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NJ Daily / BALANCE OF PAYMENTS

A G-20 Grand Bargain

March 19, 2009

The U.S. trade deficit was down $3.9 billion in January, or 9.7 percent, as exports fell, but imports declined even more. The narrowing of America's imbalance with the world is good news. But beware: This could be a sucker's rally.

The trade deficit improvement is largely a product of the spreading global recession. Consumers everywhere are buying less. There is no evidence of the structural changes that would be necessary to fundamentally alter the global account imbalances that have grown up over the last few decades and were one of the principal underlying causes of the recent financial crisis.

When the leaders of the 20 largest economies meet in London April 2, they will necessarily focus on reviving consumer demand and reregulating the global financial system. But they should also lay the groundwork for a Global Bargain to rebalance international accounts.

 

At a broad, conceptual level, this will require each of the G-20 nations to assume responsibility for its own role in destabilizing the world economy. Going forward, the United States will need to produce more of what it consumes and China, Japan and Germany will need to consume more of what it produces.

Practically, this will involve a new exchange rate regime so that in the future the values of currencies more closely reflect the strength of each economy. And it will require a revamping of trade relations with an eye to reciprocity and a balance of benefits to better apportion the costs and rewards associated with a global economy.

This is a tall order. But anything less makes another economic crisis almost inevitable.

The broadest measure of any country's economic balance sheet with the world is its current account, which measures the movement of goods, services and capital. In former President George W. Bush's first year in office, the U.S. current account deficit was 3.8 percent of GDP. In 2007, it went to to 5.2 percent. Meanwhile, in 2007 China ran a current account surplus equal to 11.4 percent of its GDP, Germany a surplus of 7.6 percent and Japan a surplus of 4.8 percent.

To balance national ledgers at the end of the year, these imbalances have required ever-more innovative recycling of funds from surplus countries to the United States. The overwhelming volume of cash involved, coupled with lax financial regulation, was a recipe for trouble.

U.S. borrowers created exotic financial products to entice deep-pocketed foreign lenders to part with their money. These proved unsafe. The global financial crisis ensued. Avoiding similar problems in the future will not simply involve better regulation, but the prevention of the re-emergence of destabilizing current account imbalances.

Most economists believe the United States can safely maintain a current account deficit of about 3 percent of GDP. While the U.S. current account deficit is now declining, if the United States is the first nation to recover from the global downturn, its current account might worsen again as U.S. consumers return to their import-dependent lifestyles.

To avoid that eventuality, Americans need to buy fewer imports and thus have less of a need to borrow abroad to pay for them. This can be achieved by Americans' consuming less and saving more.

But a sustainable current account balance might prove difficult to achieve based solely on a higher American savings rate. Returning to historic norms would require a doubling or tripling of current American saving. That would translate into a relatively lower American standard of living, a prospect that will be unpalatable to many.

Internationally, any long-term decline in U.S. consumption would also have a devastating effect on the economies of other countries, forcing a reduction in production, unless consumption abroad increased.

Enter the opportunity for the Grand Bargain. Americans need to produce more of what they consume. This can be accomplished by increasing domestic production. Similarly, the Chinese need to consume more of what they produce, improving the Chinese standard of living while reducing China's trade surplus.

A weaker dollar and stronger renminbi, as part of a global currency regime that also weakened the yen and the euro, would go a long way toward accomplishing this rebalancing by making imports into the United States more expensive and the domestic market more attractive to Chinese or Japanese manufacturers.

To reinforce that Grand Bargain, the Obama administration could reframe U.S. trade policy with an eye on making and enforcing trade agreements based on reciprocity and on attaining a more economically sustainable balance of benefits for the United States. This might mean pursuing trade, tax and other policies that encourage domestic production and discourage imports and outsourcing.

Such efforts would undoubtedly prove controversial because reciprocity and a balance of benefits have long been used as thinly veiled excuses for protectionism. They were that when the world valued consumption over all else. But now the goal of attaining and maintaining economic stability trumps consumption. If the underlying cause of the current financial crisis is structural imbalances, then exchange rates and trade policy must be tailored to avoid them developing again.

This should be the next challenge on the agenda of the G-20 and the Obama administration.

This article appears in the March 21, 2009 edition of NJ Daily.

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