The UK economy has just had a strong purgative delivered to it by Chancellor George Osborne. He has put forward a plan to cut the budget deficit, around 11% of GDP down to zero within one parliament. This is a bold step and indeed many economists think it is a wide gamble. Both the Bank of England and the Federal Reserve are aggressively expanding money supply via quantitative easing. But in fiscal policy there is a contrast. The White House would like to reflate more via fiscal policy if Congress would allow it, while the UK has set its face against fiscal expansion.
When the G20 met in London in April 2009 there was unanimity that what was needed was a co-ordinated reflation by all the countries. As we approach the G20 in Seoul, the consensus has completely broken down. Among the OECD countries, where the financial crisis was most severe, Europeans are deflating while the US is still reflating. The Chinese had an aggressive reflation package that helped its economy get back to double-digit growth while India also managed to revive growth by a milder reflation.
We still have the situation that there are global imbalances, as between the emerging countries that are in surplus and the western countries (Germany excepted) that are in deficit. This is usual in any national economy since there are savers and investors, lenders and borrowers. But the global economy is not unified in any sense. There is not only no single currency or even a single standard (as gold used to be in the 19th century) against which one can define the exchange value of a currency. There is no central bank that can regulate the lender-borrower relationship. The IMF was supposed to be in charge of the exchange rate system but since the collapse of the Bretton Woods system in 1971, it has stopped performing that function.
The London Summit of the G20 had hoped that the IMF would fill the gap in global economic governance. It was granted the ability to expand its credit base. There was hope that a super-SDR would be created so that nations with surpluses can bank them with the IMF in return for internationally acceptable means of payment and store of value. But that hope remains unfulfilled.
In the vacuum, thus far only the dollar has played the part of an internationally acceptable money. This is why the Chinese have stashed billions of dollars of their surplus in US government paper. On top of that, the quantitative easing has put more dollars into circulation. Much of this is being brought into the fast growing emerging economies and is playing havoc with their exchange rates.
This is why an exchange rate war has broken out. The Americans are hectoring China to revalue its RMB, which the Chinese resist, since it may price their exports out of the market and lead to unemployment in coastal areas. QE is depreciating the dollar (and the pound as well) but the RMB is tied to the dollar and can only break free if the Chinese policymakers so decide. Brazil and Thailand have imposed controls and taxes on capital inflows. India has so far not restricted the rupee appreciation and Pranab Mukherjee welcomed the capital inflows a fortnight ago. This may yet be the sound tactic since India needs to finance its infrastructure programme. Yet the divergence between different economies is remarkable.
There are two sorts of differences here. As between the US and Europe there is a divergence of policy about fiscal reflation or fiscal downsizing. Europeans are much more worried about sovereign debt than the US seems to be. This is a disagreement about economic theory of recovery. The US is Keynesian and Europe is Classical. But across the globe, the emerging economies (India excepted) insist on going on saving and exporting while the West would like them to consume and the West should consume less and save more but as of now it is saving more but with slower income growth which makes the extra saving more deflationary.
There is a gaping hole in global economic governance and it is obvious that the G20, which was much hyped as the new forum for global governance, is failing to deliver on its promise. Obama cannot lead as his hands are tied at home and he cannot be seen to be co-operative with China. Nor can the Chinese be seen to be accommodative with the Americans since they have their own internal compulsions. Brazil is unhappy about the exchange rate wars. South Korea can host the G20 but it cannot provide leadership. If someone else, perhaps India, does not offer a bold vision for international exchange rate truce, the world is likely to be in trouble for much longer than we need.
?The author is a prominent economist and Labour peer