Balancing Global Macroeconomic Discrepancies

April 1, 2011

On April 1, 2011, the American-German Institute (AGI) and the Brandenburgisches Institut für Gesellschaft und Sicherheit (BIGS) convened a conference on “Balancing Global Macroeconomic Discrepancies: A Question of National Security?” The conference is part of a larger project, generously funded by the Transatlantik-Programm der Bundesregierung der Bundesrepublik Deutschland aus Mitteln des European Recovery Program (ERP) des Bundesministerium für Wirtschaft und Technologie (BMWi) and the AGI Business & Economics Program, that examines American and German responses to the economic crisis.

The first panel examined German and American economic policy, answering questions such as the extent to which separate economic policy approaches in Berlin and Washington impact the German-American relationship. Does policymaking that reflects separate economic and cultural characteristics lead to effective decisions not only for either country, but also for the global economy? What role do a stable currency and price stability play in creating a cohesive society? How much can political decisions impact macroeconomic factors? Speakers Knut Brünjes (Bundesministerium für Wirtschaft und Technologie), Jacob Funk Kirkegaard (Peterson Institute for International Economics), and Sherle Schwenninger (New America Foundation) addressed these topics, as discussed below.

The economic crisis is impacted by the two great projects of globalization in the 1990s: the creation of the euro zone and the integration of the U.S. economy with Asian exporting economies. In the U.S., structural flaws allowed for long-term low interest rates, deregulation, and more liquidity. The crisis has shown that reforms are needed. One focus will be to improve the U.S.’ net export position – a move that will change the U.S.’ relationship with the rest of the world. Other small steps will be to rely less on personal consumption and to focus on income instead of debt. There are signs of recovery in the U.S. – the rate of growth from 2002 to 2007 is similar to now, although public debt has replaced private debt – but with monetary inflation and a tepid fiscal stimulus, the recovery of profits has not been supplemented with job creation. Thus, despite signs of recovery, there are concerns of a double-dip recession: consumption continues to drive the U.S. economy, real wages have declined, and the trade deficit remains. Going forward, the U.S. has a number of options: 1. A program of austerity, i.e., spending cuts without increased taxes (seen as untenable in six months); 2. Monetizing debt through the Federal Reserve; 3. Protectionism; 4. A second “post-partisan” moment, in which corporate taxes are cut, home buyers receive a tax credit, and more U.S. equities are made attractive and sold. This final option is the most likely to take hold in the U.S.

A large structural difference between the U.S. and the European Union exists: whereas the Congressional Budget Office (CBO) has a baseline deficit goal of 3 percent, the same percentage is the maximum allowed for euro zone members. The euro zone’s fiscal stance is similar to that of U.S. states; on the federal level in the U.S., the more likely political outcome is 6 percent. More tax breaks are the only likely bipartisan agreement, although this will not be enough, considering that $60 billion is only .4 percent of GDP. Thus, to solve a 2015 problem – maintaining the U.S.’ AAA rating – it will need revenues. The political impasse means that a crisis even larger than the 2008/2009 crisis will be the only likely impetus to act.

In Europe, the much-discussed banking sector reforms are an illusion, especially in Germany. The degree of political protection of banking in Europe surpasses protection of Wall Street in the U.S. A strategy of regulatory forbearance is now underway in Europe, as happened in the 1990s in the U.S. after the Latin American debt crisis, and restructuring of debt will be voluntary.

Despite the economic crisis, the U.S. has overtaken Germany as the second largest exporter (after China). The relatively stable positions of German companies have resulted in fewer exports. Still, as the third largest importer, Germany is not the cause for global imbalances. The differences between the U.S. and Europe are smaller than were portrayed during the crises, and are generally seen in the labor market: Germany has had fewer and more gradual job losses, maintained higher incomes, and restored domestic demand. German domestic investment, however, lags behind.

