A useful short paper by post-Keynesian economist Jan Kregel of the Levy Institute, focusing on the nature and causes of global financial and trade imbalances, and how they might be resolved in a way that supports global growth and employment.
Kregel argues that in today’s global economy, financial flows dominate trade flows, and are the cause of significant capital account imbalances, which drive concomitant current account imbalances.
Trade policy, such as the imposition of tariffs, and escalating trade wars, are unlikely to resolve these imbalances. On the contrary, controls on capital flows would be much more effective. An alternative to this is Keynes’s original proposal for an international clearing union, able to create liquidity not based on a national currency such as the dollar, and promote international cooperation. This seems a long way off in today’s world.
All this is along the lines of arguments made by Michael Pettis, whose ideas I refer to often on this blog. However, Pettis also links global imbalances to national savings behaviour, so that a ‘savings glut’ not invested domestically in one country can be exported abroad, and can create financial bubbles and rising debt, potentially leading to stagnation or crisis in the longer term.
The Levy Economics Institute of Bard College is ostensibly non-partisan but much of its published output is in the post-Keynesian tradition, and inspired by the work of Hyman Minsky and Wynne Godley, who both worked at the Institute in their later years. Continue reading →
There is a nice piece in this week’s New Statesman by economics commentator Grace Blakeley on the dangers of the unresolved eurozone crisis, with Germany at its heart. With growth in the eurozone currently slowing, after a brief spurt, unemployment is set to remain unsatisfactorily high in a number of countries, not least Greece and Spain. Germany itself is teetering on the brink of recession.
As Blakeley argues, resolving the crisis requires the northern states of the currency block to expand domestic demand. This is particularly necessary in Germany, the largest economy in the eurozone, which is running a current account surplus of nearly eight percent of GDP. It is thus overly dependent on external demand, and growth in world trade.
What the piece misses, maybe in order to avoid unnecessary complexity, is that a decade of wage stagnation in the 2000s, while rendering German exporters more competitive and profitable, and boosting employment, has also squeezed household incomes and raised national savings relative to investment. This is reflected in the aforementioned large current account surplus, which is by definition equal to the gap between domestic savings and investment. Continue reading →
David Pakman’s videos are well worth watching for his incisive and progressive analyses of US current affairs. But on the question of the global role of the US dollar, which he describes below, I think he is wrong. Watch this short video first, before reading my critique below.
Is the US dollar’s dominant role in world trade and reserve policy an exorbitant privilege or an exorbitant burden? I go with the latter. The argument that it is a privilege and benefits the US economically is often made. This argument draws the conclusion that the US is able to borrow and spend beyond its means as a result. The US current account deficit is therefore a good thing, as it reflects the higher consumption and lower savings that can be sustained. It also apparently allows the US to sustain a higher level of debt, whether on the part of the private sector or the government, which boosts aggregate spending or demand.
But as Michael Pettis argues in his book The Great Rebalancing, it is perhaps just as accurate to say that the dominance of the US dollar in global payments and reserves forces the US to consume beyond its means. It results in lower US savings relative to investment, reflected in the current account deficit, and higher savings relative to investment in the rest of the world.
The stronger demand for US dollars in the rest of the world produces a stronger dollar than would otherwise be the case. This makes US exports more expensive abroad, and imports cheaper in the US, and will thus tend to widen the trade deficit (exports minus imports) and the current account deficit, other things being equal. Production and employment will be lower among US exporters, who will find it harder to compete with rivals abroad. US firms producing for the domestic market will similarly find it harder to compete with cheaper imports.
Larger trade and current account deficits act to drain demand from the US economy. A larger capital account surplus is the flipside of a larger current account deficit, and represents the net inflow of funds required to fund the latter, or what the US is borrowing from the rest of the world. These funds will either be used to fund domestic investment, which can be productive or unproductive, or to fund domestic consumption.
The result is that the US savings rate will be lower relative to the US investment rate than it would otherwise have been. The savings rate could fall, while the investment rate stays the same, necessarily leading to a higher rate of consumption. Or the savings rate could remain the same, while investment, whether productive or unproductive, rises.
If the new investment is productive, and generates flows of income in the future greater than its overall cost, then the US economy will end up larger and more productive, while employment should be higher. If the new investment is unproductive, such as takes place in a housing bubble, then this will ultimately raise the debt burden and slow future growth in output and employment.
So a larger current account deficit need not be a negative factor for an economy, if the funds borrowed from abroad are used to fund productive investment. But this only tends to be the case for an economy which is short of domestic sources of finance for investment. For an economy like the US, with sophisticated and liquid financial markets, there is little evidence that domestic investment is constrained by a shortage of domestic saving. So capital inflows will tend not to lead to higher productive investment, but rather to higher unemployment or higher debt.
