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PEERLESS AND PERILED
The Paradox of American Leadership in the World Economic Order
By Kati Suominen
Stanford University Press
Copyright © 2012 Kati Suominen
All right reserved.
ISBN: 978-0-8047-8154-1
Chapter One
Rebalancing the World Economy
I call on the surplus countries ... to find the political gumption to stimulate their economies without reigniting the fires of inflation. It must be recognized that the health of the world economy does not hinge solely on US budget policy. As US budget and trade deficits decline, other countries must pick up the slack, particularly on imports from developing countries. Our focus—and this means all of us—must be on achieving balanced growth and more open economies. —President Ronald Reagan, IMF–World Bank Annual Meetings, Washington, 29 September 1987
AS THE WORLD BEGAN EMERGING FROM THE FINANCIAL CRISIS, global imbalances rebounded. In a lopsided pattern whereby the United States and many other nations such as France, India, and UK imported and borrowed, while China, Japan, Germany, and Middle Eastern oil producers exported and lent, imbalances soared in the early 2000s, reaching some 5 percent of world GDP by 2006. That year, US current-account deficit peaked at an unprecedented 6.5 percent of US GDP, a level widely viewed as unsustainable. Confidence in the US economy was expected to erode, and the dollar was deemed to fall. Exasperated by the mass influx of imports, Congress threatened steep tariffs against China. Perpetuating low US real interest rates that, in turn, stoked the housing bubble, the imbalances became one of the main culprits for the Great Crisis. It would also take the crisis to unwind them.
The risks of a world out of balance are several, from bouts of currency wars to trade protectionism and a new global economic crisis sparked by a hard landing in America. The International Monetary Fund (IMF) argues that imbalances are "a major concern for the sustainability of the recovery over the medium term" and that advanced-economy current accounts will "make increasingly negative contributions to growth." The European Central Bank echoes the warning, stating that imbalances "pose a key risk for global macroeconomic and financial stability."
At Washington's prodding, the G20 has made the imbalances the centerpiece of its agenda and created a peer review process of the members' economic policies. Success at rebalancing will be the key barometer of the G20's relevance. Unlike the other items on its agenda—financial regulations, reform of the IMF, global trade liberalization, and so on—that will ultimately be dealt with in other forums, global imbalances are the G20's core competence. Indeed, the story of the various prior Gs, starting with G4 in the 1970s, is a story of imbalances—and it is a story of US economic fortunes and clashing national interests. The group has addressed the imbalances grudgingly, only when the US economy ailed and Congress reverted to a staunchly antitrade mood. The collaboration, while difficult, had its successes, most notably the historic Plaza Accord of 1985.
The stars may seem to be aligned for rebalancing. Three of the critical factors that propelled the adjustments in the 1980s are again in place: floundering American demand, sour US trade politics, and a forum that encompasses all actors required for a solution. However, none of the main surplus nations—China, Germany, or Japan—is poised to adopt consumer-led growth strategies, while the United States is running steep budget deficits that continue to require heavy foreign borrowing. The G20 has no enforcement mechanisms to compel rebalancing, and no major economy will comply with its international commitments if those clash with domestic political imperatives—let alone overhaul its policies because other G20 nations decide it should. At the same time, Washington's bilateral carrots and sticks that compelled Japan and Germany to adjust their policies in the past—security guarantees and a credible threat of steep tariffs—are not available against China, America's main counterpart in the global cycle of money. Why the failures to tackle imbalances in the past? And what measures should the United States take to tame them—before they undo the global economy?
Uneven Balancing
The global hegemons of the past two centuries, the UK and the United States, have repeatedly run current-account deficits. Britain went through a century of chronic trade deficits from Waterloo in 1815 to World War I, despite holding captive export markets and serving as the creditor to its vast empire. The US current account was in the red for most years in 1790–1875, the heyday of America's expansion, as the New World brimmed with investment opportunities and lacked savings. Foreigners—particularly the British but also the Germans, Dutch, and the French—stepped in, funding America's railroads and canals and helping to create a continental economy.
The pattern rebounded in the late twentieth century. After World War I, the United States replaced the UK as the world's largest creditor nation; after World War II, America emerged as the premier global exporter. But as Europe and Japan recovered and industrialized, the United States, an open and fast-growing market, was on its way to becoming a net importer. Declining in the 1960s, US trade balance turned negative in the early 1970s. The Kennedy and Johnson administrations sought remedies, such as persuading European nations to purchase military hardware from the United States in order to offset the negative impact of US military expenditures in Europe on US balance of payments. But the Vietnam war–related deficits, tight labor market, and loose monetary policy decreased the US current account. Paul Samuelson, the future winner of the Nobel Prize in economics, argued that US balance of payments policy had turned "from benign neglect to malignant preoccupation."
