Rather than restoring confidence in the United States’ setting a course for sustainable recovery from the financial (and policy) failures that precipitated the global financial crisis, it created doubts about whether America was either going to maintain its medium term fiscal expansion or really come to terms with its long term structural over-spending.
In this week’s lead essay Peter Warr exposes the confusion around the problem of dealing with the US debt problem.
The US debt problem is inextricably tied up with the global and trans-Pacific imbalances problem. Current account imbalances are not necessarily a problem, as Warr points out. They reflect what economists call inter-temporal transfers between countries just like there are inter-temporal transfers among people and organisations within countries. These transfers allow higher spending by some when they might need to, using the savings of others who can afford to make them available. As Warr explains, ‘one country (the surplus country) is exchanging current goods and services for financial assets, which are claims on goods and services in the future. The other country (the deficit country) is doing the reverse’. There are gains to both parties through these transactions because ‘the initial circumstances of the countries involved are not the same. For some countries it makes sense to save more now, because they have a younger working age population, for example, in order to consume or invest more later. For others, the reverse applies’.
Why then is there so much focus on East Asia’s current account surpluses and how they need to be cut back?
The overwhelming international consensus is that the present global imbalances are unsustainable, even in the short run. East Asian countries are becoming nervous about continuing to accumulate US debt and may well decide to reduce the stock they hold. Americans are nervous about allowing the accumulation of their indebtedness to continue (though the political nerve to cut spending even over the longer run is in short supply) and they are moving to reduce the stock of debt they currently owe. The two are not mutually exclusive and could happen in tandem. They both rest on the fear that the burden of debt servicing might suddenly become intolerable for the debtors, importantly the US, and that could well result in a large and unexpectedly rapid adjustment, throwing financial and currency markets into a tailspin.
Unless there’s default, all debtors eventually have to pay their creditors, and so too Chinese and other East Asian creditors will have to be paid back by US debtors. This might not be a problem if it happens ‘gradually and predictably’. But if it happens ‘soon’, at an unexpectedly rapid rate, there could be serious adjustment problems involved, especially if current account surpluses have to be cut very quickly. If the problems can be anticipated it might be possible to avoid the large scale unemployment and other social costs that would otherwise result. ‘Growth rebalancing’, Warr points out, is essentially a problem of risk management.
That’s why Warr puzzles at the hue and cry in America that China and the other East Asian surplus economies should cut their surpluses back urgently. What that would do is put more intense adjustment pressure on debtors, including America. Winding back surpluses quickly will siphon off supplies of capital from international markets (to domestic spending in East Asia), putting strong upward pressure on international interest rates, and increasing (through higher interest costs) the burden of being in debt. That’s the last thing, one would have thought, that responsible American leaders would want right now. Keeping interest rates low while the debt burden is lowered seems a much more attractive option. A blinding glimpse of the obvious, maybe, but a point lost in the mad rush to shift the moral blame for one’s own predicament onto others.
Asia has its own problems. Ever since the Asian financial crisis, the Asian economies have, to varying extents, focused their production on exports and away from their domestic markets. If the current account surpluses are to be reduced significantly, or even reversed, they will have to reallocate resources towards production for the domestic market to avoid massive under- or unemployment. Moreover, lifting expenditure and reducing current account surpluses is a desirable objective, both because it increases national welfare and also because it contributes to stimulating a recessed international economy.
For the deficit countries the problem is exactly the reverse. But the objective is exactly the same: avoid large scale unemployment through raising the burdens of adjustment. With its huge stock of debt, the US has strong reason to maintain conditions that keep the cost of debt as low as possible. It should steel up for doing the adjusting it needs to do itself and, Warr suggests, ‘not be berating Asia to reduce its current account surpluses‘ over-soon.
Peter Drysdale