from Follow the Money

The BRICS lend, the US spends

April 22, 2006

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

How is that for brevity?  The world economy reduced to a single rhyme.  

The BRICS are Brazil, Russia, India and China - Goldman's set of big emerging economies.     With oil at $75, they really should have added in the Saudis.  Not many people, but lots of oil.

They lend to the US.  In dollars at low rates.   They probably won't get repaid in dollars with an equal (external) purchasing power.   External debt is a claim on future export revenues.   And it is pretty clear that the US is not taking on external debt to build up its future export capacity.   That suggests that the dollar will have to fall at some point. 

The BRICS might be better off lending to the US in their own currencies, not in dollars.   That is what the US did back when it was a creditor ... let the other guy take the exchange rate risk.

But right now the BRICs lend to the US in dollars, and the US is happy to spend what the BRICs want to lend.    The federal government does its part.   The sunbelt construction industry does its part.  Or at least it did.   US homeowners do their part. Even those Americans stuck in flatland with stagnant real wages and relatively stagnant home prices do their part.  They want to keep up with the Jones' on the coast.    Or at least not cut back even as they pay more to fill up their gas tanks (and Saudi and Russian bank accounts)

So long as the US generates the demand growth the world needs, the global economy grows.   What's not to like?

No one at the plethora of international meetings taking place this weekend - or for that matter, President Hu and President Bush -- will admit that they want one more year of unbalanced (but strong) global growth.  The talk, at least on the surface, is about the need to deal with global imbalances.

But I increasingly suspect that such conferences actually serve an altogether different purpose.

The BRICs -- led by China -- assure the US that they won't change their exchange rates, and will continue to add to the dollar reserves.   And the US assures the BRICS that it will keep on spending.   And everyone else concludes that they can safely chalk in another year of unbalanced growth.

Of course, no one would admit that this is what is going on.   

The US doesn't explicitly say that it will keep on spending.   The Bush Administration's official line is that it intends to cut the fiscal deficit by 2009.   But the policies backing that commitment are sufficiently thin that the rest of the world can take comfort that the US will continue to spend what they want to lend.   Among other things, keeping an Army in Iraq to prevent a low-level civil war from becoming a big civil war isn't cheap.   John Snow certainly seems far more interested in arguing that fiscal deficits don't contribute to global imbalances than actually reducing the US fiscal deficit.

And since the Federal Reserve worries about inflation and employment -- not the composition of output or the risks created if demand growth exceeds income growth -- it will conduct a monetary policy that facilitates the expansion of the US non-tradables sector to help make up for a shortage of global demand that results from excessive global savings.   That at least is my interpretation of Bernanke's recent statements.  

The BRICs don't explicitly say that they will keep on lending to the US either. 

I suspect that China won't even formally admit that it still pegs to the dollar.  But China seems far more committed to exchange rate stability than exchange rate flexibility.  Its willingness to allow meaningful RMB appreciation is every bit as much in doubt as the Bush Administration's commitment to fiscal adjustment.   So far, the RMB has moved by a bit more than 1% against the dollar since the initial revaluation.  That doesn't even offset ongoing inflation differentials between China and the US.   

The other big dollar peggers -- the oil exporters - have even less interest in a serious discussion of their outdated exchange rate pegs.   Why is the Saudi Riyal still where it was in 1998, when oil prices have quadrupled since then?    So far, the oil exporters have been very effective at keeping their pegs off the agenda.   Everyone prefers to beat up on the Europeans for the absence of structural reform - without giving the Europeans credit for allowing exchange rate adjustment.

And since oil importers keep on hoping that oil prices will fall, they don't complain too much about the high levels of savings the oil exporting countries.   Oil exporters assume that oil will be at $30 in their budgets; oil importers hope they are right - and most of the oil windfall is saved rather than spent.

So the US reasonably can conclude that if it is willing to spend, the BRICs will be wiling to lend.

Hell, the US could conclude that the BRICs are so unwilling to change their basic policies that they will keep on lending even if the US says no to CNOOC, to DPW and to a whole host of other investments in the US. 

Wanna buy a US company?  Forget about it. Wanna buy some US debt?  Be our guest.

Maybe even convertible bonds structured to skirt the CFIUS process ...  

My little story leaves out Europe.  But I think the basic message coming out of Europe is pretty clear.  Even if the BRICs start to lend, Europe doesn't really want to spend.   Europe doesn't want to replace the US as a motor for global demand growth.  Europe also doesn't want to join the BRICs in lending to the US.  It wants to sit this particular game out - for better or for worse.

No one explicitly says that they want the current game to continue.  

Everyone talks of the need for rebalancing, and hopes the rebalancing will be orderly.   The G-7 statement on global imbalances (see the Annex) is quite reasonable.  But it lacks concrete commitments from those actually in the G-7, and includes lots of demands on others.  The IMF clearly is doing a bit more to try to catalyze a bit more action that it has in the past --  but all the IMF can do is try to persuade others to take action.   de Rato has indicated that he is not interested in serving as an exchange rate umpire.   The IMF will continue to call for more exchange rate flexibility in China and the oil producers.  But it won't formally declare China's exchange rate peg an impediment to effective global adjustment.

Still, even with a bit more activity and few more words from the G-7 on the need to address global imbalances, it is hard to escape the sense that the most players will come away concluding that no one really intends to do much.  The US won't stop spending.  And the BRICs won't stop lending. 

I suspect that this is not a stable long-term equilibrium.   But it looks set to last for another year.  

Even if its political foundation looks increasingly shaky.  

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