After years of imbalance, harsh reckoning

It's been quite a week for business and economics news:

• The big Group of 20 meeting in South Korea that took some tentative steps toward correcting large and persistent global imbalances in trade and investment flows.

• The release of a bold plan to eliminate most of the federal budget deficit by the co-chairmen of the bipartisan National Commission on Fiscal Responsibility.

• The chorus of criticism of the Federal Reserve's plan to pump additional money into the economy — at home from Sarah Palin and other hard-money conservatives, and from foreign governments that see it as a backdoor way to devalue the dollar.

• And, finally, fresh concerns about Ireland, where even draconian cuts in public spending don't seem to be enough to convince investors that the Irish banking system can be rescued without bankrupting the government.

Here's the thing to understand: They're all really part of the same story — the story of how the United States was allowed to live beyond its means by trading partners that prospered by lending Americans the money to be able to consume more than they produce. It was a wonderful arrangement while it lasted, lifting millions in Asia out of poverty while letting Americans enjoy what appeared to be a higher standard of living — higher incomes, bigger homes, greater wealth, more public services. This unsustainable arrangement turned the United States from the world's biggest creditor nation into the world's biggest debtor. It was only when the credit bubble burst and the financial system nearly collapsed that it became clear how thoroughly this dysfunctional co­dependency had been woven into the world economy.

The global economy and financial system have stabilized over the past two years, but only at enormous expense — so enormous, in fact, that voters nearly everywhere have decided enough is enough. They are now unwilling — or, in the case of small countries like Ireland, unable — to borrow any more. Only now are we embarking on the painful task of unwinding those imbalances.

That was the challenge facing the leaders of the biggest industrial nations at the G-20 meeting in Seoul last week. Treasury Secretary Timothy Geithner deserves credit for suggesting a less confrontational way of defining the problem by trying to set limits on how large any country's trade deficit or surplus should be. In a market economy, the self-correcting mechanism that could gradually reduce those imbalances is a floating exchange rate that, unfortunately, is not compatible with China's state-controlled economy and its strategy of export-led growth. The result has been a ballooning trade surplus that not only creates headwinds for job creation and economic recovery in the United States, but has also sparked a dangerous competition among other countries to devalue their currencies to keep up with underpriced Chinese goods.

In Seoul, Geithner and President Barack Obama stepped up international pressure on China to raise the value of its currency — and, by implication, allow China's growth to become less reliant on exports and more on domestic consumption. But the Chinese barely budged from their long-held position.

Of course, it takes two sides to create a trade imbalance — one country that consumes too little (that's China), another that consumes too much (that's us). And certainly one measure of U.S. profligacy is the federal budget deficit. Reducing the federal deficit won't by itself do much to balance the U.S. trade account by increasing exports, but to the degree it involves increases in taxes or decreases in employment and income of government workers, demand for foreign imports will also decline. Such are the harsh realities of bringing an economy back into balance.

The bold deficit-reduction plan unveiled last week by Clinton White House chief of staff Erskine Bowles and former Sen. Alan Simpson, R-Wyo., is not only credible, fair and economically sound — it also reflects the kind of political and ideological compromise that is no longer part of the Washington skill set. It was hardly surprising that the plan was immediately panned by special-interest groups, from the elderly to major defense contractors. More disappointing was House Speaker Nancy Pelosi's dismissal of the proposal as "simply unacceptable." Even the normally pugnacious U.S. Chamber of Commerce had the wisdom and the good manners to praise Bowles and Simpson for initiating an urgently needed debate on a difficult issue and to acknowledge the inevitability of both spending cuts and tax increases.

Inevitably, the Fed's plan to buy an additional $600 billion worth of long-term Treasury bonds will put some downward pressure on the dollar, although much less than you'd imagine judging from the howls of protest from Germany and China. If these export powerhouses have a keen sensitivity to beggar-thy-neighbor trade and currency policies, perhaps it is because they themselves have used them to such great advantage over the years.

One has more sympathy for developing countries with floating exchange rates, such as Brazil or Thailand, that could see an influx of capital as a result of a weaker dollar. But it's probably time for these countries to develop techniques for controlling the flow of "hot money" into their markets.

For years, economists have warned that rebalancing the global economy would be disruptive and painful. The mechanisms by which this rebalancing is carried out can get awfully complicated. The reality, however, remains pretty simple: The only way for Americans to consume less and produce more is for our trading partners to produce less and consume more.

After years of imbalance, harsh reckoning 11/13/10 [Last modified: Saturday, November 13, 2010 3:31am]

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