America's Other 87 Deficits

2011-10-28

NEW HAVEN – The United States has a classic multilateral trade imbalance. While it runs a large trade deficit with China, it also runs deficits with 87 other countries. A multilateral deficit cannot be fixed by putting pressure on one of its bilateral components. But try telling that to America’s growing chorus of China bashers.
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America’s massive trade deficit is a direct consequence of an unprecedented shortfall of domestic saving. The broadest and most meaningful measure of a country’s saving capacity is what economists call the “net national saving rate” – the combined saving of individuals, businesses, and the government. It is measured in “netterms to strip out the depreciation associated with aging or obsolescent capacity. It provides a measure of the saving that is available to fund expansion of a country’s capital stock, and thus to sustain its economic growth.
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In the US, there simply is no net saving any more. Since the fourth quarter of 2008, America’s net national saving rate has been negative – in sharp contrast to the 6.4%-of-GDP averaged over the last three decades of the twentieth century. Never before in modern history has the world’s leading economic power experienced a saving shortfall of such epic proportions.
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Yet the US found a way to finesse this problem. Exploiting what Valéry Giscard d’Estaing called the “exorbitant privilege” of the world’s reserve currency, the US borrowed surplus savings from abroad on very attractive terms, running massive balance-of-payments, or current-account, deficits to attract foreign capital.
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The US current account, which was last in balance in 1991, hit a record deficit of $801 billion (6% of GDP) in 2006. This gap has narrowed in the past couple of years, but much of the improvement probably reflects little more than the temporary impact of an unusually tough business cycle.
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This is where America’s multilateral trade deficit enters the equation, for it has long accounted for the bulk of America’s balance-of-payments gap. Since 2000, it has made up fully 96% of the cumulative current-account shortfall.
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And that is what ultimately makes the China-centric blame game so absurd. Without addressing the root of the problemAmerica’s chronic saving shortfall – it is ludicrous to believe that there can be a bilateral solution for a multilateral problem.

Yet that is exactly what US officials, together with many prominent economists, believe America needs. Since the trade deficit is widely thought to put pressure on US jobs and real wages, the US-China trade imbalance has come under special scrutiny in these days of great angst. Yes, China does account for the largest component of America’s multilateral trade deficitmaking up 42% of the total trade gap in 2010.
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Conscious outsourcing and supply-chain management decisions by US multinationals play an important role in exaggerating China’s share. But that does little to let China off the hook in the eyes of Washington. Long-standing charges of currency manipulation provide the proverbial smoking gun that US politicians – of both partiesbelieve justifies the imposition of steep tariffs on China’s exports to the US (which totaled $365 billion in 2010). That was precisely the argument behind the US Senate’s recent overwhelming approval of a “currency bill” that took dead aim on China.

While it may be expedient to hold others accountable for America’s problems, this is bad economics driving bad politics. In an era of open-ended US government budget deficits and chronic shortfalls in personal saving, America is doomed to suffer subpar savings and massive multilateral trade deficits for as far as the eye can see.
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Closing down trade with China, while failing to address the saving shortfall, is like putting pressure on one end of a water balloon. The Chinese component of America’s multilateral trade deficit will simply migrate somewhere elsemost likely to a higher-cost producer. That would be the functional equivalent of a tax hike on beleaguered American familieshardly the solution that US politicians are promising.
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This is not to ignore important US-China trade issues that need to be addressed. Market access should be high on the agenda – especially for a sluggish US economy that needs new sources of growth, like exports. With China now America’s third largest – and by far its most rapidly growing export market, the US should push hard to expand business opportunities in China, especially as the Chinese economy tilts increasingly toward internal demand. China should be viewed as an opportunity, not a threat.
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At the same time, the US government should come clean with the American public about charges of Chinese currency manipulation and unfair trade practices. The renminbi has, in fact, appreciated by 30% relative to the US dollar since mid-2005. In broad multilateral terms – a far more meaningful gauge because it measures a currency’s value against a broad cross-section of a country’s trading partners – the “real effectiverenminbi currently stands about 8% above its most recent 12-year average (1998-2010).
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Yes, China continues to accumulate vast foreign-exchange reserves. But this is as much the result of speculators’hot moneyplays as it is a conscious and perfectly reasonable effort by Chinese policymakers to remain focused on financial stability and manage currency appreciation in a gradual and orderly fashion.
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China-bashing in the US speaks to a corrosive shift in the American psyche. It deflects attention away from those truly responsible for perpetuating the greatest saving shortfall in history. The US has been seduced by the political economy of false prosperity. That seduction has allowed America to live beyond its means for nearly two decades. Now the game is up.
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The ultimate test of any nation’s character is to look inside itself at moments of great challenge. Swept up in the blame game, the US is doing the opposite. And that could well be the greatest tragedy of all. After all, America’s 88 deficits did not arise of thin air.
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Stephen S. Roach, a member of the faculty at Yale University, is Non-Executive Chairman of Morgan Stanley Asia and the author of The Next Asia.
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OPINION

