Bankers Gone Wild in Ireland AND Germany

Nov 29, 2010Marshall Auerback

marshall-auerback-100Despite a blame-a-thon on Ireleand,  Germans banks are really at the core of the eurozone catastrophe.

marshall-auerback-100Despite a blame-a-thon on Ireleand,  Germans banks are really at the core of the eurozone catastrophe.

Much ink has been spilled in the press over the Irish problem and the laxity of the country's southern Mediterranean counterparts in contrast to the highly "disciplined" Germans. But perhaps we have to revisit that caricature. Not only has the Irish crisis blown apart the myth of the virtues of fiscal austerity during rapidly declining economic activity, but it has also illustrated that Germany's bankers were every bit as culpable as their Irish counterparts in helping to stoke the credit bubble.

One of the traditional rationales for the creation of the euro was that a single currency and strict Maastricht criteria would keep the profligate Mediterraneans and their Celtic equivalents in line. Instead, critics, particularly in Germany, increasingly see the European Monetary Union as a means for freeloading nations to offload their liabilities onto fitter neighbors.

Not surprisingly, this has engendered much discussion that perhaps it would serve Germany's interests to leave the euro, rather than booting one of the Mediterranean "scroungers" out. But as Simon Johnson has pointed out, this comforting narrative of German prudence matched up against Irish profligacy doesn't really stack up:

German banks in particular lost their composure with regard to lending to Ireland -- although British, American, French and Belgian banks were not so far behind. Hypo Real Estate -- now taken over by the German government -- has what is likely to be the highest exposure to Irish debt.

But look at loans outstanding relative to the size of their domestic economies (using the BIS data on what they call an "ultimate risk basis").

German banks are owed $139 billion, which is 4.2 percent of German G.D.P. [my emphasis]

Where were the German regulators? As my colleague Bill Black has noted:

They seem to have believed that ‘What happens in Vegas (Dublin) stays in Vegas (Dublin).' Instead, their German banks came back from their riotous holidays in the PIIGS with BTDs (bank transmitted diseases). The German banks' regulators continue to let them hide the embarrassing losses they picked up on holiday, but that cover up will collapse if any of the PIIGS default. The PIIGS will default if the EU does not bail them out, so there will be a bail out even though the German taxpayers hate to fund bailouts.

German banks' relatively high exposure to Ireland does pose the question as to whether there is some wild, Weimar-style hyperinflationista lurking deep in the heart of every German, only able to express itself fully when away from the prying eyes of fellow citizens.

All of the rescue plans that have been introduced in Ireland or Greece thus far rest on the assumption that, with more time, the eurozone's problem children could get their fiscal houses in order -- and Europe could somehow grow its way out of trouble. But the fiscal austerity being offered as the "medicine" is turning out to be worse than the disease. It has exacerbated the downturn and unleashed a horrible debt deflation dynamic in all of the areas where it was reluctantly implemented.

But here's the thing: these fiscal straitjackets obscure the history of how we came to today's horrible impasse and, more specifically, the German banks' role in helping to fuel the credit binge. Also lost is the reason why this has metastasized into a far greater crisis: as part of the eurozone, Ireland does not have the fiscal freedom to come up with a sufficiently robust government response. The UK had a comparable real estate bubble in the late 1980s, which culminated with the Soros attack on the pound in 1992 and the ejection of sterling from Exchange Rate Mechanism (the precursor to the EMU). This was a blessing in disguise. Withdrawal from the ERM saved the UK because it allowed the country sufficient latitude to reflate. Yes, the country had a major recession (in many ways a consequence of the surrender of fiscal freedom as a result of joining the ERM in the first place), but there was never a systemic risk that posed a threat to the country's overall solvency as is the case in Ireland today. And this is exacerbating the problem in Ireland because it persists in chasing its tail repeatedly with futile fiscal austerity measures.

The truth of the matter is this: the eurozone seems rotten to the core, literally. Germany represents that core. The Germans might occupy the penthouse suite, but it is the suite of a roach motel. And we know what happens to those who enter such "establishments."

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Yes, longer term the problems currently afflicting the eurozone could be sorted via the creation of a supranational fiscal authority -- a "United States of Europe". But with each crisis (Ireland today; Portugal and Spain tomorrow; Italy and then France next?), the political forces are coalescing in a radically different direction. The Germans are becoming increasingly resentful as they perceive their country as the bailout mechanism of last resort (even though the Irish experience suggests that their bankers are also guilty of many of the same excesses as the "Celtic Tiger"). The PIIGS themselves are seeing that the benefits of euro membership have been vastly overstated and in fact now act as a cancerous influence through the Germanic embrace of austerity. (Paradoxically, it has been the "profligate" behavior of those so-called lazy Mediterraneans that has enabled Germany to retain its export-driven model, as well as allowing it to run lower budget deficits than most other countries.)

The eurozone could ultimately end up like Yugoslavia writ large. Prior to the break up of that country, the relatively rich republics, Slovenia and Croatia, resented policies that transferred wealth to the poorer republics like Serbia, Macedonia, Montenegro, or the autonomous region of Kosovo. Once Tito's organizing genius disappeared, the links stitching the country together became frayed and eventually snapped as old grievances manifested themselves in newer forms. The same could happen to the Europe Union if it underwent a supranational fiscal union -- the beginnings of which are already in evidence. I think the Germans are beginning to recognize that, which is why there is discussion about leaving the euro.

But let's first be clear: German Chancellor Angela Merkel has persistently argued that it is essential that private investors, notably the bond holders, begin to suffer losses so that they will have the proper incentives to provide effective "private market discipline" going forward. She has further argued that it is fair that they suffer losses, given the premium yields they received and their lack of due diligence. That's an honorable policy. But it's like the old Irish joke of the driver who gets lost, asks for directions, and is told, "Well, I wouldn't be starting from here." By the same token, Ireland clearly illustrates that German banks, as well as their Mediterranean counterparts, would be big losers under the Merkel proposal. Ironically, German financial institutions could find themselves subject to the same kinds of bailouts that Chancellor Merkel and many of her counterparts in Berlin are urging on the Irish and Greeks.

As always, leave it to the Irish to come up with the most poetic response to the crisis. True, W.B. Yeats did not live to see this disaster, but his passionate "September 1913" does evoke the tragedy of today's Ireland and the futility of the current policy responses for their people (and beyond):

Was it for this the wild geese spread
The grey wing upon every tide;
For this that all that blood was shed,
For this Edward Fitzgerald died,
And Robert Emmet and Wolfe Tone,
All that delirium of the brave?
Romantic Ireland's dead and gone,
It's with O'Leary in the grave.

Graves that might soon include not only the O'Learys, but also the Garcias, Texeiras, Moreaus, and Schmidts if a more rational course of action throughout the euro zone is not adopted soon.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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Europe Needs a Gestalt Shift

Nov 23, 2010Stuart Holland

euro_banknotes-150The eurozone must use all available methods to implement New Deal-style programs before it's too late.

euro_banknotes-150The eurozone must use all available methods to implement New Deal-style programs before it's too late.

