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Speculation of a grand bargain by the Group of 20 to rebalance the global economy is swirling ever faster thanks to China’s surprise decision to raise interest rates for the first time since 2007.
Higher rates ought to push up the yuan, one element of the mooted deal. Whispers that the Federal Reserve will go easy with an expected second round of quantitative easing — printing money to buy government bonds — point to the quid pro quo for China, which is alarmed at the prospect of the dollar’s debasement.
Maybe there is something cooking. But if the G20 were to go beyond broad brush strokes and devise a formula for reducing the current account imbalances disfiguring the world economy, it would be rewriting the history books.
“I think they’re working on something,” said Andrew Busch, a foreign exchange strategist with BMO Capital Markets in Chicago. “I’m just not sure if it’s going to produce the results that everyone wants. The G20 is a large group. I’m not sure everyone has the same interests,” he said.
There’s the rub. The five signatories to the September 1985 Plaza Accord, widely viewed as the pinnacle of global economic cooperation, had different interests: the United States, just like today, was under intense domestic pressure to reduce its current account deficit and boost manufacturing jobs by bringing the high-flying dollar down to earth.
Japan and West Germany, both with big surpluses, might have wanted to keep the competitive edge that weak currencies gave them. But, as fellow capitalist democracies, they at least recognized the political forces at work in the United States and signed the accord, which sent their exchange rates soaring.
MIXED BUNCH
The G20, by contrast, is a much bigger, disparate group of rich and emerging economies. To be sure, it made an auspicious debut when it supplanted the Group of Seven as the premier forum for international economic policymaking. Coordination of stimulus packages during the global financial crisis won high marks.
And China, the group’s de facto No. 2, is alert to U.S. political sensitivities. But, as its leaders repeatedly stress, it is also still a developing country with a compulsion to keep creating jobs to ensure stability.
It also has an authoritarian, risk-averse government that puts its own interests before global ones. The failure of climate talks in Copenhagen springs to mind. On currency policy, it is a stance that translates into caution and gradualism.
Moreover, the lesson China has taken away from the Plaza Accord is that the yen’s ensuing spike — complemented by deficit spending and loose monetary policy — inflated a property and stock market bubble in Japan that, when it burst, ushered in two decades of economic stagnation and virtual deflation.
China’s leaders might not face re-election, but they would face virulent dissent if they struck a similar grand bargain with U.S. Treasury Secretary Timothy Geithner.
“Clearly the ‘bubble’ and its bursting in Japan have a more complex explanation than simply the monetary and fiscal mix of 1985-1987, but the fact that this is the most dramatic instance of international engagement to tackle persistent current account surpluses overshadows current debates about what the appropriate response to Chinese surpluses should be,” said Harold James of Princeton University.
Indeed, James, a professor of history and international affairs, said experience down the decades shows that it is very difficult to devise institutional mechanisms to change policies to correct current account imbalances.
For instance, pressure on West Germany and Japan at the 1978 Bonn G7 summit to act as global locomotives by expanding fiscal policy led only to inflation and, indirectly, to the fall of German Chancellor Helmut Schmidt, James wrote in a recent e-book for voxEU.org. “The lesson of the past clearly indicates that a more sophisticated approach is required rather than exerting massive pressure for exchange rate adjustment and looser monetary and fiscal policy,” he said.
KING’S WARNING
A process of mutual policy assessment being steered by the International Monetary Fund is one such avenue. But what leverage in practice can the Fund exert over the United States or China?
Getting China to switch its model of growth entails overturning deep-rooted political arrangements that have bestowed favors on export-orientated coastal manufacturers and put investment ahead of consumption for decades.
“In China and the other surplus countries, as in the deficit countries, rebalancing implies a fundamental change in the centre of gravity of the economic, and therefore political, life of the societies in question,” Jeffry Frieden, a professor of government at Harvard University, wrote in the voxEU.org book.
In Frieden’s view, the festering row over the yuan is emblematic of the domestic and international conflicts that the global financial crisis has sparked and will deepen.
Governments are likely to turn inward as their constituents show more concern for domestic matters than for global economic cooperation, he argued.
Heading off the temptation to circle the wagons is, fundamentally, what is at stake at forthcoming G20 meetings in South Korea — a gathering of finance ministers in Gyeongju this Friday followed by a summit in Seoul on Nov. 11-12.
The World Bank estimates that increased protectionism accounted for only 2 percent of the drop in trade during the global financial crisis, compared with roughly half during the Great Depression in the 1930s.
But that does not mean globalization is irreversible, no matter how extensive worldwide production chains are.
Bank of England Governor Mervyn King warned on Tuesday that major surplus and deficit countries were pursuing directly conflicting economic strategies.
“The need to act in the collective interest has yet to be recognized, and, unless it is, it will be only a matter of time before one or more countries resort to trade protectionism as the only domestic instrument to support a necessary rebalancing,” King said.
“That could, as it did in the 1930s, lead to a disastrous collapse in activity around the world. Every country would suffer ruinous consequences — including our own.”
(Editing by Tomasz Janowski)