The Nixon administration's solution, in 1971, was to break the straitjacketing gold peg. But floating exchange rates gave rise to a new worry: that countries with devalued currencies would pose unfair competition in global commerce. This was a disquieting prospect at the time, when soaring oil prices and inflation were already causing economic havoc. Worried, Treasury Secretary George Shultz convened his counterparts from West Germany, France, and the United Kingdom in Washington in April 1973.
Grudging Cooperation
Schultz's "Library Group," named after its venue, the ground-floor library of the White House, quickly became an institution. It worked on common macroeconomic problems—the terrifying specter of economic contraction as countries tightened spending and interest rates, and America's worry, global imbalances. The foursome soon proved too few for resolving the main problem vexing America, current-account deficits. In the fall of 1973, the G4 welcomed Japan, the rising counterpart of America's trade gap. The G5 was born; by 1975, the G meetings were elevated to leaders' level. In the next two years the group invited Italy, a nation with political heft in Europe, and Canada, a US ally, growing into the famous G7.
What was the tally? The Gs came together only reluctantly to address the imbalances and had trouble living up to their commitments. However, coordination was successful when it truly mattered—when the United States was about to turn protectionist and when imbalances held global trade talks hostage.
The quad's main weapon was exchange rates. In September 1973 it agreed on policies that made the dollar depreciate against the German mark. The measure, along with congressional action the following year to relax the criteria for American companies to seek trade remedies, paved the way for the launch of the multilateral Tokyo Round trade negotiations.
The G7 Bonn Summit in 1978 was another of the better efforts. Each nation shouldered some of the burden to revive global growth and cut the imbalances. Japan and Germany pledged fiscal expansion, and the United States promised to deregulate oil prices to bring down the world price of petroleum. Trade again followed, as the group committed to concluding the Tokyo Round. But even Bonn failed to work exactly as intended, in part because the interventions came past their time and in part because of unpredictables—the Iranian Revolution and the 1979 oil shock.
The best effort yet came in the mid-1980s, when Japan became the overwhelmingly largest creditor nation and the United States the main debtor. With a large share of Japanese overseas investments flowing in US bonds, the two nations created a symbiotic relationship: America sustained Japan's export-led growth model and provided a safe haven for Japanese investments, and in return Japan funded America's growing fiscal deficit. But the pressure of Japanese imports and the lack of reciprocity with Tokyo aggravated Congress. Journalist James Fallows quipped that the legendary Japanese Ministry of International Trade and Industry (MITI) seemed to Americans like "Trade Surplus Central."
Although the Reagan–Thatcher revolution spelled an end to interventionist policies, the second Reagan administration relented under congressional pressures and set out to pursue what became known as "strategic trade policy." The aim was to sharpen US companies' edge in global markets and ensure reciprocity with American trade partners, particularly Japan. The administration also decided on multilateralism. Summoning the G5, Treasury sought to both harness the three European G5 members to pressure Tokyo and to shift some of the cost of US fiscal adjustment to other nations, thereby strengthening its hand with Congress in the deadlocked fiscal policy discussions.
Seeing the US fiscal deficit as the main driver of the imbalances, Germany and Japan were loath to act, despite their genuine fears about US protectionism. For its part, the United States argued that the surplus nations were failing to do their fair share to stimulate demand. However, everyone saw the need for action. Critically, with Japanese export interests and MITI worrying about market access in the United States, domestic politics in Japan aligned behind the required adjustments. The Reagan administration pledged to curb the fiscal deficit.
The commitments were enshrined in the 22 September 1985 Plaza Agreement among the G5 finance ministers. The United States was to rein in the budget, Japan to boost private demand through tax reform, and Germany to cut taxes to stimulate its economy. All five were also to intervene in foreign exchange markets to bring down the value of the dollar. To be sure, Germany—Bundesbank in particular—resisted, and Plaza entailed practically no changes to German fiscal or monetary policies.
Plaza had an immediate effect. The following day, the dollar fell 4.3 percent against other major currencies; in the next several months, it dropped by more than 30 percent, both thanks to Plaza and because of lower oil prices and flickers of growth in Japan and Europe. The dollar's descent was so remarkable that by early 1987, the G6 finance ministers met in Paris to halt it. The Louvre Accord pledged realignments and coordination on fiscal and monetary policy matters, including major cuts in US and French budget deficits. Overall, the episode was one of successful rebalancing. The Uruguay Round that would culminate in the creation of the WTO was set in motion in 1986, and after peaking at 3.6 percent of GDP in 1987, US current-account deficit closed at 0.16 percent of GDP in 1991. The price of US goods in Japan was literally halved.