Angela Merkel has recently sought support for measures to penalize EU member states with debt in excess of 60% of GDP -- the nominal limit of the Stability and Growth Pact, or SGP. Meanwhile, Germany has introduced a balanced budget provision into its constitution. This is not unrelated to the word for debt in German, Schuld, which also means guilt and leads to Nietzsche's claim that creditors seek to punish debtors for it.

Yet what is needed in Europe now is also German: a Gestalt shift to recognize that while EU member states are deep in debt from salvaging banks and hedge funds, the European Union itself has next to none. It had none at all until May this year, when the European Central Bank began to buy up tranches of some member states' national debt. But this is both costly and ineffective. Spreads on Greek bonds have risen to 10%, which is unsustainable. A serial default of several eurozone member states is possible.

A simpler and costless solution would be to cut the Gordian Knot on national debt by transferring a share of it to the European Central Bank. If this were up to 60% of GDP, as allowed by the SGP, it would reduce the default risk for the most exposed member states, lower their debt servicing costs, and signal to financial markets that European governments have a proactive response to the current crisis, rather than being passive victims of unelected credit rating agencies. A ‘tranche transfer' would not be a debt write-off. The member states whose bonds are transferred to the ECB would be responsible for paying the interest on them, but at much lower rates.

Yet debt stabilization alone is not the answer to Europe's current crisis. EU governments are aiming to cut both debt and fiscal deficits on a scale that threatens beggar-my-neighbor deflation, denies their 2008 commitment to a European Economic Recovery Plan, and risks a double dip recession and a massive crisis of confidence both in the markets and in governments.

The eurozone needs to learn from Roosevelt's New Deal, whose success gave Truman the confidence to fund the Marshall Aid, from which Germany herself was a beneficiary. The key was borrowing to invest through US Treasury bonds. These do not count toward the debt of US states such as California or Delaware, nor need European bonds count toward the debt of EU member states.

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Many economists have claimed that Europe cannot save itself until it has the fiscal federalism to transfer resources from stronger to weaker member states. Germany is strongly opposed to this. Yet Europe neither needs such fiscal federalism, nor the ‘economic government' called for by Nicholas Sarkozy, to finance a New Deal-style recovery program. The institutions and powers are already in place.

The European Investment Bank -- already twice the size of the World Bank -- issues bonds that are its liability, not that of member states, which is why national governments need not count funding from it on their national debt. Since 1997, the EIB has been given a joint cohesion and convergence remit by the European Council to invest in health, education, urban regeneration, green technology and support for small and medium firms. Since then it has quadrupled its annual lending to €80 billion, or two thirds of the ‘own resources' of the European Commission, and could quadruple this again by 2020. This would be equivalent in funding terms to postwar Marshall Aid.

The EIB only co-finances investments. But this could be matched by net issues of EU bonds or euro bonds by the ECB, which would attract surpluses from the central banks and sovereign wealth funds of emerging economies and stabilize the eurozone. When Jacques Delors proposed such bonds in 1993, both Germany and France were opposed. Now only Germany is opposed.

Nor does this depend on the ECB in place of governments. The Lisbon Treaty confirms that the ECB's primary objective shall be to maintain price stability. But also that "without prejudice to that objective, it shall support the general economic policies of the Union in order to contribute to the achievement of the latter's objectives." This mirrors the constitution of the Bundesbank, which obliges it "to support the general economic policies of the government." The European Council is also empowered by the Treaty to define "general economic policies," and the European Economic Recovery Plan is already one of them. With the EU heading for a double dip recession, there is no risk to price stability.

This calls for a German Gestalt shift both on debt stabilization and on issuing EU bonds. Or, if Germany will not shift, their introduction -- like the euro itself -- by some rather than all member states both to safeguard the eurozone and to make a reality of a European recovery program.

Stuart Holland is a visiting professor Faculty of Economics University of Coimbra and former adviser to Jacques Delors.

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The First Steps in the Revolution Against the Banks

Nov 22, 2010Joe Costello

raised-fist-150So you want a revolution? Challenge those at the top and reclaim independence for the working class.

raised-fist-150So you want a revolution? Challenge those at the top and reclaim independence for the working class.

'Red Will' Danaher: "So, the IRA's in this too, huh?"
Hugh Forbes: "If it were, 'Red Will' Danaher, not a scorched stone of your fine house be standing."
Michaleen Flynn: "A beautiful sentiment."
-- John Ford's The Quiet Man

There's no denying this world is full of prejudice. And if you spend some time in non-industrial areas of this planet, you'd find one of the greatest prejudices is against rural farming folks from city slickers. In South America, Africa, Indonesia, you hear the urbanites level the same charges: "lazy and stupid." Among renowned political thinkers in Europe and America, where rural life has mostly disappeared, you'd be hard-pressed to find a good word for farmers over the past couple centuries. Most took Marx's view of the "idiocy of rural life." Probably the greatest exception was Jefferson. There are many reasons for his difference, but one of the biggest was his view that a small farm provided the population with the economic power and independence they needed to be democratic citizens. But Jefferson's yeoman farmer republic passed from the scene well over a century ago. In the industrial age, America never found a substitute to replace the elegance of Jefferson's small farm economic democracy. Maybe unions could have, but prejudice against workers quickly replaced that against farmers. In the last four decades, as Wall Street and the bankers sold off American industry, this was met with little opposition, particularly from the servant class.

The Irish have been well behind much of the continent and the US in industrialization; in fact, it's only been during the last several decades that the nation really began to industrialize. So we can look at Sinn Fein's late response to banking events as maybe a remnant of a still slower rural life, but they certainly make up for it with a little Irish flair. And it looks like the government will fall.

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But this begs the question: What's the excuse for the lack of an American response to our banking crimes? How long the list would be if we were to charge "economic treason;" it would be filled with the most illustrious Democrats and Republicans of the past several decades. How do we begin the long road to justice? How do we begin the discussion on reforming democracy, and what in the 21st century is the Jeffersonian equivalent of the yeoman farm, providing the economic independence necessary for democratic citizenry?

The Guardian has a piece (h/t Yves Smith) on football legend Eric Cantona's call for an organized banking panic. The whole concept has a beauty in that it turns on its head the historical view of panics into some much needed political creativity. It can also start people questioning what banking really is and how it is reformed so that its decision making is much more widely spread across society. How do we make banking more democratic? One can judge from the spokeswoman for the French Banking Federation's response that it makes officialdom nervous: "'My first reaction is to laugh. It is totally idiotic,' she told the Observer. 'One of the main roles of a bank is to keep money safe. This appeal will give great pleasure to thieves, I would have thought.'"

But what of the thievery that is modern banking, mademoiselle? Don't we have the responsibility to keep ourselves from being victims? And understand, brothers and sisters, the first reaction from any establishment against a threat is to make it ridiculous, "to laugh." Mr. Cantona is on to something.

Check out Move your Money for an American effort.

Joe Costello was communications director for Jerry Brown’s 1992 presidential campaign and was a senior adviser for Howard Dean’s effort in 2004.

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G20 Post-mortem: "Chimerica" has been a Chimera

Nov 15, 2010Marshall Auerback

marshall-auerback-100A disastrous trade war may be coming our way.

marshall-auerback-100A disastrous trade war may be coming our way.

