Balancing Act

Just to piggy-back off of Dr. Oatley's post below. Geithner wants to cap current account surpluses or deficits at 4% of GDP. What effect would that have? Well, U.S. GDP is roughly $14tn. 4% of that is $560bn. In other words, a persistent 4% deficit in the current account is still quite large. Large enough that during most periods the U.S. was well within that boundary, though not during the mid-2000s. As the picture above shows, only in the last few years has the U.S.'s balance of payments been that sharply out of balance. (Note: that is nominal yearly data.)

What's interesting to me about the G20 kicking around these types of proposals are the distributional implications:

Representatives of the world’s largest economies, meeting in South Korea, reached tentative agreement early Saturday on the need to rein in trade imbalances, as part of an American-brokered compromise on calming exchange-rate tensions that have threatened to disrupt the uneven global recovery.

The Obama administration on Friday urged the other economic powers that make up the Group of 20 to agree to curb persistent surpluses and deficits that could contribute to the next financial crisis.

The proposal, which included a numerical limit, was backed by South Korea and quickly drew support from Britain, Canada and Australia. But it met with resistance from Germany and ambivalence from Japan, both major export countries. China, whose currency battle with the United States has threatened to derail the process of global economic cooperation, did not formally weigh in.

So after a marathon negotiating session that stretched into the predawn hours Saturday, the G-20 representatives agreed on the goal of “reducing excessive imbalances” — without a specified limit — and called on the International Monetary Fund to examine the causes of “persistently large imbalances.” The draft statement, to be ratified later Saturday, will also call on countries to “refrain from competitive devaluation” of their currencies, officials said. ...

Four countries have current-account surpluses exceeding 4 percent: Saudi Arabia (6.7 percent), Germany (6.1 percent), China (4.7 percent) and Russia (4.7 percent.) But under the American proposal, countries like Russia and Saudi Arabia that are “structurally large exporters of raw materials” would be exempt from the 4 percent limit, so the pressure would have fallen on China and Germany.

Two G-20 countries have current-account deficits larger than 4 percent: Turkey (5.2 percent) and South Africa (4.3 percent). The United States is next, at 3.2 percent.

A lot of stuff in here. First note that, once again, the expansion of the G7 to the G20 seems to have made it practically impossible to reach meaningful agreements with actionable language. How to reduce these imbalances? Umm... How much should they be reduced? No hard limit. What is the consequence of not reducing imbalances? None that I can see.

Of course the most important thing is who is reducing imbalances. As Dr. Oatley noted, it doesn't matter what countries like Turkey and South Africa do. Nor Russia or Saudi Arabia. It only matters what the U.S., China, and Germany do. The U.S. is under the proposed 4% limit, so is it any surprise that that is the level Geithner picked? It's the number that directly targets China and Germany, and to a lesser-extent Japan. The U.S. is trying to make China, Germany, and Japan pay for international macroeconomic adjustment. No wonder that those countries immediately rejected a firm requirement.

Meanwhile, Justin Fox notes that Keynes proposed something very similar during the Bretton Woods discussions:

Not impossible-to-enforce targets, but a system with incentives built in that would have made big trade imbalances unattractive to both sides. There’s that little matter of creating a new global currency and getting everybody to accept it, but this was at the tail end of World War II. If the U.S. had decreed that the International Clearing Union was a go, the International Clearing Union would have been a go. But at the time, the U.S. ran big trade surpluses and assumed it would do so forever. Its delegates at the Bretton Woods meetings were vehemently opposed. So the idea went nowhere.

Imagine that! Powerful governments decided not to pursue actions that went against their domestic interests. Who could have foreseen it?

The same dynamics are still at play even if some of the roles have reversed, so asking the IMF to investigate causes is a waste of time. China, Germany, and Japan have strong domestic political incentives to pursue policies that generate large current account surpluses. Their political survival depends on continued economic growth, and their economies are so structured that growth has to come largely from exports. The IMF will surely highlight the policies that lead to these outcomes, including exchange rate machinations, but it won't matter because they won't address the underlying political processes that generate the policies in the first place. Even if leaders wanted to bite the bullet and reverse these policies, their domestic constituents wouldn't allow it.

If the U.S. wants to address this issue, it's going to take much more than a vaguely-worded G20 communique. It will have to build a large constituency of other large economies. It will have to find a way to appease Germany and Japan while isolating China. It will have to massively boost domestic savings. And it will have to push a binding agreement through the IMF or WTO. That's a very tall order right now, and I don't see how they can pull it off. As the NYT article linked above notes:

Desmond Lachman, a former I.M.F. official now at the American Enterprise Institute in Washington, praised Mr. Geithner’s message. “It’s a constructive and imaginative proposal and it broadens the discussion away from an exclusive focus on currency to the wider set of policies needed to bring balance about,” he said. “But if you don’t have the Germans and the Chinese, this isn’t going to go very far.”

He added: “They want the U.S. to reduce its deficits, but they don’t want to reduce their surpluses.”

And vice versa.