Now that the noise and dust is, for the moment, beginning to settle in the two controversial debates of this last month — the domestic American debate over the Federal Reserve Bank’s new $600 billion bout of quantitative easing (QE2), and the parallel G-20 quarrels in Seoul over currency manipulation — it may be possible to think more cold-bloodedly about the implications of both issues, and of their connectedness. For connected they surely are.
But first let us consider why there was such heat and dust over these two political spats, one about Federal Reserve Chairman Ben Bernanke’s further “easing” (a lovely, comforting term) of federal bonds, and the other disagreement, swirling around the G-20 meeting, about exactly who was distorting international currency exchange rates most — China, the United States or the rest of the world.
The internal American debate about the wisdom of the Fed making yet another attempt to re-ignite the moribund domestic economy is such a clear-cut one that we need spend little time upon it here.
The advocates of quantitative easing argue that only the Fed and the U.S. Treasury have the tools to “kick-start” a low-growth nation; some commentators, like Paul Krugman, would prefer a much greater stimulus package.
Opponents, mainly Republicans but really all fiscal conservatives, are alarmed at the extraordinary way the Geithner-Bernanke regime is willing to print themselves out of the current American depression in the fond hope that this latest stimulus will lead to more jobs, then more growth, then more tax inflow, then more balanced budgets.
The gap between the two domestic camps is existential: You either believe that giving the ailing U.S. economy a Keynesian “kick” makes a lot of sense, or you think that this is pouring bad money after bad.
One of these positions, logically, is going to turn out to be right, and the other wrong. As at present, it could be either. QE2 is either catastrophic or sensible.
But the same logic may be true, perhaps a little less so, about the angry international argument that took place in Seoul regarding the effects of America’s “easing” of $600 billion by the Federal Reserve into its economy while the United States is, for better or worse, in a decaying form, the bank of last reserve, and while the dollar, though also decaying, is the world’s chief foreign-exchange currency.
That whole debate in Seoul must have struck any sensible and detached person as a dialogue of the deaf. President Obama and Treasury Secretary Timothy Geithner maintained to the last that this fiscal loosening was a necessary step to boost American recovery; and, with America recovered, the world would surely follow suit. “Don’t do as we do; just do as we say!”
The sheer presumption that the U.S. economy today still occupies the dominant position that it did in 1945 must have made serious Europeans shake their heads, and the Chinese giggle.
Does Washington still not know that its command of the global economy has, slowly, episodically, sadly, slipped away over the past 25 years? Can it ever come to grips with the fact that it is only by now a major player on the world’s economic scene, not the big gorilla?
Still, the debate over foreign-currency manipulation is surely one in which the United States has a fair initial case. Any banker or trader in the world would affirm that China is using its massive capital reserves to control the exchange rate of the renminbi; the latter is slowly rising, but only at a pace Beijing deems good for it.
Thus, Chinese exports are undervalued, which not only distorts U.S-China trade, but forces Japan, South Korea, Brazil and South Africa to scramble to keep their own trade competitive by similar currency manipulations. China, then, is up to tricks, and in consequence its trade surpluses grow, grotesquely.
So the Washington answer is to push more and more dollars into the system, defending that strategy with the argument that it needs to stoke up a flat domestic economy. Perhaps the economy will indeed be boosted, but the other effect is to send U.S. bills abroad, and so many of them that the exchange value of the dollar is bound to decline.
Sometimes, of course, the dollar will hop back. A stupid Middle East crisis (Iran attacks Israel, or Israel attacks Iran), a North Korea “mad-dog” action or a financial crisis in another European Union country will always cause a large, temporary surge into U.S. dollars. But the secular trend is downwards, both because of the continued deficits, and because of the increasing reluctance of other nations to hold so many dollars.
Simply put, the post-1944 American-led international monetary system is slowly coming apart. That’s not really a surprise. A country of merely 4.5 percent of the world’s population and 20 percent of its gross product cannot forever carry the burden of having its currency represent 80 percent or even 60 percent of the globe’s foreign-exchange reserves.
What used to be regarded by many (for example, the envious General Charles de Gaulle) as an unfair advantage may now turn out to be a burden. Sooner or later there is going to be what economists term a “convergence” between America’s real punching power in the world (that is, its share of total global product) and its artificially high share of international foreign-exchange denominations.
For a long while, many other nations within the U.S. political orbit accepted, and didn’t make a fuss about, the artificiality of the American currency position. But those were closely bound allies — Britain, Japan, Germany, Spain, South Korea. There seems absolutely no indication that today’s rising powers — Brazil, South Africa, India — have the same deferential attitude. As to China, well, it will never march to America’s tune. The real issue is whether America, because of its indebtedness, will be soon marching to China’s.
All of which brings those of us who think about America’s place in the world back to Bernanke’s narrow-minded “quantitative easing” — $600 billion here, $600 billion there.
From a purely domestic viewpoint, the Fed’s move may have been useful and was certainly within its remit. Just a few days ago, the distinguished Goldman Sachs chief economist Jim O’Neill reminded readers of The Financial Times that “the Fed’s responsibility is to maintain high employment and low inflation, not currencies. A lower dollar may be a consequence of the Fed’s policies.”
Yet what this means in reality is that no one can control decisions made by Bernanke and his colleagues — not even President Obama, who at the moment may find his powerlessness rather useful: Fed actions to stimulate a moribund America are not intended to weaken the dollar, but they probably will, thus improving exports, and dealing a side swipe at China’s own currency manipulations.
But the White House can say that it cannot be blamed if the dollar weakens. And, after all, the central banks of many other countries are taking steps to revive their economies and keep their currencies low. So, what is the problem?
The problem is that, despite its relative decline since Truman’s day, the United States is still a massively important player in the global economy, which means that not only has it a great capacity to help the world, but also a terrifying capacity to damage the global trading system by selfish, inward-looking policies, as it once did in 1930-1934.
Such policies would not only hurt America’s economy further but also begin to weaken its vital contributions to international security. Over the longer term, no No. 1 military power can maintain vast overseas obligations if its economy is weakening relative to other, rising nation-states.
For all these reasons, it seems vital to this author that the United States on the one hand, and the other major world players on the other, cease the folly of marching to different tunes, and in different directions. No coalition army ever won a battle by that tactic.
Paul Kennedy, professor of history and director of International Security Studies at Yale University and the author, among other works, of The Rise And Fall Of The Great Powers.