Imbalances

Fred Bergsten and Arvind Subramanian lay it out:

The Obama administration is increasingly signalling that the US will not continue to be the world’s consumer and importer of last resort. The clearest statements came last month from Larry Summers , White House economics director, in a speech at the Peterson Institute for International Economics and in an interview with the Financial Times. The US, he said, must become an export-oriented rather than a consumption-based economy and must rely on real engineering rather than financial wizardry. Tim Geithner, the US Treasury secretary, and other top officials have spoken similarly of rebalancing US growth.

The logic of this new US position is not just economic. It is also strategic. Mr Summers has previously remarked on the tension between superpower status and net foreign indebtedness. US influence can be compromised if it is dependent on foreign investors to bail out its financial sector (as in the early part of this crisis) or to finance its fiscal profligacy (as China and other surplus countries have been doing for a long time)...

This long-run vision for US growth entails greater exports and probably a smaller current account deficit...

Redirecting resources away from finance and consumption towards exports and investment will require relative price shifts, for which the dollar has to move down...

If the US will not run large and persistent current account deficits, countries such as China, and probably Germany and Japan, will not be able to run large and persistent current account surpluses. They will not be able to rely on export-led growth...

But there is no guarantee that this process will continue...China has again been preventing the renminbi from strengthening and the jury is still out on whether the country intends to depart from its mercantilist growth strategy...

Put starkly, Mr Summers has stated that China can no longer behave like China because the US intends to behave much more like China. The world economy cannot have two, or even one-and-a-half, Chinese growth strategies from its two most important economies. Which will prevail?

A couple points I'd like to make here. The first is that the current-account deficit (how much our country borrows from foreign countries) is influenced by the U.S. budget deficit (how much our government borrows from both abroad and home). If we really want to correct global imbalances - if we really want to shift to an export-based economy, as we must do to avoid a long period of stagnation - then we can't be borrowing trillions of dollars a year. It's that simple. That's why I was hoping that the stimulus bill would have contained fewer tax cuts and more infrastructure spending - we need to spend our country's money on things that increase the tax base (and therefore pay for themselves in the long term). Tax cuts don't get us anything we can use tomorrow. Infrastructure does.

And this is also why I'm leery of doing universal health care coverage now. Reducing costs in the health sector is extremely important - crucial, even - for our economic performance. Cost reduction is a reform that pays for itself. But expanded coverage is probably going to cost money. And since it's politically impossible to raise the necessary taxes right now, that money will come from deficit spending. I.e., we will borrow (unsustainably) from China to give health care to a bunch of people who can't afford it - health care that will vanish like smoke when China stops lending us money and we are forced to either cut the budget or default on our debt. If we reduced costs to the point where universal coverage was affordable, it would be a different story. But that does not appear to be what the Democrats are aiming for. And I'm extremely skeptical of the argument that a public option will itself reduce costs (except maybe in the long term, which woul be too late).

My second point here is that we're starting to understand why mercantilism is important. Economists are taught to think that mercantilism - trying to make your country rich by forcing other countries to buy your exports - is inefficient. But a small but growing chorus of economists is now pushing the idea that mercantilism is useful for poor, developing countries, as long as rich countries accomodate it by running big current-account deficits. By providing a guaranteed market for a poor country's exports (think: what we did for Europe and Japan after WW2), rich countries can help the poor countries maintain the sustained investment needed for them to catch up technologically.

But when the rich "deficit" countries are no longer big enough to absorb an ever-rising amount of poor-country exports (e.g. when the poor country is 4.5 times the size of the rich country!), the strategy no longer works. We have reached this point with China, and we have suffered the consequences; as China continues to try to ram exports down our throat that we can no longer swallow, the money that they lend us to buy their goods has encouraged destructive bubbles, and the undervaluation of their currency has destroyed American export industries that, in an efficient world, would not have been destroyed. This must end.

But if it doesn't end, what are we going to do? Throwing up trade barriers against Chinese goods might be bad for our economy and theirs, but it will be worse for theirs - and thus, it may be our only way to force China to revalue its currency. It would be a desperate ploy, but if it worked, it would be good for everyone concerned in the medium and long term. We may be running out of other options.