Rx for Correcting Global Imbalance 25 comments
an article to
-
Font Size:
-
Print
- TweetThis
Martin Wolf is the well known economics commentator for the Financial Times. His book Fixing Global Finance is a good read, although it got caught in something of a time warp. The book grew out of a series of lectures given at Johns Hopkins University in March 2006; it was actually written in August 2007; and the book was published on September 23, 2008.
Timing is everything. The book captures none of the major events and government actions that took place between December 2007 and the date it was published, let alone anything that has happened since then.
It's also a worthwhile read because of the story Wolf weaves to explain the development of the imbalances in world markets that resulted in the current financial and economic crisis. The author puts forth the “savings glut” theory to describe how the world evolved through the early 2000s. It is important to understand this theory because it is the one that was developed by and acted upon by the current Federal Reserve Chairman, Ben Bernanke. The theory absolves the Federal Reserve actions of the past eight years of blame for the current financial difficulties.
The basic idea is this: Emerging economies, like China, other Asian countries, oil producing countries in the Middle East, and a few others, found that living with balance of trade deficits was dangerous for their financial health. When these countries lived with trade deficits they found themselves with frequent and rather destructive financial crises that occurred regularly. By 1998 these countries had had enough of this, and entered into a brand new phase of their development.
These emerging countries began to establish macroeconomic policies along with exchange rate management techniques aimed at fueling export-led balance of trade surpluses. “They decided to aim for highly competitive exchange rates, at which the current account can be expected to remain strong and the trade surplus helps sustain high levels of domestic activity.” Savings soared in these countries and the governments started accumulating enormous international reserves. “Two-thirds of all the foreign-currency reserves accumulated since the beginning were piled up within less than seven and a half years of the new millennium.” That is, between December 1999 and March 2007.
“If the rest of the world has in the aggregate a large surplus of saving over investment at home, it must invest this surplus elsewhere." This global savings glut, according to the theory, “caused” the resulting easy monetary and fiscal policies in the United States. The United States could have fought this but, “it cannot force its currency down by intervention against the currencies of countries that are prepared to invest in reserves without limit…In essence, whatever the U.S. fiscal authorities do, the Federal Reserve must pursue a monetary policy sufficiently expansionary to generate (high levels) of domestic demand, in order to secure the desired internal balance.” That is, the United States must produce a “high consumption” economy without savings so as to absorb the savings of the rest of the world. “The United States has been absorbing about 70 percent of the surplus savings in the rest of the world, with the difference accounted for not by increased investment but by higher consumption and a lower rate of saving.”
Wolf asks whether or not these external ‘imbalances’ are sustainable…and his answer is “yes.” He then asks whether or not they will be sustained…and here he waffles. We know that the imbalances were not sustained, and they have resulted in a major worldwide financial collapse.
This is where the timing of the book and its writing play a significant role. To me, the last chapter in the book is the only place that contains anything that approaches some of the issues that were looming on the horizon as the book went to print. This chapter reads like it was hastily added to the book while clouds were forming, in the hope that the book would be more closely tied to the events beyond its publication. At barely more than three pages, the chapter hardly serves this purpose.
I tend to lean more to what Wolf calls the “money glut” theory of the world’s financial imbalances. In this theory, these world imbalances came about from a central bank that underwrote negative real rates of interest and served as a “bubble machine” that helped distort asset markets. Within the context of the bubble, “the credit expansion was associated with what was, in retrospect, unsound lending of a particularly innovative kind, involving such strategies as securitization and special investment vehicles.” These excesses sent “spending across the frontiers, generating a huge trade deficit and a corresponding outflow of dollars.”
The case Wolf gives for the unsustainability of these imbalances fits better into the “money glut” theory. The United States, it is argued, could not continue to borrow as it had done up through 2007 because the debt loads created could not be maintained. These debt loads at some time, he argues, would create disturbances that would help to bring down the whole house of cards and cause a financial collapse. Sound familiar?
