Martin Wolf’s “The old global economic order is dead”

Posted on by

It’s become common to rubbish Serious Economists, and given their track record, it’s not hard to see why. Among other reasons, the ones that have a better grasp on how the provisioning of society actually works are usually relegated to the heterodox wilderness. That is because they lost the plot. The purpose of mainstream economics is to defend the proposition that “free enterprise” systems will (or can be organized to, with the help of said right-thinking economists) to beat command and control systems, as in evil Commies. This was a legitimate concern since both Russia and China industrialized in a generation, accomplishments that gave capitalists pause.

The top editors at the Financial Times, such as Gillian Tett and its chief economics editor, Martin Wolf, are particularly subject to orthodoxy pressures despite having exhibited some independence of mind in the past. Wolf’s latest piece, The old global economic order is dead, makes two important observations despite getting wrapped around the axel in some other ways.1 I’ll simply focus on the good bits after an intro of the constraints under which someone like Wolf operates.

I have some sympathy for Wolf because in the runup to the crisis, he (based on the work of then capital markets editor Gillian Tett and the readings of John Authers) was early to be worried about the direction of travel and the lack of good information. After the crisis, Wolf was also pumping for serious reforms, promoting the campaign by Mervyn King, Paul Tucker, and Andrew Haldane at the Bank of England. One of their big agenda items amounted to a modern version of Glass Steagall, of separating capital markets trading from traditional banking. They lost after a hard fight to Treasury, which ‘natch was all in for the banksters.

However, Wolf is also hostage to his status at the pink paper’s de facto ambassador to the Serious Economist community. He always goes to Jackson Hole. He regularly moderates Big Deal economics panels or has one on one discussions. So he winds up not arguing with Ben Bernake’s ridiculous and self-serving savings glut thesis because he needs to get on with Bernanke. I’ve also seen Wolf interview Larry Summers at a conference (although “interview” does not give quite the right image of the dynamic. Before Summers I never saw someone fill a very large room with his ego). So some cognitive capture is inevitable.

Now to the two tidbits from Wolf’s latest. The first is on sectoral balances, something we discussed extensively here back in the day. From a 2010 post, fittingly with Martin Wolf’s name in the headline:

Martin Wolf, in today’s Financial Times, uses modern monetary theory (!), also known as the fiscal balances approach, to explain why calls for fiscal belt tightening are premature.

Let’s provide a little background, courtesy Rob Parenteau of the Levy Institute:

…if we divide the economy into three sectors – the domestic private (households and firms), government, and foreign sectors, the following identity must hold true:

Domestic Private Sector Financial Balance + Fiscal Balance + Foreign Financial Balance = 0

Note that it is impossible for all three sectors to net save – that is, to run a financial surplus – at the same time. All three sectors could run a financial balance, but they cannot all accomplish a financial surplus and accumulate financial assets at the same time – some sector has to be issuing liabilities [borrowing].

Since foreigners earn a surplus by selling more exports to their trading partners than they buy in imports, the last term can be replaced by the inverse of the trade or current account balance. This reveals the cunning core of the Asian neo-mercantilist strategy. If a current account surplus can be sustained, then both the private sector and the government can maintain a financial surplus as well. Domestic debt burdens, be they public or private, need not build up over time on household, business, or government balance sheets.

Domestic Private Sector Financial Balance + Fiscal Balance – Current Account Balance = 0

Again, keep in mind this is an accounting identity, not a theory. If it is wrong, then five centuries of double entry book keeping must also be wrong.

Yves here. Many readers reject the message here instinctively. You cannot have the private sector save in aggregate AND have government run a surplus UNLESS you run a trade surplus. And the problem we have is:

1. The private sector in pretty much every advanced economy is deleveraging, as in saving. Most people, yours truly included, think that’s a good idea.

2. If those economies want to run government surpluses too, then they need to run pretty big trade surpluses

3. It is impossible for all countries to run trade surpluses at the same time.

4. Moreover, some countries that have been running large trade surpluses for quite a while (in particular China and Germany) are not willing to change course, at least not in the near future.

5. So if all these new hairshirt-wearers want to shirk public and private debt at the same time, some countries will need to run correspondingly large trade deficits (which also means they will experience rising private or public sector debt levels). There appears to be a dearth of candidates for this role.

Wolf in his current post has a wee chart which shows (although Wolf does not call this point out) how the US managed to make this conundrum worse.

