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G20 leaders want the US to cut its deficit, not the value of the dollar. But the very laws of economics are against them
It would be great if the leaders of the G20 countries knew a little economics. It might make their meetings more productive and less confrontational. The central area of dispute at the recently concluded meeting was the decision by the Federal Reserve Board to engage in another round of quantitative easing (QE2). This is intended to boost growth by pushing down long-term interest rates.
Lower interest rates will boost consumption by allowing people to refinance their mortgage and will also induce additional investment. QE2 will also likely have the effect of lowering the value of the dollar, as investors sell dollars in search of higher returns in euros, yuan and other currencies. This fact seemed to unite the rest of the G20 in their anger at the United States.
There were numerous lectures coming from various countries that the United States was taking the easy way out. The argument ran that the United States should be correcting its overspending by reducing its budget deficit. The G19 argued that this was better than the US trying to increase growth by using a lower-valued currency to reduce its trade deficit.
Suppose the US did what the G19 urged and quickly reduced its budget deficit. Suppose that it immediately closed its budget deficit by raising taxes by 5 percentage points of GDP and cutting spending by 5 percentage points of GDP. (We'll ignore, for now, the fact that the plunge in GDP would add to the deficit.) Would the G19 then be happy?
If we saw rapid reductions in the US budget deficit, then we would expect to see a substantial drop in US GDP. If GDP falls, then US imports will fall. This means that exports from China, Brazil and other countries will drop, and workers in these countries will lose jobs. This is the primary effect that would be expected from a sharp decline in the US budget deficit.
But this is only the first part of the story. The second part of the story is the theme that the advocates of fiscal austerity emphasise. A lower budget deficit should lead to lower interest rates, even if the impact will be small in the current environment. Lower interest rates will, in turn, spur growth in the United States by allowing people to refinance their mortgages, inducing more investment and causing the dollar to drop "“ and thereby improving the trade balance.
Well, what do you know? We're back at a lower-valued dollar leading to an improvement in the US trade balance.
It is difficult to imagine what economic theory the QE2 critics in the G19 could possibly have in their heads. The United States was running big trade deficits in the years following the east Asian financial crisis in 1997. These deficits were caused by a large real appreciation in the value of the dollar against the currencies of the region and most other world currencies.
This should not have happened. In the textbook theory, rich countries like the United States and Germany are supposed to be exporters of capital. On this point, it is worth distinguishing the trade surplus of Germany from the trade surplus of China. Germany is a rich country with a stagnant or shrinking labour force. We would expect Germany to be an exporter of capital. China, on the other hand, is a very rapidly growing developing country in which capital gets a very high rate of return. Textbook economics says that China should be an importer of capital, not a huge exporter.
The blame for this anomaly goes beyond China. The punitive measures that the International Monetary Fund (IMF) imposed on the east Asian countries during their financial crisis, under the direction of the Rubin-Summers Treasury, made developing countries fearful of accumulating debt.
The response of the east Asian countries and the developing world in general was to shift to a pattern of trade in which they build up huge surpluses, so that they need never worry about being forced to beg the IMF for a bailout. This meant deliberately keeping currencies undervalued, so that their exports would enjoy a competitive advantage.
This pattern of trade created in the wake of the east Asian financial crisis should be reversed, but there is no plausible way to get from here to there that does not involve a decline in the value of the dollar. In the system of floating exchange rates, that is how trade adjusts. If the G19 are unhappy about the necessary decline in the dollar, then they are not upset with the United States, the Fed and QE2; in reality, they are upset with the logic of economics.
There is not much that President Obama or anyone else can do to help them on that score.
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15 November 2010 2:09PM
Yes, you're absolutely right in everything that you're saying. Cutting the deficit would indeed destroy US economy.
Which leaves me to wonder, why has the US-backed IMF been forcing such a course on action on various nations for decades, and continues to do so?
15 November 2010 2:14PM
But the very laws of economics are against them
Only because the US rewrote the rules at Bretton Wods and now want to rewrite them again to suit themselves. So why should the emerging powers of the east obey rules written to benefit the US, especially if they are trying to rewrite the rules to benefit themselves again. Maybe if America hadn't done away with the Gold Standard and substituted it with the Dollar America would be in a better and stronger position.
I can't see any of the Asian countries revaluing their currencies to benefit the US, when the US has always used the power of the dollar to benefit itself.
Textbook economics says that China should be an importer of capital, not a huge exporter.
But that's an American text book, not a Chinese one, I think the rules are once again about to be rewritten.
