Increasingly, Trade is an Open Confrontation

In recent days, there has been open confrontation brought about by increased global participation in international markets. President Obama announced that his recovery plan includes medium-term growth and doubling exports in ten years. Democrats are pressing the administration to declare that China manipulates the exchange rate and, in retaliation, that he should set a tariff of 25 percent.

These developments cast doubt on theories of comparative advantage, which predict that all countries have a place in international markets and can create win-win scenarios in the exchange. Instead, trade is an open confrontation among producers of the same products, with all seeking to expand exports and accelerate economic growth.

This situation confirms past analytical errors in the examination of the financial crisis. It was originally attributed to liquidity and solvency problems and was felt that large bailouts held solutions. Today, it is clear that these outcomes were mere manifestations of a more serious structural fault in the international economic system.

As noted in my book “The Global Recession,” on one hand, Asian countries were engaged in large expansions of exports and held continual account surpluses to boost growth. On the other hand, the U.S. operated with continual account deficits to finance over-inflated asset valuations. The system collapsed because exports and asset prices could not increase indefinitely.

From the beginning, international trade arrangements were made to encourage the devaluation of the dollar against Asian currencies. Thus, the U.S. initially revived with increasing exports, reducing the current account deficit. China experienced a reduced account surplus, expansion of fiscal deficits and rising wages.

In the despair of free-fall, things proceeded very differently. All countries looked at tripling fiscal deficits, with the average level exceeding 5 percent of GDP. This slowed the global recession in six months, but did not correct the underlying cause of the recession.

Just as not all countries could increase exports, they could not, across the board, increase fiscal deficits. The outcome has been a rise in debt and current account deficits in the U.S. and Europe, as well as an indefinite issue of dollars to produce a devaluation.

Mid-sized European countries like Greece, Spain, Portugal and Ireland are besieged by large current account deficits and high indebtedness. Instead of dealing with imbalances in exchange rates, devaluation or financing fiscal deficits by issuing money, they are doomed to serious adjustment programs based on fiscal and monetary austerity, wage repression and recession.

The U.S. situation is more comfortable. Reserve currency can be issued indefinitely to maintain high current account deficits and high indebtedness. Nevertheless, devaluation of the dollar generates reprisals and crises in other economies, the effects of which accrue to the U.S.

Global circumstances have created a great fear of current account deficits and debt. Now, countries across the board will go with trade intervention and protection, replacing tax breaks for current account surpluses. As all cannot meet their goal, it will feed back into an anarchy such as that at the the beginning of the worldwide crisis. If export supply exceeds demand, excess inventory holdings may come back to threaten the recovery.

After three years, we have failed to normalize the international order. The global economy is exposed to vulnerabilities that can lead to crisis in Europe, Japan and even in the U.S., as well as serious interference with consolidating any recovery.