Wednesday 18 March 2009
US needs to display leadership, not panic
As the world reels from a financial crisis whose origins lie in bad United States banking practices and monetary policy, it may seem counterintuitive to argue that it is the US that will play the most important role in determining the outcome of the crisis and the impact it will have on the rest of the world, and especially on Asia.
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US needs to display leadership, not panic
Michael Pettis
16 March 2009
As the world reels from a financial crisis whose origins lie in bad United States banking practices and monetary policy, it may seem counterintuitive to argue that it is the US that will play the most important role in determining the outcome of the crisis and the impact it will have on the rest of the world, and especially on Asia.
Unfortunately, however, the US does not seem to be taking the leadership role necessary to help create the institutional framework that will govern trade and capital relationships over the next few decades. On the contrary, it looks like a government so panicked by domestic worries that it is failing in its global role.
The centrality of the US to any resolution is based on some obvious and some less obvious conditions. For the obvious, the US is easily the largest economy in the world and, just as importantly, its economy and its financial system are among the most flexible, so the adjustment to the crisis is likely to be much faster in the US than elsewhere. It will probably be the first major economy to emerge from the crisis, although this is not likely to happen soon.
Less obviously, the US commands the most valuable economic resource in the world right now. In a world struggling with declining demand, the US provides the greatest amount of net demand to the rest of the world via its large trade deficit.
This is crucially important. One inevitable and necessary consequence of the global crisis is that US over-consumption must decline significantly, and as it does, the US trade deficit must also contract sharply.
Although most commentators would agree that US over-consumption has been a serious problem and must decline, the decline of US over-consumption has a serious corollary.
It was the willingness and (until now) ability of US households to fund their consumption binge that permitted many countries, most importantly in Asia, to generate high growth rates by constraining domestic consumption and diverting resources to expanding production as quickly as possible.
As long as US households were able to import large and increasing amounts of foreign goods, Asian policies aimed at expanding production did not need domestic consumption to justify the expansion.
No longer. US consumption is declining rapidly and there is almost no way Asian countries can expand domestic consumption quickly enough to make up the difference.
The speed with which US consumption adjusts will be crucially important in determining the speed with which Asian and other countries adjust, and a too-rapid adjustment would be very harmful.
This means that the US and the rest of the world if they work together can play an important role in managing an orderly adjustment with the least adverse consequences for the world economy.
But it does not seem that the US policymakers understand their role or are willing to propose the necessary steps that will lead to an optimal global programme for addressing the adjustment process.
Aside from the fact that the brutal confirmation process has left the government with many important posts in economic policy-making unfilled, the impression I and others have received in Washington is of policymakers struggling frantically to deal with the domestic crisis and too worried to wonder or consider what the world might look like as we emerge from the crisis.
Many would argue that this should not be surprising. There will be time enough for that later.
By the same token US and other policymakers should focus first on rescuing their respective economies and financial systems and only after, when the crisis has stabilised, worry about what the new global institutional framework should look like.
This is not the time for the US, in its panic about domestic conditions, to forget about the rest of the world. It must frame its own adjustment in the context of its impact on struggling economies around the world. The crisis will eventually end, but we will have to live a long time with its political consequences.
Michael Pettis is a professor of finance at the Guanghua School of Peking University and a senior associate at the Carnegie Endowment for International Peace
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