Here’s today’s Age and SMH column. I noticed last night, via Matt Cowgill, an interesting argument that it’s the Germans who should exit the Euro. It was an interesting idea, and another illustration of the themes in my column.
When the allies met in New Hampshire’s Bretton Woods in 1944 to agree on the postwar international monetary architecture, John Maynard Keynes offered one of his many plans. He got much of it through but failed on one major point. Today, Europe’s agonies illustrate the wisdom of his quest. Indeed, the ghost of Keynes’ failure at Bretton Woods may come to haunt us all. Let me explain.
Keynes’ General Theory re-examined the pre-modern, discredited ideas of 17th century mercantilism. Mercantilists pictured international trade as competition between nations with each seeking to amass ”treasure” by maximising its trade surplus.
The founders of modern economics, Adam Smith and David Ricardo, showed how confused this was. ”Treasure” is a means to the good life, not an end in itself. And mostly countries don’t compete with each other. Rather, trade enables them to complement each other by exporting what they’re best at producing and importing what they’re not.
But Keynes saw further dynamics at work. First, the policies that produce trade surpluses – undervalued exchange rates and industrial policies – gain their own political constituencies and momentum. Second, deficit countries must borrow to fund those deficits – from surplus countries. This makes sense if it funds sufficiently worthwhile investment opportunities such as Australia’s resources.
But if increased debt simply funds consumption, international lenders will eventually restrict credit, plunging the country into recession and austerity. With further domestic consumption unsustainable,and further domestic investment unattractive, the unemployed can only be got back to work if they’re producing output for others – that is exports.
Add a slew of distressed creditor countries in the same position and you have a recipe for stagnation amid a global tug-of-war between distressed debtor countries trying to export and intransigent mercantilist creditors protecting their trade surpluses.
If all this sounds familiar, it should. Because the morality tale being played out in Europe is not as it seems. Yes, the spendthrift Greeks had austerity coming whatever happened. But other countries such as Ireland and Spain ran budget surpluses while their private sectors binged on debt. But now they’re all caught in the vice of stagnation as the Germans lecture them to export their way to prosperity while maintaining trade surpluses that prevent them from doing so.
Keynes’ Bretton Woods proposals sought to engineer a way around this impasse by requiring creditor nations to make room for debtor expansion by reducing their trade surpluses, funding foreign investment or rescheduling debt. But in 1944, America wouldn’t agree to such cramping of its style.
In fact, freed from the requirement to do so, America proceeded nevertheless to act largely as Keynes’ had hoped. Understanding its own (enlightened) self-interest as aligning with global prosperity, and spurred by Cold War rivalry, their Marshall Plan rescued western Europe from the deficit trap by gifting it vast sums of money.
With America’s hegemonic leadership underpinning the great golden age of growth, the ”Japanese miracle” was underpinned by mercantilist export-led industrial development.
A prosperous world had room for one mercantilist, but Japan’s model became increasingly widely emulated. Some of its imitators still borrowed abroad, which makes good sense since poor countries usually have far more investment opportunities than savings to pay for them.
However, this strategy fell out of favour after its perceived failure in the Asian financial crisis of 1997. Thereafter, Asian countries, particularly China, redoubled their mercantilist efforts. Since then we’ve entered an upside down world with capital flowing from poor nations such as China to rich ones.
As Japan and Europe stagnated, and the Chinese cranked up their trade surpluses, the Americans were forced to cut interest rates to avoid recession, and the Chinese funded the spending by buying American bonds at negligible rates of return.
And so, as the Asian export machine amasses treasure, the stage is gradually being set for the kind of stagnation evident in Europe today. It may take decades to bite, cloaked as it will be by the burgeoning growth of the developed world. But there is another way.
Like Keynes, we can all hope to see the great nations of the world once again embrace their enlightened self-interest, forsake their trade surpluses and treasure chests and embrace instead greater prosperity for their own people and those of other lands.
Postscript: Here’s the podcast of the column on my regular stint with Alex Sloan on ABC Canberra - with some general horsing around thrown in.