In late 2007 the global economy began to stumble, slipping into the abyss of a deep recession and financial panic. We are only now recovering from this stumble, in large part due to an unprecedented level of fiscal and monetary stimulus. Yet, no sooner is daylight within reach, we start attacking each other, tearing each other down.
The two starkest battle lines being drawn are between the Greeks and the Germans and the Chinese and the Americans.
Last month, there was enough clear headedness that I could post a parody of the madness that has overtaken Europe in Video: The Germans take on the Greeks. But, no more. It is clear, the political nerves are frayed. You’ve got ‘Italy’s worse, and the Germans stole our gold’ and German Leader Says Euro Zone Should Consider Expelling Countries That Threaten Regional Stability. That pretty much sums the battle lines up.
On the Chinese – US front, I have been warning for some time that protectionist rhetoric has a slippery way of turning into trade war reality. Some people seem to think the U.S. isn’t risking a trade war, and that ‘the Chinese started this anyway’ or something to that effect. In any event, the feeling is the Chinese will take it on the chin while the US will get off relatively unscathed – if it actually does come to a tit-for-tat trade war. But is that really true? A trade war transfers wealth from domestic consumers to the protected producers and decreases consumption demand. Lest we forget, the US banking system is hiding hundreds of billions in toxic assets in loan-to-maturity, level three and off balance sheet asset pools. The US is hardly a bastion of economic strength.
Ryan Avent has it right when he says:
I agree with Paul Krugman and Mr Wolf that actions taken by both Germany and China have been unfortunate. The world would be better off if Germany went ahead and committed to a deal on Greece and if China resumed its RMB appreciation. But I also understand the domestic political constraints those actors face—constraints which suggest that other powers are unlikely to be able to force action. And I believe that both Germany and China recognise what they must eventually do and are prepared to do it.
And I think that the extremely narrow focus on these particular issues, and the increasing willingness to draw a line in the sand over them, is misguided and troubling. Is the RMB peg really the biggest impediment to global recovery? What about economic policy in Japan? What about the conservatism of the ECB? What about the dysfunctional political system in America, where deficit politics is the order of the day while unemployment is near 10%?
There’s nothing wrong with pointing out how Germany and China can do better. But urging leaders to pick a fight over the issue of trade surpluses is not going to be helpful.
There is more than just a whiff of economic nationalism in the air. Is this not exactly the same spectacle we witnessed in the 1930s?
I see all of this as an inevitable consequence of the first truly synchronized global recession since the 1930s. After two plus years of economic stagnation, we’ve reached a point – everywhere it seems – where policy making is increasingly dominated by domestic political concerns. People are fed up with the status quo. They want no more economic pain. And they’re willing to throw the bums out unless this ends.
Politicians respond to this sort of thing. And it’s my feeling that this has led people to crawl back into their ideological positions and hold firm. This is what I see happening in Europe. This is what I see happening in the healthcare debate, on stimulus and on deficits in the U.S. and it is what I see happening in the U.S. – China debate as well.
Ultimately, from a US perspective, this leads us back to the stimulus package and bailouts and their importance. You only get one crack. This is what I said in early 2009. It was what Paul Krugman was saying. And he was right. Obama wasted a golden opportunity; he should have applied a LOT more stimulus, nationalized and liquidated bankrupt financial institutions, and hit the reset button. The Chinese, at least, understood the stimulus part and should be credited with saving the global economy. Now, we are still in an economic malaise and the political battle lines are hardened.
Since some have commented that I am offering criticisms without solutions, below is what I recommend:
1. China – U.S.
I made my case for what the Chinese could do in the last post This is the problem with China’s currency peg. Most of this has to do with spurring domestic demand, something the Chinese are already doing. As Stephen Roach has been saying, adding a lot more oomph to the Chinese social safety net will provide a further boost.
As for the US, an overt act of protectionism is not going to get the job done. On the other hand, coordinating opinion with Europe, India other Asian exporters and multilateral organizations on side behind the scenes is the right approach. The weak renminbi is not just America’s problem. The US or the EU could go to the Chinese and say, ‘look, its in your best interest to revalue. It increases your citizens standard of living, it decreases the value of commodities upon which you’re dependent and it increases your purchasing power of other hard assets. How much are you willing to move your peg per annum? We want 9%.’ I believe this is a reasonable negotiating stance that could work. It also has the hidden threat of retaliation which is credible given the support of multilaterals and the EU.
It is not a softly-softly approach, but rather a speak softly, big stick approach. To me, this is a much more well-thought out approach than simply ‘bleeding China.’
2. EU- Germany – Greece
As I have been saying all along, the resistance to a Greek bailout in Germany is fierce. Everyone claims the Greeks haven’t even asked for one – and I imagine this is technically true. Nevertheless, there is a clear funding problem in the medium term that must be met.
So, I suggest a two-stage approach. In the short-term, we would need a trust-but-verify approach that only the IMF could institute. Greece would continue as planned with the budget measures they have already enacted. However, the Greeks could, therefore, be assured that – should it face liquidity problems – the IMF would intercede and ensure the Greeks stick to their budgetary plan. From a political perspective this takes the heat off Germany and supports their austerity agenda. For the Greek government, it gets cover domestically: ‘we didn’t create this mess; the former government did. And we’re not forcing the cuts; the IMF is. The key, of course, is that the IMF funds be available as a loan for temporary fiscal stimulus to support liquidity over the medium-term in exchange for concrete promises on longer-term budget issues. This would attenuate any economic pressure.
Over the long-term, the proposed European Monetary Fund makes sense. However, first and foremost, let’s call it a European Harmonisation Fund because this is the purpose – harmonisation.
For example, within the United States, I imagine there are substantial interstate capital account imbalances between individual states. Florida might have a substantial capital account surplus because of all of the retirees moving there. While New York could have a capital account deficit because of the financial sector wealth. (I don’t know if this is true. The example is just illustrative). But you wouldn’t hear New Yorkers screaming bloody murder about the profligacy of Florida. Nor would you hear the Floridians yelling about New York’s enormous current account surplus.
The point is the United States has more well-harmonised internal market because of the free movement of labour and capital, a common language and federal automatic stabilisers. This is what the Eurozone lacks. And this is why we can change the unbelievable EMF – and its inflammatory expulsion clause into the more believable EHF.
I hope this offers some concrete policy solutions and puts more context around the politicization of economic problems we are now witnessing. It makes sense that in 1931, the same general recession weariness began to manifest itself in the very same political way – and that this increased the likelihood of a catastrophic depression as I believe it does today.