OCTOBER 28, 2011

Four Reasons Keynesians Keep Getting It Wrong

Concern over future tax rates is one of the main reasons for reduced investor confidence.

By ALLAN H. MELTZER
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Those who heaped high praise on Keynesian policies have grown silent as government spending has failed to bring an economic recovery. Except for a few diehards who want still more government spending, and those who make the unverifiable claim that the economy would have collapsed without it, most now recognize that more than a trillion dollars of spending by the Bush and Obama administrations has left the economy in a slump and unemployment hovering above 9%.

Why is the economic response to increased government spending so different from the response predicted by Keynesian models? What is missing from the models that makes their forecasts so inaccurate? Those should be the questions asked by both proponents and opponents of more government spending. Allow me to suggest four major omissions from Keynesian models:

First, big increases in spending and government deficits raise the prospect of future tax increases. Many people understand that increased spending must be paid for sooner or later. Meanwhile, President Obama makes certain that many more will reach that conclusion by continuing to demand permanent tax increases. His demands are a deterrent for those who do most of the saving and investing. Concern over future tax rates is one of the main reasons for heightened uncertainty and reduced confidence. Potential investors hold cash and wait.

Second, most of the government spending programs redistribute income from workers to the unemployed. This, Keynesians argue, increases the welfare of many hurt by the recession. What their models ignore, however, is the reduced productivity that follows a shift of resources toward redistribution and away from productive investment. Keynesian theory argues that each dollar of government spending has a larger effect on output than a dollar of tax reduction. But in reality the reverse has proven true. Permanent tax reduction generates more expansion than increased government spending of the same dollars. I believe that the resulting difference in productivity is a main reason for the difference in results.

Third, Keynesian models totally ignore the negative effects of the stream of costly new regulations that pour out of the Obama bureaucracy. Who can guess the size of the cost increases required by these programs? ObamaCare is not the only source of this uncertainty, though it makes a large contribution. We also have an excessively eager group of environmental regulators, protectors of labor unions, and financial regulators. Their decisions raise future costs and increase uncertainty. How can a corporate staff hope to estimate future return on new investment when tax rates and costs are unknowable? Holding cash and waiting for less uncertainty is the principal response. Thus, the recession drags on.

Fourth, U.S. fiscal and monetary policies are mainly directed at getting a near-term result. The estimated cost of new jobs in President Obama's latest jobs bill is at least $200,000 per job, based on administration estimates of the number of jobs and their cost. How can that appeal to the taxpayers who will pay those costs? Once the subsidies end, the jobs disappear—but the bonds that financed them remain and must be serviced. These medium and long-term effects are ignored in Keynesian models. Perhaps that's why estimates of the additional spending generated by Keynesian stimulus—the "multiplier effect"—have failed to live up to expectations.

The Federal Reserve, too, has long been overly concerned about the next quarter, never more than in the current downturn. Fears of a double-dip recession, fanned by Wall Street, have led to continued easing and seemingly endless near-zero interest rates. Here, too, uncertainty abounds. When will the Fed tell us how and when it is going to sell more than $1 trillion of mortgage-related securities? Will Fannie Mae, for example, have to buy them to hold down mortgage interest rates?

By now even the Fed should understand that we do not have a liquidity shortage. It has done more than enough by adding excess reserves beyond any reasonable amount. Instead of more short-term tinkering, it's time for a coherent program to start gradually reducing excess reserves.

Clearly, a more effective economic policy would aim at restoring the long-term growth rate by reducing uncertainty and restoring investor and consumer confidence. Here are four proposals to help get us there:

First, Congress and the administration should agree on a 10-year program of government spending cuts to reduce the deficit. The Ryan and Simpson-Bowles budget proposals are a constructive start. (Note to Republican presidential candidates: Permanent tax reduction can only be achieved by reducing government spending.)

