What the U.S. Needs To Do Now

Today, President Obama is scheduled to outline a set of proposals for reforming the regulation of U.S. financial markets. The goal, of course, is to minimize the odds of another crisis ripping through financial markets.

Regulation does have a role to play in achieving that objective but we must not lose sight of other factors and measures that go more directly to the heart of the matter. That is to say, at ground zero in this whole mess is a huge set of imbalances in the world economy; to get out of the bubble-and-bust pattern that has settled in during the past decade, these disequilibria must be corrected.

And so far, there aren’t any good indications of such. That is not a good omen. One can have the best regulatory system in place but it will be like a sieve if the structural imbalances in the economy are not turned down.

The chief imbalance manifests most directly as a chronic deficit in the U.S. balance of trade, which has in recent years stood at about 6% of GDP. That means, as a nation, the U.S. is consuming and investing 6% more than it’s producing. Ordinarily, such an imbalance does not persist for very long – market forces would drive consumption lower in the deficit country and drive it higher in the surplus country.

But those market forces are not being allowed to operate. Many countries in the world, notably Asian countries such as China, are pursuing industrialization strategies based on export-led growth and are suppressing the value of their currencies against the U.S. dollar. They need to de-emphasize such export-led growth in favor of domestic-led growth. As well, they need to allow their currencies to appreciate against the U.S. dollar (or, on the flip side, let the U.S. dollar fall against their currency).

As for the U.S., its spendthrift ways need to be dialed down to get national spending more in line with production. By some combination of measures, the rate of internal savings needs to be raised. This starts with, as former Fed chairman Paul Volcker says, “a strong sense of monetary and fiscal discipline.”

There are no signs of such discipline at present. Indeed, U.S. monetary and fiscal policies are set to accommodative extremes not seen since World War II. Now that the risk of financial collapse has subsided, they should be reined back. This may trigger stagnation for a time but that is not to be feared. The U.S. is not Japan; it is a deficit country whereas Japan is a surplus country. Japan needs to stimulate its economy more, the U.S. less.

Living within its means is what the U.S. has to do to bring about a sustainable solution to the imbalances that are generating grave disequilibria. Just as good, it will put pressure on trading partners to abandon their export-led industrializations in favor of domestic-led industrializations — because if the U.S. is living within its means, it won’t be buying as many exports from other countries. For more thoughts on this theme, see the article, Averting Armageddon.

Comments

[rick12345:]

just sounds like a shift in power to me and about time. all empires eventually collapse and now is simply america's turn.

Jun 17 07:09 PM

[Moon Kil Woong:]

I agree with the author in that Asia's export led economies are equally responsible for this mess. China can not just sit back and blame the US. It plays an equal and pivotal role to the global trade imbalance and the consequences (market instability). Of course, the Fed needs to get wise and tighten. The Treasury and Congress would also be wise to embark on an austerity program to head off an inevitable forced austerity program. However, given the squeamishment for elected officials or their "independent central bank" to suffer any short term pain for long term prosperity this is unlikely.

Thus inflation and more instability is being baked into the cake (which is quickly turning into a lard ball with frosting).

Jun 17 10:00 PM

[Speedspirit:]

America is not the bad guy here. The American people that is. The real America has been under attack forever by the British. This is just the latest manipulative power struggle to destroy America and its respectability. What the people of the United States of America need to do is stop paying thier taxes, stop paying thier mortgages, stop paying thier credit cards and raise some hell with Washington. The Fed needs to be abolished for obvious reasons and the Treasury needs to be in control as it is written in the Constitution. Forget reregulation its a farse. They are just setting us the people up for the slaughter or a vaccine!

Jun 17 10:28 PM

[Tony Petroski:]

The author: America's trade imbalance: "Ordinarily, such an imbalance does not persist for very long – market forces would drive consumption lower in the deficit country and drive it higher in the surplus country."

