Dr. Michael Ivanovitch

Source: The US needs to clean up its monetary excesses and twin deficits

  • The world is moving on, but America is still nursing the deep wounds of the last financial crisis.
  • Allowing higher U.S. inflation rates, as some Fed officials advocate, would be the ultimate disaster.
  • A meaningful decline of U.S. trade deficits would give an impetus to growth at a time when the scope for economy’s fiscal and monetary support has virtually vanished.


Global talking forums, such as the G-20, show that unhelpful rhetoric and an allegedly obstructionist behavior in official international organizations are not the way to advance America’s interests. Those organizations have been built and underwritten by America at some of its finest hours of enlightened world leadership.

Washington neocons, famously seeking a “full-spectrum global dominance,” will not be the only people to note, with a tinge of sadness, that a real “program” speech for the G-20 was delivered last Friday at a Buenos Aires summit by China President Xi Jinping. They will also shake their heads in disbelief seeing that the BRICS (Brazil, Russia, India, China and South Africa) summit, on the same day, ripped the West’s addiction to indiscriminate sanctions warfare, while urging constructive multilateral relations and a regulatory update of the World Trade Organization.

All that is a world away from the first G-20 summit in Washington, D.C., in November 2008 at the height of the global financial crisis that ushered in the Great Recession.

The U.S. is still nursing the deep wounds of that epochal debacle.


Come to terms with crisis legacy

The Fed’s monetary base (M0) has skyrocketed from $820 billion in early 2008 to $3.5 trillion as of the last reserve reporting date on Nov. 21, 2018. Over the same period, excess reserves in the U.S. banking sector, funds banks can readily lend out, have followed a similar path from monthly averages of $1.5 to $2 billion to an astounding $1.7 trillion.

That extraordinary monetary creation is what it took to keep the U.S. economy afloat.

America’s fiscal picture is even more worrying — and literally getting worse by the day. The price of bailing out the U.S. economy has been a near doubling of the gross public debt from 64 percent of GDP in 2007 to 105.5 percent at this writing. And the debt is on an unstoppable upward trend as the public sector budget deficit continues to widen toward 5 percent of GDP.

The U.S. external deficits predate the financial crisis as a problem reflecting America’s low savings rates, and free-trade policies in a world of mercantilists free-riding on the American economy. As a result, Washington’s net foreign debt at the end of the second quarter of this year shot up to $8.6 trillion, an increase of $891.2 billion from the previous three-month period. By the end of this year, the fresh new liabilities to the rest of the world are likely to rise by an additional half-a-trillion dollars.

Clearly, errors of trade policy can’t be blamed on the rest of the world. America’s trading partners simply took advantage of the country’s open markets and its growing purchasing power.


Fixing monetary excesses and the twin deficits is a difficult work-in-progress, where screaming and kicking rear ends, as one U.S. official boasted recently, cannot be substitutes for effective economic policies.

To start with, leave
the Fed
alone to operate as it sees fit, but hold it to account for the impact of its policy choices on growth, employment and price stability. Fed officials who believe that solutions lie in allowing higher inflation rates will probably get a briefing by their colleagues, or the central bank’s economists, about the wisdom of such a policy option.

Surplus addicts should follow the South Korean example

Price stability is a precious public good — a situation where investment decisions and contractual relationships are made under assumptions of stable prices, because the monetary authorities are trusted to deliver a stable purchasing power of the currency they manage. It’s something like the German Bundesbank before the monetary union, where no German politician would dare talk about the monetary policy, and where it would be unthinkable that a Buba official would ever publicly urge higher inflation rates.

Fiscal policies are a question of national priorities. The U.S. debt and deficit numbers are clear — and they are not good. Budget constraints must be respected. There is a political and market sanction if they are not. The Fed’s independence also means that it should never validate unreasonable fiscal policy choices. Normally, fiscal and monetary policies must be closely coordinated to deliver a noninflationary policy mix for a steady and sustainable growth.

A benign neglect of trade deficits is an equally serious policy blunder. Those deficits are a subtraction from American GDP. They are wealth transfers to trade partners and sources of American foreign debt because deficits have to be covered by U.S. debt instruments in exchange for foreign savings.


For almost two years, Washington has been in a virtual state of siege because the Chinese, the Japan and the Europeans don’t care about threats and taunts. Those economies are piling on their U.S. trade surpluses with abandon.

It should not take a dinner on Argentinian beef and a big delegation to convince the Chinese president to do “something” about his soaring U.S. trade surpluses. Xi knows he has a $400 billion trade problem with the U.S., and he knows that he needs to get that down. But Xi has been given a wonderful grace period because he has to negotiate Washington’s requests to stop forced technology transfers, illegal intellectual property acquisitions, illegal export subsidies, etc.

The solution here is simple. Washington should ask Beijing for a prompt reduction of its trade deficit. How China does that is its own choice.

Think it can’t actually be done that way? Well, in the first nine months of this year, South Korea slashed its U.S. trade surplus 22.3 percent, after a 17 percent cut for last year as a whole. That is a respectful gesture of a true friend and ally: A 39.3 percent surplus cut since U.S. President Donald Trump took office.

The others can do that too, but the truth is the Chinese, the Japanese and the Europeans don’t want to do it.

And the U.S. should not leave it to the Chinese to change the structural problems. American companies should be prohibited from allowing forced technology transfers, or other forms of intellectual property thefts. Cyber-enabled thefts should be dealt with appropriate technologies that America has. Bilateral market access and investment practices should be matters of strict reciprocity, or as a Scorsese drama character would put it: “Same to you, fellas.”


Investment thoughts

Washington is mixing up trade problems with other agendas involving China, Japan and Europe. That’s been a non-starter for two years now. U.S. trade deficits with those economies continue to grow. On current policies, there is no end in sight.

The huge, and increasing, trade deficits are dampeners of U.S. economic growth at a time when the scope for supportive monetary and fiscal policies has practically vanished. A meaningful reduction of America’s nearly trillion-dollar trade deficits would spur growth of import competing industries. There would also be new wealth creation if foreign imports were to be replaced by products and services generated through foreign direct investments in U.S.-based production facilities.

Germany automobile manufacturers will be talking about such investments in Washington this week. They should get all the help they need to set an example of how excessive imbalances in automobile trades, and beyond, are being brought down by local manufacturing.

U.S. growth prospects would brighten considerably if Washington could get a substantial relief on the trade front — and provided the Fed continues to focus firmly on price stability.

Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.