There has been a considerable amount of discussion about current account imbalances in light of last weekend's failed G20 summit. For the most part, the meetings focused less on currency levels per se and more on the underlying trade imbalances. In particular, they discussed the threshold at which both surplus and deficit nations should work to mitigate the extremes implied by deficits/surpluses in excess of 4% of GDP.

Of course, one could argue that the focus on current account imbalances, rather than exchange rates per se, was simply a means by which the Americans could discuss China's pegged rate regime so that Beijing didn't appear to succumb to US pressure and "lose face". But fundamentally, the US dollar/Chinese yuan exchange rate has long constituted a huge source of financial instability in the global financial architecture. Although today's focus on China tends to highlight its huge and growing bilateral trade surpluses with the US (and to a lesser extent, the Euro bloc), less appreciated is the degree to which its exchange rate policies have historically impacted its Asian neighbors and continue to do so to this day. As recently as 1994, Beijing precipitously devalued the renminbi against the greenback, taking it from 5 to 8.4, a 60%+ devaluation. Even this action understates the magnitude of the change, since it was preceded by a period during which the country's monetary and financial authorities embraced a policy in which the yuan declined some 60 percent against the dollar.

So much for the need for policy incrementalism, as the Chinese persistently respond today when confronted with calls for a substantial yuan revaluation! In the late 1990s, Beijing's earlier policy of "beggar thy neighbor" might have engendered comparatively minimal disruption domestically, but it exported the economic dislocation to East Asia and Japan. The cost advantage of these devaluations, conferred on China's exporters, significantly eroded the trade competitiveness of other East Asian and Japanese exporters. They therefore threw their collective current accounts into substantial deficit by the mid-1990s and set the stage for the Asian financial crisis of 1997 and Japan's "lost decade." (It also set the stage for Japan's implementation of a zero-interest-rate policy, which ultimately provided the foundation for the so-called "yen carry trade" -- another grave source of future financial instability.)

I have already argued that QE2 has minimal impact on the amount of new net dollars in existence. But the viscerally hostile Chinese response to the Fed's policy suggests that they see in it echoes of their own policy of the early 1990s (in spite of the fact that the US has a freely floating exchange rate, not a currency peg).

Most defenders of Beijing justify the pegged rate regime on the grounds that it has helped to move the country up the technological curve and thereby enhance living standards. Perhaps, but India has done it without adopting a similarly mercantilist policy. In any event, the improvements of living standards facilitated by rapid export growth and income gains in China are still heavily skewed toward the exterior regions, rather than the interior of the country.

There could have been better ways for China to improve the living standards of its people. It is perfectly understandable why Beijing adopted the Asian mercantilist model, as it worked so well for the nations of Northeast and Southeast Asia. But it makes no sense for a country of 1.5 billion people with a huge domestic market that its manufacturers could potentially supply for decades. India also seems to have improved the living standards of its people, but it has adopted a much more balanced economic model (and correspondingly less trade friction with the US and EU).

Although Beijing no longer explicitly pegs its currency against the greenback, it does so against a basket of currencies of which the dollar is still the largest component. It therefore remains a pegged rate regime in all but name. This type of currency regime is generally not the best institutional structure for an economy because it entails a surrender of monetary/fiscal sovereignty and builds in an inherent financial fragility. In China's case, the fragility has been somewhat masked by the fact that it continues to run trade surpluses but, as noted above, it has effectively "exported" the financial destabilization associated with currency pegs to its trading partners.

So what is the problem with a currency peg? A nation with a currency peg can run external deficits (on the current account) for a time, as long as there are sufficient foreign reserves so that the central bank does not need to contract the monetary base (its liabilities). In particular, if investment is targeted at productive ventures that build extra export capacity and if the nation has enough foreign reserves, then a current account deficit for a time can be beneficial in the longer term.

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But persistent current account deficits become particularly problematic for a nation running a currency board. The nation faces the continual drain of its foreign reserves, which has two impacts. First, the peg comes under pressure. Second, the central bank has to contract the monetary base, which has a negative impact on aggregate demand. A sharp deterioration in the current account can quickly create a crisis because the economy has engineered a sharp domestic contraction (normally, by sharply raising interest rates) to reduce imports, but also risks running out of reserves and occasionally has to default on foreign currency debt (either public or private).

While the higher rates may attract foreign capital inflow, they are also deflationary. Proponents of this arrangement argue that deflation starts a process of internal devaluation (wages and prices fall) and increases the competitiveness of the export sector. But it is clear that currency peg arrangements, which eliminate the capacity of the central bank to run discretionary monetary policy, lead to pro-cyclical policy outcomes. So in boom times, with exports strong, the monetary base expands and interest rates fall. Monetary policy reinforces the demand boom.

But if exports fall and thus aggregate demand weakens and/or foreign capital outflow occurs, then the monetary base contracts and interest rates rise, causing a further contraction. Moreover, when times are bad, the treasury may not be able to fund its current budget position (if in deficit). So fiscal policy has to contract, which worsens the situation.

Clearly this is not a problem for Beijing today, as it runs a huge current account surplus. But if it were to revalue its currency and retain the peg (rather than let it float), a future major collapse in export growth would be highly problematic because it would engender a loss of capacity to build foreign currency reserves and support local demand.

Needless to say, China's peg has NOT been particularly helpful to the US as a whole, either. In general the dollar-yuan peg has helped to perpetuate a weirdly destructive symbiotic relationship between China's military, which seems to be making lots of money from the speculative enterprises that persistently pop up in the US, and Wall Street, which has become a major beneficiary as the agent that recycles these capital flows back to the US. In the meantime, the peg displaces US workers via low-cost Chinese labor facilitated by technological advances, which drives further outsourcing by US corporations. To offset the impact, the US government has consciously built up its "FIRE" (finance, insurance and real estate) sector, which has "leveraged" the rest of the economy as its employment and profits grew at a faster pace (it received 40% of the nation's profits before the bust). Leaving aside the issue of "productive" versus "unproductive" labor, it certainly appears in retrospect that the FIRE sector has played an outsized role in the US economy, in effect offsetting the loss of manufacturing capacity. The "market" is now trying to downsize the FIRE sector, but current policy seems designed to resist that. All efforts are aimed at keeping leverage high as the Fed and Treasury try to get banks to lend again -- as if another private debt bubble is the cure for what ails the economy.

That all might begin to change. After observing the latest G20 fiasco, it is conceivable that American government will feel that it has no choice but to move toward tariffs, especially as fiscal policy is likely to remain constrained by a hostile GOP-dominated Congress. The numerical targets on current account imbalances were the last warning shot to forestall the protectionist option. This has now failed.

