In 1899, Rudyard Kipling, the English poet, wrote a poem entitled, ?The White Man?s Burden?. The poem engenders such strong emotions that few bother to read it. But the subtitle was ?The United States and the Philippine Islands?. It was an exhortation, not directly to British colonialists wallowing in a sense of misplaced superiority, but to the hesitant American colonialists in the Philippines which they had won in the Spanish-American war of 1898. Exactly 110 years later, outgoing US Treasury Secretary, Henry (Hank) Paulson has taken heed of Kipling and updated the theme in his valedictory remarks to the Financial Times. Essentially he said, pity the poor American, struggling under the burden of having the world?s reserve currency. They have to spend wildly in order to offset the rest of the world?s desire to save. They have to endure asset market bubbles as the rest of the world practices caution.
The notion that the problem with the world economy is that other people save too much is politically attractive in the US. But it has three fundamental problems with it. First, of all the explanations for the US current account deficit, it is not the most parsimonious: that almost 190 countries, with different exchange rate regimes, stages of economic development, economic structures and levels of economic growth should all decide to save too much so that the 191st, has to run an offsetting deficit. You could imagine a savings and spending decisions being more randomly spread across 192 countries. Incidentally, I do not recall during the Asian crisis anyone saying that the problem is that the rest of the world is saving too much. I do recall, US Treasury officials warning against bank bail outs and WTO-busting subsidies.
The second problem with the savings-glut thesis is that if the rest of the world?s current account surplus was a result of a desire to save more, we would expect to see weak imports and sluggish growth in the savings countries, not record growth in GDP and imports. A more parsimonious explanation is that US macro-economic policy was too loose, which spurred US consumption, which, given that the US economy represents almost one quarter of global GDP, pulled in imports driving overseas growth and trade surpluses. Those in search of greater detail and persuasion should look for ?Official Reserves and Currency Management in Asia: Myth, Reality and the Future? by Genberg, McCauley, Park and Persaud, published by the CEPR in 2005.
The third problem with Paulson?s excuse is that he is effectively claiming that the US is a powerless hegemon. Were US policy makers powerless in the face of the flow of savings from China, a country that in nominal terms is one quarter the size of the US?
If you genuinely worry about the flow of international savings into your economy would you push interest rates down to a record low and hold them there? Would you embark on a record, unfunded tax cut? Would you persist in these policies while unemployment is knocking on historically low rates and your current account deficit blows out?
The fundamental, age-old problem is that American policy mistakes are felt hardest outside the United States, courtesy of the dollar being the world?s reserve currency. Those countries that did not pursue reckless lending to sub-prime sectors, did not run up large deficits and to be a little Calvinist about it, did not enjoy the overspending, are being struck down just as hard by the global freezing of money markets. It reminds me of US Treasury Secretary in 1971, John Connolly saying to his European counter parts that the dollar was ?our currency, but your problem?. It would seem that the real burden is not being carried by Americans, but by the rest of the world.
I would not take Mr. Paulson?s words at face value. But if we did for a moment, it would appear that neither the US or the rest of the world are happy about US financial hegemony. Perhaps this is the time to resurrect the idea of a shared reserve currency. The idea, a version of ?Bancor? first proposed by John Maynard Keynes in 1943 is that countries would be allowed to buy a limited allocation of SDRs (special drawing rights, comprised of an average of major trade-able currencies) at a small discount to the market price in their local currency. The discount would be set small enough to keep the SDR a hard currency and large enough to support its adoption and satisfy normal growth in reserve demand. This would make the financial system more resilient and less dependent on US monetary responsibility, though it would also place greater financial discipline on the US. Expect to hear more about this in the coming months.
The author is chairman of London-based Intelligence Capital, governor of the London School of Economics and Emeritus Professor of Gresham College in the UK