February 10, 2008
The US should be running a current account surplus, have a very strong currency, have no debts and enjoy permanently low interest rates, kept down by its huge savings – but the opposite is the case.
The day the Federal Reserve slashed interest rates, I listened to Latin American economists and business leaders discuss what they thought the future held for the southern neighbours of the US. The Mexican central bank governor, referring to the carnage in Wall Street, the sub-prime crisis and the credit crunch, jokingly remarked: ‘‘At least we didn’t cause it this time.”
He was referring to the fact that, typically, banking crises start in what we term emerging markets. Over the years, western stock markets have been rattled by such episodes as the Latin American debt crisis of the 1980s, the meltdown in the ‘Asian Tiger’ economies in 1997 or the default of Russia in 1998.
All of these stories had one theme in common – the countries were living beyond their means and they were over-dependent on foreign loans, which ultimately caused the entire unsustainable edifice to come crashing down.
Interestingly, the reaction to these crises from Washington has always been vaguely puritanical. In fact, sometimes the language from the US capital is distinctly moral in tone. After a crisis, the delinquent countries are told to take the pain, suffer the consequences of their own aberrant behaviour, reform and be cleansed.
The Latin Americans – more than most – have had to accept regular lectures on economic purification from the Calvinistic northern continentals.
Interestingly, now that the US is going through its own troubles resulting from precisely the same reckless behaviour that landed the emerging markets in trouble in the past, the message from Washington is very different.
Rather than telling the American people that they have to purge themselves after ten years of binging, the American authorities are doing everything in their power to prevent any economic hangover.
The US is scrambling around for financial anaesthetics in whatever form it can find. The Federal Reserve is slashing interest rates, the dollar is being allowed to fall and George Bush is ramming through yet another tax cutting/government spending package to try to stave off the day of reckoning.
The Americans are trying to borrow their way out of this crisis, despite the fact that borrowing got them into this hole in the first place.
So, in terms of the consistency of the global economic message, it’s one rule for the poor and another one for the rich. This weekend, the G7 finance ministers are meeting for one of their regular chinwags. One wonders will any of them highlight this fairly obvious anomaly.
But instead of pointing the finger, the issue is how did America get into the position of resembling a huge emerging market, gorging on consumer goods that it cannot afford and borrowing other people’s money to sustain this lifestyle?
As much as the story of China, India and Russia has dominated global economic discourse for the past 20 years, the long-term erosion of America’s economic hegemony is the flip side of that globalisation coin.
Sometimes with all the razzmatazz of the presidential election, we forget that we might very well be observing the gradual decline of a great power. (This is bad news for Ireland, as America remains our best friend and main economic ally.)
In traditional economics – the stuff you learn in school and university – countries are poor because they lack capital. This capital constraint prevents people from getting the best out of their natural talents. Yet countries face a dilemma – in order to accumulate capital, they need to generate a current account surplus, which usually comes from saving more than they invest.
But if a poor country saves rather than invests, its standard of living falls – which is hardly a national objective. To get around this conundrum, traditionally, the poor countries import capital from the rich ones,which they fuse with their own labour to make stuff.
They can then sell this stuff back to the rich countries and, in doing so, generate the cash to pay back the loan and maybe have a bit left over to re-invest. This, in a nutshell, is one of the principal ideas behind Gatt, free trade and the present trends towards more globalisation. (There are others, but let us stick to this for a while.)
In this globalised world, the US – because it is the richest country on earth – should be a net lender to the poorer regions of the globe. It should be running a current account surplus, have a very strong currency, have no debts and enjoy permanently low interest rates, kept down by its huge savings.
But the opposite is the case. The US is sucking in capital from much poorer countries that arguably need it more. It is running the largest current account deficit in economic history and is allowing its currency to devalue constantly – despite the White House suggesting that it is wedded to a strong dollar policy.
At the same time, it is printing IOUs to the rest of the world in order to finance itself. And, rather than urging the American people to tighten their belts as it does when the other ‘emerging economies’ find themselves in difficulties, the American authorities are telling their people to borrow even more. To put this in context, the US needs to borrow more than $7 billion a day just to sustain its current lifestyle.
We now have the confusing spectacle of the richest country in the world behaving like one of the poorest and most irresponsible. It is trying to maintain a lifestyle that it simply cannot afford and, in doing so, it is creating the conditions for the ongoing decline of American power.
Just consider for a minute the relationship between China and America. What does the huge trade imbalance between the two countries tell us? One way of looking at it is that China is subjugating the living standards of its own people to enhance the living standards of Americans. This seems to make no sense, yet this is what is happening.
The Chinese current account surplus is now close to $200 billion, while the American current account deficit is moving towards $900 billion.
This means that $200 billion of Chinese money that could be spent in China is being spent outside the country, and $900 billion of the rest of the world’s money, which could be spent in poorer countries, is been hoovered up by the US.
If you visit China, it’s not hard to see why the Chinese would be better off spending the cash at home, building infrastructure or simply allowing the Chinese people to benefit materially from their hard labours.
But the Chinese government seems content to let the Americans enjoy themselves with Chinese money, while keeping its own people in relative privation, despite the country’s recent wealth.
However, the rest of the world needs US demand to keep us in clover. They buy what we make. So we have a global conundrum. No country ever borrowed its way to prosperity as the US is trying to do now.
Despite all its talk about rectitude, financial probity and the need for transparency and responsibility, the US is behaving like a large emerging market, and no amount of gushing coverage of its presidential election can disguise this. Something will have to give.
Can it just keep borrowing money and repaying loans in its debased currency? Not likely. The next president will have to find away out of this conundrum. If he or she can do this without a recession, it will be quite a Houdini act.