Domestic US political considerations for the President and his party might well mandate a more radical tack. Consider the recent midterm election results. The Democrats sustained huge losses in the rust belt. These states have been traditionally Democratic. True, some went for Reagan in the 1980s, but Obama got them back in 2008 and thereby won the election. He needs this region. He can forget about the South: there, we have all kinds of constituencies that voted against him. He'll never win over the Christian right, the plutocrats who narrowly vote their pocketbooks, and so forth. Obama needs to win back members of his disaffected base, especially younger voters who didn't show up because they face a hopeless employment situation. But he won't get this group back to the polls unless he focuses on jobs. The independents will also be hard to get back without this, because they too are disgusted by the government's cronyism. But even if the President wins back a large number of disaffected independents and the youth vote, he still needs the rust belt. He therefore has to attack China, the outsourcing of jobs, and focus on Beijing's currency (which he has recently called "undervalued", potentially setting the stage to name China as a "currency manipulator" with the World Trade Organization). If Obama doesn't do this, the Democrats should just wave a white flag in the next election and not waste money campaigning. This is the US political reality as long as the unemployment rate is above seven percent and Corporate America is nuts about cutting costs by moving to low wage platforms abroad. A trade war, complete with tariffs, could well prove inevitable.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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Currency Wars and QE2: How Bad Ideas Can Plague the G20 Meetings in Seoul

Nov 11, 2010Mario Seccareccia

A fiscal policy reversal threatens global economic recovery.

A fiscal policy reversal threatens global economic recovery.

When the G20 leaders met in Washington in the depth of the financial crisis in November 2008, there was an optimistic note that such an august body of world leaders could coordinate policy to get the world economy out of the crisis. To some extent, this significant coordination in preventing the world economy from collapse took place, despite the criticism of the deficit hawks and neocons that the sky would fall as a result of the important and much needed doses of fiscal deficits at the time. However, slowly, these neocons have been gaining influence and garnering political momentum through their continued fear-mongering about the so-called unsustainably high budget deficits in most Western countries. In reaction to the political pressures and media hype, these world leaders have been changing their discourse and reshaping their policy in conformity with what their critics have been articulating. Indeed, as discussed in a previous post, we have now witnessed a complete U-turn in fiscal policy since the last summit of the G20 leaders in Toronto in June 2010.

Given the uncertainties connected with private sector spending, economists well-steeped in the Keynesian tradition would argue that this reversal in fiscal policy is probably the biggest threat to a significant recovery of the global economy today. Instead from the G20 world leaders in Seoul this week and from economists working for such important international agencies as the IMF and the WTO, we are being told that the principal threat to world prosperity are imminent currency wars which are being fueled by a declining US dollar in the international currency markets.

In a world economy in which all countries are seeking to get out of the recession via a policy of export-led growth, the fact that the US dollar is declining significantly may well trigger "beggar-thy-neighbor" currency retaliations. However, it belongs to the G20 leaders to prevent such a currency war, by addressing the actual source of the problem. But what is the source of these currency threats? The source is, of course, the lack of sufficient world demand, with each country being currently under economic pressure domestically to grab a larger share of what is essentially a shrinking world demand through near-sighted mercantilist policies of export-led growth. If the problem is a shrinking global demand, the solution would hardly be what the G20 leaders committed themselves to in June by cutting government expenditures to deal with their ballooning budget deficits. Clearly, a more enlightened policy would be to stimulate domestic demand through stronger boosts of expansionary fiscal policy that would also stimulate private domestic spending, much as it had been understood in November 2008.

In contrast, we are now being told that the culprit is the sliding US dollar. And, what is the supposed cause of the depreciating greenback in the foreign exchange markets? According to these policy leaders, the offender is the original fiscal stimulus that led to a build-up of excessive reserves that had not been sterilized by the Federal Reserve authorities, dubbed "quantitative easing" (QE). This excessive accumulation of reserves or QE, whose intent was to insure that central bank-controlled interest rates should remain at their lowest possible level to encourage private sector spending, is now also supposedly putting strong downward pressure on the US dollar.

To the ordinary reader, all of this reasoning may sound quite logical. However, the analysis rests on an outdated and pernicious theory that has been completely discredited since the early 1980s and, perhaps, even more so, during the present crisis: namely old-line "monetarism" -- a theory associated with ideas of Milton Friedman. According to the old monetarist framework, when a central bank raises the amount of reserves in the banking system (resulting, say, from federal government deficit spending), these reserves will be lent out to creditworthy borrowers who, in turn, will increase their spending. These higher expenditures will eventually trigger a higher inflation and, with it, an accompanying depreciation of the value of the currency in the foreign exchange markets. It is this monetarist model of the transmission mechanism of money to economic activity and prices which presently seems to be etched in the mind of these leaders and their economic advisors and which guides them to see the problem as one of excessive public spending and the ensuing excess reserves in the banking system.

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But where is the evidence to support this view? It is true that reserves have been multiplied by many hundredfold over the last several years through the US Fed's purchases of either government or private-sector securities (in an attempt to bring down also long-term interest rates). It is also true that the Fed has not sterilized these excess reserves, although it is highly debatable that the Fed hopes that the mere existence of these excess reserves would encourage banks to lend more. However, these advocates of the supply-led view of bank lending do not seem to comprehend that US banks could be sitting on as many reserves as the Fed wants but, unless there are creditworthy borrowers out there, these reserves are irrelevant to the dynamics of credit expansion. In any case, as we all know, if the theory was correct, we should have been experiencing hyperinflation as a result of the exponential rise of these reserves because of QE in the US since 2009. But nothing is further from the truth. Moreover, the reason for the declining US dollar is simply because the US has become less attractive for footloose financial capital which goes where the returns are highest. It is certainly not because of QE but essentially because US interest returns are very low and because the US economy is in a very deep recession, which makes the latter less attractive to foreign capital.

What is hoped is that the G20 leaders will break away from a narrow focus that rests on reliance on private sector spending as the only legitimate source of economic growth and to go back to what had originally inspired them to engage in significant public sector spending at their historic meeting in November of 2008. All these G20 countries are prematurely cutting back on public spending today and, by so doing, have left themselves vulnerable to engaging in ridiculous and futile currency wars that had once plagued the world economy of the 1930s. Surely they could learn from the mistakes of the past. The biggest threat to world prosperity is not the potential for so-called currency wars, which are merely the symptom of a deeper problem -- that is, the lack of sufficient aggregate demand in a world economy that continues to generate persistent mass unemployment. This fear-mongering over currency wars and the blaming of US policy because of QE is just a diversionary tactic from the Chinese and German governments to continue with their export-led strategy à outrance and to deflect criticism of their own mercantilist policies cum domestic austerity that are endangering the stability of the world economy.

Mario Seccareccia is editor of the International Journal of Political Economy.

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How Do You Say "Hypocrite" in German?

Nov 8, 2010Marshall Auerback

marshall-auerback-100Before throwing rocks at the U.S. for its spending, Germany should take a look at its own crumbling glass house.

marshall-auerback-100Before throwing rocks at the U.S. for its spending, Germany should take a look at its own crumbling glass house.

Okay, I did a few years of German language study, so I know that the real word for hypocrite is "Heuchler". But when I read the latest guff from Germany's Finance Minister criticizing America's economic policies, I'm afraid that Wolfgang Schauble's name immediately sprung to mind for a substitute. In an unusually undiplomatic manner, German Finance Minister Schauble criticized the U.S. Federal Reserve's recent decision to undertake another round of quantitative easing, arguing that it wouldn't help the U.S. economy or its global partners.

