Growing Imbalances in the "Global Economy" Threaten to Sink All Boats
Wednesday, July 26, 2006
|Alan Tonelson is a Research Fellow at the U.S. Business & Industry Educational Foundation and the author of The Race to the Bottom: Why a Worldwide Worker Surplus and Uncontrolled Free Trade are Sinking American Living Standards (Westview Press).|
I suppose it was inevitable: Just as the Doha Round of world trade talks was missing a recent deadline and nearing oblivion, one of the peppiest globalization cheerleaders dragged out the old stock-market-collapse warning. “The breakdown of the trade talks,” predicted Institute of International Economics Senior Fellow Jeffrey Schott, “would likely precipitate adverse shocks in financial markets.”
Although Schott is simply desperate to salvage a trade negotiation so misbegotten that even outsourcing multinationals are lukewarm, he’s right to connect the worlds of trade and finance. Only like so many others, he’s drawn the wrong connection. Usually, Wall Street barely notices trade talks. (Seriously – could your broker define “Doha”?) But the recent turmoil in global stock markets has been profoundly affected changes in global trade and investment flows over the last fifteen years. It represents the latest in a string of warnings that the breakneck brand of globalization dominating this period is leaving the world economy more unbalanced and thus more unstable than at any point since the end of World War II. In fact, the distinctive evolution of trade and investment flows since the early 1990s is turning the entire global economy into a gigantic bubble – just as superheated and fragile as any of the individual asset bubbles that have emerged lately in America and throughout the world.
As even many Wall Street bulls now fret, the world economy today stands at a genuine inflection point. Talk of a “Goldilocks” era of “just right” growth that could create widespread prosperity without triggering inflation now seems a distant memory – although it was all the rage in financial circles scant weeks ago. Now recent good times are increasingly attributed to unprecedented government stimulus policies. This glut of easy money has propped up the U.S. and other major economies by inflating bubbles in assets ranging from real estate to emerging markets, but above all by buoying consumption in the United States, by far the world’s biggest engine of growth.
Because this ocean of cheap credit is now starting to fuel inflation as well as growth, monetary authorities nearly everywhere are tightening credit in hopes of restraining prices by slowing growth to a more sustainable pace.
Normally, such tightening exercises are no big deal. True, central bankers regularly overdo it, but for all the political outcry invariably heard, the damage to fundamentally sound economies is rarely deep or lasting. (That’s why central banks in most major economies are politically independent.)
This time, however, the angst expressed about higher U.S. and global interest rates is more justified, and the reasons point back to the vastly underappreciated effects of breakneck globalization on the U.S. economy and world economy.
The main problem is even more serious than the increase in inflation relative to growth. Instead, it is that, despite the record stimulus that has been injected into the U.S. economy in particular recently, inflation-adjusted growth itself is well below record levels. The Fed drove short-term interest rates down to five-decade lows after 9-11. The federal budget balance swung from significant surplus to deep deficit thanks to a combination of tax cuts and ramped up entitlements and defense spending. Rock-bottom interest rates, moreover, produced an earthshaking but largely unforeseen side-effect – along with a housing boom, they sparked a consumption boom paid for by mortgage refinancings. Yet this extraordinary pro-growth policy environment has produced growth that is actually weaker than in several other periods of much more modest government stimulus. U.S. consumption, meanwhile, has also become increasingly dependent on fresh credit rather than earnings or on new savings, as inflation-adjusted wages continue a three-decade sag, and the household savings rate has recently turned negative.
Record stimulus without record growth is a formula for trouble, as is increasingly debt-dependent consumption. The former reveals that the U.S. economy’s engines are stalling – i.e., generating less and less growth bang from each new stimulus buck. The latter reveals that Americans no longer finance many of their purchases in a responsible manner. In other words, bubble-like qualities have begun to permeate a U.S. economy that drives the global economy.
No wonder investors everywhere fear a global and especially an American monetary tightening. Even a simple return to historical normal U.S. credit conditions (along with normal budget discipline) could trigger far more than a manageable cyclical recession. Given the U.S. economy’s high degree of leverage, and the declining growth produced by this leverage, a long, deep American downturn could result. Worse, given an export-happy world’s heavy reliance on U.S. growth, this downturn could quickly spread internationally, and gather powerful momentum in the process.
