G20: Why to avoid a re-run of the 1930s
A few months before he killed himself, the Austrian novelist Stefan Zweig wrote this, about the 1930s:
"All the pale horses of the apocalypse have stormed through my life: revolution and famine, currency depreciation and terror, epidemics and emigration; I have seen great mass ideologies grow before my eyes and spread, fascism in Italy, national socialism in Germany, Bolshevism in Russia and above all the ultimate pestilence that has poisoned the flower of our European culture, nationalism in general."*
The 1930s, which began with a financial crisis, would see the worst depression in capitalism's 200 year history, and then a combined trade and currency war which solidified the world into competing economic blocs. By the time some of those blocs ran out of natural resources, towards the end of the decade, the pathetic military machines they had possessed in 1929 had become capable of conquering countries where those resources lay, wiping out whole parts of their populations in the process.
The great cosmopolitan cities, like Zweig's Vienna, would be scoured of all that was cosmopolitan: their Jewish communities, their academic freedom, their modern art, their gay nightclubs, their labour movements.
This is why you do not voluntarily want to re-enact the 1930s. But it is the shadow of the 1930s that has fallen across the G20 summit in Seoul. The leaders emerged, as we knew they would, without what David Cameron called "a glistening headline" - only 12 months after they had signed up to one glistening paragraph after another in Pittsburgh.
The sticking point, we are told, is "the global imbalances". Once arcane, today everybody who can read a newspaper, or Wikipedia, knows basically what they are: China produces, the west consumes; China saves, the west borrows; China exports, the west imports. This arrangement, which was once vaunted as a kind of yin-yang harmony pictogram for the world economy is now seen, rightly, as dysfunctional.
However, another way of putting it is that globalisation itself has become dysfunctional - or at least the form in which it has developed for 20 years.
To solve the imbalances you have to understand their causes - and there is a wide literature on this, which I will summarise.
The two main theories are called "savings glut" versus "over-borrowing". The over-saving thesis says: China's workers and businesses save too much and spend too little, the surplus capital in the world depresses the rate of interest and that cheap money flows into the western financial system creating boom and bust cycles.
The "over-borrowing" thesis says: America's population has become addicted to cheap credit, credit has replaced rising real wages, de-industrialisation pursued for a fast buck by firms offshoring their operations to China means the USA cannot restore its trade balance.
There is a third theory, advanced by economists at the Bank of France among others, known as "the investment strike": because (for the reasons outlined above) general rates of return are low, non-financial companies under-invest to keep headline rates of profit high. This too ensures the major part of capital remains in the financial system, depressing returns and creating bubbles. Martin Wolf's book "Fixing Global Finance" contains a much more detailed account of all this than I can give here.
It should come as no surprise that the proponents of blaming China are US economists, including Fed chief Ben Bernanke, and that supporters of the over-borrowing explanation are mainly sympathetic to the emerging markets.
But the trade, production and consumption imbalances are only one part of the story. The other is the labour market. Looked at from a labour market economics point of view, the problem is this: in the USA real wages have stagnated on some measures since 1973; in China, though they are rising, the labour market barely functions: large parts of wage costs are borne in the form of dormitory accommodation and three meals a day in the works canteen; anecdotally when western companies try to pay their workers more they are prevented by the CCP or its union, the ACFTU. In both sides of the world economy, the sustainable sources of consumer demand are depressed.
So one answer to "the imbalances" would be for real wages to rise both in China and in the West - however, put like that, "correcting the imbalances" looks more like "rolling back the Thatcher, Reagan, Deng Xiaopoing revolution in labour flexibility".
So how could the imbalances be resolved? On paper it is obvious: China has to stimulate domestic demand - not just for railways and bridges but for consumer goods and services - by raising wages and bringing in a welfare state. I have met farmers in China using 60% of their disposable income to send one child through university. Meanwhile the west has to become more industrial, its consumers have to save more and become less obsessed with buying cheap tat at large supermarkets.
America, above all, has to get its productive capacity back. If you wanted to be really controversial you could say that everywhere has to become a bit more like Sweden and Germany. I say controversial of course because, outside of these two countries, the "social model" they represent is widely despised.
So here is the challenge: you either rebalance through collaboration or you do it through competition.
America could easily plot a course to re-industrialise, upskill, raise wages and raise savings (and eradicate debt) as follows: trade controls against China and Latin America, massive money printing to stimulate inflation and shrink the national debt, aggressively devalue the dollar. The problem is it is half doing this without really trying: its QE2 policy does stimulate inflation and depress the value of the dollar. This is what Alan Greenspan meant when he wrote, two days ago in the FT:
"America is also pursuing a policy of currency weakening. The suppression of the renminbi and the recent weakening of the dollar are, of necessity, producing firming exchange rates in the rest of the world to, as they see it, the rest of the world's competitive disadvantage."
