A Warning from Dr. Issing:
Off prudentBear, Noland's summary excerpt.
Why aren't we hearing about the rest of the Western World decrying our deficit problem? The Matrix lives...
prudentbear.com
A Warning from Dr. Issing:
Fortunately, there is also exceptional analysis to share with readers this week. Below are extensive excerpts from a speech delivered by Dr. Otmar Issing, European Central Bank Chief Economist, Tuesday at the German British Forum in London. His comments offer somber Straight Talk from one of worlds? most astute Central Bankers.
Europe and the US: Partners and Competitors ? New Paths for the Future
ecb.int
?It was just a few weeks after 11 September 2001, when the German British Forum met in London. On that occasion, I had already the privilege to participate in a panel on ?a new framework for the US-European partnership.? In my introduction, I stated that ?... such traumatic events ? hitting us as individuals, as nations and as a community of nations ? have led us to rediscover a sense of purpose, reaffirm common values and act in solidarity. This brings people closer together in times of trial.? Unfortunately, this sense of closer-than-ever ties across the Atlantic has not lasted long. Two years and two wars later, the relationship has proved rockier than expected?
?I would like to briefly elaborate on the issue of global imbalances, which have attracted so much attention. While the notion of global imbalances may have different meanings to different people, the interpretation which will underlie my talk this evening concerns the international flow of goods, services and capital. Such imbalances manifest themselves in large trade and current account deficits in some countries, with corresponding surpluses in others. When one talks about global imbalances in this sense, one, of course, is immediately drawn to the persistent US current account deficit, which has existed more or less continually since the early 1980s and which currently runs at roughly 5% of GDP. As a consequence, the net liabilities of the US vis-à-vis the rest of the world increased to around 23% of GDP by end-2002 ? compared with less than 5% in the early 1990s?
There are three main reasons why a large current account deficit that goes beyond such medium-term equilibrium considerations may be a cause for concern? First, persistent current account deficits ? and, in particular, trade deficits ? may give rise to protectionist pressures in the deficit country. If the country is a major trading nation, this may pose a serious threat to the global trading system. Second, there is the risk of a disorderly adjustment. And third, world savings may not be allocated efficiently?
Regarding the risk of a disorderly adjustment, it should be emphasised that any excessive current account deficit will need to adjust eventually. What cannot last, will not last. The crucial issue is whether the adjustment will be orderly or involve a large and disruptive change in key economic variables. Such a disorderly adjustment would affect not only the rest of the world but, in particular, the deficit country itself, turning this issue into a truly global one. There are a number of factors, which may increase the risk of a disorderly adjustment. For example, the longer the flow imbalances exist and the larger they ? and the associated stock imbalances ? are, the larger the required adjustment back to more reasonable levels would be. The risk of a disorderly adjustment is likely to increase with the magnitude of the needed adjustment. A further factor that may play a role in determining the orderliness of the adjustment process is the composition of the capital flows which finance the current account deficit. In particular, ?hot? portfolio flows may quickly reverse direction in a highly integrated global financial system characterised by close substitutability of different markets with respect to the diversification benefits they offer?
At a minimum?it should be ensured that capital flows occur in an environment, in which timely and accurate information about investment projects is available, so that capital can flow to uses with the highest (risk-adjusted) rates of return. The importance of this condition is highlighted by the accounting irregularities at US companies, which resulted in an overstatement of actual profitability?
Another reason why the efficiency of the allocation of global savings may be an issue is that, more recently, the external deficit of the United States reflects actions by public entities rather than private sector interactions. On the one hand, the US saving-investment gap is at present largely a public one, reflecting the increase in fiscal deficits. On the other hand, the financing of the current account deficit has shifted from private funds to public funds, as many central banks ? in particular in Asia ? are engaged in large purchases of US government securities. Given the historical track record of public entities with respect to the efficient use of funds, this shift towards the public sector ? both on the financing and on the allocation side ? may in itself provide some cause for concern.
The current level of the US current account deficit is in the longer run unsustainable and an adjustment will eventually occur, whether actively supported by macroeconomic policies or not. The question is only whether it will happen in an orderly fashion. By supporting an adjustment sooner rather than later policy-makers could, in principle, help to ensure such a gradual and orderly adjustment, while at the same time possibly contributing to a more efficient use of global savings and safeguarding the global trading system by limiting protectionist pressures. This would be in the interest of all countries involved, including the United States.
I sometimes have the impression that Europe and the United States are separated by two different schools of thought in that respect. In Europe the view seems to prevail that a problem with the US current account deficit indeed exists, while on the other side of the Atlantic many people do not consider this to be a problem, at least not for the US, but rather for Europe. Consequently, Europe should find a solution to it. Paraphrasing a statement, which former US Treasury Secretary Connolly made with respect to the US currency, one could summarise this view as ?It may be our deficit, but it is your problem.? It is, however, important to acknowledge that this is an issue of global relevance, as the smooth adjustment of a situation that is unsustainable is in the interest of countries on both sides of the Atlantic and also the rest of the world. Indeed, it appears that, despite the occasional rhetoric to the contrary, policy-makers in the US are well aware of the potential negative consequences of a disorderly adjustment on the US economy.
