Source: Bloomberg
U.S. Earns Blame for Trade MessFollowing the slim pickings in Seoul, the U.S. may soon have to choose between making hard decisions concerning its tax and spending policies or endangering a pillar of its post-war prosperity: the open, rules-based trading system which has served it so well.
Focusing on the link between America’s fiscal mess and the health of the international trading system will come as a surprise to those who think that the main forces imperiling world trade are German or Chinese policies. From their perspective China’s policies -- and especially a currency kept artificially low by the government -- are forcing other countries to react in kind, either by devaluing their own currency or adopting even blunter instruments that impair trade.
Also, from their perspective, Germany’s refusal to stimulate its domestic demand is placing strain on all its trading partners, especially the debt-stricken countries in the European periphery. In the process the global trading system is filling with frictions that could severely undermine its smooth functioning.
And yes, there is no doubt that both Germany and China can do more to support world growth, though in fairness, China’s dynamism and massive stimulus during the darkest days of the crisis have already done so more than any other country.
But getting the U.S.’s policies right and its fiscal house in order is more important for sustained growth domestically and in the rest of the world than anything that can be done by China and Germany, economies that are respectively one-third and one- quarter the size.
Big Spenders
America’s exhortations for other countries to do more to rebalance the global economy (read “spend more!”) tend to gloss over the fact that the U.S. was, after all, responsible for the biggest consumption and construction binge in history and has enacted tax cuts it couldn’t afford. Americans know this, of course, but that doesn’t make their Group of 20 sermons any more persuasive.
America’s calls for other countries to mend their ways -- namely, to stop saving so much -- are made with two related objectives in mind. The most pressing is to help offset weak demand in the U.S. This is an issue on which the U.S. is almost in a panic because, alone among the advanced countries, its safety nets are pitifully weak while its unemployment rate is stuck near the highest levels since World War II.
Yet, even as Washington preaches stimulus abroad, a gridlocked Congress is incapable of agreeing on continuing with fiscal stimulus or on temporarily extending the Bush-era tax cuts. Without action on these fronts, the U.S. could be confronted with a stimulus in reverse in 2011 amounting to about 3 percent of gross domestic product.
Washington’s Role
Washington’s other objective is to keep its current account deficit, which has come down to around 3 percent of GDP, from surging again once the recovery takes hold. Too bad, then, that politically gridlocked Washington has done nothing so far to confront the many structural weaknesses that account for the U.S.’s dismally low national savings rate.
What would this take? For example, legislators would need to ensure that once the crisis abates, the U.S. will adopt a consumption tax in the form of a value-added tax and a much higher gasoline tax, drop the mortgage-interest tax credit, pay Social Security and Medicare as a function of need and not just of age, extend the retirement age, and curtail defense and other spending. Many of these measures are included in proposals by the co-chairmen of the Federal Deficit Reduction Commission.
We aren’t naïve. We know how politically toxic these measures are, and are aware that congressmen steer as far away from them as possible. But adopting them will only put the U.S. roughly on a par with what other advanced countries are doing. Moreover, enacting these long-term reforms would reassure markets and provide the fiscal space for helping the long-term unemployed and strapped local authorities in 2011.
Fed’s Role
But none of this is happening, leaving the Federal Reserve as the only game in town. With overnight interest rates at zero, enter quantitative easing, alias QE2.
Unfortunately, the combination of looser monetary policy and tighter fiscal policy is a recipe for a lower dollar, and is the opposite of what the rest of the world is looking for from the world’s reserve currency at a time of great concern about exchange rate and trade frictions. Emerging economies are already in a panic over a wall of hot money that is advancing on them.
The way Washington’s actions are seen by its partners should hold no mystery. The push for global rebalancing and current account targets, the president’s goal of doubling exports, quantitative easing, calls on countries to stop intervening in currency markets add up to only one thing -- a lower dollar.
The U.S. Congress’s inability to agree on appropriate fiscal measures to help people who elected them is regrettable, but it shouldn’t have to result in global currency and trade wars.