Bernanke Fires a Shot Across Summers' Bow

Includes: DIA, QQQ, SPY
by: Howard Richman

Economic events have been moving quickly this past week:

  • On March 5, The Economist reported Chinese Premier Wen Jiabao saying that China would not be increasing its budget deficit beyond its current 3% of Chinese GDP, a combination of infrastructure projects, defense buildup, and WTO-illegal export subsidies. (In comparison, the U.S. budget deficit will likely be 12% of GDP this year.)
  • On March 8, the Financial Times reported President Obama’s chief economic advisor Lawrence Summers giving China a pass, saying, “The old global imbalances agenda was more demand in China, less demand in America. Nobody thinks that is the right agenda now.” Summers was suggesting that Europe join the United States in trying to stimulate the world’s economies out of the recession without help from China and the other Asian mercantilists. Europe quickly nixed that approach.
  • On March 10, Federal Reserve Chairman Ben S. Bernanke began a speech about the current status of the American financial sector with a statement that directly contradicted Summers, saying that global imbalances lay at the heart of America’s financial crisis.

Only the first part of Bernanke’s speech was about imbalanced trade. He began:

The world is suffering through the worst financial crisis since the 1930s, a crisis that has precipitated a sharp downturn in the global economy. Its fundamental causes remain in dispute. In my view, however, it is impossible to understand this crisis without reference to the global imbalances in trade and capital flows that began in the latter half of the 1990s….

The global imbalances were the joint responsibility of the United States and our trading partners, and although the topic was a perennial one at international conferences, we collectively did not do enough to reduce those imbalances.

He said that our experience parallels the Asian Tigers crisis, meaning that if global imbalances are not addressed, the United States could be heading toward a dollar collapse. Specifically:

In certain respects, our experience parallels that of some emerging-market countries in the 1990s, whose financial sectors and regulatory regimes likewise proved inadequate for efficiently investing large inflows of saving from abroad. When those failures became evident, investors lost confidence and crises ensued. A clear and highly consequential difference, however, is that the crises of the 1990s were regional, whereas the current crisis has become global.

He also took an indirect swipe at the Obama administration’s wasteful stimulus plan. He noted that the foreign savings coming into our country since the mid-1990s had been misspent by America on consumption, not investment, perhaps alluding to the way the Obama administration let Congress take almost all of the infrastructure investment out of its stimulus plan. Bernanke said:

The details of the story are complex, but, broadly speaking, the risk-management systems of the private sector and government oversight of the financial sector in the United States and some other industrial countries failed to ensure that the inrush of capital was prudently invested…

If Bernanke’s view wins out, then the United States will address the global imbalances, resulting in a resurgence of American manufacturing. If Summers’ view wins out, then the United States will continue to borrow money from abroad to pay for wasteful government give-aways and environmental foolishness, which will cause American manufacturing to lose market share to global competition and could lead to an eventual dollar collapse.

Bernanke’s Speech Still Inadequate

Although Bernanke understood that the global imbalances resulted from a chronic lack of saving relative to investment in the United States and to an extraordinary increase in saving relative to investment in many emerging market nations. He did not point out that these savings differentials were largely government produced.

A full 60% of the foreign savings coming into our country and causing our trade deficits from 1996 through 2007 were sent to us by Bernanke's fellow central banks, mostly by the central banks in the mercantilist countries who were borrowing money from their own people, using their borrowed money to bid up the dollar, and then sending the dollars purchased to the United States as loans, which were passed on by American banks to American consumers.

Their borrowing from their own people suppressed consumer spending in the mercantilist countries while their loans to the United States caused American interest rates to fall, American consumer borrowing to surge, and American household savings to collapse.

These government-produced savings flows were the deliberate policy by Japan, first, followed by China and other Asian countries, later, in order to obtain and perpetuate a trade surplus with the United States. Only the current depression brought Japan into a negative trade balance this past month for the first time in 75 years.

Bernanke also failed to distinguish between the large capital inflows from China and the other Asian countries with inflows from oil-producing countries, but the latter were not significant until about 2004.

Furthermore, Bernanke did not suggest a plan for how to achieve trade balances. There are two alternatives: (1) a new international institution to achieve balanced trade and (2) unilateral action to achieve balanced trade. We will discuss each in turn.

New International Institution to Achieve Balanced Trade

The World Trade Organization has failed. Its rules permitted the unsustainable imbalanced trade that led to the current global collapse when the American consumer, not getting sufficient income from exports, could not keep borrowing more and more to buy imports.

The international community could replace the World Trade Organization with an organization designed to produce sustainable trade growth, like the one that John Maynard Keynes advocated for the post-war world during World War II. His institution was to have very different requirements for trade surplus countries and trade deficit countries (Volume 25 of his collected writings, pages 79-81), with the goal of keeping trade in balance. Here is what his institution would require of trade surplus countries:

A Surplus Country shall discuss with the Governing Board (but shall retain the ultimate decision in its own hands) what measures would be appropriate to restore the equilibrium of its international balances, including

  • (a) measures for the expansion of domestic credit and domestic demand:
  • (b) the appreciation of its local currency ... or, if preferred, an increase in money-wages;
  • (c) the reduction of excessive tariffs and other discouragements against imports;
  • (d) international loans for the development of backward countries.

On the other hand, countries with a trade deficit would be allowed to take the following actions:

  • (i) restrictions on the disposal of receipts arising out of current trade and ‘invisible’ income.
  • (ii) import restrictions, whether quantitative or in the form of ‘duty-quotas’ (excluding however prohibitions genuinely designed to safeguard e.g. public health or morals or revenue collection);
  • (iii) barter arrangements
  • (iv) export quotas and discriminatory export taxes;
  • (v) export subsidies either furnished direction to the state or indirectly under schemes supported or encouraged by the state; and
  • (vi) excessive tariff.

Unilateral American Action to Achieve Balanced Trade

If the rest of the world is not cooperative. The United States could take unilateral action to balance trade. Warren Buffett’s Import Certificates plan would do so. American exporters would earn marketable Import Certificates which would allow a proportional value of imports into the United States. Those who wished to import into the United States would be required to have their imports accompanied by Import Certificates.

When Senators Dorgan and Feingold fleshed out Buffett’s plan as the Balanced Trade Act of 2006, they had the amount of imports permitted by a certificate change in order to gradually balance non-petroleum trade over a period of 5 years.

If the United States imposed Import Certificates to balance trade, then other trade deficit countries would soon follow suit. The result would be balanced world trade without the need of any international regulatory agency. If trade were balanced, countries would be hurting themselves when they subsidized exports or put up barriers to imports. Import Certificates would end the current era of predatory trade and begin a new era of balanced free trade.

Lawrence Summers now knows that he was wrong when he claimed "Nobody thinks that [addressing global imbalances] is the right agenda now." In fact, there is someone quite important who thinks exactly that. Bernanke just fired a shot across Summers' bow. Summers would be wise to change course.