Yet keeping interest rates artificially low and the world economy flush with liquidity is hardly an option. It could stoke inflation further and re-heat the asset bubbles that are now widely recognized as fragile and dangerous. In addition, America’s massive and soaring indebtedness to the rest of the world itself will eventually force interest rates up, as the nation’s creditors demand greater compensation for assuming higher and higher risks. Just as important, today’s easy-money policies have so far shown no potential to solidify the U.S. economy’s foundations and turn debt-fueled consumption into healthier earnings-fueled consumption. In fact, they have simply rewarded and consequently subsidized ever-greater borrowing.
Thus the world’s fundamental economic dilemma is not the recent emergence of so many individual investment bubbles, or the return of a 1970s-style trade-off between growth and inflation, or faltering investor confidence in the post-Greenspan Fed. Even the sudden increase in global investors’ perceptions of risk has only reflected, not caused today’s troubles.
The fundamental problem is that, although most major trading powers keep growing more dependent for their growth on American consumption, a bubble-izing America’s ability to sustain that consumption is declining. Even more disturbing, because this indispensable source of global growth is weakening, the world economy itself looks increasingly like a bubble.
Policymakers will never reverse this vicious cycle unless they understand its origins. A genuine search for answers inevitably leads to recent globalization policies.
In the first place, recent U.S. globalization policies have set the stage for a steady bubble-ization of the American economy. They helped to limit severely the growth of America’s productive capacity, and therefore of the earnings power needed to support the first world lifestyles Americans expect. Since the 1970s, when Europe and Japan were completing their economic comebacks from wartime devastation, U.S. leaders have mostly ignored predatory trade policies in these regions that ravaged many U.S. industries. When the costs of this neglect became intolerable in the mid and late 1980s, and Washington remained indifferent to American industry’s plight, victimized U.S. multinational companies shifted gears. They successfully pressed for a new trade strategy that restored and even widened their profits, but that further weakened the nation’s wealth-creating capabilities.
These companies generally dropped their calls for opening Japanese and European markers and convinced American leaders to pursue numerous trade agreements with low-income countries, like Mexico and China, that were designed to encouraged the offshoring of not only American factories but increasingly laboratories and their lucrative employment opportunities. Such investments were portrayed to Congress and the public as magnets for American exports
to potentially huge emerging markets. Greater demand for U.S.-made products and higher American wages and earnings power would follow. But their main effect was to promote the supply of the U.S. market from ultra low-cost production sites, and thus to displace domestic production and workers, and to depress wages.
The second major effect of these globalization policies was political. American leaders felt pressure to keep the nation’s workers happy and spending robustly even as their inflation-adjusted wages and benefits were falling. Hence the gusts of monetary and fiscal stimulus that pushed consumer spending far beyond earnings levels, and that provided the bubble’s hot air.
This American bubble has been globalized by the persistent failure of leading U.S. trade partners to increase their own consumption and importing significantly, and by Washington’s equally persistent failure to adjust sensibly. Japan and Europe (notably Germany) have remained Scrooge-like spenders as well as closed economies that prefer to grow through net exports – especially to the profligate United States. Most of America’s newer third world trade partners also limit imports and vigorously promote exports – again, especially to the United States. These countries, however, generally have little choice. Despite their new productive prowess, they are strapped with gluts of labor that will for decades hold down wages even in advanced manufacturing and professional sectors, and keep their people on the whole far too poor to afford even the goods they produce.
Further, because most major trading countries are so consumption-challenged and so reluctant to import, they have invested many of their export earnings in their biggest customer, the United States, and not in their own economies. This massive credit flow comes from low wage countries like China as well as high wage countries like Japan, and represents the ultimate source of Washington’s ability to keep America’s consumption and living standards artificially high.