So what can be expected of the global financial system? “Not much,” Wolf concludes. The efforts to reform the IMF have been feeble at best. The countries of the world are just not going to work together, regardless of how much it costs them not to. Therefore, relying on the “savings glut” theory, Wolf argues that the emerging countries must look after themselves. These countries, he feels, are going to have to create “a sound domestic-currency-based financial system” to pull themselves up by their bootstraps so as to avoid further cases of financial crises. (A current take on this can be found in Wolf’s Financial Times column of January 20, 2009.)
If one believes in the alternative, the “money glut” theory, then the solution is much easier. The imbalances can be solved by getting leadership in the Federal Reserve that will not underwrite asset bubbles. But that is not the major issue at the present time…or is it?
Fixing Global Finance, by Martin Wolf. (The Johns Hopkins University Press, Baltimore), 2008.
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication in the last week
Seeking Alpha 100 » -
Fastest Climbers
Those with the largestSee all
increase in followers
in the last week
Fastest Climbers » -
Top Commenters
Top commenters,
as ranked by their peers-
1
User 353732
-
2
Moon Kil Woong
-
3
doubleguns
-
4
optionsgirl
-
5
Mayascribe
Top Commenters » -
1
-
Top Instabloggers
The 100 most activeSee all
Instabloggers.
Top Instabloggers » -
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
What should then happen is that the bubbles need to be deflated in a process where selling begets selling etc. As the asset deflation continues legions of powerful interest groups and politically powerful constituencies start complaining very loudly and the taxpayer is fully funded to rescue the situation.
This process is non-Darwinian and ensures that survival is not of the fittest but those with the sharpest elbows and friends in government.
The problem is not Americans spending money to employ people from other parts of the world. This spending employed people and helped other countries achieve their potential for productivity. Rather the problem is those countries taking that money and hoarding and lending it, rather than spending it to employ Americans.
It seems to me that the savings glut theory confuses cause and effect. Loose monetary policy causes prolific spending, not the other way around. The reverse of the savings glut theory is the monetary glut theory, which has the correct cause and effect relationship.
It all seems very simple to me, which makes me think that there may be more nuance to all this than I am recognizing.
Excellent comment stream here. Thanks.
Spending is not a bad thing. If I spend money to employ you to do something, and you spend money to employ me to do something, then that's a win-win. Money isn't there to be hoarded. You're supposed to spend it to get people working.
Americans did their job. We employed the world. It's now their turn to employ Americans. If they do we'll spend again creating productivity for all. If they don't, then the relationships will collapse.
Government's role is not to deal with problems in a reactionary fashion - this could never work, but to lead the country consistently and with steady hands, anticipating problems along the way (whether such problems are internal or external) and making small corrections along the way, with the ultimate goal of staying the course in mind.
The incompetent Bush administration and Bush's Fed are to blame for our current problems, as these problems all developed and were exacerbated by their policies and under their watch. In the few days that Obama has been in the office, he has not yet made any decisive moves to brake with the failed fiscal policies of the past 8 years. I am hoping for the best, but preparing for the worst...
My personal solution is to lower the costs of production in the US as it impacts labor, government, and financial sector. NOTE, I am not an advocate of tariffs, or currency controls, or other Patrick Buchanan type policies.
LABOR MARKET CHANGES
1) Freeze the minimum wage.
2) Universal healthcare. This burden needs to be removed from business. People, especially children, need a GOOD healthcare safety net.
3) Eliminate grades 10 through 12 for students who wish take an alternate program in practical training and move them to community colleges where they can be trained to function in society. We spend so much time trying to teach kids geometry, science, art, history etc that we've lost site of the fact that these kids need to make a living.
GOVERNMENT CHANGES
1) Open California, Florida, and New England to drilling - WIDE OPEN!!! This creates US jobs and reduces trade deficit.
2) Streamline and encourage construction of many new nuclear power plants. This also creates US jobs and reduces the trade deficit. Specifically change the spent fuel recycling regulation that leaves us with tons of unspent radioactive fuel. THIS IS THE PROBLEM!