He could well be right. We've argued much the same against "QE2". Where we draw the line is Schauble's subsequent comments from the same article:

Germany's exporting success is based on the increased competitiveness of our companies, not on some sort of currency sleight-of-hand. The American growth model, by comparison, is stuck in a deep crisis... The USA lived off credit for too long, inflated its financial sector massively and neglected its industrial base. There are many reasons for America's problems-German export surpluses aren't one of them.

No crisis in Europe? The threat to the euro, the establishment of a bailout facility, the involvement of the IMF, these were all figments of the market's collective imagination? Even Goethe is unworthy of such flights of imagination!

One thing is clear from the remarks that continue to emanate from Germany's policy makers, including the latest from Schauble. They do not understand basic accounting identities. They fail to see any kind of relationship between their own export model and their trading partners.

It is ironic (and more than a touch hypocritical) that Germany chastises its neighbors, like Greece, or its trading partners like the U.S., for their "profligacy", but relies on these countries "living beyond their means" to produce a trade surplus that allows its own government to run smaller budget deficits.

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It's even more extreme within the euro zone proper. The European Monetary Union bloc as a whole runs an approximately balanced current account with the rest of the world. Hence, within Euroland it is a zero-sum game: one nation's current account surplus is offset by a deficit run by a neighbor. And given triple constraints -- an inability to devalue the euro, a global downturn, and the most dominant partner within the bloc, Germany, committed to running its own trade surpluses -- it seems quite unlikely that poor, suffering nations like Greece or Ireland could move toward a current account surplus and thereby help to reduce its own government "profligacy". It is hardly worth pointing out that these stringent conditions were largely the creation of former German Finance Minister, Theo Waigel, or that Germany itself was a serial violator of the so-called "Stability and Growth Pact" throughout much of the 1990s and early 2000s.

That history aside, the dirty little secret of the European Monetary Union is that it locked Germany's main export competitors into the monetary union at hopelessly uncompetitive exchange rates, thereby entrenching Germany's export dominance, and its selfish, mercantilist model.

Germany's policy-making elites are unprepared to acknowledge any of this. Symptomatic of the current government's blindness is its agreement to extend the temporary bailout arrangements with the euro zone and make them permanent as a quid pro quo for the EMU nations achieving "fiscal discipline ... to bring deficit and debt onto a more sustainable path."

It is more than stating the obvious to note that the only reason the euro has not blown apart in the past few months is because the European Central Bank, contrary to the wishes of Germany's policy-making elites, has continued to backstop the PIIGS' debt, thereby preventing an even broader economic/financial calamity within the European Monetary Union. How else does a fundamentally insolvent nation like Ireland survive with a budget deficit to GDP ratio of 32%?It could  abandon the current system or put the capacity in place to deal with asymmetric demand shocks (that is, a unified fiscal authority) the European Council. But at the behest of Mr Schauble's German government, it has instead just introduced measures which will make the situation worse both in the short-run and in the medium-term, when the next negative demand shock arrives.

The entire European Monetary Union structure is a mess. The euro zone members are all trapped within this monetary monstrosity, Germany included. Germany might occupy the penthouse suite, but it's the penthouse suite of a roach motel. The EMU was conceived under profoundly anti-democratic circumstances (the German voters never had a chance to vote by referendum on whether to abandon the Deutschemark in favor of the euro), so it isn't fair to extend the charge of hypocrisy to the nation as a whole. But the German people have been significantly ill-served by elitist technocrats such as Wolfgang Schauble. As one of the architects of European Monetary Union during his time under the Kohl Administration, he at least bears some responsibility for this abominable fiscal/monetary halfway house, which serves nobody's interests, Germany included. Herr Schauble would be on much stronger grounds to critique U.S. policy making if he had the guts to acknowledge this and try to sort out what he helped to create before hypocritically lecturing Americans on their profligate ways. Our "sins" enable them to sustain their export juggernaut.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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The 2010 Elections: What Went Wrong?

Nov 2, 2010Daniel Berger

elephant-and-donkey-150Republican ideology and policies created this mess. So how did Democrats squander the opportunity? In the first post of a two-part series, Daniel Berger explains how we got where we are.

elephant-and-donkey-150Republican ideology and policies created this mess. So how did Democrats squander the opportunity? In the first post of a two-part series, Daniel Berger explains how we got where we are.

Regardless of the outcome of the 2010 elections, the Democratic Party urgently needs a fundamental re-evaluation of its political strategy. The 2008 election of Barack Obama could have been a watershed event in U.S. politics -- not unlike Reagan's election in 1980, which initiated the 30-year political dominance of the Republican Party. It still could be.

Obama won a substantial majority based on a strong showing among young people, minorities, and other voter groups far outside the Republican political base and ambit of influence. Together with a narrow plurality among independents, Obama's vote -- if replicated in future elections -- could represent a durable, long-term majority. Moreover, as a result of Obama's election, the Republican Party has splintered into two factions: an extreme mainstream and the ultra-extremist Tea Party. This opens up the possibility of a complete marginalization of the Republican Party to permanent minority status if the Democrats can co-opt its moderate element and demonize its extremes.

But Democrats have had difficulty capitalizing on an apparent fundamental shift in the political landscape. They are actually struggling to maintain political control, even though the major problems facing the nation are directly attributable to 30 years of Republican neglect and misrule. Despite legitimate efforts by the Administration to begin to address these problems, Obama and his allies on Capitol Hill are being blamed for them.

Notwithstanding the role of the Republican Party and its destructive policies, which are directly responsible for current conditions, any rebuke which the Democrats receive in the elections would also be a direct product of the Party's own ineffective political strategy and that of the entire progressive political movement.

It is almost inconceivable that, during the worst economic conditions in 80 years, a conservative populism has arisen which, among other things, calls for the abolition of the national government. This comes after a recent collapse of private sector economic activity that caused mass unemployment. It required the national government to be the spender of last resort to stave off an economic catastrophe and support a slowly recovering economy. Eighty years ago, parallel conditions (which, left unchecked by the national government, spiraled out of control into the Great Depression) ushered in a progressive political movement responsible for the greatest era of political, social and economic reform in the history of the country. The 20th Century became the American Century and the U.S. was admired, even revered in the world.

Yet where is progressive populism now? Why haven't masses of workers; members of the middle class who are unemployed, underemployed and underpaid; and their allies staged mass rallies to protest the behavior of Wall Street? Where are protests against the business sector for overdoing layoffs, or at least against the Tea Party, the intellectual and political successors of the Ku Klux Klan?

At the very moment of recent political triumph for the Democratic Party and its progressive allies, at a moment in which the nation, for the first time in 30 years, has begun to take action to address its fundamental problems, all progress could be quickly lost in the 2010 elections.

The nature and intensity of the opposition make clear that differences between the two parties now do not reflect competing visions of the future, but rather represent the future versus the past and reasonable change versus the entrenched, and often corrupt, status quo. Normally -- particularly in a moment of crisis -- the political argument in any rational political system would be resolved (as it was here during the Depression years) in favor of the future. So why are we now deeply worried that the argument will be resolved in favor of the past?

