QE2, Global Trade Imbalances and Currency Manipulation
There’s been much talk about the international reaction to quantitative easing (QE2) in the US, with questions being raised over currency manipulation. So much attention in fact, that even Sarah Palin felt the need to cite Germany’s opposition to the Federal Reserve Bank’s action (although she could’ve used a little fact-checking). With G20 leaders set to meet, currency manipulation is a hot topic, however, the real underlying issue is the global imbalances that have generated such international volatility.
This question in many respects relates back to the Dollar. International criticism of QE2 has come from the leading economies in Europe (Germany), Asia (China) and Latin America (Brazil) and many others in between. Now for starters, it’s not a bad idea to start discussing international currency valuations and their roles in contributing to trade imbalances. But in trade imbalances lies the real, important point of international consequence.
Let’s take a step back for a second. In an economy, Consumption + Investment + Government +/- the balance of trade=aggregate demand (written neatly, it’s C+I+G+/-(X-M)=AD, and AD=GDP). When one of the components of GDP runs a deficit, another component must run a surplus in order to maintain GDP. At the same time, when one sector contracts, another must expand to maintain an equilibrium.
For quite some time now, the US has been running a major trade deficit with our international trading partners. And herein lies my primary concern with the global criticism levied at the US for QE2. These countries sounding off against the US were some of the primary beneficiaries of the underlying instabilities that have taken hold in the global economy. China in particular, in accumulating large Dollar reserves, put artificial pressure on their own currency in order to encourage the flow of goods to continue to travel from China to the US, rather than the other way around.
After the Asian Crisis in the 1990s, countries with export intensive economies learned that the easiest way to smooth out their own internal economic volatility was to accumulate reserves in the currency of their primary trade partner (the US). While these reserves were/are an effective way for these countries to maintain stability over the short-to-mid term, they promote longer-term instability. Moreover, the accumulation of reserves is in and of itself the suppression of demand. It requires taking money out of the global economy and stashing it on the sidelines with no near-term intention to spend it.
Joseph Stiglitz is easily the single most thoughtful and important thinker on the question of global trade imbalances and in a recent article at the Guardian, Dr. Stiglitz offered his solution to the global economic stalemate:
The answer to this seeming stalemate is simple: resume global growth, and appreciation of the currency will naturally follow. Restoring growth requires that all governments that have the capacity to expand aggregate demand do so. The US has a special responsibility, both because of its culpability in creating the global crisis and because it can borrow at low interest rates…. This is the time for the US to make the high productivity investments it needs. Spending on things such as high speed rail and green technology would actually improve America’s balance sheet. Higher growth would generate more tax revenue and lead to a lower long-run national debt. Such actions would not only help the US, but also have strong positive spillovers both in the short run (from the increased growth) and in the long run (from the technological improvements) for the rest of the world.
Both the US and China need structural changes, not just a realignment of exchange rates. Even in the short run, there is much they could do to contribute to global aggregate demand: increase wages, for example. In both countries, median household income has not kept up with growth. (Today, US median income is lower than it was in 1997!)….
This alternative rests on co-operation – mutual commitments to fiscal expansion, structural reforms and correcting trade imbalances by all countries (not just China). For some, exchange rate realignments will be a part of this; for others they may not. But each country will determine the best way of achieving agreed goals, with due attention to negative and positive externalities.
A new global reserve system or an expansion of IMF “money” (called special drawing rights, or SDRs) will be central to this co-operative approach. With such a system, poor countries would no longer need to put aside hundreds of billions of dollars to protect themselves from global volatility, and these would add to global aggregate demand. [emphasis added]
Check out the rest of the article over here. The idea of a global reserve system makes a whole lot of sense. It’s something which Dr. Stiglitz talked about at length in his recent book, Freefall (check out the review here). Running deficits or surpluses in perpetuity simply cannot work. Neither can the pre-2000s system whereby export intensive economies received rushes of hot money and were then forced by the global economic community (the IMF and World Bank) to raise interest rates in order to protect their currencies, while domestic economies needed lower interest rates to stimulate the domestic economy.
Now in many respects, the problem in even broaching the issues raised by Dr. Stiglitz is the lack of political will in the United States to take the necessary actions. That being said, the discussion amongst the G20 nations needs to start with a common understanding as to the negative effects of the substantial and growing international trade imbalances. The critique in the wake of QE2 leveled at the US in many respects sidesteps this natural starting point. Finding some sort of international common ground in fixing imbalances could help generate the political will necessary in the US to undertake actions like a major infrastructure investment.