No Mas! New Policies not old mistakes

There
appears to be a somewhat interesting controversy afoot in explaining the reason
for the emerging markets panic and in establishing a solution for it. The
approach of Gavekal would simply like to keep the Ponzi scheme of past years
rolling forward. According to that view because the US has the reserve currency
the US current account deficit is theoretically unbounded and the US should use
its domestic demand to drive global growth stimulating the rest of the world
particularly in the developing economies.

Been there.
Done that.

shrink

Instead, of
going back to the old mistakes, we should all be aware that the reason for
these ongoing US deficits has been the export targeting of the US market by
developing economies wishing to tap US domestic demand. They have done this by
keeping their currencies artificially weak and have done this by buying dollars
to keep the dollar strong and by investing in the US… when there has been no
good reason to do so.

It should
be perfectly obvious that with the US unemployment rate having risen, with US
consumption outstripping investment  and
with the US as a relatively high-wage country around the world there hasn’t
really been any reason for firms to invest funds in the US market. Nor were US
banks adept at recycling, choosing instead to over-lend in the US housing
sector. As a result monies that were invested in the US for the purpose of
keeping foreign currencies weak versus the dollar necessarily went hunting for
unproductive investments. Because there were far more funds available than
there were profitable investments to be funded trouble ensured. Can we be
surprised that a crisis developed? Now Gavekal want to do it again.

If your
view of the US is a suckling pig that must offer a teat to any developing
country that wants one, surely that’s a model for trade to get in trouble.

By now
everyone should be aware that Germany has the largest current account surplus
in the world and it shows no sign of dissipating it. The US is starting to
contract its current account deficit but not because it has improved its
competitiveness but because it’s developing its natural resources namely
energy. The US nonoil deficit continues to get worse. Gavekal is right about exploitable
net demand becoming more scarce.

The Gavekal
explanation of the recent market panic is that the Fed sought a weaker dollar
with negative real interest rates…this is another example of someone arguing
from ‘the facts’ to a convenient –if incorrect- conclusion. Central banks
around the world kept interest rates low; inflation was low too. The US was
aiming its policy at domestic demand, by far the biggest effect from low rates
was on demand at home. There may have been some international fallout but the
Fed was definitely not aiming to weaken the dollar. As someone who has worked
at the Federal Reserve Bank of New York and in the currency area I can assure
you that the Fed does not view itself as the principal architect of US exchange
rate policy. It is widely recognized that that option belongs with the US Treasury
and when it comes to foreign-exchange matters the Fed has a minor toehold to
have some say in the discussion. There can be no doubt the US interest-rate
policy was aimed at the domestic economy and at domestic demand with the
foreign-exchange aspect viewed as a side effect rather than as a principal
policy goal.

 

The US
rarely aims its policy at international matters. But it is a large open economy.
Its policies are aimed at its economy but because the economy is ‘open’ there
are international repercussions.

Still, it
would be far better for the developing economies to balance their growth and to
develop their own domestic demand. China is being forced to do it out of
necessity. China is the quintessential bull in the china-shop that ran such an
aggressive exchange and trade policy that ruined the playing field. China, a developing
economy, ran current account surpluses! China sought to get a growing share of
global production and, as its GDP grew, the consumption share of GDP in China fell…
so much for ‘development.’  China was mercantilist.
China kept its wages low and never allowed its exchange rate to matriculate. China
broke the exchange rules which call for a surplus country’s exchange rate to
rise. And now with the Western economies floundering and so highly in debt,
China can no longer expect to gain the export penetration that once fueled its
growth and it must turn to domestic demand. It’s a lesson that other smaller
developing economies need to learn.

The US central
bank’s reserves also need to be pulled and as a share of GDP and in no way
should we look for those to expand or to take that expansion is a sign of
continued growth or anything good going on in the US economy. In fact these
sorts of arguments made by Gavekal given time would almost certainly bring about
the antithesis argument criticizing these policies for driving the US into even
greater debt and to a larger consumption share of GDP.

 

Instead, in
the time, the US  should be redressing
these excesses.

Panics come
when markets lose their grip or focus. When the paradigm begins to change in a
way that’s inexplicable and when market participants are no longer sure who or
what is in control you can get panic selling. Developing economies need to
change their models. And change can be destabilizing. They need to balance
their growth. They need to develop their own internal demand along with
production. The watchword needs to be balance- not more US dependency.

 

And the US
needs to shrink its current account deficit. And, perhaps ominously for the
rest of the world, it needs to shrink even the nonoil portion. The US needs to
improve the competitiveness of its good sector in order to create jobs. And
developing the energy sector alone is not going to do that.

The
international paradigm is changing. It should change. It must change. This
challenge is bound to create some turmoil. We can hope that at the end of the
turmoil we get policies realigned in the right direction rather than
backtracking on the progress we’ve made. To continue to make more of the same
old problems worse would be a real shame.

    



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