The unprecedented and growing gulf between the world’s main producers and consumers is creating a global economy that capitalism’s founding fathers would find so intrinsically shaky and unsustainable as to be preposterous. These 18th and 19th century thinkers envisioned a world of countries with various productive specialties determined by the resources and skills nature gave them. This global division of labor, moreover, would generate self-balancing commerce, as the world’s leading trading powers collectively bought nearly all of what they collectively sought to sell. Such a system would lay a durable foundation for global prosperity.
Yet the world’s burgeoning America-centered trade and investment imbalances indicate that the nation’s natural advantage increasingly is not producing anything. Rather, it is consuming. Moreover, deficits rooted in robust production in low-consumption regions mean that today’s worrisome global imbalances are structural in nature. They cannot be eased by the natural swings of the business cycle, or by standard policy tools that seek to tweak the cycle. The imbalances will continue soaring until the trade policies change. So, consequently, will the threat of a catastrophic collapse of this global house of cards.
As noted recently by my colleague William Hawkins (“Banking on China,” June 17), many leading Wall St. bears, like Morgan Stanley’s Stephen Roach, recognize how today’s trade imbalances threaten the global economy. But they adamantly refuse to recognize that unilaterally changing the trade flows is the only effective remedy. Indeed, they spend so much energy stigmatizing “protectionists” in Congress and elsewhere that they forget how dismally their preferred solutions have failed – and why.
For example, counting on America’s export-obsessed trade partners to import more voluntarily has proven futile for decades. For better or worse, these countries have decided that their current mercantilist strategies are at least better than any conceivable alternative. Trade barriers, moreover, will surely prevent foreseeable future increases in third world consumption from automatically translating into more net imports just as they have in higher income countries.
For similar reasons, cooperative exchange-rate proposals and even calls for unilateral dollar devaluation
are non-starters as well. If the world’s currency manipulators either saw the global merits in truly free currency markets, or viewed them as consistent with their own national interests, they would have stopped manipulating already without American hectoring. And they could offset
a U.S. devaluation either by matching America’s moves or by substituting other trade barriers for their currency protectionism
Such international approaches to global imbalances are not totally hopeless, but they need one key ingredient for success: Threats and, if needed, actions by the United States to start restricting imports unless or until the mercantilists come to the table in a distinctly cooperative mood. This brand of hard ball comes straight from Bargaining 101, but most so-called realists from Wall St. or academia seem too wed to outdated ideologies or to invested in the status quo to acknowledge the imperative of Washington brandishing a big protectionist stick
The establishment’s bromides about Americans’ need to save more, meanwhile, conveniently ignores a widely accepted economic truth: Wealthy people save much more than poor people. In other words, the best way to restore America’s historic frugality is to use trade policy to bring home high-wage jobs in manufacturing and tradable services back on-shore – not to hope for hard-pressed American workers to suddenly turn more frugal, or for timorous politicians to start demanding sacrifices from voters.
And as for restoring national competitiveness by fixing America’s schools, that option doesn’t even qualify as serious in an era of the widespread offshoring of info-tech and professional services jobs to countries like China and India. The tide can only be stemmed by changing the plethora of trade agreements that have given multinational companies such powerful incentives to supply the U.S. market from super-low-cost, reasonably productive foreign bases. As long as the trade-outsourcing policy status quo continues, even successful efforts to fix the schools would simply wind up producing scientists and engineers for jobs that no longer exist.
One of the bedrock insights of modern economics is that there are no free lunches. Even with the most creative financial innovations, production and consumption mut be kept in some sustainable balance. Recent globalization policies, and especially the outsourcing trade deals at their core, have held out to multinationals and their apologists in academia and public policy one of the most seductive free lunch promises of all time – of a world in which all the workers would continue to consume like Americans, but increasingly get paid like Chinese or Indians.
The concocting and pursuit of this fairy tale by the economic establishment has pushed the world far into uncharted policy waters and exposed it to frightful dangers. It is all too clear that the massive act of common sense needed to restore balance will have to originate outside its ranks.
Alan Tonelson is a Research Fellow at the U.S. Business & Industry Educational Foundation and the author of The Race to the Bottom: Why a Worldwide Worker Surplus and Uncontrolled Free Trade are Sinking American Living Standards (Westview Press).