I've heard about this "trade imbalance" my whole life. America has always had a "trade imbalance."

I've puzzled over this "fact" for a long time. Supply and demand will win over published "facts" and government statistics. Sooner or later, a country that permanently runs a trade deficit will witness a collapse of its currency.

1) Government statistics aren't always (almost never?) accurate. The "deficit" is really in balance over the long run.
2) Trade statistics don't take into account huge black-market activity: Drug trade, pirated DVD's, net influx of illegal immigrants, etc.
3) Trade partners massively inflate their reported statistics because in many cases, if the numbers (for them) don't show export growth, the reporters are shot.
4) Negative news fits the American Establishment Media agenda: "America in Decline."

I've tried my best. If America has a permanent trade deficit with the whole world for my whole life, how do we still exist as a great nation with currency people are still willing to hold?

Jun 18 12:30 AM

[Dave Wrixon:]

Actually, the US is a victim of its own success and the roots of the problem lies in the Dollars status as the reserve currency. Even more so now that the US is about lose it status as the World's largest economy. Actually,strictly, it did that with the formation of the Eurozone.

The World Reserve Status of the dollar has both been an asset and a curse, and is largely responsible indirectly for both of the twin deficits and the consumer debt that are now murdering the US economy. The US cannot cope with being solely responsible for the World's monetary system any more than it is in the interests of the rest of the World to let it do so. The Chinese seem to have recognized this problem and whilst looking for alternatives probably won't push for the Yuan to replace the dollar although it is an obvious candidate.

The problem, however, is how to remove sufficient of those foreign held dollars without creating even greater problems. Of course the dollar will weaken but in many respects that is desirable. A certain amount of inflation is require to make the debt more manageable, and a weaker dollar would certainly help resolve the trade imbalances.


On Jun 17 10:00 PM Moon Kil Woong wrote:

> I agree with the author in that Asia's export led economies are equally
> responsible for this mess. China can not just sit back and blame
> the US. It plays an equal and pivotal role to the global trade imbalance
> and the consequences (market instability). Of course, the Fed needs
> to get wise and tighten. The Treasury and Congress would also be
> wise to embark on an austerity program to head off an inevitable
> forced austerity program. However, given the squeamishment for elected
> officials or their "independent central bank" to suffer any short
> term pain for long term prosperity this is unlikely.
>
> Thus inflation and more instability is being baked into the cake
> (which is quickly turning into a lard ball with frosting).

Jun 18 01:01 AM

[derryl:]

Tony Petroski wrote, "If America has a permanent trade deficit with the whole world for my whole life, how do we still exist as a great nation with currency people are still willing to hold?"

As the world's reserve currency, the US$ is the world's 'gold'. Nations hold gold to back up their own currency. They want to hoard their gold, not spend it, so they don't demand that the US sell them stuff and take its money back.

First we had the gold standard, with national currencies backed by their holdings of gold and international trade denominated in gold: if you imported something you paid in gold. Then we had the gold-dollar standard, with international trade denominated in US$ but theoretically convertible to gold at $35 per oz. Now we have the informal dollar standard, where the US$ is still the global currency but is no longer even in theory convertible to gold.

The dollar is, like gold used to be, used to 'anchor' national currencies whose value might otherwise be suspect. A Pole might not sell you his house for zlotys, but he will sell it for 'hard currency', which means US$.

So as the supplier of the world's 'gold', the US has been able to run huge deficits in trade of goods by paying for imports with the US$ those exporters need to hold and to use for their own imports. With increased 'globalization' over the past 3 decades there has been increased demand for global money, which is US$. As the originator of this global currency, the US has enjoyed 'seignorage', which is the ability of a government to coin or print money then spend it into the economy and leave it there because the economy needs the circulating cash supply.