3) Create more tax breaks for business investment in this country and remove tax credit for investment in foreign countries.
4) Eliminate the corporate income tax.
FINANCIAL MARKET CHANGES
1) Less Leverage: Current margin requirements should apply to ALL publicly traded equity regardless if the purchase was made through a broker or through a quiet backroom deal. 40 or 80 to 1 leverage should be a thing of the past.
2) Financial institution transparency. Before a bank can do business in the US it must expose every single one of its assets to public scrutiny.
3) Asset bubble protection. All government policies that promote asset hoarding by consumers should be eliminated. We can begin with real estate. Eliminate the mortgage interest tax.deduction. Next, a home mortgage15% down payment should be required by law. Second, the automobile industry: Consumers have "hoarded" automobile by purchasing massive gas guzzling SUV. CAFE standards should apply to SUVs and trucks, AND there should be a road surcharge payable at the time of purchase and a corresponding tax rebate on high mileage counterparts. Our savings rate will rise when the consumer stops hoarding assets.
4) Make long term capital gains tax free. Need I say more than this?
First, make China and other totalitarian regimes become democratic. Why is this. Rather than wealth in those countries be spread out so there is a middle class, they always have all wealth concentrated to the few that are only interested in gaining more wealth rather than improving anything in the country. Therefore, you get what... no domestic consumption and unstable political situations that only encourage more hoarding, oppression, and savings.
You can also not do business or limit your business with countries that do not allow an open market system or a dollar/Euro, or other peg. Those pegs although set unfavorably for the US etc. at least creates a limit of how much they can cheat before their economies catch up and there is diminishing returns. Letting countries continuously slide their currency down just makes for a large economic imbalance between them and their importing friends that is unhealthy in the long run for both.
You can blame the US for the auto industry failure though. In the case of Japan vs. the US auto industry, it was not so much a monetary imbalance as the fact the auto industry wouldn't change or embrace Deming's principles which he tried to get them to take in order to reform themselves. The US auto industry is the same of the US because their executives sat on their laurals until the 70's and even then refuse to reform. Rather they beg the government for support every few years or so to fund their R&D, give them tax breaks, or bail them out. Their $25 billion dollar binge for R&D was not the first or the last corporate begging from them.
So how do we correct global imbalances. It must be done jointly. The US can't and won't do it alone. Why should we? We depreciate our currency and then the world does. We save and the world blames us for the recession. We should save more. The main issues is they should spend more. They don't, can't, or won't.
Trade is a 2 party thing. So trade issues must be solved with 2 or more parties. So far I hear no one on the other side agreeing to take any pain on behalf of the US.
Yes, the rest of the world has fueled America's consumption, helping their economies to grow tremendously. But America's consumption was not built on productive output; it was built on debt and the wealth effect from asset bubbles. The Fed and the previous administrsation are prime culprits here.
An analogy is a respected guy in town who loses his job. As a respected citizen he is afforded credit to allow him to maintain his standard of living. Let's say I am a restauranteur and that I studiously serve this respected citizen before and after he lost his job. I am prudent and save much of my revenue. One day this citizen will have to make a major correction in his living standards because he cannot find equal paying work if at all. Unfortunately he is even worse off than when he simply lost his job because he is heavily indebted and the powers that be put him and the financial system in that situation.
America's consumption in the last decade or more has become increasingly hazardous, and prudent authorities should have started far earlier to address it.
In his article, Mr. Hansen argues the exact same points I believe are - both, at the root of America's economic decline, and pointing to the solution that will restore American economic prosperity. It is not the collapse of the housing market, as Mr. Bernake has stated; It is not the current "Credit crunch" as a range of "experts" argue; It is not purely the drop in US employment,
Mr. Hansen argues that:
"There is another proximate cause (at the root of America's economic crisis) which explains the employment drop – failure to expand technologically. At some point we took our eyes off of the ball. We stopped investing in ourselves. Without this investment, new jobs were not created. Companies became obsessed with short term over long term profits. Bonuses based on current stock value caused executives to keep focused on one year horizons. We exported R & D overseas to save costs. Small businesses stopped being created at past rates.".
