APPLES AND ORANGES

November 11, 2010

How can we hope for any meaningful agreement to rebalance the lop-sided international trade system when heads of state and talking heads, finance ministers and financial gurus condemn deficit countries (i.e. the USA) in terms that ought to be reserved for surplus countries (China in particular)? One key to success at this week’s G-20 summit – and any future endeavor of this sort – is to recognize the fundamental difference in the significance and legal status of weak or weaker currencies.

On the one hand, some countries – China and others today, Japan for a long time in the past –systematically intervene in foreign exchange markets in a way that produces and perpetuates massive imbalances. The evidence of such policies lies in the huge excess foreign currency reserves and persistent trade surpluses. (China acknowledged a monthly surplus with the world of $27.1 billion in October, the second highest level this year. The result is yet another record level for China’s official reserves.)

Such behavior is inconsistent with IMF Article IV, which obligates members not to manipulate exchange rates in ways that prevent the adjustment of unbalanced trade flows and international payments or produce a competitive advantage. The logic is clear: when countries run big surpluses, the exchange rate should be allowed to strengthen so as to reduce the imbalances. Not to do so is a violation of Article IV and a shortsighted assault on the very international trading system that enabled export-oriented countries to grow so successfully. China has not done so.

On the other hand, the United States at long last is changing macroeconomic policies in ways that will, if market forces are allowed to work, produce a weaker dollar for a period of time. At the same time, Americans – individuals and businesses – are deleveraging and substantially increasing their savings. Banks have greatly strengthened their balance sheets and tightened the undisciplined credit expansion of the last decade. Interest rates have been held close to zero. Together, those steps should work to reduce the imbalances that burden the international system. The logic of Article IV also applies: when a country runs persistent trade and current account deficits, its exchange rate should weaken. American policy — which consists of much more than just a weaker dollar -- upholds Article IV and reinforces the flexibility of the international system in the face of massive imbalances.

The contrast between China’s perpetual surplus machine and the United States' self-corrective medicine is as plain as apples and oranges, illegal and legal, destructive and constructive. Those who cry out in horror that the industrial countries shouldn’t attempt to increase their exports fail to understand how markets work and make a mockery of the system from which export-oriented countries have hugely benefitted.

There is no perfect level for exchange rates, interest rates, money supplies, trade balances or current account balances. They must be allowed to rise and fall as necessary to maintain the overall stability of the system. To paraphrase Lord Keynes: “When circumstances change, our policies change. What do you do?” That’s the essence of Article IV. Those who insist on their right to run perpetual surpluses or who want to condemn the US to run perpetual deficits need a remedial course in economics. Without a better understanding of this fundamental economic truth, there is little hope for any lasting positive result from the G-20, now or ever.

Charles Blum

LOOKING FORWARD

November 5, 2010

This week’s election results – especially the sweeping Republican gains in the House of Representatives and governorships across the country – will be analyzed for years to come. Many observers attribute the Republican tsunami to widespread anger with the Obama/Pelosi agenda. In particular, health care and cap and trade legislation are often singled out. Yet health care divides the American public pretty evenly between those who want to repeal Obamacare and those who like it and even want it to go farther. Cap and trade, of course, died in the Senate and may not revived soon, if ever. It has not adversely affected anyone’s household or corporate budget.

Others single out the stimulus measures as the cause of the Democrats’ debacle. Exit polls confirm that voters divided evenly between those who thought the stimulus measures – some of which are still to materialize -- had helped the economy, those who believed it had hurt the economy, and those who felt that it had made no difference.

Voting decisions are complex, of course, and I’m sure there is some validity to all these factors and many more. My own take is a bit different, however. Consider the following answers to three questions reported by the Wall Street Journal on November 3:

• When asked which issue was the most important in determining their vote, 62 percent responded the economy. Health care was a distant second at 18 percent health care, followed by immigration at 8 percent.
• When asked who was to blame for the poor economy, 35 percent answered Wall Street, 30 percent George W. Bush, and only 23 percent Barack Obama.
• Those voters living in a household that had experienced unemployment voted Democrat by a relatively slim 51-48 percent margin.

These answers are not surprising. They suggest that voters, while not holding the Obama administration principally responsible for the economic mess we’re in, do hold it mainly accountable for failing to provide a strategy for getting out of it. Throwing more stimulus money around the economy helter-skelter is not seen as the answer. The perceived added cost of health care and energy is similarly rejected as a response to our economic woes, as some Democrats tried to portray their health and environmental reforms.

Rather than angry, voters seem to me anxious. Rather than “frustrated with the pace of our economic recovery,” as Obama put it the morning after, they are fearful that government hasn’t got a clue about how to change the structure and functioning of our economy so that we can resume the growth of investment, jobs and income on a sound basis without endless borrowing from foreign creditors.

This election was, sadly enough, too much about the past. Democrats lost in part because they failed to produce a viable economic strategy; Republicans won despite their failure to produce one of their own. Together, the parties demonstrated that it is difficult and dangerous to move forward while gazing intently into the rear-view mirror. Both parties need to do better – and soon – so that America can do better.

Charles Blum