An obvious downside of being the world's supplier of hard cash is that you get used to printing money and buying stuff rather than producing goods and trading for other goods. The road to sustainable wealth, good jobs and a balanced economy is industry, not the printing presses. In the long term it probably is not beneficial for the US that its dollar is the global reserve currency, though in the post-war Bretton Woods-cum-Nixon era there has been no alternative to the US$. Eventually IMF Special Drawing Rights or some other supernational currency may replace the dollar. There is no other national currency remotely close to able to replace the dollar, now and into the foreseeable future, so if and when the US$ loses its reserve status it's mark of the beast one world currency here we come.

Jun 18 01:06 AM

[Dave Wrixon:]

Largely agree. The problem is that "New Gold" is proving to be near worthless paper.


On Jun 18 01:06 AM derryl wrote:

> Tony Petroski wrote, "If America has a permanent trade deficit with
> the whole world for my whole life, how do we still exist as a great
> nation with currency people are still willing to hold?"
>
> As the world's reserve currency, the US$ is the world's 'gold'. Nations
> hold gold to back up their own currency. They want to hoard their
> gold, not spend it, so they don't demand that the US sell them stuff
> and take its money back.
>
> First we had the gold standard, with national currencies backed by
> their holdings of gold and international trade denominated in gold:
> if you imported something you paid in gold. Then we had the gold-dollar
> standard, with international trade denominated in US$ but theoretically
> convertible to gold at $35 per oz. Now we have the informal dollar
> standard, where the US$ is still the global currency but is no longer
> even in theory convertible to gold.
>
> The dollar is, like gold used to be, used to 'anchor' national currencies
> whose value might otherwise be suspect. A Pole might not sell you
> his house for zlotys, but he will sell it for 'hard currency', which
> means US$.
>
> So as the supplier of the world's 'gold', the US has been able to
> run huge deficits in trade of goods by paying for imports with the
> US$ those exporters need to hold and to use for their own imports.
> With increased 'globalization' over the past 3 decades there has
> been increased demand for global money, which is US$. As the originator
> of this global currency, the US has enjoyed 'seignorage', which is
> the ability of a government to coin or print money then spend it
> into the economy and leave it there because the economy needs the
> circulating cash supply.
>
> An obvious downside of being the world's supplier of hard cash is
> that you get used to printing money and buying stuff rather than
> producing goods and trading for other goods. The road to sustainable
> wealth, good jobs and a balanced economy is industry, not the printing
> presses. In the long term it probably is not beneficial for the US
> that its dollar is the global reserve currency, though in the post-war
> Bretton Woods-cum-Nixon era there has been no alternative to the
> US$. Eventually IMF Special Drawing Rights or some other supernational
> currency may replace the dollar. There is no other national currency
> remotely close to able to replace the dollar, now and into the foreseeable
> future, so if and when the US$ loses its reserve status it's mark
> of the beast one world currency here we come.

Jun 18 02:45 AM

[Fighting Yoda:]

Asian countries have surplus production capacities, US has surplus consumption. Some middle ground has to be reached - US has to decrease its consumption, Asia has to both increase internal consumption and also kill capacity, and maybe US has to increase its production. Wall Street paper shuffling nonsense businesses must go. This has to happen- it would be slow and not so painless process. What will come out at the other end I am not sure of the from, but some stability and parity would emerge.

US definitely has to get out of it’s borrow and consume mentality. US has only been able to do it by abusing its currency reserve position. Now being the largest debtor in the world its dollar reserve position is in complete peril. It is hanging on to it by a thread because there is no other viable alternative today. Alternatives will emerge - they have to - the world will not stand any longer for this American gluttony.

Jun 18 02:58 AM

[Ferdinand E...:]

The financial people everywhere made bad bets, and the American voters made the worst bet of all when they relected George W. Bush.

Bush is gone, and in theory a brilliant American government has taken the place of that gentleman and his cronies. In theory! As for the bad bets, it should be easy to make sure that they can't be made in the future. Sure the consuming will have to be reduced, but when you dance you eventually have to pay the piper.

Jun 18 11:08 AM