The Limits of Current Strategies of Democrats/Progressives

The Democrats seem currently to be following these discrete -- sometimes overlapping -- political strategies. First, apparently both the White House  and the Democratic Congress believe that decades of ideological warfare between liberalism and conservatism has sickened the voting public to this type of conflict and has opened the door to a non-ideological political appeal. Such an appeal could presumably identify a set of problems requiring the collective attention of the country and develop a corresponding set of policy solutions based on the best available information and ideas, whatever their ideological origin. This could be called "policy approach" to politics.

While a policy approach is a good approach to governance, its effectiveness as a political strategy is questionable. The problems facing the country are complex. Unfortunately, issues that are poorly understood -- or even inaccessible to the public -- are easy targets of demagoguery and outright falsification (as the recent "debate" over health care showed).

This is particularly true in the current 24/7 media environment, where any proposed idea is intensively scrutinized -- and inevitably distorted -- by the media. As a result, public support for any policy proposal must be established at the very outset of its consideration and at every step along the way. But this is impossible in the current environment, where the Republican Party isn't committed to a good faith discussion and resolution of differences. Thus, any policy proposal can be effectively derailed (or even demonized) if it is not shielded by an aggressive countervailing public relations campaign.

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A second strategy which the Democrats seemed to have adopted has been referred to as "centrist." Until recently, conventional wisdom has held that any political party must move to the center to establish and maintain political support. The Democratic Party represents 25-40% of the electorate. The liberal base is even smaller. So the leadership reasons that it must appeal to moderates and independents to win elections. While liberals, moderates, and independents largely agree on social issues, they disagree -- sometimes sharply -- on many other issues. As a result, Democrats have to straddle the fence between these factions. On policy issues they have had to settle for the most modest form out of fear of losing support among "moderates." They can never address the fundamental causes of a problem without worrying about alienating a group, nor can they articulate a general guiding principle. Thus, Democrats can never adequately explain the true nature of a problem and why action is necessary, so they seem to act out of political opportunism rather than principle.

All this creates profound unease with the largest faction of the Democratic Party, the liberal base. For these reasons, Democrats wind up rarely appealing to them and almost appear to be running away from them.

The President has a related, but discrete, problem. He was elected in large part by young people and minorities, who not only provided votes but also idealism, energy, and grassroots organization. Obama has seemingly deserted this base by not focusing, at least rhetorically, on issues that are important to it. The best example is immigration. The Republican Party's political agitation served up the issue on a silver platter to the Democrats. Their inability to capitalize on it among Latinos and other minority groups is truly mystifying.

The Republicans, on the other hand, never pursue a "centrist" political strategy and always follow a "base" strategy. This causes the Republican Party to adopt extreme rhetoric and policy positions while allowing it to maintain a degree of coherence in its positions, as it is constantly pointing out that it acts "out of principle."

Although Republicans do not try to expand their base by compromising their "core" beliefs, they have tried to move the political center to the right. The conservative movement has constructed an effective network of think tanks, front groups, and media assets that have virtually unlimited resources. This "Right-Wing Message Machine" has been winning the war of ideas, despite the progression of political and social ideas over the last 100 years and social scientific evidence, all of which overwhelmingly favor progressive policies.

One example of the success of the conservative movement in moving the conventional wisdom to the right should suffice: public spending to stabilize the economy. Richard Nixon famously asserted early in his first term, "We are all Keynesians now." This statement reflected not only his Administration's embrace of Keynesian policy, but a consensus in both parties over modern macroeconomic theory. Nonetheless, 40 years later, conventional wisdom explicitly rejects the role of fiscal policy and, in particular, temporary government spending to make up for a collapse of private sector demand. This can only reflect the triumph of right wing ideology over all experience and reason.

In a third strategy, it is also possible that Democrats are specifically appealing not so much to the general public, but to the business and professional elites in this country. These elites have a remarkable degree of influence at all levels of American society -- not only by influencing political decision makers, but by acting as decision makers themselves. Our government, particularly at the national level, consists of a revolving door between the business and public sectors. In effect, they form a class of permanent technocrats and are as close as it gets to a ruling class in the U.S. For this reason, to get anything done politically in the U.S. it is necessary to have their support.

This latter point represents a double-edged sword for the Democratic Party. On the one hand, these elites follow a simplified form of the policy approach seemingly favored by the Democratic Party. Moreover, they are fairly well informed about the context in which policy decision-making takes place. So, unlike the public, it would be possible to make a serious appeal on policy grounds to the elites. Also, to their credit, they are almost all liberal on social issues.

However, at this particular moment, an all-out appeal by the Democratic Party to the elites is treacherous both policy-wise and politically. They tend to be reasonably well informed about business, their professions, and the state of the country, but they are not particularly knowledgeable about specific policy issues. They can be easily misled about -- or willingly distort -- policy issues, particularly on subjects that are counter-intuitive.

Worse, they also exhibit serious policy biases -- acting to protect their industries, professions, and permanent employers, and exhibiting biases reflecting the tension between private sector and collective action. The elites are devotees of the market and neo-liberalism. As a result, the elites have a general bias against government intervention in the market and policies designed to level the playing field or re-distribute wealth.

A good example of elite bias is their tendency to support "Free Trade." Arguments in favor of free trade never take into account labor protections such as prohibitions against child labor; wage and hour standards; occupational safety and health protections; the right to organize; or prohibitions against work place discrimination. Nevertheless, free trade is an article of faith among the business and professional elites in the U.S. It is also an open secret that the private sector -- in particular, the large multinational corporations headquartered or operating in the U.S. -- has openly advocated free trade as a way to end-run government work place regulations, lower their labor costs, and increase their profitability.

Thomas Frank makes an important point in "What's the Matter with Kansas." In his book, Frank addresses the following seeming paradox: Why would average working people in Kansas  -- home of staunch early 20th century progressive political populism -- vote against their economic interests and overwhelmingly support the Republican Party, the acknowledged party of Big Business that has systematically dismantled manufacturing and blue collar work in Kansas? Frank, a sociologist, found that on the key issue of jobs and overseas outsourcing, the Democrats were no better than the Republicans. Since there was no alternative on this issue, people in Kansas went with the Republicans, who they favored on some social issues. Frank's conclusion -- and his book -- are a devastating indictment of the Democratic Party on this critical issue.

The irony is also too palpable not to note. Historically, the Democratic Party has been the party of labor and the working class and the Republican Party of business and the elites. But, as we have just seen, the Democratic Party now has tilted strongly toward the business and professional elites on a key issue of outsourcing (and many other issues) as its progressive populism has been hollowed out with the passage of time. Meanwhile, the emergence of conservative populism has been bought and paid for by Big Business to pave the way for the Republican Party to regain power, so as to avoid regulations favored by the Democrats and abhorred by the Republicans. The degree of political bad faith is astonishing. You just have to love politics in this country.

Daniel Berger is an attorney in the field of complex litigation, including securities and anti-trust litigation, and has a broad-based knowledge concerning the structure and functioning of the US economy and US financial markets. He practices in Philadelphia.

