October 16, 2018
Safeguarding A Rules-based Trading System against America First Trade Economics
by Dr. Mari Pangestu, Universitas Indonesia
“Without concerted effort and a coalition of willing leadership, including from the EU and East Asia, the future of the rules-based trading system will remain under threat.”–Dr. Mari Elka Pangestu
Despite expectations that the US Federal Reserve would raise interest rates, capital flows to the United States have led to the appreciation of the US dollar against most major currencies.
The hardest hit countries are Argentina and Turkey, which are experiencing fiscal issues complicated by their political situations. Brazil, South Africa and the emerging countries in Asia have also been affected — albeit at a lower rate of depreciation of their currencies in the 10 to 12 per cent range. Even Australia and China have experienced depreciation of around 8 per cent and 5 per cent respectively.
The level of depreciation experienced by different economies reflects how investors perceive their different fundamental macroeconomic conditions, especially the level of their current account and fiscal deficits and policy outlooks.
The rising US dollar raises questions about the capacity of emerging economies to service their dollar-denominated debts and the vulnerabilities this could expose in their financial systems. Even if the current economic conditions point to a low potential for contagion from Argentina and Turkey, IMF Managing Director Christine Lagarde recently warned that ‘these things could change rapidly’. The uncertainty that already exists is a clear and present danger.
The uncertainty in the world economy has been increasing since Brexit and the election of President Trump in 2016, and in 2017 as the United States left the Trans-Pacific Partnership and announced many threats to impose trade restrictions. This uncertainty has heightened since January 2018 when US President Donald Trump made good on his threats to remedy bilateral trade deficits — what he sees as ‘unfair trade’ practices against the United States — by imposing tariffs on imported solar panels and washing machines, followed by aluminium and steel.
Since March, the greatest uncertainty has been from the brewing tit for tat trade conflict between the United States and China, which started with the imposition of 25 per cent tariffs on US$50 billion worth of China’s exports to the United States. China retaliated with the same sized tariffs on the same amount of trade from the United States. Trump then escalated the trade war further in September with the announcement of 10 per cent tariffs on US$200 billion worth of China’s exports to the United States.
The US–China trade conflict and the uncertainty surrounding it is expected to have knock on effects on global trade and investment flows. The impact of the reduction in China’s exports to the United States on China’s growth will reduce China’s imports, which in turn will impact the many countries that China has become a major trading partner for.
This means that China and other countries facing US trade restrictions will look for new markets for their goods. The situation has already led some countries to impose restrictions or initiate trade remedy investigations, for instance on steel. This uncertainty has and will continue to influence trade and investment, as businesses evaluate how the increased restrictions will affect their supply chains.
It is too early to tell how large the disruption will be, as it is not easy to dismantle supply chains. But the costs down the line could be great as businesses re-evaluate their trade and investment decisions to insulate themselves from tariffs rather than to maximise their competitiveness.
The most concerning aspect of all this is that, after 75 years of being its greatest advocate, the United States is now the biggest threat to the future of the rules-based trading system that has provided predictability and fairness in the way the world engages in trade. There is no clear light at the end of the tunnel.
The key question is: what is Trump’s intention? Is it to change the rules of the game to benefit the United States and address China’s ‘non-market-oriented policies’ or is it just anti-trade and America First? Assuming it is the former, there are at least three important responses needed.
First is safeguarding the stability of the World Trade Organization (WTO) as the overarching framework to provide predictability, fairness and stability. To this end, it is vital that the WTO dispute settlement mechanism continues to operate. The test case is the Chinese and EU case against US steel and aluminium tariffs and getting past the blocking of panel judge nominations by the United States.
Ensuring that the United States does not use blunt unilateral instruments to address its concerns also means that reforms to the WTO rule book are needed. More must be done to address concerns around intellectual property rights, investment, the environment, labour, competition policy, subsidies, tax, digital data and the treatment of developing countries.
Second, the process of opening-up must continue, with or without the United States. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership is a good start. And it is of the utmost importance that the Regional Comprehensive Economic Partnership negotiations are concluded in November this year. These are all important processes to signal the continued commitment of East Asia to expanding markets and fostering flows of trade and investment.
Third, and what most will agree is the most important process, is unilateral reforms. Given increased global uncertainty and limited policy space for fiscal stimulus, structural reforms are a must for East Asian countries, especially China. These range from trade and investment reforms, as well as reforms related to competition policy, intellectual property, the role of state-owned enterprises and sustainability. As in the past, unilateral reforms are more successfully undertaken when there is peer pressure and benchmarking from international commitments.
Without concerted effort and a coalition of willing leadership, including from the EU and East Asia, the future of the rules-based trading system will remain under threat.
Dr. Mari Pangestu is former Indonesian trade minister and Professor at the University of Indonesia.
This article appeared in the most recent edition of East Asia Forum Quarterly, ‘Asian crisis, ready or not’.
