Stephen King: Like Comic Relief but with bigger chequebooks

The US has failed to pledge its 0.7 per cent of income to the needy elsewhere in the world
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The Independent Online

Hand-wringing, soul-searching, pledge-giving. The World Economic Forum at Davos was all of these and more. As a way of extracting promises from governments, companies and individuals, it was an impressive event, even if the majority of those in the audience set upon by a pledge-seeking Sharon Stone looked more embarrassed than inspired.

Hand-wringing, soul-searching, pledge-giving. The World Economic Forum at Davos was all of these and more. As a way of extracting promises from governments, companies and individuals, it was an impressive event, even if the majority of those in the audience set upon by a pledge-seeking Sharon Stone looked more embarrassed than inspired.

The good news is that help appears to be on the way for those who need it most. If there was an overriding theme from this year's World Economic Forum, it was a commitment to help the most vulnerable in the world. Gordon Brown should be a satisfied man. His plans for an International Finance Facility designed to bridge the gap between the short-term fiscal constraints on rich nations and the immediate economic needs of poor nations are rapidly gaining ground.

Meanwhile, more and more European countries are signing up to a key aspect of the Millennium Development Goals (MDG), namely the pledge to devote 0.7 per cent of gross national income per year to foreign development. Gerhard Schröder pledged Germany's contribution on Friday. It was all a bit like watching Comic Relief, but with bigger chequebooks and, in Herr Schröder's case, fewer jokes.

All of this suggests that the G7/G8 meetings in London this coming weekend will be busy focusing on poverty and debt relief, leaving discussions about currencies and the like on the sidelines. Whether the meetings can come to any meaningful conclusion is, however, another matter altogether. Despite Ms Stone's efforts and, on a slightly bigger scale, Bill Gates' wallet, the US has still failed to pledge its 0.7 per cent of income to the needy elsewhere in the world. Without that slug of money, though, it's difficult to see how the MDG will carry any real credibility. For whatever reason, the world's richest nation has found it difficult to dig deep.

One reason for this might well be that the US is more reliant on aid than anyone else. Whether or not it needs this aid is another matter altogether, but the dependency is most definitely there. Compared with some of the world's poorest countries, the US also has a significant advantage: it can borrow a lot more and it can borrow at remarkably low interest rates. Furthermore, if it ever found itself wondering how to repay its debts, it could always opt for currency devaluation: given that everyone lends to America in dollars and not in other currencies, the immediate effect of a dollar decline would be to punish the foreign creditors, leaving the domestic debtors with a satisfied smirk on their faces.

What I'm referring to is, of course, the current account deficit within the US balance of payments. In recent years, the deficit has increasingly been funded by Asian central banks. They, in turn, have attempted to resist upward pressure on their currencies against the dollar, and the only way in which they have been able to do so has been to buy dollar assets - Treasuries of various maturities, agency paper and some high-quality corporate paper - to offset the private-sector inflows that would otherwise drive their currencies up to higher levels against the dollar. In essence, Asian central banks are lending the US money on preferential terms which, in turn, can be used by US consumers to buy Asian goods.

I attended a number of meetings in Davos where the great and the good of the economics profession debated the US current account deficit, the role of Asian central bank intervention, the absence of domestic demand growth in the eurozone and Japan, and, more broadly, the potential solutions to global economic imbalances. Although there was broad agreement as to what the problems were - and some agreement as to what might be the right policy solutions - there was a weary acceptance that, whatever the "right" solutions were, they were unlikely to be pursued.

If there was one area where virtually everyone agreed that action was required, it was the ballooning US budget deficit. Some also thought that US real interest rates were too low, contributing to excessive consumer borrowing, aided and abetted by rapid house-price inflation.

There was also a belief that the dollar would have to fall further, although there was a lot more disagreement about how far it should fall, against which currencies it should fall and over what time period it should fall. The renminbi was much discussed, but there was a broad acceptance that any currency adjustment that might be tolerated by China would make little real difference to the size of external imbalances.

Although there were many calls for the eurozone and Japan to boost domestic demand, the mechanism by which this injection of vigour into their economies was to be achieved was not very well spelt out. In any case, with ageing populations, the eurozone and Japan should be putting money aside for a rainy day, investing savings abroad where workers will be in more plentiful supply in a few years' time and, hence, running current account surpluses. A sudden rush for consumer-led growth probably doesn't make a lot of sense over the longer term.

All in all, it was a case of rounding up the usual suspects. It's easy to suggest reasons for the existence of external imbalances. It's easy in some cases to argue that because the imbalances have been around for a long time and have caused little real damage as yet they no longer matter (a bit like saying that because the time bomb that's ticking away in the corner hasn't yet exploded the room no longer has to be evacuated). It's a lot more difficult, though, to spell out what would happen in the absence of policy initiatives.

Could the US current account deficit expand forever? No, because the US is already getting close to the debt spiral that until now had mostly typified emerging market foreign debt and Italian domestic debt. With foreign liabilities rising at an increasingly rapid rate, the US will eventually wilt under the weight of debt service costs built up after year upon year of excessive borrowing.

Would a dollar decline on its own solve the problem? No, because the scale of decline required would prove hugely disruptive to the performance of the global economy. Specifically, other regions - notably Japan and the eurozone - have few policy levers with which to boost domestic demand to offset weaker exports.

So what else could happen? Ultimately, US domestic demand has to slow down. For the most part, people at Davos agreed with this conclusion but were unwilling to spell out, in the absence of policy initiatives, how this might happen. The answer, surely, comes from a higher cost of capital. If the Fed doesn't do it, it will have to come from the markets. And there are only so many ways in which this could happen. A rise in US bond yields. A widening of corporate bond spreads over Treasuries. A sell-off in equities or properties. Or, dare I mention it, the onset of deflation, pushing up real interest rates to more painful levels.

And, if any of this happens, all of the promises made to the poorer countries, all of the commitment to the eradication of poverty, will amount to not much more than a hill of beans. Good economic policies to help the poorest citizens depend on good economic management of the industrialised world: and with no agreement on the right policy solutions, good economic management may be in rather short supply in the years ahead.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com

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