Panel 6: The Global Economy

 

Professor Daniel Drezner argues that we are currently facing an existential crisis in the global economy. There is a crisis in the financial markets, driven in part by a failure to properly assess the valuation of assets. In energy markets, there is the emergence of a kind of feedback loop concerning state control of energy resources; those states that exert the most control over their oil reserves tend also to then invest less in exploration and maintenance, leading to greater oil scarcity. Export barriers on food, and the failure to develop a functioning carbon market, are also serious problems for the global marketplace. Contrary to the claims of those who argue that the state is eroding in power, Drezner argued, there is actually a reassertion of the state control in the form of state-owned enterprises and soverign wealth funds. And it seems to be working: the ideas that countries like China are promoting with its strict regulation, of things like the financial markets and the internet, are having some measure of success. Similarly, elsewhere we are seeing states engage in incipient investor protection, and trade liberalization has stalled. The best case hope for the upcoming Doha round is that the negotiations are finished by this year; yet neither president is likely to ratify it, especially over the short term.  Drezner pointed out that a number of different scenarios are possible: a return to the 1970s, with shifts in market power may also accompany shifts in political power. Bu the prediction of a return to the 1970s also need to be careful; many of those who predicted a permanent U.S. decline in the 1970s were wrong, as the U.S. experienced a thirty-year renaissance. And yet the worst case scenario is a return to the 1930s: a wholescale rejection of the open market, and an alarming and perhaps unsustainable mismatch between the power in the global financial institutions and the power in the actual market. Professor Drezner speculated that the return to financial situation of the 1970s is more likely.

 

Charles Dumas of Lombard Street Research pointed out that by early 2006 the U.S. had clearly gone beyond its debt capacity. The U.S. had become an export-lead, overheating economy, and it had as much debt as it can service. It is not an unsolvable problem, but for the next five years the U.S. will face high levels of government debt and problems in the equity markets. Its best solution for the U.S. would be a mix of devaluation of debt and deflation of the dollar. The Fed has essentially accepted the devaluation now. But by seeking an inflow of cash to offset deflation of the dollar, it has witnessed a serious drop in real income, which has affected American standard of living and made the prospect of recession worse. At the moment, the Chinese investment in U.S. debt is allowing the U.S. to buy back private debt and manage the market efficiently. But the Chinese are also seeing their trade balance shift back to normal, and their reserves are diminishing. This is good news: it means that the world economy is rebalancing. But it is not without its dangers; if the Chinese allows liberalization of capital so that Chinese investors can seek better rates of return elsewhere, it will increase the burden on the U.S. debt, increase inflation and interest rates and hurt the standard of living that Americans face. 

 

Sudeep Singh of Caxton Europe Asset Management pointed out that the U.S. consumers are going through a classic developing country dilemma: spending too much on consumption and investing too little in their own economy. Investment in the housing markets has sustained excess U.S. consumption for a very long period of time. But now we are likely to see a drop in value of dollars and increase in inflation, but then an enforced end to spending for U.S. consumers. In truth, Singh argued, the U.S. had a negative savings rates because they were using houses as massive ATMs; this was obviously unsustainable. To get themselves out of this, the U.S. is going to have to accept a basic restraint: to save more than they spend. And there will have to be a basic adjustment, because Western banking systems are overly invested in the unstable U.S. housing market and the readjustments in that market will continue. There is a ray of hope: if the U.S. can stabilize its trade and financial relationship with China, and prevent further severe write-offs and devaluation, it may be able to muddle through this crisis. But it will take a very long time for U.S. consumers themselves to recover from this, and the Washington consensus – which was followed everywhere bur Washington – will be challenged. The best way to steer through this crisis is to have a strong economy, with a budget surplus, to insulate your country from the shocks. 

 

All in all, a gloomy session. None of the panellists believe that the current global financial crisis is going to be short, or have modest effects. But there is no reason to despair, if the U.S. can work in partnership with China and other key players to ensure stability.