The understanding many have of the economy (based on the incorrect premise that investment comes out of pre-existing savings, as opposed to loan proceeds that banks can create from thin air) is that household savings fund business investment. That’s a big reason for the disquiet over government deficits…aren’t they crowding out business? No, because first, businesses set their return targets too high, so they will just about never invest enough to generate full employment. In fact, they WANT unemployment so as to keep wages down and be able to discipline labor. Second, our terrible government accounting system feeds the prejudice against government spending, since it does not create an income statement and balance sheet, which would differentiate spending from government investment.

But third, as we pointed out in a Conference Board Review article in 2005, The Incredible Shrinking Corporation, US companies in aggregate were not just under-investing but net saving, as in slowly liquidating. This tendency has gotten even worse via stock buybacks.

Wolf, having (per our 2010 post) having once-upon-a-time tried to argue against austerity, skips over the key issue:

Sectoral savings and investment balances are revealing indicators of this last challenge. Foreigners have been running a substantial savings surplus with the US for decades. US businesses have also been in balance or surplus since the early 2000s, while US households have been in surplus since 2008. Since these sectoral balances have to add to zero, the domestic counterpart of US current account deficits has been chronic fiscal deficits.

What you see, if you squint a bit, is consistent with the “Shrinking Corporation” article: companies had been borrowing to invest in growth. In aggregate, around 2003, they started engaging in the highly unnatural and ultimately destructive behavior of giving up on capitalists by investing in their companies and instead, for the most part, became obsessed with cost-cutting. You see government borrowing picking up the slack.

The related point, again not often enough made, is what “investments” are made matters. Household borrowing has been found to be economically unproductive. For governments, it matters over time whether investments are productive (clean water, good roads and bridges, cheap broadband, for starters) or are exercises in big-ticket pork, like our military.

The second useful point Wolf makes is on China’s unbalanced economy. The Manichean thinking cognitive bias among many readers is staggering. Just because the US has made a complete mess of its once-formidable advantages does not mean that China isn’t a source of instability too. From Wolf:

Michael Pettis is, in my view, correct that the world economy cannot easily accommodate a huge economy in which household consumption is 39 per cent of GDP and savings (and so investment) correspondingly huge. What is also clear is that the latter has also helped drive what the Rhodium Group judges a successful Made in China 2025 policy.

Many explicitly reject the idea that there is such a thing as overinvestment. Huh? Are you old enough to remember the dot-com era? The US produced a shit-ton of Internet businesses, as in way way more than the market would support, so most died. The US had another overproduction crisis in the railroad boom of the later 1800s, when promoters were able to launch rail lines, irrespective of the actual commercial potential, because they could make a killing on the stock trading. Some were even built duplicating barely successful or money-losing lines between the same city pairs.

Wolf points out that China has a large enough potential internal market to solve this problem. But the Chinese continue to save at very high rates. He notes:

China has the option of expanding domestic demand and so offsetting lost US demand. Matthew Klein responds, in his excellent Substack The Overshoot, that China has long had this option but has failed to use it. My answer is that China must now do so and thus will indeed choose to expand demand rather than accept a huge domestic slump. We shall see.

The reason Chinese save so much is the lack of social safety nets and worker protections, such as a minimum wage. And yes, China could readily solve this problem but Xi is hostile to it. As we wrote in 2023, incorporating a comment by PlutoniumKun (who follows the Chinese press as well as development literature):

China seems not just to be having what would be expected difficulty in changing from an investment/export led growth model to one with domestic consumption being far more important. China also appears to have an ideological, or one might say political problem in making this shift. Higher consumption would require lower savings rates. Not only do Chinese consumers not feel secure enough to do that (too much history of crises in China and its neighbors) but China under Xi is unwilling to implement the social safety nets that would encourage more spending.

I don’t want to take up too much time with this intro, but some relevant recent sightings. Note that Setser among other things is the man on dollar holdings and flows outside the US:

And now extracts from the points made by PlutoniumKun

But the reality is that a crisis is inevitable for any country pursuing an unbalanced growth model – i.e. by focusing on investment and exports over domestic/consumer led growth. This is baked into the standard model – and the Chinese are fully aware of this, and have been since at least the 1980’s and 1990’s when I started following (from afar) the Chinese economy from a development economics perspective. Back in the 1990’s the Chinese devoted very significant resources to studying the Japanese late 80s collapse, later the 1990s Asian crisis, and the multiple crashes which foiled numerous countries over the past century or more from crossing the threshold from upper-developing to developed country status. There is a line of thought among some China analysts that Xi was selected and given extraordinary powers specifically to deal with what was foreseen to be a very difficult transition from a the current development model to ‘developed’ status, which has always overtly been the holy grail for the CCP.

