Decoding the G-20 Drama

There was a big brouhaha at the G-20 summit this week over
what they're dryly calling "global trade imbalances."

In the simplest terms, what this boils down to is
this: Americans buy too much stuff from China. The Chinese stuff is
artificially cheap because of currency manipulation, but also because of labor
repression that keeps wages down. And because wages are so low, Chinese people
don't buy very much stuff, so the money from exports piles up.

China is expected to have a trade surplus of $270
billion this year, while the United States is expected to have a trade deficit
of $466
billion. Other countries have trade imbalances too, but these are the
biggies.

The trade deficit hurts the U.S. economy because money spent
on imports is money not spent on U.S. products that support jobs in this
country. Also, to fund this deficit, the United States has to borrow money from
abroad. And if the deficit keeps growing, the day may come when foreign
investors are no longer willing to lend.

Last month, Treasury Secretary Timothy Geithner tried to get
the other G-20 governments to agree to limit their trade imbalances to no more
than 4% of GDP. How did he pick 4% as the target? Well, it's probably no mere
coincidence that China's surplus is expected to exceed that mark this year (4.7%),
while the U.S. deficit is expected to fall below it (3.2
%). Geithner was basically told to take a hike.

So what's a U.S. policymaker facing a nearly 10%
unemployment rate to do? One option would be to reinvigorate U.S.
manufacturing through targeted public investment. You could pay for it by
increasing taxes on the ultra-rich or by taxing financial speculation. Sadly,
the outcome of the mid-term election likely put the kibosh on that kind of
stimulus spending, at least for the next two years.

Instead, the Fed, which doesn't have to worry about Tea
Party opposition, did what's called "quantitative easing" - another
unnecessarily abstract term that basically means they're printing money, to the
tune of $600 billion. Their idea was that all this cash will lubricate the
wheels of the American economy, get credit flowing again, and create jobs.

This is largely based on faith. As Brazilian
Finance Minister Guido Mantega put it, "It doesn't help things to be
throwing dollars from a helicopter." Brazil and other fast-growing emerging
markets are worried that the Fed-created cash, instead of financing U.S. job
creation, will slosh into their economies, where interest rates are higher.
This would drive up the value of their currencies, making their exports less
competitive. Wolfgang
Schaeuble, the finance minister of Germany, which is a trade surplus
country like China, declared the Fed's action "clueless."

Such tough jabs are unusual among finance ministers. What
seemed to really get their blood boiling was the fact that the Fed announced
the action without giving the other governments as much as a heads up. This
week's G-20 summit in Seoul, Korea concluded without any meaningful agreement,
other than a timid pledge
to "refrain from competitive devaluation of currencies." So much for the G-20
fulfilling its self-declared
status as the "premier forum for international economic cooperation."

Meanwhile, to deal with the surge of short-term "hot" money
that could drive up the value of their currencies, Brazil, Taiwan, and several
other countries are imposing various forms of controls on capital inflows.
However, this is not really an option for the 52
countries that have signed U.S. trade or investment treaties which severely
restrict the use of this policy tool. If they violate these restrictions, they
run the risk of facing expensive lawsuits from affected foreign investors.

Hopefully the Obama administration will now recognize that
bans on capital controls are outmoded and work to revise them. As Dani Rodrik,
of Harvard University puts it,
"capital controls are now orthodox."

While giving governments the authority to use policy tools
at the national level to control capital flows is critical, this patchwork
approach is not ideal. We need a new international monetary system that can
help prevent the kind of "currency wars" we're seeing today. That's something
French President Nicolas Sarkozy plans to put at the center of the G-20 agenda
now that he has taken over the presidency of that body for the next year. Let's
hope he can get the other leaders to stop squabbling and take the challenge
seriously.