Blogs & Comment

What the U.S. really needs to do

Today, President Obama is scheduled to outline a set of proposals for reforming the regulation of U.S. financial markets. The goal, of course, is to minimize the odds of another crisis ripping through financial markets.
Regulation does have a role to play in achieving that objective but we must not lose sight of other factors and measures that go more directly to the heart of the matter. That is to say, at ground zero in this whole mess is a huge set of imbalances in the world economy; to get out of the bubble-and-bust pattern that has settled in during the past decade, these disequilibria must be corrected.
And so far, there arent any good indications of such. That is not a good omen. One can have the best regulatory system in place but it will be like a sieve if the structural imbalances in the economy are not turned down.
The chief imbalance manifests most directly as a chronic deficit in the U.S. balance of trade, which has in recent years stood at about 6% of GDP. That means, as a nation, the U.S. is consuming and investing 6% more than its producing. Ordinarily, such an imbalance does not persist for very long market forces would drive consumption lower in the deficit country and drive it higher in the surplus country.
But those market forces are not being allowed to operate. Many countries in the world, notably Asian countries such as China, are pursuing industrialization strategies based on export-led growth and are suppressing the value of their currencies against the U.S. dollar. They need to de-emphasize such export-led growth in favor of domestic-led growth. As well, they need to allow their currencies to appreciate against the U.S. dollar (or, on the flip side, let the U.S. dollar fall against their currency).
As for the U.S., its spendthrift ways need to be dialed down to get national spending more in line with production. By some combination of measures, the rate of internal savings needs to be raised. This starts with, as former Fed chairman Paul Volker says, a strong sense of monetary and fiscal discipline.
There are no signs of such discipline at present. Indeed, U.S. monetary and fiscal policies are set to accommodative extremes not seen since World War II. Now that the risk of financial collapse has subsided, they should be reined back. This may trigger stagnation for a time but that is not to be feared. The U.S. is not Japan; it is a deficit country whereas Japan is a surplus country. Japan needs to stimulate its economy more, the U.S. less.
Living within its means is what the U.S. has to do to bring about a sustainable solution to the imbalances that are generating grave disequilibria. Just as good, it will put pressure on trading partners to abandon their export-led industrializations in favor of domestic-led industrializations — because if the U.S. is living within its means, it wont be buying as many exports from other countries. For more thoughts on this theme, see the article, Averting Armageddon.