I don’t think there is much doubt that the current situation in China is very serious. In my opinion, the housing crisis is a symptom, not the cause of the current problems (in reality, the Chinese economy started showing signs of strain even before Covid). The core problem being several decades of internal debt build up and chronic mal-investment along with an overdependence on rising property values to underpin spending at a local level. But the housing issue alone is gigantic – by any objective measurement it is vastly greater as a proportion of the economy’s size than the Irish and Spanish crashes of 2007-9. When you add in demographic issues and climate induced strains, this is potentially much more than just a cyclical downturn.

It is highly unlikely for there to be a financial crash as the Chinese banking and finance model is very different from in the west…But it is increasingly recognized within China (this is very obvious reading between the lines in various statements from Beijing) that the current model has finally run out of steam and needs fundamental overhauling.

The problem is that this has been pretty obvious for some time, but despite numerous policy statements going back at least 2 decades (the big ‘change’ was supposed to happen after the 2008 Olympics), very little has been done…There has to be a very significant transfer of wealth to ordinary citizens through higher wages and better social welfare provision in order to boost consumer spending (one of the few things orthodox and heterodox economists agree on when looking at China). And as for debt – in theory, this is a simple problem to address (i.e. monetize/forgive it in one form or another), but there appears to be an unwillingness to even discuss this option within high level circles in China.

The irony to me is that having studied the Japanese crash intensively, the Chinese may somehow manage to replicate exactly the mistakes the Japanese made….

While it can be argued that the current property/investment boom is not as bad in China as it was in Japan, in other respects the Chinese economy may be a lot weaker than Japan was at the time – for all its modernity, China is still essentially a poor country – significantly poorer than, for example, Russia or Turkey, and probably not even matching Mexico. What is unique about China is its enormous size, which allows it to mobilize resources and dominate economic sectors in a way small developing countries can’t. But then again, this has never helped India, which also has some very advanced technological sectors.

The other huge problem – ironic given demographic problems – is youth unemployment. This seems to be a characteristic of fast growing export-led economies once they rise above the sweatshop levels of development – both Japan and South Korea have had huge problems in keeping up employment levels even at times when their economies have been seen to be healthy when measured in GNP. In simple terms, I don’t think you can keep up a high level of employment if you insist on suppressing wages and consumer demand. But this is integral to an export/investment model of development…

A few years ago, I would have been fairly confident that the CCP could pull it off, especially with someone as impressive as Xi at the helm. But more recently there are increasing signs of inept leadership, groupthink and poor decision making at higher levels of government in Beijing, going right to the top. There is a lot of rot among our leadership classes everywhere, not just in the west.

So again, a warning against black and white thinking. Just because the US is now terribly led and China has much more competent people in charge, as well as many technological advances of which it can be very proud, does not mean it cannot also be hostage to economic idea and/or social values that are keeping it from executing seemingly obvious solutions to its economic pressures.

____

.sup>1 There is a BIG complicating factor with respect to the data Wolf relied on at the top of his piece, which is also the foundation of the US tariffs policy. Mind you, I am not suggesting with the information below that the US does not have a big balance capital account surplus, but that reliance on multinational accounting data that shifts revenue to tax havens like Ireland overstates it. This is the 50,000 foot version of the argument from hidden wealth/tax evasion maven Gabriel Zucman; he has some more recent papers I need to mine to properly present his findings. The author who made this summary argues Zucman *must* be wrong, hence the need to look at later work (this sort of thing reminds me of other *musts* like US housing prices could never decline on a nation-wide basis). So:

Economist Gabriel Zucman’s paper “The Missing Wealth of Nations” proposes that a substantial part of the large U.S. net debt of the last 15 years is actually accounted for by U.S. tax evaders who have opened accounts in foreign tax havens, and then have reinvested their money in the United States. Such investments would look like foreign investments in the United States, but would actually be U.S. domestic investments. Zucman concludes that as a result, the U.S. capital account surplus must be lower than reported.

Print Friendly, PDF & Email

16 comments

  1. Froghole

    Thank you very much for all of this, and specifically for outlining the constraints under which many op-ed columnists function. I was actually quite surprised to read much of this, because Wolf never really struck me as being someone who needed to operate under any constraints. He seemed to exude considerable self-confidence, and have periodically seen him almost enthroned in some of the best seats (stalls circle) in the Royal Opera House. He has been at, or near, the top of the tree at the FT for almost 40 years. What he does seem good at is surfing the successive waves of bien-pensant economic and political fashion, almost to the point of caricature. Perhaps an heir to Paul Einzig or Harold Wincott (though was he in their class?), and comparable in many ways to the younger Walter Lippmann. I have become ever less of a fan, and have gradually shifted from being an ardent disciple (>20 years’ ago) to becoming circumspect and then, over the last decade and a half, frequently relying on him to guide me into believing the precise opposite of whichever idea he has been promoting. My disaffection with him has more or less mapped my disenchantment with The Economist.

