Monday, December 08, 2008
But is this true? Or is it a rather perverse distortion of his economic analysis? Consider the following, from Martin Wolf of the Financial Times:
In other words, countries like Germany, Japan and China must lead the way through stimulus, not the US. Admittedly, one can certainly argue that Japan is too constrained by public and private debt, approximately 350% of GDP, to participate, as is Germany because of unfunded future health care and pension obligations. So, that would leave China alone.
As I have pointed out previously, the most interesting feature of the global imbalances has been the corresponding pattern of domestic financial imbalances. The sum of net foreign lending (gross savings, less domestic investment) and the government and private sector financial balances (the latter the sum of corporate and household balances) must be zero. In the case of the US, the counterparts of the net foreign lending this decade were, first, mainly fiscal deficits, then government and household deficits equally and, finally, government deficits, again (see chart). During recessions, the private sector retrenches and the government deficit widens. Similar patterns can be seen in other high-income countries, notably the UK. Housing booms helped make huge household deficits possible in the US, the UK, Spain, Australia and other countries.
So where are we now? With businesses uninterested in spending more on investment than their retained earnings, and households cutting back, despite easy monetary policy, fiscal deficits are exploding. Even so, deficits have not been large enough to sustain growth in line with potential. So deliberate fiscal boosts are also being undertaken: a small one has just been announced in the UK; a huge one is coming from the incoming Obama administration.
This then is the endgame for the global imbalances. On the one hand are the surplus countries. On the other are these huge fiscal deficits. So deficits aimed at sustaining demand will be piled on top of the fiscal costs of rescuing banking systems bankrupted in the rush to finance excess spending by uncreditworthy households via securitised lending against overpriced houses.
This is not a durable solution to the challenge of sustaining global demand. Sooner or later – sooner in the case of the UK, later in the case of the US – willingness to absorb government paper and the liabilities of central banks will reach a limit. At that point crisis will come. To avoid that dire outcome the private sector of these economies must be able and willing to borrow; or the economy must be rebalanced, with stronger external balances as the counterpart of smaller domestic deficits. Given the overhang of private debt, the first outcome looks not so much unlikely as lethal. So it must be the latter.
In normal times, current account surpluses of countries that are either structurally mercantilist – that is, have a chronic excess of output over spending, like Germany and Japan – or follow mercantilist policies – that is, keep exchange rates down through huge foreign currency intervention, like China – are even useful. In a crisis of deficient demand, however, they are dangerously contractionary.
Countries with large external surpluses import demand from the rest of the world. In a deep recession, this is a “beggar-my-neighbour” policy. It makes impossible the necessary combination of global rebalancing with sustained aggregate demand. John Maynard Keynes argued just this when negotiating the post-second world war order.
In short, if the world economy is to get through this crisis in reasonable shape, creditworthy surplus countries must expand domestic demand relative to potential output. How they achieve this outcome is up to them. But only in this way can the deficit countries realistically hope to avoid spending themselves into bankruptcy.
The implications of such a policy are significant, however. As Wolf suggests, there is a fundamental imbalance in the global economy resulting from subsidized export in the US and UK economies. As access to the credit necessary to finance the purchase of these goods has evaporated, along with the credit required to sustain growth in private business activity, there is only one relatively sustainable path forward: a rebalancing of global trade whereby the US and the UK export more and import less, while countries like Japan, Germany and China import more and export less.
Of course, this is not a new perspective. Cassandras have been predicting serious disruptions in the global economy because of these imbalances for decades, all the way back to the Reagan era. But, finally, with the glorious ascendency of neoliberal finance, their predictions have beem confirmed. Indeed, neoliberal finance, and the turbulence associated with it, was the inevitable outgrowth of a trading system whereby countries perpetually exported into the US and amassed imcomprehensible sums of US dollars through current account surpluses, but that is a subject for another day.
Eventually, with the restoration of a reliable network of trade and finance, all economies would grow through increased production and commerce. But there is a major price to be paid by the US and the UK before entering this brave new world. For an indefinite period of time, due to the reduced availability of credit, and the need to save to finance economic development, there is no way to avoid a reduced standard of living, with its attendant insecurities, as I observed in July 2007. Former Federal Reserve Board Chair, and high level Obama economic advisor, Paul Volcker has been hinting at this as well in his recent statements.
But is this politically feasible? The US has been centered around the American Dream wherein each succeeding generation aspires to live better through increased consumption than the ones before them. It is hard to imagine Americans engaging in delayed gratification, as the Germans, Japanese and Koreans did after World War II, to rebuild the economy. If anything, the gradual decline of Argentina througout much of the 20th Century seems more plausible, with the emergence of a domestic form of Peronism to administer the distribution of increasingly scare resources. Obamamania may, in fact, signal the birth of this kind of politics within the US, an entertainment oriented, personality based movement in a landscape of shattered party structures, a landscape where collective action imbued with any ideological overtones is impossible.
And, then, there is the enormous elephant in the room, a US military industrial complex that costs approximately one trillion dollars a year, if not more. Cold War Keynesians will say that such expenditures stabilize the economy and provide technological benefits for domestic industry. Such an invocation of the 1950s and 1960s misses the obvious fact that economic conditions have changed radically since that time, when the US was the dominant economy on earth, not to mention that many believe that massive military spending is partially responsible for our current predicament.
Cold War Keynesianism was sustainable in an era of growth and surplus, but, now, how can the US evolve from running current account deficits to current account surpluses unless funds are redirected from the military to the domestic economy? How can the US avoid a catastrophic collapse in living standards, and the social unrest associated with it, if Americans are going to be required to reduce consumption and save to not only finance economic development, but also preserve the most expensive military organization in world history? Obviously, it can't.