To Push or to Pull, That is the (G-20) Trillion Dollar Question
Americans are, naturally, focused on the domestic policies and domestic economy. However, the world is round, and we all live on it. Globalization is a reality, because many of the most important resources, such as oil, and many of the most important problems, such as carbon driven climate change, are global in nature. Even if economies want to go back to nationally focused units, the flow of people, money, resources, and problems, as well as security threats such as terrorism and war, mean that the planet has gotten too small to hold purely self-interested nations, and the problems have gotten too large to ignore.
Next week will mark a global meeting of the 20 largest economies, the "G-20" London Summit. In advance of this, Barack Obama penned an op-ed. It received a good deal of coverage, without receiving enough attention. Money’s view was rather cursory, more or less a summary. In the face of open divisions between the EU and the US over it’s contents, this is as curious as the protests are quaint, it is not free trade, but the lack of it, that has created this crisis. It is America’s insistence on opening some work for competition, while keeping a store of protected industries for itself: defense, housing, bulk agriculture, and health care, that has made this crisis. It is not some distant group of capitalists who are the threat, but our own appetites, and unwillingness to sate them in any way but with oil and the products made with it. Richard Baldwin is closer to the mark: the developing world made the crisis, but everyone is afflicted by falling demand, whether developed Japan or developing China. Global GDP is projected to fall this year, for the first time since World War II. CDS and CDO have accomplished with USSR and PRC could not: denting the march towards global development.
There are small stories of the G-20, such as bloggers being present, but the larger story is simple, and the subject of today’s Bernard L. Schwartz symposium at the New America Foundation. The question is what will replace the US consumer as the engine of global growth? This is one of the roots of what is called the problem of global imbalances.
Traditional macro-economists, such as Paul Krugman and Ben Bernanke take the view that there is a "savings glut," that is, insufficient demand in certain areas of the globe, plus fears of instability leading to a high liquidity preference in emerging nations. Basically, high savings nations fear currency crisis, and so accumulate more dollars than they really need, they then want to save these dollars someplace while having them readily accessible in case of a currency crisis. However, Dooley, Folkerts-Landau, and Garber, found that interest rates did not reflect a global savings glut. Dooley and Garber argue that it was insufficient regulation, and insufficient moral hazard not savings glut or capital imbalances, that were the source of the crisis. This argument: was it lenders too willing to lend, or borrowers too eager to borrow, is, in fact, hollow. The savings glut hypothesis and the fraud hypothesis do not divide the world between them.
The "fraud" view does not correctly account for the repeated blow ups of the world financial system since the collapse of Bretton Woods. This is not to discount the roll of fraud in the bubble, the need for enforcement, moral hazard, and bringing structured finance and securitization into the light of orderly markets. Every new form of financial instrument had it’s birth as a means of fraud. From the paper money of the Yuan dynasty, to stock in John Law’s South Sea Bubble, to the robber baron’s trusts, to the dot com bubble, almost every innovation has been to get people to pay no attention to the reality behind the curtain. In the end the realization was made, sometimes after a great deal of experimentation, that promises as paper have value, but they have to be backed by the force of law. Better than the gold standard, as the old joke runs, is the lead standard.
Collateralized Debt Obligations are not, in themselves, strange. If you think about it, government is a giant CDO, with some parts that promise to pay come what may, and others paying out only when times are good. Likewise, a CDS is insurance. They were not, however, held to the standards of corporations or insurance in the real world. Credibility in finance disappears the moment it is questioned, and the failure of the financial order has undermined the credibility of the current monetary order.
We can see this from, for example China openly agitating for using the Special Drawing Rights of the IMF, XDR in financespeak, rather than the US dollar as the world’s "reserve currency." We see it also in a plan authored by a UN commission headlined by Joseph Stiglitz to have a UN economic council independent of the Security Council. We see it in Ki-moon’s call for a trillion dollar developing world stimulus package. Fraud has a cost, that cost is credibility. The loss of credibility is not at critical proportions, but it has led to a search for new ideas. But if recent fraud were the heart of the problem, how to explain the inflation of the 1970’s, the Savings and Loan debacle of the 1980’s, the dot com bust of the 1990’s? How to explain the fiscal crisis that swept through the world in 1997. Was it all fraud? To accept the fraud driven view is to enter into a world where yesterday did not happen.
The reality is that both the fraud and the glut views are held within the administration, and they are acting on both. The legacy assets program that Geithner offered was designed to bring investment demand off the sidelines, hence accepted the global savings glut view, and was meant to get the financial system to accept more regulation. There is no inconsistency in believing that there was too much investment demand, and that brought out the worst element. The market cheered getting free money, but the call for enhanced regulation was distinctly muted. In fact, as Senator Sanders has pointed out the foxes are being nominated to guard the chicken coop.
