The wars of austerity

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27-10-2010

Robert Skidelsky - The Wars of Austerity

The Wars of Austerity
Robert Skidelsky
Project Syndicate | Monday, October 18, 2010

LONDON – I have become increasingly less hopeful about prospects for a rapid recovery from the global recession. Coordinated fiscal expansion ($5 trillion) by the world’s leading governments arrested the downward slide, but failed to produce a healthyrebound. The current frustration is summed up by The Economist’s recent cover headline: “Grow, dammit, grow.” There are two reasons to be pessimistic. The first reason is the premature withdrawal of the “stimulus” measures agreed upon by the G-20 in London in April 2009. All the main countries are now committed to slashing their budget deficits. The second reason is that nothing has been done toaddress the problem of current-account imbalances. Indeed, the talk nowadays of currency wars leading to trade wars is reminiscent of the disastrous experience of the 1930’s. The problem of current-account imbalances is closely linked to the existence of a world savings glut. One part of the world, led by China, earns more than it spends, whereas another part, notably the United States, spends morethan it earns. Provided the surplus countries invest in the deficit countries, these imbalances pose no macroeconomic problem. Indeed, this was the nineteenth-century pattern. A system of foreign investment, pivoting on London, channeled the savings of rich (or surplus) countries to the poor (or deficit) countries. Despite many financial crises and defaults, this creditor-debtor relationshipworked, on the whole, to the benefit of both sides. Rich-country investors earned a higher rate of return than they would at home, and poor-country recipients raised the development finance they needed. There was no persistent tendency to deflation. The current system is superficially similar, but with one crucial difference: the flow of saving now goes from developing countries like China to richcountries like the US –that is, from countries where capital is scarce to countries where it is abundant. The global savings glut is the result of this perverse relationship. Unlike Great Britain in the nineteenth century, China does not view its surpluses as an investment engine. It undertook reserve accumulation in the late 1990’s as a form of self-insurance against capital flight. Reserveaccumulation was also a by-product of China’s deliberate currency undervaluation to promote export-led growth strategy. The result is that China and other East Asian countries own a large and growing stock of US Treasury bills. Through financial intermediation, these government securities helped finance the western consumption and speculative boom that collapsed in 2008. Cheap money in the West was the“correct” Keynesian response to the flood of saving from the East. But, because there were insufficient outlets for “real” investment in countries that already had all the capital they could
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27-10-2010

Robert Skidelsky - The Wars of Austerity

use, cheap money proved to be a dysfunctional way of dealing with the problem of excess saving. Therecession reinforced the pattern of poor countries lending to rich ones. With vigorous recovery in East Asia and stagnation in the West, global imbalances have grown. And, as former US Federal Reserve Chairman Alan Greenspan recently noted, “US fixed capital investment has fallen far short of the level that history suggests should have occurred, given the dramatic surge in corporate profitability.” Inshort, we are heading full steam ahead into the next collapse. There are two broad strategies for unraveling the linked problems of current-account and saving-investment imbalances. The first is to weaken China’s incentive to accumulate reserves. In April 2009, Zhou Xiaochuan, Governor of the People’s Bank of China, proposed the creation of a “supersovereign reserve currency” to remove the...
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