This is exactly my position/.
In short, I believe:
...to restore America's economy, we must restore American Manufacturing. To do that, we must re-invest both in technology R&D and domestic production capacity and strengthen our "domestic treasury of US owned intellectual Property and skilled workforce."
Further, we would be smart to fund this re-investment in America, as much as we can, from monies extracted from those countries who are currently benefiting most, either by exporting products to us or off-shoring jobs for us. (This refers to my recommendation that the US impose a tariff on importers that they could offset by earning US jobs creation credits.
Otherwise, the remaining tariff proceeds would be directed to fund US R&D and export credits for manufacturers. And, best of all, the foreign countries, not the American taxpayers, would be the ones funding the restoration of our industries, jobs, and global trade balance.
This would create jobs in the USA...good jobs for Americans...which, in turn would point us in the direction to improve our current import/export gap and thereby start to regain the vital corporate and personal tax base that is needed to combat our spending deficits and which we've been "exporting" to those countries we import from or outsource to. (Not forgetting to take advantage of cutting Gov't spending wherever we can.)
I've attached the link to Mr. Hanson's article. I hope you will read it.
seekingalpha.com/artic...- ... -recession
On a side note:
Another critical thing to restore in America, is "Honest American Business Ethics." That is a topic for another thread, though.
SteadfastMason
----------------------...
That was an interesting analogy, except up to the point where you imply that the guy (America) can never get a good job again.
You make it seem like America can't do the work we've paid other countries to do, but that's not true.
America can easily make all the products we currently hire other countries to make. Either they stop hoarding the money America pays them, or we'll stop buying from them and make the products here.
And as far as the debt, it's denominated in dollars and so you can see the implication.
The problem is not that America lost its job. The problem is that America started trading with misers and usurers. Either they change their behavior or America will stop employing them.
Thanks for the feedback.
I see some problems with your solution:
1) America is not a state run economy, that means on the micro-level, american companies succeed through survival of the fittest; components of production are largely labor, processes, and material. The first two are available abroad at orders of magnitiude lower costs, and material costs are commoditized globally. How can you stop any firm from using these advantages and winning. Outsourcing is just beginning -- almost any service that does not require coming to your house will be available globally (eg: medical, tax, accounting, law, education...etc). We would have to put serious tarriffs on foreign goods and services, and that would slow this trend for awhile, but would stop our influence and involvement globally.
2) Even if we addressed the cost problem above, the education level of the average American is even today below the standards in many countries. Literacy in many developing countries is flying high and education curriculae are often far more demanding. The MCAS programs recently implemented in the US are behind the testing regimes used in many countries. Granted their students are not as creative as the ones here, but they emerge very competent and disciplined. The education investment in the stimulus is vital, IMO.
I think as a country we will wake up to the fact that there are no shortcuts, we have to compete globally both in talent and cost; this is going to be a hard transition.
There are hundreds of ways countries could spend their trillions in surplus to hire Americans. Imagine if you were China, and sitting on two trillion dollars gained from a decade of trade surpluses, and American companies were eagerly waiting for you to spend. Imagine all the wonderful things you could buy from America. Healthcare, education, intellectual property items, infrastructure, food and on and on. The list is endless.
But that’s like offering Scrooge an expensive catered meal. As Dickens said, he would rather eat gruel in a cold darkened room to save money.
Hopefully, achieving competitive superiority in the plastic bowl manufacturing industry will not become the pinnacle of America's realistic aspirations for restoring a vibrant manufacturing / employment base. But, if we can't even compete with a factory on the other side of the world at making a plain plastic bowl that sells for under a buck that was nearly 100% made by a machine (aka: no issue with labor differentials between China and USA), then how can we begin to secure financing necessary to make larger capital expenditures to build more complex and comparable quality products and that the consumer will want to buy...that are made with more efficient machines, in more efficient factories, and with more effective techniques...to keep more of America's dollars circulating within the our economy...contributing to our country's tax revenue, cash in circulation, and trickle-down employment growth?