But how can an adjustment be achieved? A slowdown in the deficit country?s growth rates relative to the rest of the world typically plays an important role in any such adjustment. This could, for example, mean an actual growth slowdown in the United States, thereby reducing the demand for imported goods and services, or a growth acceleration in the rest of the world, which increases the demand for US exports. If we had to decide on one or the other, the choice would not be difficult ? it is higher growth everywhere else. This preference is also reflected in frequently heard demands from the other side of the Atlantic that Europe should generate faster growth to aid the adjustment process. In this respect it is extremely important to specify how this higher growth is to be achieved. Artificially stimulating the economy by large budget deficits and/or inflationary monetary policy is no viable option. In fact, history tells us that such policies can only provide temporary straw fires, with potentially damaging long-term consequences. To illustrate this point let me briefly take you back in time to the mid-1980s. At that time, the US-dollar had been appreciating rapidly over a number of years and the US current account stood at around 3% of GDP ? at that point a post-war historical peak. Concerned about the potential side effects and risks involved in such an unsustainable situation, policy-makers from the main industrialised countries decided to tackle this problem in a coordinated fashion. In addition to agreeing to bring down the external value of the US dollar, they also decided that Europe and Japan should pursue policies aimed at stimulating domestic demand. They would thus become the ?locomotives?, which would bring about the adjustment, while at the same time raising global growth. In the so-called Louvre Accord in 1987 the governments and central banks of the major industrialised countries, for example, agreed that Japan would ?follow monetary and fiscal policies which will help to expand domestic demand and thereby contribute to reducing the external surplus.? We all know what happened subsequently. The expansionary policies in Japan and, in particular, the monetary easing that was involved contributed to an asset market bubble, which burst and led to a decade of very sluggish growth and created structural imbalances which are still constraining growth in Japan to some extent today. Seen from this perspective, some of the problems of today's world economy date back to misguided policies triggered by efforts to solve global imbalances.
Instead of short-term activism, which is likely to create imbalances in other areas and does not solve the underlying problem, sustainable policies are needed, with a view towards the medium and long-term?
The ECB?s forward-looking policy with the objective of ensuring medium-term price stability together with necessary structural reforms is thus an indispensable condition for raising the potential growth rate of the euro area economies. In that context, one of the main reasons why such a policy is effective in providing a growth-enhancing environment is that it anchors and stabilises people?s expectations about future price developments. Therefore it is crucial to carefully guide those expectations, rather than try to manipulate them to obtain short-term benefits, while endangering the longer-run credibility of the overall monetary policy strategy?
In that context, let me briefly address an argument that is sometimes made to justify the demand for a more aggressive expansionary policy in Europe. According to this argument, the United States have contributed to strong global growth in the second half of the 1990s, thereby ?saving? the rest of the world, and in particular Europe, from stagnation and recession. This implies, according to the proponents of this argument, that it would now be Europe?s turn to do likewise and to provide the needed growth impetus. This argument is not new and was used already extensively in the mid-1980s when the world economy, as I said earlier, found itself in a similar situation as today. But the argument is as wrong and dangerous today as it was then. The United States has not conducted macroeconomic policies with a view towards the world, thereby sacrificing domestic policy objectives in favour of global considerations. Both then and now, for good reasons the focus has been on the United States and the resulting policies happened to provide the rest of the world with some benefits ? at least in the short run. This stance was succinctly summarised by Federal Reserve Chairman Greenspan in a 1999 Senate hearing: ?We would never put ourselves in a position where we envisaged actions we would take to be of assistance to the rest of the world but to the detriment of the United States.? As a consequence, the argument ? which is sometimes elevated to the standard of a ?moral obligation? ? that European policy-makers should forego important domestic policy goals is untenable. This is especially true if such goals were to be sacrificed in favour of short-term stimulus measures, which would not solve any of the underlying real problems, which give rise to the existing imbalances?
Although faster growth in the rest of world may support the adjustment process, part of this adjustment will eventually have to come from an adjustment of the saving-investment gap in the United States? A considerably larger correction will be necessary for the public saving-investment balance, with the current fiscal stance certainly not being sustainable in the long run. Such a correction will in all likelihood imply lower growth for some time. The choice is, however, not between correction or no correction, but between a correction sooner rather than later. The current situation is not sustainable and an adjustment is inevitable. A timely one may in the end be less costly than a postponed but eventually more disruptive one?
Regarding the current global imbalances, the euro area will play its part in trying to ensure that the adjustment will be as orderly as possible. However, it would be dangerous to believe that excessive expansionary measures would be a valuable contribution. They would be in the interest neither of the US nor of the euro area, as they would give rise to imbalances elsewhere which would have to be corrected at some point in the future as well. Even now, there is certainly no lack of liquidity in the world.
Stability ? also on the global level ? begins at home and a narrow focus on the external side is certainly too short-sighted. In particular, the notion that higher growth ? regardless of how it is achieved ? is beneficial for the global economy, is fundamentally flawed. Rather than shifting imbalances between countries and regions, a more sensible approach would be for macro policy-makers to provide the framework within which sustainable growth can be achieved. For monetary policymakers, this means trying to achieve medium-term price stability? The orderly adjustment of existing global imbalances should always be considered as an issue of shared interest. We can only succeed in this respect, if we act as partners, rather than as antagonistic competitors. In the longer run, domestic and global stability, national and international interests, do not conflict, but go hand in hand.?
I will let Dr. Issing?s brilliant ?central banking? speak for itself. It is both frustrating and disconcerting that there is no one in our country speaking his "language". I believe the ECB recognizes that the inevitable adjustment is long overdue and will likely commence in the not too distant future. |