Tim Geithner hit back that he had no such intention, but in China, they do not care about the ideas inside Timothy Geithner's head, they care about the actions he is taking.
When it gets to this point what you need is a grand bargain; a spectacular (glistening if you like) gesture to which all sides sign up. That is what Keynes urged the participants at the London Conference in 1933:
"Our plan must be spectacular, so as to change the grey complexion of men's minds. It must apply to all countries and to all simultaneously. Each at the same time must feel able to remove barriers to trade and to purchase freely. If we all begin purchasing again, we shall all have the means to do so."
At that point the world's leaders were three years into the post-crash reality and trade war was looming. On 21 September 1931 Britain's new coalition government had left the gold standard, after pay cuts in the Royal Navy led to the Invergordon Mutiny, and a resulting run on sterling. Though they did not have the theoretical means to understand it, Britain had inadvertently saved itself from the worst of the Depression by devaluing sterling ("We didn't know you could do that," one hapless former Labour minister famously said). It had "beggared thy neighbour".
America, meanwhile, stuck to the old orthodoxy: though it was to begin Quantitative Easing in April 1932, it would stick to gold until 1933 - forcing itself to adopt deflationary monetary policy even as it tried to escape recession.
The lesson of the early 1930s has been drawn for us by one of the modern world's greatest economists:
"If monetary contraction propagated by the gold standard was the source of the worldwide deflation and depression, then countries abandoning the gold standard (or never adopting it) should have avoided much of the deflationary pressure. This seems to have been the case...There is a strong link between adherence to the gold standard and the severity of both deflation and depression"
That is a quote from Ben Bernanke's 1991 paper, The Gold Standard, Deflation and Financial Crisis in the Great Depression (with Harold James). Bernanke shows that countries that devalued their currencies first, recovered first. Those that refused to do so were driven by the orthodoxy of the time, shared by capitalist and communist alike, that strong currencies linked to metal were the only guarantee of economic stability.
Right now, countries are beginning to draw conclusions from Bernanke's insight: nobody wants to be the last person to devalue. Right now the USA is inflicting currency pain on all its supplier countries except China; China is inflicting pain on the USA through its dollar peg; Germany and Sweden are inflicting pain on the rest of Europe by using their competitive advantage within a mini-Gold Standard known as the Euro to outproduce the so-called PIGS, which are close to penury.
If the currency war continues, sooner or later trade war will follow.
What politicians are learning is that you can't stop trade wars by meaningless declarations: you can only do so by co-ordinated policy and by a massive shift in assumptions and accepted wisdom. By massive, heroic gestures like the ones Keynes urged. Geithner himself has put his finger on what such a gesture might entail: a one-time voluntary cap on trade surpluses by China, Germany and the other exporting countries in return for a reduction in budget deficits and debt. This is what never got close to happening at Seoul.
They are also learning that democracy and recession are great drivers of trade and currency war: though the central bankers form an unelected global club, the politicians they technically serve have to get elected every five years or so. There is a chance, sooner or later, that a party will come to power in a western democracy committed to overt trade and currency competition with other countries, whether it's the Greek KKE with its desire to leave the Euro or the Teaparty wing of the Republicans with their desire to declare trade war on China.
In addition, as my colleague Stephanie Flanders has pointed out, this was the summit where global consensus slightly fractured: the world view of the global south and emerging Asia was for the first time equally represented. Gordon Brown may have declared the Washington Consensus is dead, at London in April 2009, but it was in Seoul that the non-consensus emerged. The Washington Consensus, it is clear, will not be replaced with a new unity, but a new agreement to disagree.
This is where it becomes problematic - because unlike the 1930s, the world economy is massively more interlocked: in fact it is fused rather than interlocked; it is networked together by global financial flows, derivatives, multi-country production lines, massive raw material trade dependency.
Just take a look at the objects in front of you, and on your person, as you are reading this and make a list of where they come from; and then take your wallet out and ask how much credit would be available on your plastic were the source of it to be only the savers of your own country. Any return to competing trade blocs would shatter the modern world just as completely as 1914 shattered the world of coffee, cake and coloratura that nurtured Stefan Zweig.
Of course, what we now rely on is the various bilateral and multilateral bodies - the IMF, WTO, EU etc - to try and patch things up. They may have missed their chance for a spectacular circuit breaker but they could still patch things together. Even if patching things together is not as good as doing a deal on trade, climate change and currencies it is what they have to do.
Because there is one more reason why we do not want to re-run the 1930s if we can avoid it.
When the "pale horsemen of the apocalypse" visited Zweig's generation, it came as a total shock to them that they brought genocide, war, bombing of civilians, forced migration, disregard for the Geneva Conventions in war, and the overt attack on rationality by mobs devoted to medieval ideologies.
Unhappily, these phenomena are familiar to us already.