Posted: 21 Aug 2010 12:55 AM PDTJohn Plender in his comment at the Financial Times, “Great dangers attend the rise and fall of great powers
It is a discomfiting historical fact that great power shifts in the global economy are dangerous. They have tended to coincide with extreme financial dislocation, currency turbulence and trade friction. This is because the aspiring new boy on the block is usually a protectionist-inclined creditor country that is reluctant to shoulder international responsibility commensurate with its economic strength.Yves here. There are a number of different ways to frame this change, both as to when it took place and what its triggers were. World War I forced the end not merely of British ascendancy, but the powerful hold of monarchies and landed aristocracy on political power through much of Europe. No one saw this sea change coming; the summer of 1914 was gay, and while many saw war in the offing, it was expected to be a short affair.
Consider the transition from British to US hegemony after the first world war. From 1918 the US rejected the Versailles treaty, opted out of the League of Nations and had nothing to do with German reparations, although it collected war debts from the allies. Britain’s liberal attitude to trade allowed the US to run a big trade surplus. Meantime, the young and inexperienced Federal Reserve pursued lax monetary policies in the Roaring Twenties while unwisely trying to prop up the ailing pound.
Similarly, I’m not certain whether greater US engagement could have shifted the tide sufficiently after World War I to have prevented many of the woes that followed. The US was a late entrant and thus would have no basis for playing a leading role in crafting a post-war order. Many stakes were put in the ground with the Treaty of Versailles. Moreover, the US appears not to have been up to the task of international stewardship, even if it had aspired to that position. Keynes’ Economic Consequences of the Peace depicts the US representatives as skillfully manipulated and marginalized. Back to the Financial Times:
When the Fed belatedly pricked the resulting bubble in 1929, the Jazz Age came to an abrupt end, banks collapsed and the depression ensued. As the US exported its problem of deficient demand to the rest of the world, it failed to provide leadership to prevent an outbreak of disastrous competitive devaluations and was unwilling to act as a global lender of last resort to collapsing banks.Yves here. The US was having enough trouble attempting to right its own economy, particularly since initial enthusiasm for Roosevelt by quite a few businessmen and financiers quickly soured. The idea that the US could act as a lender to foreign banks seems quite implausible. And I’m not certain this supports Plender’s argument, that the US should have done more. As we’ve noted before, there are tradeoffs among international integration, national sovereignity, and democracy. Plender is arguing (basically) for the US running roughshod over national sovereignity and democracy to salvage an international financial order. There are very few windows where the stars align for that strategy to be both politically viable and economically sound. One was in the wake of World War II devastation, when the US, with 50% or world GDP, was unquestionably dominant, and the Axis nations were prostrate politically. Back to Plender:
The next case in point is postwar Japan. Japanese economic growth was export-led, fuelled by an undervalued yen and subsidies for exporters. It was a model that worked as long as Japan was not a significant economic power. Yet by the late 1960s Japan was the second largest economy in the world. It was also running a huge trade surplus with the US.Yves here. There’s an implication that Japan should have sought a dominant role, but first, Japan was and is a military protectorship of the US, and second, Japanese would really rather not deal with foreigners. Moreover, Plender suggests Japan’s real estate and stock market bubbles were an accident. In fact, the authorities were in favor of them, because they thought the wealth effects of higher asset values would spur more domestic consumption, which would in turn offset the dampening effects of the fall in exports caused by the rise of the yen. The authorities raised rates because the bubbles were producing income and wealth disparities and undermining Japan’s highly valued social cohesion.
International efforts to address imbalances and stabilise an overvalued dollar in the Reagan era had unintended consequences – not least that Japanese intervention in the yen-dollar rate had the same bubble-inducing outcome as the Fed’s efforts to prop up sterling in 1927. The pricking of the bubble led to 20 years of economic stagnation.
Back to Plender:
China’s challenge to the US is similarly export-led and its current account surplus is the biggest contributor to the Eurasian savings glut that led to the credit bubble and the global imbalances behind the financial crisis. Yet despite its success, China’s economic model generates wasteful over-investment and under-delivers to ordinary people, who have the lowest share of private consumption in GDP in Asia. In a country that enjoys double-digit growth rates, employment growth has been running at a paltry 1 per cent a year, while real returns on savings are negative. As with Japan at its peak, the economy delivers a poorer quality of life than the per capita income figures suggest, with pollution, adulterated food and bad employment conditions posing threats to health…Yves here. Notice how Plender sees the political obstacles in China put the onus on the US to force changes. Most policymakers are wedded to the idea of free trade, but with a high unemployment rate and slack resources, the US would come out ahead by implementing protectionist measures (although corporate CEOs might not fare as well). As unemployment continues to be high and foreclosures continue to exact a toll, pushing back against mercantilists like China will look more and more attractive.
What is needed globally is for both debtor and creditor countries to rebalance their economies. The debtors need to tidy their balance sheets, while the creditors need to bump up domestic consumption, let currencies float and reduce export dependence. This would also be in China’s own interest because its economy is in disequilibrium. It cannot, among other things, prevent inflation and asset-price bubbles while running an artificially low exchange rate. Yet the obstacles to change are formidable. The key to rebalancing towards consumption, says Mr [Charles] Dumas [of Lombard Street Research], may be relaxation of government control over its citizens, which is unlikely to happen. There are also powerful lobbies against change, not least the inefficient producers who have been featherbedded by a cheap currency and whose economic survival depends on continuing undervaluation.
There is, then, a Chinese policy impasse. How does the world escape from its dire potential economic consequences? One scenario might be muddle-through: the US responds to an impending economic slowdown with looser fiscal and monetary policy, at the cost of racking up more debt and a crunch later on. Another would see US fiscal conservatives prevent budgetary loosening, while monetary policy remains lax. This would cause the US current account deficit to shrink sooner rather than later.
Either way, the risks of a protectionist backlash against China would rise. Under either scenario, the world’s creditor countries would ultimately see their chief market dry up. The main difference is in the timing. When, you might well ask, will the creditors wake up?