    Perhaps the millstone of housing debt which weighs upon the political economy of China is preventing it from leading World financial policy. Maybe we’re in the early ‘thirties all over again: of the UK being too weak to exercise effective international leadership, and the US not being strong enough (or, rather, perceiving itself not to be so), with the whole system slipping into the ensuing void, per Kindleberger.

    Reply
    1. Colonel Smithers

      Thank you.

      I don’t disagree.

      Wolf is a regular on CNN’s Global Public Square (Fareed Zakaria). He has other outlets, so could talk out of turn.

      It will be interesting to hear / read what Wolf makes of ring fencing being watered down.

      It would be interesting to hear what you think of the roll back of the post-2008 reforms, the feeling in Whitehall that this government, not a year old, feels like the last year of the Brown government and suggestions from some restive Labour MPs that the Treasury be split into two or even three departments.

      Reply
      1. Terry Flynn

        I’ve just had a comment OKed about the need for a new left wing party one to counter Reform.

        I’m maybe gonna be too ill to do much but I’m in contact with the Electoral Commission about setting up such a party.

        Watch this space if you’re UK.

        Reply
        1. Henry Moon Pie

          I think your timing is excellent, Terry. Assuming Reform takes over at the national level in a few years, your Left (Populist?) party has some time to get organized so that it’s ready to go when people get sick of Reform–and they will.

          And I hope your health lets you play the role you’d like with this effort.

          Reply
          1. Terry Flynn

            I had telephone conversation with London civil servant involved with elections. Being a civil servant he had to be non-partisan. But I’m good at reading between the lines…… everything he said screamed “if your health holds out PLEASE do it”.

            They know already that in 2027 in the city elections Reform will cull Labour. Massively.

            We desperately need a progressive alternative. The London guy couldn’t say this but I knew he wanted to.

            Trouble is though I’d relish the fight, I have dodgy heart.

            Reply
      2. Froghole

        Many thanks, Colonel!

        With respect to the roll-back, the whole point of the Cobbold/Bolton cultivation of the eurocurrency markets, which revived the City after 1955/57 was that it would undercut Glass-Steagall (especially Regulation Q). As such, the ‘success’ of the City (though not of Britain) was founded upon regulatory arbitrage. It should therefore be no surprise that, after a period of mimicking Frank/Dodd (presumably to propitiate regulatory departments within US HQs) the British authorities should have quietly relaxed their approach to regulation, and that worries about the diminution of the City should have accelerated that. In other words, undercutting the US is that whole basis of the City.

        Splitting the Treasury is an old song. Of course, and as you will recall, there was the conspicuously unsuccessful DEA experiment of 1964-69, which the Treasury went out of its way to sabotage. It did not help its cause that Brown was a sot – useless and sometimes violent after lunch – and Shore was perceived as being Wilson’s golden boy or ‘lapdog’ (though the latter’s sheen was soon tarnished). Naturally, the Treasury went out of its way to subvert the DEA, and Eric Roll had to send officials down the corridors of Great George Street in order to appropriate (i.e., steal) typewriters from the Treasury. IIRC the early work of another FT journalist, Sam Brittan (‘The Treasury Under the Tories’ (published early in 1964) played a not inconsiderable role in Wilson’s determination to cut the Treasury down to size. Although Wilson was much enamoured of French-style indicative planning (viz. Brown’s abortive national plan) he ought to have recalled France’s unhappy experiment will dividing the finance ministry in the Louvre during the provisional government in 1944-45: Mendes France became minister of national economy, and Pleven became minister of finance: the Radical Mendes France wanted a prices and incomes policy in order to suppress the prevailing inflation, whilst the technocrat Pleven wanted to let the market control prices. De Gaulle, anxious about a dirigiste policy (and about giving the PCF, then in office, further suasion over the economy) backed Pleven, leading to Mendes France’s resignation and the merger of his ministry back into the finance ministry. Thus, the laissez-faire interest which dominated the finance ministry trumped state control. Much the same happened in 1966, when Brown’s national plan was effectively crushed by Callaghan’s July Measures. In other words, the management of the exchange rate by the Treasury easily trumped the development of a coherent plan. I suspect that any revolt against Reeves would have a similar result, and it is noteworthy that the section on industrial policy was much the feeblest part of the 2024 manifesto – drafted under the supervision of Ravinder Athwal… erstwhile head of the Treasury’s planning unit.