15 November 2010 2:22PM
Straw man time? What the G19 want is for the US to make progress with its deficit and not to resort to money printing as the fix-all policy solution. I don't think anyone has called for the US deficit to be reduced quickly, rather more moderate views just suggest the US needs to commit to a plan to reduce the deficit over time, as part of a longer term plan to make the US economy more sustainable.
15 November 2010 2:22PM
We are at a turning point in economic affairs. Technology is destroying jobs faster than they can be created at an accelerating rate and the jobs themselves are going to the most competitive nations such as China. China is competitive because government spending is just 20% of GDP against our 55%. We, in the UK, Europe and the USA have grown fat on domination of trade and industry since WW2 and the government, like any monopoly has expanded, abused its power and pauperised industry. From now on economic growth will not create employment. Until recently when new technology needed fewer workers demand, profits, investment or all three increased thus creating jobs to compensate. But now technological development is rapidly destroying jobs faster than they are created. The evidence is everywhere. The US economy is growing but not creating work. Unemployment is 20% in Spain, huge and hidden in France, the UK, Italy, Ireland and elsewhere. In the UK part-time work has grown from 24% to 27% of jobs in a year, 8% are economically inactive and huge numbers of adults are virtually unemployable, millions of the self-employed are marginal, we expect to shed 600,000 public sector workers but most of those remaining are superfluous. Two thirds of 18-21 yr olds are students but many of them are unemployable on graduation. Our biggest employer is retail but they are under pressure from online sellers such as Amazon that have far lower costs, employ very few and are highly automated. Most large shops are automating checkouts and experiments in automated shelf stacking are going well. Our second biggest employer is food processing but that too is automating rapidly. We are adjusted to agriculture, mining and manufacturing employing less than 5% of the workforce [down from 60% in 1953] but it was still a shock when Honda announced that the manufacture of a new car here will create just 200 jobs; a generation ago it would have been 20,000. All industry is affected. Professionals are finding more and more of their donkey work can be automated. Banking is now rapidly shedding workers. Education has huge potential for automation. No work is immune. The few high wage economies that can compete with low wage economies such as Germany and Japan do it by off-shoring, automation and moving up market. To compete we must do the same but it will not increase employment. Even in China industrial employment peaked some years ago whilst production continues to soar because of rapid automation. ABB, Honda, iRobot and others are investing billions in robots that will do a vast range of simple jobs over the next few years in agriculture, hospitals, offices, farms, factories and homes such as cleaning, security and portering. Robotics is at the same stage as personal computers in the 80s or mobile phones in the 90s but with thousands of times more powerful technology to develop it. The cost of automation is falling and the cost of people is increasing. Many believe the cross over point is imminent where it will be more cost effective to use a robot for any simple job which will bring a huge expansion in robot investment and an acceleration of their power per £. The power of robots is only limited by AI which is IT and IT is doubling in power per £ annually with no end in sight. Eventually a robot will be able to do anything a person can do and a lot more besides and even the manufacture of robots is automated. Wealth will be created but mostly by machines not people. It is OK having wealth and goods without work but it is important that we do not have a few doing everything with most on welfare. Governments must encourage part time and casual work but in an essentially market economy. All our needs will be met by a few days work a month but work will remain critical to structure our lives and the main means of wealth distribution even though it will occupy less of our lives. Of course, if we could we would not start from a position of £4trn of debt but we must. Ironically, China and the other eastern powers copied the Hong Kong model, lean and mean public sector with low simple taxes. If only we had continued with that model too. We in the West have very little time to cut spending, if possible at the rate of some 10% annually for if we don't, no-one will want anything we do in ten years.
15 November 2010 2:23PM
Only because the US rewrote the rules at Bretton Wods
You can't rewrite the rules of economics at Bretton Woods or anywhere else.
It's like trying to rewrite the rules of physics, they're not really amenable to conference resolutions.
15 November 2010 2:34PM
Printing money for ever is no solution.
If 19 out of 20 developed, sane economies are saying black while the USA continues to say white, the USA should at least pause to consider for a moment whether it is the proverbial inmate in the asylum, bemoaning the fact that it remains sane while the rest of the world has gone mad.
15 November 2010 2:34PM
It's like trying to rewrite the rules of physics, they're not really amenable to conference resolutions.
They aren't at all like the laws of physics- those are based on evidence and sound conclusions...economics is based on witchcraft and nonsense. When physicists do massive damage to the world it's because they meant to, when economists do it it's because they don't understand their subject.
15 November 2010 2:36PM
a performer dances during an anti-G20 protest in South Korea.
Pretty much sums up the seriousness of the 'opposition'.
15 November 2010 2:36PM
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