After an intense week of election campaigning on Labour’s economic record, the Chancellor angrily dismissed IMF warnings about the state of the UK’s public finances and took time out from a whirlwind round of international talks to step up his onslaught on Conservative tax proposals.
Mr Brown will no doubt manage to sustain his upbeat spin on the outlook for Britain at least until polling day has safely passed. But might a third term at the Treasury for Britain’s longest-serving modern-day Chancellor yet prove a stint too many? In a post that can shred political reputations, Gordon Brown has been both skilful and lucky. During his tenure thus far, he — and Britain — have escaped fairly unscathed from upsets in the global economy. But after the relative plain sailing he has enjoyed since 1997, could the Chancellor soon face more severe tests as the world enters rather more turbulent and dangerous economic waters? On the face of it, neither Mr Brown nor his fellow finance ministers from the Group of Seven leading economies seemed much perturbed in the Washington sunshine by either the immediate risks or more long-term, fundamental imbalances that bedevil global prospects. In their communiqué the G7 concluded that the global recovery remained “robust” and that their expectation was for further “solid growth” worldwide, despite the “headwind” of soaring oil prices.
Yet beneath this rosy gloss, there was a tone of edginess to the G7 conclusions, and a palpable sense of unease seemed to have infected the Washington gatherings. Despite their avowed confidence in the outlook, the G7 ministers called for “vigorous action” to tackle global imbalances.
An outbreak of jitters is well justified, and the G7 delegates are not alone in their sudden apparent nervousness. It is shared by some of the more influential and authoritative observers of the world economy.
Paul Volcker, the former Chairman of the US Federal Reserve and one of the most respected figures among international policymakers, is among those who are deeply worried. In a recent analysis in the Washington Post, he wrote: “Circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot.”
The dangers highlighted by Mr Volcker were illustrated with crystal clarity in last week’s World Economic Outlook assessment from the IMF. The core problem is the divergent performance of the world’s big economies, with the present global expansion dependent on the continued robust growth of the US and China, while the eurozone struggles and Japan’s latest revival threatens to stall.
This uneven pattern of growth has left world prospects dependent on a US expansion fuelled by America’s extravagant consumers and fiscally lax Government. The world is reliant on an America that is living far beyond its means, with national spending exceeding income by more than a fifth over the past five years.
The result has been that the US has now gone from being the world’s biggest creditor to its biggest debtor in just two decades, with an annual current account deficit expected to reach 7 per cent of GDP by the end of this year, and annual government borrowing of more than $400 billion (£210 billion).
This American profligacy can be sustained only by the continued confidence of investors in the US economy, and their willingness to keep accumulating American IOUs.
The key players in this game are the Asian nations, led by China, which have pegged their currencies to the dollar. These countries’ central banks have continued to acquire billions in US Treasury bonds as they act to prevent their own currencies rising against the greenback. The resulting strong Asian demand for Treasury bonds keeps US market interest rates low, even as America’s debts spiral upwards. So Americans can carry on borrowing and spending, while Asia can carry on selling them its goods at artificially competitive exchange rates.
What worries the IMF, Mr Volcker and many others is that, as this situation persists, and the resulting current account imbalances grow ever wider, something has to give. The US cannot live on borrowed funds for ever and payback time will arrive. And as the pile of foreign claims against American assets grows ever larger, Asian and other creditor countries may lose their willingness for ever more dollar holdings.
Economists acknowledge that the Asian-American quid pro quo could perhaps carry on indefinitely. But the nagging fear is that it could unravel abruptly, with grave repercussions. If markets were to decide that the situation were unsustainable, triggering a collapse in the dollar, Wall Street would be hit hard, and US Treasury bond prices would tumble, driving US market interest rates upwards. The result would almost certainly be an American recession, and perhaps an outbreak of protectionism.
This threat is well known. What exercises Mr Volcker and others such as Raghuram Rajan, the IMF’s chief economist, is the persistent failure of the G7’s leadership to confront the dangers and take action.
Mr Volcker says: “What really concerns me is that there seems to be so little willingness or capacity to do much about it.” And Mr Rajan sounded an almost plaintive note last week as he acknowledged that the necessary reforms could be painful and unpopular, but voiced the hope that “true leaders” might emerge to “rise above ordinary politics and focus beyond the here and now”.
Some hope. The necessary measures are as well known as the problem. America needs to spend a lot less and save a lot more.
But if the US is to accept the resulting slowdown in its domestic growth while its economy as a whole keeps growing strongly and sustaining global activity, it needs both a weaker exchange rate and more potent demand for its exports abroad.
In turn, this means that the eurozone has to do something to reignite its own domestic demand and to grow more rapidly. A weaker dollar, driving the euro upwards, would thwart this, so Asia too must play its part by allowing exchange rates to rise.
All of this is certainly extremely tricky to engineer. But despite the G7’s calls for “vigorous” action, there is little sign that this will amount to more than words. As the IMF made clear last week, Washington’s commitment to the required drastic reduction of its budget deficit is far from credible, while the eurozone’s record on delivering pro-growth reform is lamentable.
At the G7’s sessions, the finance ministers of the big economies appear content to spend their meetings fiddling with a rag-bag agenda of issues and personal hobby horses than focus on the big issues. The ever-changing cast of ministers scarcely helps. Like seven unwise monkeys, members try to hear no evil, see no evil and speak no evil when it comes to the growing dangers facing their countries’ prosperity.