After all, what are the ingredients needed to make virtually anything in the US? Long-term Funding (at favorable terms) for plant and equipment, R&D, production and supply chain and distribution network, raw materials, skilled/specialized labor, energy, legal/Copyright/licens... tax and other regulations, and a solid marketing growth plan...long-term committment to growing the business, and plenty of elbow grease.
SteadfastMason
Below, is another example as to why America impoirts from China rather than manufacturing in the US. The following is an excerpt from a case study citing Chinese Factory Wages at Huangwu Toy factory,
www.chinalaborwatch.or...
Huangwu No. 2 Toy Factory (Also called Junda Huangwu Toy factory)
Huangwu Management Zone
Dong Keng Township, Dongguan City
Guangdong Province, China
Ownership: Hong Kong capital (Huangwu No. 2 Toy factory is a subsidiary of Tsun Tat Toy
Company Ltd. / Tsun Tat Company.)
Factory Phone: 07 69 3381405
300 workers / half men, half women
Wages:
Paid 43 cents an hour and $3.45 a day;
- In spray paint department, workers paid just $0.000387 cents per piece;
- If workers fail to meet their production quota, their wages fall to 15 to 18 cents an hour,
which is less than half the legal minimum wage;
- Workers are routinely cheated of their legal overtime wage—losing at least $13.33 a
week, or 25 percent of the overtime pay due them;
- One month’s wage is always withheld.
Regular Wages
- 28 yuan per day (if a worker completes the assigned quota)
- 43 cents an hour (.4315659)
- $3.45 a day (8 hours)
- $17.26 a week (40 hours)
- $74.80 a month
Room and Board:
The workers are housed in dorms with nine double-level bunk beds and five to 18 people housed in each crowded room. There are two electric fans, but in the summertime, the rooms remain
unbearably hot and humid. There are no private bathrooms. Each floor has a public bathroom and showers—but only one floor offers hot water. Many workers have to take cold showers at night. Room and board is free, but the workers have to pay 10 yuan a month ($1.23) for water and
electricity, and have to cover the cost of breakfast.
(in the example cited in the case study) "In violation of the law, workers are not provided health insurance or inscribed in a pension program:"
Article 72 of China’s labor law mandates that all companies—including foreign invested enterprises—must inscribe all their workers in social health insurance and pension programs, with both company and workers paying into these programs. Huangwu Toy factory management blatantly ignores this law as well.
According to another study, Does Outsourcing really Benefit Third World Workers like Americans Believe? adm.hfcc.edu/~pkearly/PeerReview ... oussan.htm
"As of 2002, the average income per capita in the United States was $43,760 USD, which was reported by the U.S. Department of Commerce. If the $3.44 per week is totaled for one year, the overseas laborers’ yearly income totals to $178.88 USD, which is about 245 times less than the average American worker.
...When American consumers pay $125 for Nike sneakers made by workers in Indonesia who earn 31 cents an hour… Someone is benefiting, but it isn’t American consumers.”
SteadfastMason
I don't mean to beat the miser/usurer analogy to death, but instead of hoarding and investing all this money why don't they use some of it to buy goods and services for their people?
We export the ONLY thing we have that the Chinese want...the info they need to copy us, without any real fear of legal reprisals.
Their strategy is to pirate the US. And American trade policy has, so far, fed right into their hand, substituting short-sighted and poorly negotiated technology exports without teeth...or appetite... to ensure our intellectual property laws are upheld and honored by the Chinese.
SteadfastMason
On Jan 31 09:07 PM user578974 wrote:
> Why would China want to pay for intellectual property when they can
> steal it?
The reason they make the $0.99 plastic bowls is their cost of living is so low there that they can live selling these bowls in a limited quantity whereas a company here would require higher volumes or price.