Building our way around the deflationary threat

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.

However, in a global slump a country that can increase its share of global exports can generate jobs producing those exports. And that’s directly at the expense of jobs in countries that lose market share. This was generally understood – by statesmen if somewhat less by economists – during the Great Depression.

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, a newly triumphant America, the new global hegemon scotched any 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” could be underpinned by mercantilist industrial development built on exports to America.

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.

This entry was posted in Economics and public policy, History, Politics - international. Bookmark the permalink.
Subscribe
Notify of
guest
18 Comments
Oldest
Newest Most Voted
Inline Feedbacks
View all comments
Pedro
Pedro
9 years ago

You should read Krugman’s recent post about optimal currency area theory and the euro. The problem in the eurozone is not mercantilism it’s monetary. Krugman said that the euro has stoked the shock and stuffed the response.

And generally speaking, the “value” and danger of mercantilism is very different since the abandonment of gold and managed exchange rates. The chinese trade surplus is no big deal in the US economy when you look at the size of it. Speaking of which, I’ve read that the chinese have adopted mercantilist policies to protect themselves from currency shocks and not for the old reasons.

derrida derider
derrida derider
9 years ago

A really good article. Its a great explanation for non-economists of the “big picture” of postwar world economic history and how current travails developed from that history. True, you’ve had to simplify or overstate in a few places to make the narrative clear (eg Japan wasn’t the only mercantilist, mercantilism can in certain circumstances be very rewarding even as it is internationally damaging, American rejection of Keynes’ schemes was driven by the correct suspicion that one of his his aims was to preserve the remains of the British Empire). That’s inevitable though.

BTW you’ve clearly read Volume 3 of Skidelsky’s great biography of Keynes, which I reckon is simply the finest biography I’ve ever read.

Dan
Dan
9 years ago

Great piece. Have you read Yanis Varoufakis’ The Global Minotaur?

Dallas Beaufort
Dallas Beaufort
9 years ago
Reply to  Nicholas Gruen

Its a pity those who read Krugman only look at his economics and no further discussion is entered into about his observation regarding zoned zones. But then regulatory pump priming of tangible assets fails to meet a broader set of concerns when most played the pump.

Pedro
Pedro
9 years ago

Don’t worry, I don’t take him too seriously!

john r walker
john r walker(@annesanders)
9 years ago

Nicholas It is a good piece.
Isn’t the stumbling block for a ‘marshal plan’ for the EU, the not unreasonable belief that it would simply be diverted to the same old things :subsidies to farmers , unneeded apartment blocks and holiday houses , rights to rents allocated to privilege and so on?

Dan
Dan
9 years ago
Reply to  john r walker

It’s a good point. When the US undertook capital development of Japan and Germany, they did so as occupiers, with significant influence over allocation.

On a slightly different tack, China’s Marshall Plan is in Latin America and Africa.

john r walker
john r walker(@annesanders)
9 years ago
Reply to  Dan

Do go on :)

Dan
Dan
9 years ago
Reply to  john r walker

The model is different on the two continents, but in both cases comes from a recognition that China’s prime export markets in the West are floundering and will be for a while; in any event, to make a sweeping (but I think correct) statement, the Chinese are quite happy to move to the next phase of their economic development (producing capital goods; they want to emulate Germany). Alongside this, the task of raising domestic demand to a level where it can absorb China’s output is very challenging, not least because of the inflationary pressures it would unleash. So generating demand offshore, as the US did with after WW2 on the understanding that this external demand would then be recycled back into the originating economy (and so on, and so on), is China’s policy preference here.

In Latin America, the model is like a ‘booster’ for pre-existing resource industry. Ports, railways, etc. Chinese investment in Brazil went from (iirc) $17bn in 2009 to $300bn in 2010! And of course much of the primary produce capacity thus invested in will go to… China. Rinse and repeat.

In Africa, there’s much less pre-existing development/infrastructure/skilled workforce so the model is much more FDI rather than leveraging existing outfits’ capacity, along with an influx of Chinese migrants who are (a) working on the big projects there and (b) starting small businesses there selling to both the Chinese migrant community and to the locals. David Harvey reckons it has neocolonialist overtones but I’m not conviced; African leaders seem generally pretty happy about it, at least thus far.

Two corrolaries definitely worth mentioning: the dollarisation of Africa (the Chinese need to do something with those dollars, and hey, Africa’s happy to take a few), and the hollowing out of the Brazilian manufacturing industry as they re-orient themselves back towards primary production (for better or worse).

derrida derider
derrida derider
9 years ago
Reply to  Nicholas Gruen

Keating is right about how after the Soviet Union collapsed the Yanks missed a golden opportunity to lock in world peace and prosperity (and incidentally extend their reign as hegemon, as the Bretton Woods/Marshall Plan sequence did) . But I well recall plenty of smart people advocated exactly that strategy at the time, when Keating was Oz’s Treasurer, then PM.

He doesn’t say whether he gave the Yanks the benefit of his advice when it might have made some difference.

Pedro
Pedro
9 years ago
Reply to  Nicholas Gruen

Even if the Germans agree to inflate, which they should, I can’t see how the Euro can be saved, at best they can postpone the break up. Perhaps people might think it better to get through the crisis first, but the break up of the euro is bound to be a crisis so they may as well use this one.

A ruskie marshall plan would have been stolen. The problem in russia was the culture, not wartime destruction.

Pedro
Pedro
9 years ago
Reply to  Pedro

I think the one good thing the chinese learned from the russians in the 20th century is to unwind socialism slowly. Of course, it’s in the self-interest of the boilersuit guys anyway.

paul walter
paul walter
9 years ago

Niemeyer economics didn’t work in the thirties and there is no reason to think it will work in our time.

derrida derider
derrida derider
9 years ago
Reply to  paul walter

Silly, Otto Niemeyer was more concerned with the health of the British banks (which, to be fair, were and are central to the British economy) rather than the Australian economy. From that POV his advice was perfectly sound. In fact Ms Merkel is currently giving similar advice to southern Europeans from similar motives.