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Love in the Time of the Haitian Cholera

Nov 2, 2010Rev. Marcia Dyson

haiti_map-150The Haitian people's will to survive, and thrive, is mighty. But they also need our assistance in battling crisis upon crisis.

haiti_map-150The Haitian people's will to survive, and thrive, is mighty. But they also need our assistance in battling crisis upon crisis.

I've always admired the haunting beauty and sad grace of Gabriel García Márquez's novel "Love in the Time of Cholera". But I never imagined that his title would conjure the force we'll need to fight Haiti's freshest suffering: an outbreak of cholera that threatens the loss of thousands of lives.

It's fitting that the novel in which Márquez temporarily loosens the hold of magical realism is the one that symbolizes Haiti's plight today. There's little state magic to speak of, and the economic realities that this country faces are tragic and legion. But my God, the will and spirit of the people remains indescribably, well, magical, to say the least. I've gotten to know Haiti and its people a lot better over the last two years as I've served and traveled throughout the complicated outlines of this besieged geography.

Haiti's present troubles may yet prove faithful to a script that seems passed down from on high: A small but mighty colony of oppressed black subjects will resist and rise just when nobody gives them a chance in hell to survive. That was certainly true of Haiti at its birth.

In 1804, the nation roared into existence after a decade-long slave revolt fomented by Toussaint Louverture, which ultimately resulted in Napoleon getting beaten at his own game -- and the world's first republic winning independence from France.

Haiti's will to rise was certainly challenged during U.S. military occupation of the country from 1915 to 1934, and its national urge to strength was surely suppressed as the U.S. exerted direct or indirect control of the Haitian economy from 1905 to 1947.

And through a string of tyrants, incompetents and soiled idealists at the helm of the nation (some with American support, or at least with our willingness to look the other way while the country was lost and looted), Haiti's people have managed to keep faith, even though that faith has been unjustly savaged and satirized as "Voodoo" -- with the scare quotes in tow -- little more than a hodgepodge of hocus pocus and superstition.

But that's the retail version of Vodou, pushed in the marketplace of ignorance and bigotry. In Haitian Vodou, practiced widely by much of the population, the spirits of the departed -- sa nou pa we yo, those we don't see -- don't fly away, but remain near to those left behind, permitting the suffering living the triumphant advantage of laughing in the face of death.

That's not a fatalistic position, but a supremely hopeful one. After all, the living have had so much death to defy. Is Vodou any more unrealistic a remedy than, say, colonial exploitation and schemes of duplicitous rationality deployed by would-be saviors in military or ministerial garb?

This doesn't mean that it's a pie-in-the-sky piety that isn't vexed by the mortal wounds of poverty and catastrophe. On the contrary: It's a source of spiritual resilience in the face of tragedy. The bipolar opposition between science and soul doesn't exist in Haiti, at least not in any reasonably concrete fashion. (For that matter, there isn't even a neat division between, say, Catholicism and the catechism of indigenous spirituality that flows effortlessly through the syncretic religious experience that is a noted strength of the African Diaspora.)

Even as we respect the homegrown spirituality of Haitian residents, we've got to ramp up the material resources they so desperately need. After the January earthquake left the nation in shambles and rubble, and 300,000 souls lingering near the living, you'd think God, or at least nature, might leave the Haitian folk alone long enough to recover. Until that theological dispute can be resolved, the political and ecological elements, as well as the moral ones, must be engaged.

We need to send more medical personnel and supplies to tamp down a fever of cholera that has pandemic written all over it. That's for sure. And we certainly need to send more money to responsible agencies to relieve the suffering. No argument here.

But we also need to ask some tough questions. Beyond the cholera crisis, is there a crisis in political legitimacy in Haiti and the United States, where real fault may be found in the use, or misuse, of international aid money? Regardless of the source of the outbreak, it's likely that most Haitians see it as a plague of nature. But what role does man play in this tragedy, especially through shortsighted priorities that diverted needed attention away from structural responses to Haiti's suffering? For every bottle of water sent, an inch of water pipe could have been built. For every tent erected, a transitional house could have been constructed. Simple, yes, but sound, too.

As U.S. taxpayers, are we aware of where this country's $1.15 billion pledge to Haiti is going? Do we know what sustainable deliverables are being guaranteed by contractors and suppliers? Finally, what of the African Diaspora's response to Haiti, especially from her benighted kin in America?

Sure, we brag about Louverture; we even sing the praises of the TransAfrica Forum and other groups that champion Haitian self-determination and effective governance. But in truth, we leave the economic and moral heavy lifting to white celebs like Sean Penn, Mia Farrow and George Clooney. Where are our black celebs -- besides Wyclef Jean -- in the fight for Haiti? What about the rest of us? Where do the sun-kissed children of the black experience stand in times of greatest crisis for our people in Haiti?

We need black love in the time of Haiti's cholera. We need the spirits of the departed ancestors to rally the will of the people to survive. We need the revolutionary spirit of Louverture and other slaves to course through our veins. And we need the sacrificial energy of black American brothers and sisters to circulate all the way to Haiti. Otherwise, we are in peril of losing our souls and condemning our brothers and sisters to even more rubble and disease.

Marcia L. Dyson works with the Fondation Lucienne Deschamps in Port-au-Prince, which is dedicated to education and the training of teachers.

A version of this post originally appeared on The Root.

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G20 Currency Accord Collapses Under the Weight of its Own Contradictions

Oct 25, 2010Marshall Auerback

marshall-auerback-100Our leaders are making decisions based on flawed premises -- but what we really need is jobs, jobs and more jobs.

marshall-auerback-100Our leaders are making decisions based on flawed premises -- but what we really need is jobs, jobs and more jobs.

Treasury Secretary Tim Geithner appeared fixated on US trade at last weekend's G20 Summit in South Korea. While it is misguided to focus solely on current account imbalances, there is a certain kind of perverse logic behind his thinking. Given that the US government is likely to cut back on spending in the near future, which won't do anything good for our consumption here at home, one can understand the Treasury Secretary's preoccupation with trade imbalances. In an economy that is far below full employment, higher exports could generate sufficient demand so that, as much as you might be exporting an increasing amount of your domestic output to increase the per capita consumption of foreigners, there is also an accompanying increase in US consumption because of the multiplier effects of more employment. Remember that per capita outputs, and per capita consumption, do not only rise because of imports, but also because we have more people employed. After all, while the Chinese are exporting ever more, they are also slowly increasing their own per capita consumption, especially as more and more of the disguised unemployed in the Chinese countryside become employed in the export sector.

But is the optimal policy truly to target current account imbalances? No. The right policy response is to work toward a full employment policy by vastly expanding fiscal policy. The US government is fully capable of doing this on its own without any global cooperation.

It is true that many of us have been saying for years that exports are a cost and imports a benefit, so therefore the US should maximize net imports. We have got absolutely no traction with this argument because it is a contingent statement, true only at full employment. So while we have suggested fiscal policies designed to get us to full employment, until the rate of unemployment is reduced substantially it is much harder to make the case that maximizing net imports is a good strategy in an economy that is far below its production possibility curve (i.e., far below full employment).