The capital inflows to the US, resulting in a capital account surplus, and reflected in the gap between domestic investment and savings, described by some commentators as a shortage of savings, are the consequence of excessive savings relative to investment in the rest of the world, or a ‘savings glut’.
Savings and investment must be equal for the world economy as a whole, but can be out of balance for individual countries. If savings rise in one country but investment does not, the surplus must be exported abroad, and lead either to higher investment or lower savings in the rest of the world, so that global savings and investment continue to balance.
The US can only be a net borrower from the rest of the world and therefore continue to run a current account deficit if foreign economies are net savers in aggregate relative to the US. Economies such as China, Japan and Germany have run the largest current account surpluses (meaning that they are net savers) in recent years. It is their policies as much as those in the US which lead to a lower savings rate in the latter.
This is because, for the world as a whole, the balance of payments must balance! Current account deficits in some countries must be offset by current account surpluses in others. The major surplus countries are avoiding significant appreciations of their currencies by accumulating dollar reserves. They do this in part to sustain relatively weak currencies which boosts net exports by making their exporters more competitive.
These surplus countries are relying on their exporting sectors to boost demand, growth and employment because the growth in their domestic demand is relatively weak. So any rapid appreciation of their currencies would hobble their exporters and growth would falter. It would also probably take some time for the necessary adjustment and certain economic reforms in order for domestic demand to take up the slack.
The surplus countries therefore have a strong incentive to sustain the status quo, which helps to maintain the dollar as the dominant world currency, keeping it stronger than it otherwise would be. This is the exorbitant burden which the US, and ultimately the world, must carry.
All this played a significant role in causing the global imbalances which led to the Great Recession of 2008. These imbalances need to be resolved in order for the world to begin a new period of sustained growth. So Trump and his advisers may be on to something when they complain about the US trade deficit. It may therefore be a good thing if the dollar becomes less widely used for global trade and the accumulation of reserves, whether this is intended or not. Everything else being equal, a decline in the dollar would help the US economy rebalance in the longer run, boosting growth and employment and reducing the debt burden.
Is there a solution to all this, which would go beyond Trump’s muddled bluster? There is, and it has been around since the formation of the Bretton Woods institutions in 1944. It was then that Keynes proposed the creation of an international currency, bancor, which would be used to prevent excessive international payments imbalances and the unsustainable buildup of debt, which he strongly believed would tend to stifle growth. His US counterpart Harry Dexter White rejected the idea.
We have been left with Special Drawing Rights (SDR), a basket of international currencies maintained by the IMF, which were created in 1969 as the Bretton Woods system of fixed exchange rates and managed international payments began to unravel.
If, as Keynes had hoped, something like the SDR were used more widely, then global payments imbalances should be less severe and more easily resolved. But this would, in the short to medium run, and contrary to the arguments of many economists, benefit the US economy and harm the major surplus countries which would be less able to run up large current account surpluses by keeping their currencies relatively weak and boosting their exports. Despite this, the argument should be made that it would create a more balanced global economy, and more sustainable growth.
Perhaps the trick is to appeal to the right vested interests, since ultimately consumers in the current surplus countries would benefit. Exporters in the US, and also in other major and long-standing current account deficit nations, such as the UK, would gain too.
As ever, one can’t ignore the politics. For Trump, whose muddled policies are currently encouraging a stronger dollar, a successful reduction in the US current account deficit might reflect a reduced global role for the US, as Pakman argues in the video, but a less dominant dollar would ultimately be good for US growth and stability. There might be some debate over whether the outcome would be making America ‘great’ again or not. But more widely-used SDR would also be a good thing for the prosperity and stability of the global economy, though this is perhaps a long way off, if it happens at all. Politics will get in the way of good economics, and not for the first time.
Despite a brief revival, the world economy is slowing again. A more sustained recovery will require international cooperation to reduce external imbalances in a way that reduces unemployment and maintains low inflation.
This post explores the role of the role of internal and external balance (or lack thereof) in helping us find a return to a more sustainable prosperity. These ideas form much of the theoretical content of The Leaderless Economy by Peter Temin and David Vines, which was published in 2013.
So do we need another policy scheme for restoring global prosperity? I would argue that we do. Global growth picked up in 2017 but, apart perhaps from the US, has begun to falter recently, not least in the UK, but also in continental Europe. Many economies have accumulated high levels of private and public debt, and have made little progress in reducing them. Continue reading →
More thought-provoking words from Michael Pettis on global economics and politics, particularly the relationship between the US and China, the pressures on international trading relationships and the two countries’ roles in future decades.
He describes the options open to the dominant global powers in restoring a more sustained pattern of growth and prosperity: one country can lead, or we can all get together and cooperate over economic policy.
He suggests that we are living through a period during which neither are likely. Furthermore, the experience of the 1920s and 30s demonstrate that this power vacuum could be bad for us all.