Waning Salience
Underpinning the G5 and G7's success at rebalancing were US global power and leadership. Other major economies and US allies, in particular, agreed to policies to balance America's current account as a price for the security and economic benefits of US presence in world affairs. In the 1960s Europeans accepted US proposals to control current-account shortfalls in exchange for America's security umbrella. Even if reluctantly, the Japanese acquiesced to Plaza and Washington's bilateral trade agenda as a quid pro quo for open US markets. The Middle Eastern nations that paid for part of the first Gulf War helped terminate two decades of US current-account deficits.
In the 1990s the salience of the imbalances dissipated. Granted, governments still intervened to realign exchange rates—strong yen in 1995, weak yen in 1998, and weak euro in 2000, respectively—when they failed to match the underlying economic fundamentals. But the imbalances dissipated as the Japanese economy imploded in a real estate crash. US current-account deficits settled below 2 percent of GDP in most of the 1990s and even in 1998 were still moderate, at 2.6 percent. US exports and economy thrived, and with growth averaging almost 4 percent in 1995–1999, the fiscal deficit narrowed and ultimately vanished. Americans were more positive about trade than they had been in years. The North American Trade Agreement (NAFTA) passed in 1993, and the Uruguay Round was completed in 1994. The European G7 members were focused on their own affairs. Germans were steeped in the reunification process, and Western Europeans in general labored to integrate the Eastern half and launch the euro and the European Central Bank.
Macroeconomic policy coordination was also less useful. Developed nations established inflation-targeting regimes, effectively tying their hands in monetary policy making. The effectiveness of interventionism was questioned as the foreign exchange market grew too large for governments to move. The G7 shifted its focus from mutual adjustments to global economic challenges—the Asian financial crisis of 1997–1998, IMF reform, global macro economic surveillance—and expanded into such noneconomic topics as counterterrorism, nuclear security, and environmental protection.
Collectively Consistent?
By the mid-2000s, the imbalances came back with a vengeance. As in the 1980s, the pattern was again primarily transpacific—one where the United States consumed, imported, and borrowed, and Asia, especially China, saved, exported, and lent. In 2006 the US current-account deficit stretched to a historic 6.5 percent of US GDP, with Chinese imports making up a third of the total. The quadrupling of oil prices between 2002 and the summer of 2007, in part a result of Asia's insatiable demand for raw materials, added insult to injury. Imbalances stretched to some 5 percent of world GDP in 2008, the year the world would enter the worst financial crisis since the Great Depression.
Reacting to the global financial firestorm and recognizing the importance of emerging markets for mending the world economy, in November 2008 the George W. Bush administration convened the first-ever summit of the leaders of the twenty leading economies. Rather than the usual group of seven or eight, now the heads of industrialized powers would write a plan for ending the crisis and reviving the global economy with such ascending economies as China, India, Brazil, and Indonesia. The Economist announced this was "not a new Bretton Woods—but a decisive shift in the old order."
While historic, the event did not represent an abrupt shift in global affairs. The G20 had been launched already in 1999 at the level of finance ministers and central bank governors as an outgrowth of a discussion between President Bill Clinton and Singaporean Prime Minister Goh Chok Tong on ways to further economic dialogue between the G7 and emerging nations.
The Clinton administration had a number of reasons to expand the G system. Reverberating across the emerging world, including the pivotal Russia and Turkey, the Asian crisis showcased the effects of financial contagion on US economic and strategic interests, while the costly rescues soured relations with Congress. Closer vigilance would be required to keep the rising economies in line. The US economy was also growing more dependent on the emerging markets. By the end of the 1990s, almost a third of US trade was with emerging and developing nations, and some 40 percent of US FDI went to markets other than the European Union or Japan, particularly Asia and Latin America. There were further market opportunities to cultivate, as well: the G20 represented 4.2 billion consumers out of the planet's 6.8 billion, more than five-fold the 750 million in the G7 nations. Leadership on Wall Street and in Washington galvanized opinions, as Goldman Sachs singled out the BRICs as the coming world growth engines and the Brookings Institution called for adjusting global governance to reflect the economic transformations.
(Continues...)
Excerpted from PEERLESS AND PERILED by Kati Suominen Copyright © 2012 by Kati Suominen. Excerpted by permission of Stanford University Press. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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