US
will take easy option By
Hossein Askari and Noureddine Krichene
Although the fallout of the financial
crisis has been pervasive and acknowledged, its
direct impact on the clash of ideologies and
economic cooperation seems to have become only
recently apparent.
Legislation on urgent
economic initiatives and policies is at a
standstill in the United States and the latest
gathering of Group of 20 ministers and central
bank governors in Paris has resulted in little
that is worthwhile on economic and financial
cooperation among countries.
In the end,
disagreements and conflicts could quickly mushroom
at any time, leading to increased protectionism on
trade and
capital controls to stem the
flow of "hot" money from the US to emerging market
economies. It is time to listen more and to accuse
less if we are to avoid years of stagnation and
high unemployment and a reversal of globalization.
The standoff in the US Congress is likely
to continue for some time. Although both sides of
the aisle readily acknowledge the long-term
unsustainability of huge budgetary deficits, they
are oceans apart in how to address it - measured
cuts while economic activity is weak or
significant cuts to forestall larger deficits;
where to cut; and what of tax increases now, later
or never?
At the global level, the
presidency of the G-20 is with President Sarkozy
of France for 2011. His changing agenda has six
elements:
reducing current account imbalances and
fostering economic coordination;
reforming the international monetary system;
tackling commodity price volatility;
improving financial regulation;
contributing to development, especially
helping Africa; and
fighting global corruption.
To make an
"effective" and significant result in even one of
these areas before the November heads of state
meetings in Paris would be exceptional, but in all
six? Yet, President Nicolas Sarkozy has implicitly
acknowledged the difficult road ahead by
enumerating these difficult and intractable
problems facing the global economy.
While
the global economy and financial system continue
to be in the worst shape of any time since the
Great Depression, the weekend meetings in Paris
produced little understanding, cooperation or
commitment to restore hope for a sustained
turnaround. Namely, because they could not agree
on the current account as indicator of emerging
problems, they resorted to changing the definition
of the current account to exclude interest on
foreign exchange deposits. In addition to "newly
defined" current account, other indicators include
the level budget deficit and public debt, private
debt and saving rates.
But while they have
adopted these, at future meetings they will have
to agree to how to assess these indicators to
decide when, for example, a current account or the
budget deficit or the level government debt is a
problem. This will be much more problematic.
These target indicators are not biding in
any sense but will be used to draft guidelines for
coordinating economic policies. But even then,
these are simply policy "guidelines" for
coordinated policies. In essence, there is much
more negotiating required in order to arrive at
something that will be at best seen as a broad
policy guideline, something that each country will
use differently to arrive at different policy
prescriptions.
There is no doubt that the
Barack Obama administration's continued loose
monetary policy and rapid increase in fiscal
deficits has fueled conflicts within the G-20. US
Treasury Secretary Timothy Geithner blames China
for the large current account deficits of the US;
he reasons that an undervalued yuan increases
American imports from China, reduces American
exports to China and thus widens the US current
account deficit. He has been trying to align
Europe and emerging economy countries against
China's currency policy.
The US Congress
has endorsed the Geithner thesis and has even
threatened to adopt unhelpful legislation to
punish China. Such a unilateral approach to global
cooperation shows little understanding. The US
conveniently forgets the impact of its own fiscal
deficits and near-zero interest rates on its
external imbalances and the fact that China does
not dictate these to the US.
Money market
interest rates are 0.1% in the US and 6.8% in
China. The US fiscal deficits have to be financed
by someone. In the past, this has fallen on China.
If the US deficit is not financed by China or by
other countries, it will have to fall on the US
private sector and, under the current economic
conditions, this would only further stall US
economic growth and lead to even higher levels of
US unemployment.
Secretary Geithner wants
to cap external current account imbalances at 4%
of GDP. Why doesn't he just do this himself? What
is he waiting for? Why redefine the current
account and negotiate? Here's how he can do it.
Slash government spending and cap fiscal deficits
at 1% of GDP. He will get there. But just imagine
the massive fallout on unemployment. And yes,
he'll be fired from his position in rapid order!
The Fed's overtime money printing is a tax
and its near-zero interest rates are highly
distortionary. The fiscal deficit corresponds to a
bundle of real resources that has to be mobilized
in favor of the US spending programs. The Fed buys
Treasury bonds and pays with painlessly printed
dollars. Who is paying for the deficit now?
Consumers are paying in the form of rising food
and fuel prices and less noticeably in other
rising prices such as healthcare and tuition fees.
Because the dollar is a world reserve currency,
even the poor around the world are paying their
share in the inflation tax that finances the
fiscal US deficit and the profits of speculators.
Of course, other countries can inflate their
currencies as suggested by Fed chairman Ben
Bernanke (see below), but it will only tax
themselves and not foreigners. Call it the justice
of the international monetary system.
Bernanke, in his recent testimony to the US
Congress, called on all countries to appreciate
their currencies in order to solve their food and
fuel price inflation. Clearly, he refuses to see
the other side of the coin.
An
appreciation of foreign currencies vis-a-vis the
US dollar poses another set of problems for the
US, making US imports expensive and in turn
fueling domestic inflation as in the 1970s, when
the US dollar depreciated against trading
partners' currencies. The role of the dollar as a
reserve currency would be threatened.
Furthermore, as long as the Fed keeps
printing money, an appreciation of foreign
currencies vis-a-vis the dollar will do much less
to help exports as these will be absorbed by
increased domestic demand and exports will be
somewhat impeded by a rise in the cost of raw
materials and other inputs. Exports priced in
dollars will jump, in part offsetting the benefit
of a dollar depreciation. Extremes are not the
best solution; a balanced approach should be the
way ahead.
President Obama's policies over
the past two years have both short-run as well as
long-run implications. In the short-run, budgetary
deadlocks will continue.
In the short run,
spending cannot be curtailed and tax rates cannot
be raised. The only political solution is
inflationary financing of deficits through money
printing and near-zero interest rates. The deficit
will have to blow up the external current account
or depress the US economy. There seems to be
little hope for a sound compromise between the
sharply divided political ideologies.
The
long-term prospects of deficits make future fiscal
and money policies highly intractable. While every
populist politician can readily expand government
spending, there is no politician who would roll
back spending or stop inflation financing when
public finances become unmanageable.
The
future is looking more ominous by the day as it
will be very difficult to restrain fiscal deficits
or drain the trillions of dollars that have been
injected by the Fed into a fragile financial
system. The most likely scenario is an
inflationary course with much international
recrimination.
Hossein Askari is
Professor of Business and International Affairs at
the George Washington University. Noureddine
Krichene is an economist with a PhD from UCLA.
Their latest co-authored book is The
Stability of Islamic Finance (John Wiley and
Sons 2010), with a foreword by Sir Andrew
Crockett.
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