Second, reduce corporate tax rates and expense capital investment by closing loopholes.

Third, announce a five-year moratorium on new regulations.

Fourth, adopt an enforceable 0%-2% inflation target to allay fears of future high inflation.
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Now that the Keynesian euphoria has again faded, perhaps this administration—or more likely the next—will recognize the reasons for the failure and stop asking for more of the same.

Mr. Meltzer, a professor of public policy at the Tepper School, Carnegie Mellon University and a visiting scholar at Stanford University's Hoover Institution, is the author most recently of "Why Capitalism?" forthcoming from Oxford University Press.
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Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved


October 27, 2011 11:00 pm

A firewall to stop Europe’s crisis spreading



When leaders of the largest economies meet next week in France, our citizens will be watching for the same sense of common purpose that allowed us to rescue the global economy two years ago from a financial crisis that was sparked by years of irresponsibility.
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Because of the co-ordinated action the G20 took then, the global economy began to grow again. Emerging economies rebounded. In the United States, we’ve had 19 straight months of private sector job growth and added more than 2.5m private sector jobs.

Still, progress has not come fast enough and today the global recovery remains fragile. Around the world, hundreds of millions of people are unemployed. Disruptions in oil supplies, the tragic earthquake in Japan, and Europe’s financial crisis have contributed to the slowdown. Emerging economies have begun to slow. Global demand is weakening.


Our challenge is clear. We must stay focused on the strong, sustainable and balanced growth that boosts global demand and creates jobs and opportunity for our people. This requires action in several areas.

First, as the world’s largest economy, the United States will continue to lead. The single most effective thing we can do to get the global economy growing faster is to get the American economy growing faster. That’s why my highest priority is putting Americans back to work. It’s why I’ve proposed the American Jobs Act, which independent economists have said would create nearly 2m jobs, boost demand and increase US economic growth. It’s why I signed landmark trade agreements with South Korea, Colombia and Panama to create jobs, keep us on track to double our exports and preserve American competitiveness.
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At the same time, we’re building on the nearly $1,000bn in spending cuts agreed this summer. I’ve put forward a comprehensive and balanced plan to substantially reduce our deficit over the next few years in a way that does not hamper the current recovery and that lays the foundation for future growth.
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Second, the crisis in Europe must be resolved as quickly as possible. This week, our European allies made important progress on a strategy to restore confidence in European financial markets, laying a critical foundation on which to build.

Given the scope of the challenge and the threat to the global economy, it is important for all of us that this strategy be implemented successfully – including building a credible firewall that prevents the crisis from spreading, strengthening European banks, charting a sustainable path for Greece and tackling the structural issues at the heart of the current crisis.
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The European Union is America’s single largest economic partner and a critical anchor of the global economy. I am confident that Europe has the financial and economic capacity to meet this challenge, and the United States will continue to support our European partners as they work to resolve this crisis.
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Third, each nation must do its part to ensure that global growth is balanced and sustainable so we avoid slipping into old imbalances. For some countries, this means confronting their own fiscal challenges. For countries with large surpluses, it means taking additional steps to support growth.
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For export-oriented economies, it means working to boost domestic demand. A critical tool for accelerating that shift is greater flexibility in exchange rates, including exchange rates that are market-driven.
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Avoiding old imbalances also means moving ahead with financial reforms that can help prevent another financial crisis. In the United States, we’re implementing the strongest reforms since the Great Depression.
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Across the G20, we need to make sure banks maintain the capital they need to withstand shocks, and there needs to be greater oversight and transparency to avoid excessive risks, especially with regard to derivatives.
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Finally, the G20 nations must deepen co-operation on the range of global challenges that affect our shared prosperity. We need to move ahead with our commitment to phase out subsidies for fossil fuels and transition to 21st-century clean-energy economies. As we promote the development that gives nations a path out of poverty, we can focus on the infrastructure, finance and good governance that unleash growth. Even as we work to save lives from the drought and famine in the Horn of Africa, we need to continue investing in the food security and agricultural productivity that make future famines less likely and communities more self-sufficient.
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When we met in London two years ago, we knew that putting the global economy on the path to recovery would be neither easy nor quick. But together, we forged a response that pulled the global economy back from the brink of catastrophe. That’s the leadership we’ve demonstrated before. That’s the leadership we need now – to sustain economic recovery and put people back to work, in our own countries and around the world.

The writer is US president
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Copyright The Financial Times Limited 2011.


