This passage from Martin Wolf got me thinking:
China’s exchange rate regime and structural policies are, indeed, of concern to the world. So, too, are the policies of other significant powers. What would happen if the deficit countries did slash spending relative to incomes while their trading partners were determined to sustain their own excess of output over incomes and export the difference? Answer: a depression. What would happen if deficit countries sustained domestic demand with massive and open-ended fiscal deficits? Answer: a wave of fiscal crises.
Neither answer is acceptable; we need co-operative adjustment. Without it, protectionism in deficit countries is inevitable. We are watching a slow-motion train wreck. We must stop it before it is too late.
For some reason this brought to mind Charles Kindleberger, who argued, in The World in Depression, that the role of the stabilizer in managing the global economy can be summed up by the following five tasks:
1. maintaining a relatively open market for distress goods;
2. providing countercyclical, or at least stable, long-term lending;
3. policing a relatively stable system of exchange rates;
4. ensuring the coordination of macroeconomic policies;
5. acting as a lender of last resort by discounting or otherwise providing liquidity in a financial crisis.
Arguably, the U.S. has performed each of these quite well since the end of the Cold War. Also arguably, it is a combination of these that has led to the recent financial crisis and global recession. What do I mean? Well, the U.S. has kept open a market for goods, which has led to the export-oriented industrialization in Asia but has also created the massive macroeconomic imbalances that led to the crisis. The U.S. has also led to a system of (mostly) stable exchange rates, esp. in regards to China which pegs directly to the dollar, and the Chimerican macroeconomy has been symbiotic and well-coordinated for quite some time. These, also, led to a huge current account deficit in the U.S. America hasn't strayed from providing global liquidity either, although China has done its best to sop much of it up and spend it in American debt markets. This, too, was a large part of the economic crisis.
My point? Perhaps the U.S. should have provided less of an open market for excess goods, or fought the fixed valuation of the yuan to the dollar. Perhaps the U.S. should have actively tried not to coordinate so well with China, and instead competed more directly in export markets (or refused entry into the WTO until China had a managed-floating exchange rate, or levied tariffs on China for the same reason, etc.). Perhaps, by trying to act as a stabilizer, the U.S. actually facilitated the conditions that lead to instability. Perhaps the U.S. should have been just a bit more isolationist, a bit more closed, and a bit more uncooperative.
I'm not saying that Kindleberger is wrong, but I think there is something of a paradox here. Are the actions that the hegemon should take during global recessions the opposite of what they should do during expansions? I'm not sure. But something is definitely missing from Kindleberger's account: an exit strategy. Policies that are appropriate during downturns are not always appropriate during normal times, and policymakers generally aren't nimble enough to simply reverse course after the crisis has passed. Unwinding is hard, takes a long time, and can cause new crises if not done properly. It's a fine line to walk, and so far most states don't seem to be very good at it.
(ht: Angry Bear)