Unfortunately, there are no shortage of people who have forgotten not only yesterday, but the entire 20th century. One example is the misnamed Heritage Foundation which is agitating for unvarnished Hooverism:
A government that acts intrusively and with market-killing borrowing, taxing, spending, or regulating can do a lot of harm. Governments doing such things cooperatively in a group like the G-20 can do even more harm.
as the way to restore growth. Unfortunately, their entire premise, that a series of tax cuts for the very rich will restore investment demand and therefore the entire bubbleconomy. It is a point of view popular with the science denial crowd. Fortunately, cooler heads are beginning to prevail. The reality is that "growth" as the right understands it is asset inflation. This is why despite continued declines in oil consumption and rising inventories, interest in oil and other "stuff" as it is called in finance, is already returning. Even as houses continue to fall, inflation has jumped in the UK. Resource shortages will return, the reasoning goes, no matter what shape the recovery takes. Creating investment demand, does not create a supply of ideas to fill it. In fact, a global rich that is well pampered has less, not more, reason to be hungry and looking for success.
This is why merely spending will have much the same effect, with a few well worn pathways in the economy attracting more and more attention. These can easily lead, as the led in Japan, to merely mounting debt, as governments engage in zombie development: doing the same things that were done 50 years ago to develop economies that are already developed. American can use a few more super-highway connections, but it doesn’t need a new super-highway system. If public investment demand can do things that private investment demand cannot do, because private investment must not only create wealth, but find somewhat to monetize it, governments can recapture wealth through taxation. For government investment, so long as someone is making money someplace, it will come back. This is why low marginal tax rates are hurting public investment: it is harder to recapture public investment, if no one is paying back. The developed world has been in a race to the bottom on taxation with Saudi Arabia for a generation. However, we can’t win the race to the bottom of the oil well.
So what is the truth. The truth is staring us in the face, and is the root cause of all of the points mentioned: global imbalances, mesöinflation, fraud, and the unhappiness with the US dollar hegemony. That root is lack of investment supply. Investment supply would allow the bottlenecks to be substituted around. Investment supply would create a compelling way to develop the "saving" economies. Investment supply would attract capital, and produce returns. The essential problem was that the United States attracted capital, but did not have any ideas on how to utilize it. Instead, we built houses. This is the equivalent of redoing offices in a bankrupt company.
Thus the question, the real one, is how to recapitalize the financial system. Martin Wolf usefully pointed out that there are two options. One is to allow a debt for equity swap in the major financial institutions, the other is to provide government money to recapitalize them. The first is deemed unacceptable because the very people who have to be brought back in to kick start the investment cycle again, would be the ones taking a bath from the debt for equity swap. The second is very costly, and already the willingness to spend in Washington and Europe is at an end. These are really the same lack of investment supply problem as before. If there were something that needed doing, that we had some idea how to do at scale and producing more happiness, then the old legacy liquidity could be crammed down. If there were something that needed doing and that we had some idea how to do at scale and producing more happiness, then it could be taxed to pay off government recapitalization. Government recapitalization, to work, implies an as yet untouched stream of revenue which the government can open: whether by creating property rights to spur activity to secure wealth and status, or by removing uncertainty to spur risking taking, or by jumping over some barrier to entry through education or research. With this, and a strong understanding of how to accomplish what needs to be done, everything becomes simpler: real productivity rises, rather than merely borrowing productivity from the future, investment can be paid back with the benefits created, and there will be work to do.
How to accomplish this? That’s the subject for real inquiry in the present, how to turn the large store of needs, into a stream of actions. The US, as the center of the developed world economy must lead on this. Obama, as the President of the United States, is the only person who can provide the umbrella for that leadership. Congress, with it’s calls to cut investment in his budget, which even Obama’s own budget director has implied does not go far enough in public investment, must stop worrying about protecting legacy wealth, and providing for future growth.
What can the G-20 summit accomplish given the depth of the problems, and lack of direction? The clear first step is to put down the Hooverite revolt against what has been learned in the last century, and that is that attempts to freeze progress at moments of crisis lead to deeper crisis in very short order. It is the lesson of 1925, when the industrialized nations of that time attempted to reimpose the gold standard. The result was an even more profound crisis in only 4 short years, one which would swallow them and the entire world they knew in a global conflict. The G-20 summit is in the shadow of the same impulse, and it is essential to re-architect the global financial apparatus. The more conservative thinkers are appalled at the idea that the monetary order that emerged post-collapse of Bretton Woods might be attacked, because living off of dipping a small cup in the Niagra Falls of finance is the only world they have ever known, just as the world of the classical international Gold Standard was the only world that the leaders of 1925 had ever really known. But it must be done, because the misdirection of capital to providing cheaper consumption for the US has reached it’s limit.