NEW HAVEN – I have not been a fan of the policies of the US Federal Reserve for many years. Despite great personal fondness for my first employer, and appreciation of all that working there gave me in terms of professional training and intellectual stimulation, the Fed had lost its way. From bubble to bubble, from crisis to crisis, there were increasingly compelling reasons to question the Fed’s stewardship of the US economy.
That now appears to be changing. Notwithstanding howls of protest from market participants and rumored That now appears to be changing. Notwithstanding howls of protest from market participants and rumored unconstitutional threats from an unhinged US President, the Fed should be congratulated for its steadfast commitment to policy “normalization.” It is finally confronting the beast that former Fed Chairman Alan Greenspan unleashed over 30 years ago: the “Greenspan put” that provided asymmetric support to financial markets by easing policy aggressively during periods of market distress while condoning froth during upswings.
Since the October 19, 1987 stock-market crash, investors have learned to count on the Fed’s unfailing support, which was justified as being consistent with what is widely viewed as the anchor of its dual mandate: price stability. With inflation as measured by the Consumer Price Index averaging a mandate-compliant 2.1% in the 20-year period ending in 2017, the Fed was, in effect, liberated to go for growth.
And so it did. But the problem with the growth gambit is that it was built on the quicksand of an increasingly asset-dependent and ultimately bubble- and crisis-prone US economy.
Greenspan, as a market-focused disciple of Ayn Rand, set this trap. Drawing comfort from his tactical successes in addressing the 1987 crash, he upped the ante in the late 1990s, arguing that the dot-com bubble reflected a new paradigm of productivity-led growth in the US. Then, in the early 2000s, he committed a far more serious blunder, insisting that a credit-fueled housing bubble, inflated by “innovative” financial products, posed no threat to the US economy’s fundamentals. As one error compounded the other, the asset-dependent economy took on a life of its own.
As the Fed’s leadership passed to Ben Bernanke in 2006, market-friendly monetary policy entered an even braver new era. The bursting of the Greenspan housing bubble triggered a financial crisis and recession the likes of which had not been seen since the 1930s. As an academic expert on the Great Depression, Bernanke had argued that the Fed was to blame back then. As Fed Chair, he quickly put his theories to the test as America stared into another abyss. Alas, there was a serious complication: with interest rates already low, the Fed had little leeway to ease monetary policy with traditional tools. So it had to invent a new tool: liquidity injections from its balance sheet through unprecedented asset purchases.
The experiment, now known as quantitative easing, was a success – or so we thought. But the Fed mistakenly believed that what worked for markets in distress would also spur meaningful recovery in the real economy. It raised the stakes with additional rounds of quantitative easing, QE2 and QE3, but real GDP growth remained stuck at around 2% from 2010 through 2017 — half the norm of past recoveries. Moreover, just as it did when the dot-com bubble burst in 2000, the Fed kept monetary policy highly accommodative well into the post-crisis expansion. In both cases, when the Fed finally began to normalize, it did so slowly, thereby continuing to fuel market froth.
Here, too, the Fed’s tactics owe their origins to Bernanke’s academic work. With his colleague Mark Gertler of NYU, he argued that while monetary policy was far too blunt an instrument to prevent asset-bubbles, the Fed’s tools were far more effective in cleaning up the mess after they burst. And what a mess there was! As Fed governor in the early 2000s, Bernanke maintained that this approach was needed to avoid the pitfalls of Japanese-like deflation. Greenspan concurred with his famous “mission accomplished” speech in 2004. And as Fed Chair in the late 2000s, Bernanke doubled down on this strategy.
For financial markets, this was nirvana. The Fed had investors’ backs on the downside and, with inflation under control, would do little to constrain the upside. The resulting “wealth effects” of asset appreciation became an important source of growth in the real economy. Not only was there the psychological boost that comes from feeling richer, but also the realization of capital gains from an equity bubble and the direct extraction of wealth from the housing bubble through a profusion of secondary mortgages and home equity loans. And, of course, in the early 2000s, the Fed’s easy-money bias spawned a monstrous credit bubble, which subsidized the leveraged monetization of housing-market froth.
And so it went, from bubble to bubble. The more the real economy became dependent on the asset economy, the tougher it became for the Fed to break the daisy chain. Until now. Predictably, the current equity market rout has left many aghast that the Fed would dare continue its current normalization campaign. That criticism is ill-founded. It’s not that the Fed is simply replenishing its arsenal for the next downturn. The subtext of normalization is that economic fundamentals, not market-friendly monetary policy, will finally determine asset values.
The Fed, it is to be hoped, is finally coming clean on the perils of asset-dependent growth and the long string of financial bubbles that has done great damage to the US economy over the past 20 years. Just as Paul Volcker had the courage to tackle the Great Inflation, Jerome Powell may well be remembered for taking an equally courageous stand against the insidious perils of the Asset Economy. It is great to be a fan of the Fed again.
Stephen S. Roach, former Chairman of Morgan Stanley Asia and the firm’s chief economist, is a senior fellow at Yale University’s Jackson Institute of Global Affairs and a senior lecturer at Yale’s School of Management. He is the author of Unbalanced: The Codependency of America and China.