Economic crisis

Europe’s rescue plan

This week’s summit was supposed to put an end to the euro crisis. It hasn’t

Oct 29th 2011
from the print edition
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YOU can understand the self-congratulation. In the early hours of October 27th, after marathon talks, the leaders of the euro zone agreed on a “comprehensive package” to dispel the crisis that has been plaguing the euro zone for almost two years. They boosted a fund designed to shore up the euro zone’s troubled sovereign borrowers, drafted a plan to restore Europe’s banks, radically cut Greece’s burden of debt, and set out some ways to put the governance of the euro on a proper footing. After a summer overshadowed by the threat of financial collapse, they had shown the markets who was boss.

Yet in the light of day, the holes in the rescue plan are plain to see. The scheme is confused and unconvincing. Confused, because its financial engineering is too clever by half and vulnerable to unintended consequences. Unconvincing, because too many details are missing and the scheme at its core is not up to the job of safeguarding the euro.

This is the euro zone’s third comprehensive package this year. It is unlikely to be its last.

Words are cheap…

The summit’s most notable achievement was to forge an agreement to write down the Greek debt held by the private sector by 50%. This newspaper has long argued for such a move. Yet an essential counterpart to the Greek writedown is a credible firewall around heavily indebted yet solvent borrowers such as Italy. That is the only way of restoring confidence and protecting European banks’ balance-sheets, thus ensuring that they can get on with the business of lending.

Unfortunately the euro zone’s firewall is the weakest part of the deal. Europe’s main rescue fund, the European Financial Stability Facility (EFSF), does not have enough money to withstand a run on Italy and Spain. Germany and the European Central Bank (ECB) have ruled out the only source of unlimited support: the central bank itself. The euro zone’s northern creditor governments have refused to put more of their own money into the pot.

Instead they have come up with two schemes to stretch the EFSF. One is to use it to insure the first losses if any new bonds are written down. In theory, this means that the rescue fund’s power could be magnified several times. But in practice, such “credit enhancement” may not yield much. Bond markets may be suspicious of guarantees made by countries that would themselves be vulnerable if their over-indebted neighbours suffered turmoil.

Under the second scheme, the EFSF would create a set of special-purpose vehicles financed by other investors, including sovereign-wealth funds. Again, there are reasons to doubt whether this will work. Each vehicle seems to be dedicated to a single country, so risk is not spread. And why should China or Brazil invest a lot in them when Germany is holding back from putting in more money?

Together, these schemes are supposed to extend the value of the EFSF to €1 trillion ($1.4 trillion) or more. Sadly, that looks more like an aspiration than a prediction. And because the EFSF bears the first losses, its capital is at greater risk of being wiped out than under a loan programme. This could taint France, which finances the rescue fund and has recently seen its AAA credit rating come under threat. Since the EFSF depends partly on France for its own credit rating, a French downgrade could undermine the rescue fund just when it is most needed.

If the foundations of the firewall are too shallow, then the bank plan plunges too deep. By the end of June 2012, banks are expected to establish a core-capital ratio of 9%. In principle, that is laudable. But if banks have months to reach their target, they can avoid raising new equity, which would dilute their shareholders' stakes, and instead move to the required ratio by shrinking their balance-sheets. That would be a terrible outcome: by depriving Europe’s economy of credit, it would worsen the downturn.

Then there is Greece. Although the size of the writedown is welcome, euro-zone leaders are desperate for it to be “voluntary”. That is because a default would trigger the bond-insurance contracts called credit-default swaps (CDSs). The fear is that a default could lead to chaos, because the CDS market is untested. That is true, but this implausibly largevoluntary writedown will lead investors in other European sovereign bonds to doubt whether CDSs offer much protection. So while the EFSF scheme is designed to offer insurance to bondholders, the European leaders’ insistence that the Greek writedown be voluntary will make euro-zone debt harder to insure.

…but trust is nowhere to be found

Europe has got to this point because German politicians are convinced that without market pressure the euro zone’s troubled economies will slacken their efforts at reform. Despite a list of promises presented to the summit by Silvio Berlusconi, Italy’s prime minister, Germany has good reason to worry. But it needs to concentrate on institutional ways of disciplining profligate governments, rather than starving the rescue package of funds. As it is, this deal at best fails to solve the euro crisis; at worst it may even make it worse. As the shortcomings of each component become clear, investors’ fears will surely return, bond yields will rise and banks’ funding problems will worsen.

