, bad, wise, unwise, feasible, unfeasible or anything else. It simply raises the question of whether it is a coincidence that when the dominant global power did not use state power to seek foreign markets, the degree of competition and ultimately violence among players on the international stage was markedly lower than in previous periods. If not a coincidence, then the full weight of the American nation behind a strategy of maximizing exports could have massive unintended consequences.
Yves here. And just as with Spain, if US is to reduce private sector and government borrowing at the same time, other than via selective private sector/public sector defaults, we too would have to run serious trade surpluses.
Be careful what you wish for.