If one thing is clear about the outcome of the G20 meeting in Seoul, South Korea, it is that the United States left the summit worse off than it began. China and Germany’s staunch rejection of the US proposal to target countries’ current account balances revealed these nations’ relative willingness to endure a competitive currency devaluation game. Emerging economies’ protests about the Federal Reserve’s latest quantitative easing plans, meanwhile, underscored these nations’ newfound confidence in asserting their economic interests vis-à-vis the United States. The Fed, meanwhile, argued its plan was not intended to devalue the dollar, which emerging economies worry will lead to currency spikes and asset bubbles abroad.
But the Fed decision dealt a sharp blow the US’s economic rebalancing strategy. China’s complaints about the Fed’s plans were not diminished by the announcement on the eve of the meeting that its trade surplus in October leapt to $27.1 billion from $16.9 billion the previous month, despite the slew of protests by US officials and threats by Congress to erect retaliatory tariffs to combat China’s currency peg. The meeting’s communiqué failed to even mention China’s currency policy, even though other Asian economies are equally perturbed about China’s undercutting of regional exports through a weak yuan. US President Barack Obama, meanwhile, squandered more precious political capital by failing to square away a pending free-trade deal with his South Korean counterpart, Lee Myung Bak, on the summit’s eve.
All this for a quantitative easing plan whose risk is decidedly greater than its uncertain reward. US economists, including the Fed’s own board members, don’t even agree on whether the plan will work. Many US economists back the Fed’s argument that—despite emerging market suspicions—quantitative easing is not a deliberate devaluing of the dollar. While that may be true, the notion that the policy will boost aggregate demand through a two-pronged effect is dubious. The first effect, the argument goes, will boost consumer demand through lower mortgage rates (largely driven by long-term Treasury rates), which allow people to increase equity on their homes by refinancing. As the yields on long-term bonds sink, investors will also begin piling into equities with higher returns, an indirect lift for household incomes and, by extension, consumer confidence and spending. The second effect relies on US businesses, which in theory will respond to lower borrowing costs with increased investment and hiring.
But this argument assumes that the main driver of high US unemployment—which the Fed plan is attempting to target—is cyclical, rather than structural. That means domestic firms are not hiring mainly due to a lack of demand for their products and services. In a 15 October speech, Fed Chairman Benjamin Bernanke said the Fed sees “little evidence that the reallocation of workers across industries and regions is particularly pronounced relative to other periods of recession, suggesting that the pace of structural change is not greater than normal.” Economists who support this view have pointed to a recent survey of small businesses by the National Federation of Independent Business, which found that far more businesses cited poor sales—rather than the quality of labor—as their most pressing problem. But Federal Reserve Bank of Minneapolis president, Narayana Kocherlakota, argues just the opposite. He says the unemployment problem has more to do with factors such as under-skilled workers not matching businesses’ higher-skilled job openings. Recent changes in the so-called Beveridge curve—a correlation used to measure structural changes in employment—support this theory. Typically, the curve shows job vacancies rising as the unemployment rate falls. But data from June 2009 to August 2010 indicated the curve has shifted, with unemployment rates rising even as job openings expanded. And the jobless rate may be worse than official numbers suggest, since temporary jobs in sectors like construction will likely fall off as US fiscal stimulus fades.
Nor is it clear that lowering borrowing costs would boost business investment, since interest rates are already near zero, and large corporations can already easily borrow from the private markets. Smaller businesses, which supply the brunt of US jobs and rely more on bank lending, may not be helped by lower interest rates since they rely more on loans from midsized banks, whose lending is still constrained by the toxic mortgage-related debt sitting on their balance sheets.
President Obama responded to emerging market concerns about the Fed’s plan by arguing that expansionary US monetary would benefit these countries long-term, eventually stoking US demand for emerging market exports. But he failed to acknowledge the short-term hardships these countries would face because of the resulting cheaper dollar. In doing so, the United States overestimated the quantitative easing’s economic potential, while underestimating the political fallout of its growing isolationism, even as it attempts to rally international support against China’s undervalued currency.
Roya Wolverson - Staff writer on economics at the Council on Foreign Relations in New York. Previously she worked as a financial reporter for the “Wall Street Journal's” “SmartMoney” magazine.