The second panel focused on the connection between welfare and security in times of global economic and financial crises. The speakers, Klaus Deutsch (Deutsche Bank Research), Jeffrey A. Frieden (Harvard University), Matthias Matthijs (American University), and Robert von Rimscha (Auswärtiges Amt), addressed some of the following questions: How much independence does a country lose when it consumes more than it produces in the long run? Does postponing consumption to an undefined time in the future or valuing the title of “export world champion” limit development potential in the rest of the world? What dangers exist for societies when they become fiscally unstable or if the global economic and financial systems falter – or even breakdown in some places?

The causes of the global macroeconomic imbalances are viewed differently by economic and political experts. Generally four reasons are cited: 1. The deficiency of U.S. savings; 2. The successful integration of the ITC sector in the U.S. economy; 3. The Sino-American codependency, in which China and other Asian countries financed the U.S. current account deficit through their large currency reserves built up after the Asian financial crisis in 1997/1998; and 4. The glut of global savings, which put downward pressure on U.S. interests rates and encouraged U.S. spending.

During the debt crisis surrounding Greece in 2010, two opposing views were developed: One, put forth by the French, emphasized growth and European economic government without involving the IMF; the other, propagated by Germany, focused on price stability and national fiscal discipline with IMF support being conditional for any bailout. With the establishment of the European Financial Stability Facility (EFSF), IMF involvement, as well as the “amending” of the Lisbon Treaty, and now the permanent European Stability Mechanism (ESM), the German view would prevail. However, there are limits to this response: While the proposals calmed the markets in the short term, they are no long-term solution. There is a need for European re‐balancing, taking into account public and private debt flows, but currently there is no political move toward that direction. While in Europe, Germany can force almost all of the adjustment process onto the European periphery, China cannot force an adjustment onto the U.S. and neither can the U.S. force an adjustment on China as this would hurt both parties involved. The imbalances in Europe will not lead to any security issues, however, because the institutional instruments of the EU are too strong even though a possible outcome might be a long period of economic stagnation. A lack of coordination between China and the U.S. on the other hand could lead to a serious conflict in the form of a financial crisis or a trade war, as no institutional mechanism to deal with these imbalances exists at the moment.

This will also pose a risk for the global economy, as China and the U.S. represent the most important global economic relationship. China is currently focused on increasing its domestic investments to develop a domestic market and thus to create employment for its growing urban middle class. The financial crisis in 2008-2010 has further spurred this development in China, which in turn means that China is not interested in achieving a global equilibrium any longer but rather focuses on attracting foreign direct investment. This behavior will lead to a shift in Chinese-U.S. relations. A possible U.S. bond market crisis in 2012/2013 will further lead to policy changes. Europe is only a marginal player in this relationship. Furthermore, Europe has turned its focus inward following the sovereign debt crises in Greece, Ireland, and Portugal. Europe will likely experience a decade of slow domestic growth, which will impact the German economy more negatively than a burgeoning Asian economy would help Germany.

The current U.S. focus on financial austerity, which has become a societal consensus in the U.S. that transcends party lines, has direct and indirect consequences for the country and the world. The U.S. will have to make very difficult political choices between its economic demands and its national security interests in the coming decades. Previously, U.S. national interests and goals were determined and then the means were found; this will change. The public discussion about the military intervention in Libya, which focused immediately on the cost equation of this war, is a recent example of how this debate has already changed in the U.S. Contradictions between foreign and domestic policies will become more and more apparent: Food aid for example is a very ineffective foreign policy tool, yet it is very valued by U.S. farmers. Global health aid on the other had is very effective but has no domestic constituency which could lobby on its behalf during budget cuts. After World War II the U.S. experienced a confluence of economic and national security interests, a consensus which held through the Cold War. Today, economic and national interests often diverge such as in the Middle East or vis-à-vis China. Indirect effects of U.S. austerity should also be expected: Austerity tends to make the U.S. more isolationist. Additionally, the U.S. population already views globalization as one of the main causes for its current economic problems and does not see the link between U.S. national security interests and an integrated global economy. Strains between the U.S. and the global community are likely to follow.