US

I recently looked at what happened to private financial balances inside the eurozone. Today’s post looks at what happened to the current account deficits. It fills out the broad story of the eurozone’s across-the-board shift into becoming a very large capital exporter. It is complementary to an excellent post by Gavyn Davies, who addresses the sources of the ongoing adjustment.

As it happens Michael Pettis, professor at Peking University, and author of the excellent book, The Great Rebalancing (Princeton and Oxford: Princeton University Press, 2013) has a complementary post.

In this, he argues that Spain had no choice over what happened to it during the 2000-07 period, given the deliberate policies of Germany, which were aimed at generating a large current account surplus (“improving competitiveness” being the normal way of talking about this form of structural mercantilism). If one’s principal trading partner is seeking to generate a huge current account surplus and so exporting capital, he argues, then a country is effectively forced into running the counterpart deficits, whatever the consequences.

I agree with this analysis of what happened. Indeed, I have argued along these lines for several years, in trying to explain the roots of the eurozone crisis, which is a balance-of-payments cum financial crisis, of which fiscal deficits are a symptom, not, except in the case of Greece, a cause. 

The role of fiscal deficits in deleveraging

“You can’t get out of debt by adding more debt.” How often have you read this sentence? It is a cliché. I am going to argue that, to a first approximation, this obvious, even banal, statement is the reverse of the truth, which is that the only way to get out of debt is to add more debt. What matters is who adds the debt and in what form. To put it more bluntly, it depends on who these“you” are.

As I have done in two previous posts on the theme of “balance-sheet recessions”, I am going to focus on the US, because it is the most important country now going through the post-crisis deleveraging process.

Let us start with an obvious and crucial fact: at the world level, net debt is zero. For an individual country, net debt is how much foreigners have lent to residents less how much residents have lent to foreigners. In the case of the US, net debt at the end of 2011 was 44 per cent of GDP, roughly an eighth of gross debt. 

Capitalism in crisis

Three years ago, when the worst financial and economic crisis since the 1930s gripped the global economy, the Financial Times published a series on “the future of capitalism”. Now, after a feeble recovery in the high-income countries, it has run a series on “capitalism in crisis”. Things seem to be worse. How is this to be explained?

 

What can we see in the world economy in 2012? Risks galore, is the answer.

The debt crisis of the high-income countries is already four and a half years old. Yet it shows no sign of abating, particularly in the eurozone. While emerging and developing countries are in reasonably robust condition, they would be vulnerable to an intensification of the crisis, which could hit them via several channels: trade, finance and remittances. Many countries – both high-income and developing – are in a weaker condition than they were in 2008 and would, accordingly, find it harder to respond effectively.

 

Anniversaries are a time to take stock, to ask where we have been and where we might be going. 2011 offers three remarkable anniversaries: the economic reform of India and the fall of the Soviet Union, both in 1991; and the terrorist attack on the US on 9/11/2001. What should we think about these three events, today? Here are a few tentative answers.

Is it too soon to tell? Yes. It always is. Each generation changes its view of the past in light of the present. That will continue, if not forever, at least indefinitely. We might well disagree about the significance of events that took place centuries ago. It is far too early to tell what these events might mean. Today, for example, 9/11 looks far less significant than it did at the time. One significant act of nuclear terrorism would transform that judgement.

Which of these events might posterity view as the most important? My guess is that it will be the economic reforms in India. The decision of the Indian government, under prime minister P. V. Narasimha Rao and his then finance minister Manmohan Singh (the present prime minister of India) to launch fundamental economic reforms on July 24 1991, in response to a severe balance of payments crisis, was a world-transforming event, in at least five respects.