09 June, 2009

CFR panel on the global consequences of the financial crisis

Is it good news for the US? A May 12th panel discussion included several scenerios, but in general it was optimistic. From Joe Nye:

To what extent has this crisis changed our views of what will be the relationship between the major powers in 10 to 20 years time? And when it first broke, the conventional wisdom -- Steinbrueck, the German finance minister, said this is the end of American dominance. Putin -- not Putin, Medvedev followed suit. Even my friend Michael Ignatieff, who's going, we hope, to become prime minister of Canada, said now that American power has reached high noon, Canada should be adjusting its policies elsewhere.

I think all this is wrong-headed. It's a big mistake to draw long-term conclusions from short run -- I mean, right now, you just project a linear projection of where we are, it looks bad. In fact, even those short-run -- or those predictions that were made at the beginning of the crisis have already been falsified. Decoupling -- remember decoupling?


NYE: Well, that got knocked on the head. The crisis was supposed to be the crisis of the dollar. Well, what happened to the dollar? Up, not down.

And then you say, yes, but China's doing well -- 6 percent growth this year -- America, not. We're somewhere in the negatives -- 3 percent, let's say, negative. But, you know, what's interesting is the decline of China's growth rate from 10 percent to 6 percent is greater than the decline of our growth rate. And that means the time when China would catch up with the United States in overall economic size doesn't get closer; it gets further out. I mean, Goldman Sachs's famous 2040 when they catch up, then they shortened it to 2027 -- well, you know what? It's going back to 2040.

On the other hand, Phil Zelikow does a very good job of reminding people that structurally, it's not possible to keep everyone happy, and a lot of people aren't.

The basic international political economy that we're revisiting today was forged in the late 1970s and early 1980s. And I want to remind some of you who took economics of the famous Mundell-Fleming impossibility theorem. The Mundell-Fleming impossibility theorem, for which Robert Mundell, a Canadian economist, won a Nobel Prize, stated that there are three desirable things you might want to have. You might want to have capital mobility, free movement of capital. You might want to have stable exchange rates. And you might want to have national autonomy in controlling your monetary policy, basically national economic autonomy. Those are three desirable things. Mundell argued you can never have all three of those things. You can only have two of those three things; pick which two you want.

The Bretton Woods system was liberal in many ways, on trade, especially. It was not a liberal system for capital mobility. Capital mobility was government-brokered and highly limited. This began to erode in the 1960s, and it was a system beset by constant crises, the -- no need to go into details. And therefore -- because what had happened is they resolved Mundell's theorem by saying, "We're going to sacrifice capital mobility to have stable exchange rates and national autonomy, because we're going to use national Keynesianism, and we want to have the freedom to do that." And then that system broke down and collapsed in the early 1970s.

What replaced it? What replaced it was a new solution to the Mundell theorem in which you sacrifice national autonomy to a very large degree. You get more stable exchange rates -- somewhat stable exchange rates and a high degree of capital mobility. That -- there were big crises that tested the formulation of that, bracketed by -- from the British IMF crisis of 1976 to the Third World debt crisis and Mitterrand's famous u-turn of 1982. Now, that is important.

The question is, today, are we going to revisit that solution to the Mundell theorem? And the place where it is most likely to be revisited is not the United States, nor in East Asia, which relies on capital mobility. It is in Europe. It is in Europe where, actually, it was tested most severely in the late '70s and Mitterrand's France, and it is in Europe where it may be tested again. Mitterrand made the u-turn in 1982 after he tried a national Keynesian approach. He was broken, basically, by the Germans and the European monetary system, by the way, who had also disciplined the Americans during the Carter administration. And finally the Americans gave in and appointed Paul Volcker in 1979 after they had bucked against Europe, for those of you who think the Americans always make the rules. The Germans really had been the anchor throughout, partly because of their continuing coalitions that always had the Free Democrats as a critical partner playing a governing role in their economic policy.

Now, the Germans are still actually the anchor in the way Europe has been approaching it and -- (inaudible) -- hard-money policy Europe has generally been adopting lately. That's being tested right now in Germany and in European politics. Not only are there the East European problems, which have gotten some attention. In some ways, I'm more worried about Southern Europe over the -- over the near term. But look at what's happening in German politics, per se. Oskar Lafontaine and others are now joining hands with some of the old former East German communists and they're making a square assault on the whole fundamental premises of the social market economy that has governed the German economy for the last generation. They're going after the Mundell theorem.

If and when Germany cracks, where is France? Then where is Europe? And where is the system as a whole?

The other key, everyone seems to agree, is whether China will grow its internal market to the point that some dollars are flowing out, rather than just in. This is seen as being a "responsible stakeholder" and a necessity for a country that has no alternatives to holding dollars. I'm not so sanguine about it.

The Global Consequences of the Crisis, Session One in the Stephen C. Freidheim Symposium on Global Economics on Financial Turbulence and U.S. Power

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