Trade war and more borrowing – no thanks!

The Obama package to save the world is now under scrutiny to see if it can even save America. Adding too much public borrowing to protectionism is not a winning recipe for success.

I can see why Mr Obama thinks that if he is going to borrow and spend such huge sums, he should at least say that the money should be spent on American supplies and American labour. After all, he will reason, the point of the package is to revive the US economy, so it must make sense to spend the money on employing Americans. The USA has been importing too much. It would make little sense for the US state to borrow more and spend it on imported Chinese steel or Japanese cars.

Unfortunately things are not as simple as that. Drawing up a list of useful purchases where the US is more likely to win the contracts is one thing. Placing a ban on products and labour from overseas is another. If the USA moves from the former to the latter, other countries around the world may follow suit, making it more difficult for the USA to export its goods. There would be no winners from a trade war.

Sometime the world has to address the huge imbalances between countries that lies behind the current crisis. Of the five largest economies in the world at the start of the crisis, two, the USA and the UK were borrowing too much, spending too much and importing too much. Three, Japan, Germany and China were saving too much, exporting too much and lending too much. Part of the crisis lies in the painful process of seeking to adjust to a point where the three creditors import and spend more, and the two debtor countries borrow less and export more.

Policies in the UK and the US to borrow more and spend more may delay this adjustment. In the UK the government’s attempts to offset the iron laws of economics have led to a sharp collapse in the pound, cutting the spending power of all of us and putting us off buying so many imported goods. This is offsetting some of the fiscal profligacy and thwarting the government’s hopes of avoiding a fall in living standards. If the US overdoes its attempts to borrow its way out of trouble, it too could run into difficulties requiring higher interest rates and a lower value for the dollar. The US reflationary package is dependent on the goodwill of the creditor nations continuing to hold US government bonds and adding to their holdings as new ones are issued in huge quantities.

The world needs agreement between lenders and borrowers. Adjustments need to be made by both groups of countries. The successful exporters and savers do need to spend more and save less. China has announced a reflationary package with that in mind. They do need to allow their currencies to appreciate, so imports are cheaper and more attractive to them. Some of this has happened with the sharp upward movement in the yen and the lesser upwards moves in the Chinese and German currencies. It is in the interests of the creditor countries to reflate, as their economies are being hit hard by the collapse in demand for their exports which have accounted for such an important part of their past economic activity. Germans need to buy more of their own manufactured cars and trucks, and the Chinese need to buy more of their own electricals and textile products, as the debtor nations can no longer afford to.

The US and UK authorities are taking very large risks by thinking both that they restore consumption levels to the unsustainable ones of the boom, and that they can at the same time underwrite their bloated banks and stand behind all their bad and doubtful loans. Their attempt to do so has not succeeded in avoid a severe downturn anyway, but it is delaying the adjustments needed to get back into some kind of balance on trade and in finance. Mr Brown seems to think the UK’s credit is unlimited and any kind of spending is a good idea. Mr Obama must be careful not to go the same route, as we need a solvent USA tackling the twin deficits he has inherited. The USA needs a period of borrowing less and exporting more.