        Reply
  2. Colonel Smithers

    Thank you, Yves.

    With regard to Wolf, he sat on the Vickers committee that recommended the “ring fencing” of retail banking from trading, what the quartet felt they could get away with. Three candidates to succeed King, Tucker, Haldane and regulator Adair Turner, wrecked their chances of doing so, by pushing for a modern Glass-Steagall, and paved the way for Carney (who had met Cameron and Osborne at the Oxfordshire estate, Cornbury, owned by the brother in law of Carney’s wife, Lord Rotherwick, where and when the idea was conceived). Ring fencing is likely to be watered down, if not repealed, as Reeves seeks to reboot the British economy.

    It’s interesting that you conclude with Zucman. As the Eurozone crisis* erupted, I recall meetings with King, Tucker, Turner and Haldane. The Bank of England trio talked about Greek tax evasion and how much of that was reinvested, via the UK and its dependencies and Cyprus, in Greece. We understood that it was the same here.

    *The Bank of England trio were clear that Sterling’s value should not be allowed to rise as investors sought a safe haven from the Eurozone turmoil. Capital controls were under consideration.

    Reply
    1. Yves Smith Post author

      Oh, I missed or forgot Wolf was actually ON the Vickers Committee. I also neglected to mention Turner as one of the good guys. Thanks for including that.

      Reply
  3. Mikel

    “A few years ago, I would have been fairly confident that the CCP could pull it off…”
    I had to start changing my tune as well.

    Reply
  4. PlutoniumKun

    I’ve usually thought of Wolf in the same way as I see Dani Rodrik, Brad Setser or Adam Tooze – economists smart enough to know the orthodoxy is mostly wrong about most of the big questions, but who chose to work within the Overton Window to keep their position at the table. Its a tricky balancing act, and you often have to read between the lines to see what they really think (or possibly I’m being too generous to them).

    Many thanks Yves for pointing out that economic recklessness is not solely the preserve of the US and the west in general. Pettis has been pointing out for many years that by definition, massive trade surpluses cannot go on forever, and are likely to become politically unsustainable before they become economically unsustainable. This is exactly what we are seeing now. Trumps attempt to reorder things may be reckless and incompetent (assuming this isn’t just a huge grift opportunity), but its also clear that the surplus countries, namely Germany, China, Taiwan, Japan and ROK, are in a bind and are potentially making huge errors in their response. It needs to be repeated over and over again, that running a manufacturing trade surplus in the long run is not a sign of economic virtue, its an indicator that the industrial sector of a country is stealing money from its workers/consumers. Just as the US economy was hijacked by Wall Street and the UK’s was stolen by the City, those ‘surplus’ countries economies were hijacked by their industrial capitalists and rentiers.

    Reply
    1. Ignacio

      It is indeed troublesome to see the Chinese stubbornly stick to a model which no longer fits the international economic situation as Setser points out.

      Reply
  5. lyman alpha blob

    30 years ago as the US offshored its manufacturing, I predicted (not tooting my own horn here – this was fairly easy to see coming) that China would benefit, develop its own economy and create a burgeoning middle class, and at some point it would begin selling the goods it produced to its own massive domestic market. So this –

    “Wolf points out that China has a large enough potential internal market to solve this problem. But the Chinese continue to save at very high rates.

    ~snip~

    The reason Chinese save so much is the lack of social safety nets and worker protections, such as a minimum wage. And yes, China could readily solve this problem but Xi is hostile to it.”

    -explains a lot. Does he feel China is just not ready yet? Setting a minimum wage would surely make exports less competitive. But wouldn’t it also increase the purchasing power of its own citizenry? And if Xi’s opposition is truly ideological, which I can understand – the rampant consumerism by the USian population which is literally trashing the world isn’t something to emulate – can’t something be done to steer the population toward spending on less or non-destructive items? Surely the Chinese could make products built to last instead of the current model which demands that we all repurchase cheap junk once it inevitably breaks. Not all commodities are created equal after all.

    Reply
  6. Adam1

    WOW! Extremely eye opening article.

    I’d suggest Kalecki be awarded a Nobel prize because it seems the elite everywhere can’t fathom the idea that ordinary people deserve more of the pie and are willing to drive their home countries over the cliff to prevent any meaningful increases in sharing – they just don’t deserve it! or so they think of all the peons.

    Reply

Leave a Reply

Your email address will not be published. Required fields are marked *