A sensibly constructed fiscal policy that incorporates a Job Guarantee program would be a great start. But let's be honest: It ain't gonna happen anytime soon, especially given the likely configuration of the future Congress after the midterm elections.

Failing a big fiscal response, then, there clearly is a big problem ahead for the US. The latest data from the US western ports indicate that the American economy has gone from a very rapid pace of expansion in exports on a sequential and year on year basis to small declines in exports on a year on year basis and more severe declines on a sequential basis. And a veritable tsunami of Chinese imports is now hitting our shores, the product of China's own substantial build-up of its export capacity last year (which is where their government deployed the majority of its fiscal resources).

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Why is US trade deteriorating? In part because the rest of the global economy might be slowing. But the more significant cause is China's over-investment in industrial tradables and the consequent pressures for greater Chinese exports and a greater degree of Chinese import substitution. More restrictive fiscal policy, added to deteriorating trade accounts, likely equals higher unemployment. It seems almost inevitable that this will engender more than mere threats from the American government next year. Tariff increases appear to be in the cards.

The upshot is that Beijing is going to be hit with the collateral damage via a trade war. Their economy's dependence on export growth  represents a clear and present danger. So the Chinese are doing themselves no favors by maintaining the pegged rate regime, which they should abandon as soon as possible -- largely for their sakes, not ours. Consider the following: According to the Hurun report on China's wealthiest individuals, 95% of those on the rich list earned their money by focusing on domestic consumption; just 5% are export moguls. Clearly this domestic consumption sector wants to grow from the bottom up, but Chinese government policy currently prevents it from doing so.

That said, you can see why Beijing doesn't take kindly to the "helpful suggestions" from the US, which are riddled with contradictions. On the one hand, Congress and the Treasury are accusing China of currency manipulation designed to increase its net exports. Meanwhile, the Federal Reserve, via "QE2", is trying to force a run out of the dollar to appreciate the currencies of our trading partners so that the US can export its way out of its Great Recession.

Similarly, Beijing has been raising its rates on concerns that the Chinese economy is overheating. But our Treasury Secretary is urging them to increase their already booming domestic demand so that they can buy more US output. At the same time, Geithner wants countries with trade deficits like the US to boost saving and cut spending. Fine, except that it seems odd to add to an already booming economy in China while the US is slumping and Geithner talks about the desirability for us to rein in long term deficits and therefore reduce demand.

At a basic level, the incoherence in the American proposals is symptomatic of a broader policy making problem when one operates from a flawed paradigm. Policy makers like Tim Geithner have long been clueless on domestic federal budgets. This time around, however, his focus on current account imbalances might be logical, but only as the stupid outgrowth of a misguided understanding of public reserve accounting. In many respects it is nothing but a sideshow, one which conceals the fact that most of the policies of the Obama Administration are only making matters worse (such as turning a blind eye to fraud as part of financial "reform").

The irony, of course, is that when China does begin to enact policies that allow its population to fully consume the fruits of its own economic output, then we'll be paying a lot more for basic stuff. Remember how great it felt to be paying $5.00 per gallon for gas during the oil price spike in the summer of 2008? That's going to be child's play compared to what's ahead. But we aren't taking advantage of the gift that China is giving us. And things will only get worse, because we remain prisoners of a 19th century gold standard mentality.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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Joseph Stiglitz: The New World Economy

Oct 25, 2010Lynn Parramore

joseph_stiglitz-150This is the sixth and final installment of  "The Influencers,” a six-part interview series that Lynn Parramore conducted in partnership with Salon.

joseph_stiglitz-150This is the sixth and final installment of  "The Influencers,” a six-part interview series that Lynn Parramore conducted in partnership with Salon. She caught up with Joseph Stiglitz, Nobel laureate and the Roosevelt Institute's Chief Economist, to talk about the changing global economy. Stiglitz explains that while the US has traditionally been an economic superpower, it may have to forfeit that role.

Lynn Parramore: People have said that before the crash, the U.S. provided the world's consumer of last resort. How much has the world changed in that respect?

Joseph Stiglitz: Well, before the crisis, the United States was living beyond its means, and much of what it was spending beyond its means was consumption. It is still the case that the United States is living beyond its means, but the good news is that the households are now beginning to save. But on the other hand, the government deficits have actually increased. So the fact is, the U.S. is continuing to spend beyond its means. Now in the long run, this can't continue, and that is what is sometimes referred to as the problem of global imbalances. It changed a little bit since the crisis, but the fundamental problems that have given rise to it have not been corrected.

China is running a massive export surplus, and this is beginning to emerge as a political issue. What's your take on this?

Well, China's problems are distinctive, and in some ways just the opposite of ours. They have a savings rate of 50 percent. China's not the only country that's running large surpluses; Germany's running surpluses that are largely comparable as a percentage of GDP, and Saudi Arabia has surpluses that are also large. The focal point of the debate in the United States has been exchange rates -- concern that the exchange rate between the U.S. dollar and Chinese currency is distorted by government intervention on their part. Adjustments of exchange rate are not likely to fully resolve the problem of global imbalances. In fact, from 2005 to 2008, the time when the crisis occurred, China had basically increased the value of its currency by 20 percent, which is about two-thirds of what most people had thought was the exchange rate adjustment that was needed.

Even if China continues to allow its exchange rate to appreciate, it is not going to solve the U.S. problems. The U.S. will be buying apparel and textiles from Sri Lanka, Bangladesh. It's not likely to start making them itself. And so it is a shifting of blame to say that is the U.S. problem. The problems in the U.S., I think, are more fundamental. It does hurt Sri Lanka and Bangladesh to have an exchange rate that might be distorted in that way, but it won't resolve the more fundamental problems of America's trade deficits.

Policy-makers often talk about the U.S. as the world's indispensable nation. Is that consistent with how you view America's place in a post-crash world economy?

Well, America is still the largest economy in the world, and in that sense it is going to continue to be a central player. Even the most optimistic forecast for China's growth suggests that it will be a quarter century before China is comparable in size, and even then, China's per capita income will be markedly lower than it is in the United States. And I think the United States is likely to continue to be the source of innovation, the source of higher education. So, the role of the U.S. is going to continue to be very, very strong. But there was a short period between the end of the Cold War and the crash of Lehman Brothers where the U.S. was the superpower not only militarily, but economically. It had a very strong role in dictating the terms of international agreements. That position is not likely to be restored.

Let's talk about the U.S. stance toward the crisis in the European Union. The rescue is being done as a joint project between the European Union and the IMF. What's your take on the role of the IMF in a new world economy? There have been some proposals, for example, to restructure the IMF. What do you think about that?

It's very clear that the IMF has taken a much more constructive role in this crisis than in earlier crises. Dominique Strauss-Kahn as the leader has really changed many of the policies and orientations, talked about the importance of unemployment, the necessity to have counter-cyclical fiscal policies, so in that way there has been a very big change in the role of the IMF. On the other hand, there is concern that if the IMF could change so quickly in one direction, it could change just as quickly back to where it was, and that raises very fundamental issues about governance, the need for changes in governance to make sure they are reflective not only of the advanced industrial countries and not only of the financial sectors in the advanced industrial countries, but of a broader representation of views.

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