Yet again, disaster will loom. And yet again, the ECB will end up staving it off. Fortunately, Mario Draghi, the ECB’s incoming president, made it clear this week that he realises that is his job. But therein lies the tragedy of this summit. An ECB pledge of unlimited backing for solvent governments would have had a far better chance of solving the crisis months ago, and remains the best option today.

At this summit Europe’s leaders had hoped to prove that their resolve to back the euro was greater than the markets’ capacity to bet against it. For all the backslapping and brave words, they have once again failed. There will be more crises, and further summits. By the time they settle on a solution that works, the costs will have risen still further.


October 27, 2011 6:48 pm


China could play key role in EU rescue

By Jamil Anderlini in Beijing and Richard Milne in London


China is very likely to contribute to the eurozone’s bail-out fund but the scope of its involvement will depend on European leaders satisfying some key conditions, two senior advisers to the Chinese government have told the Financial Times.


Any Chinese support would depend on contributions from other countries and Beijing must be given strong guarantees on the safety of its investment, according to Li Daokui, an academic member of China’s central bank monetary policy committee, and Yu Yongding, a former member of that committee.


“It is in China’s long-term and intrinsic interest to help Europe because they are our biggest trading partner but the chief concern of the Chinese government is how to explain this decision to our own people,” said Professor Li. “The last thing China wants is to throw away the country’s wealth and be seen as just a source of dumb money.”


He added that Beijing might also ask European leaders to refrain from criticising China’s currency policy, a frequent source of tension with trade partners. The US argues that an intentionally undervalued renminbi unfairly supports Chinese exports.


In spite of discomfort among some Europeans about Chinese investment, the comments represented a fillip to eurozone leaders hours after a summit aimed at calming the two-year-long sovereign debt crisis. Financial markets reacted with relief at the deal, which included a plan to recapitalise European banks, make them accept a loss of 50 per cent on their holdings of Greek debt and boost the firepower of the rescue fund, known as the European Financial Stability Facility.


Bank shares soared while the euro strengthened 2.2 per cent against the dollar. But in a sign that investors were still at heart nervous about how the eurozone debt crisis would play out, Italian government bond yields first sank to 5.7 per cent, before rebounding to 5.9 per cent, near their euro-era highs.


Klaus Regling, head of the EFSF, was due to arrive in Beijing late on Thursday for discussions with senior Chinese leaders on whether and how much China might contribute. Nicolas Sarkozy, the French president, telephoned his Chinese counterpart Hu Jintao a few hours after the summit ended to discuss the rescue plan but there was no immediate announcement on any Chinese involvement.


European leaders agreed that the EFSF would explore two plans to increase its remaining firepower from about €250bn to €1,000bn. One would be to offer investors insurance on selected government debt while the other would create a special fund in which the International Monetary Fund or countries such as China could invest.


With $3,200bn in foreign exchange reserves, roughly a quarter of which are believed to be held in euros, China could be willing to contribute between $50bn and $100bn from the reserves to the EFSF or a new fund set up under its auspices in collaboration with the IMF, according to one person familiar with the thinking of the Chinese leadership.


“If conditions are right then something a bit above $100bn is not inconceivable,” this person said.


One condition China might ask for is that its contribution be at least partly denominated in renminbi, which would protect its investment against currency fluctuations. China would buy euro-denominated bonds but repayments would compensate for any changes in the value of the renminbi, which has appreciated nearly 20 per cent against the euro in the past three years.


Reflecting the unease in Europe, the head of Germany’s industry association, said he feared Chinese help could “come at some political cost”. Hans-Peter Keitel told the FT: “Asking a non-eurozone nation to help the euro would give the other nation the power to decide the fate of the single currency.”


The global focus on how China might contribute to the European rescue plan illustrates its increased influence on the world stage and many in Beijing believe this crisis presents an opportunity for it to display global citizenship and responsibility commensurate with its rising status.


Beijing’s main concern is how any contribution to a European bailout will be viewed domestically by an increasingly informed and critical populace.


Any mis-steps in helping Europe could cause problems with domestic public opinion – the Chinese people will watch very carefully what their own government does,” Prof Yu said. European leaders also must have a clear plan of what to do and they must show China they have the political will as well as the support of their own people; if we see protests and chaos all the time, then China won’t have confidence in Europe’s political ability.”
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Addditional reporting by Gerrit Wiesmann in Berlin
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Copyright The Financial Times Limited 2011