Why the winners of our global economic system must spend to lift slowing growth
Andrew Sheng says the reserve currency countries, who gained the most from the system, should keep the game going by bearing higher credit risks
There is grave concern that the world economy is slipping into what Harvard professor and former US Treasury secretary Larry Summers calls global secular deflation. In simple terms, growth has slowed without inflation, despite exceptionally stimulative monetary policy. Summers’ view is that the advanced countries can use fiscal policy to stimulate growth, using massive investments in infrastructure. If need be, this can be financed by central banks.
The world is moving into secular deflation because the largest economies are all slowing. Unconventional monetary policy applied since the 2007 financial crisis has brought central bank interest rates to zero or negative terms in economies accounting for 60 per cent of world gross domestic product.
Most economists blame the slow growth on “lack of aggregate demand” or “excess aggregate production”. The rich countries are mostly ageing and heavily burdened with debt, so they cannot consume more. After the 2007 crisis, emerging market economies have slowed, as demand for their exports has slowed. We are in a vicious circle.
The present global monetary order is a result of America’s decision in 1971 to de-link the US dollar from gold. The old order, set at the Bretton Woods conference of 1944, centred around a system of global fixed exchange rates. The flexible exchange rates that followed have resulted in a system where everyone seems to be devaluing their way out of trouble.
Does global secular deflation have something to do with this flexible system?
My answer is yes. The reason lies in what I call the Mahjong Winner’s Curse. The Chinese game of mahjong has four players with a limited number of chips. If one player wins constantly, he or she ends up with all the chips and the game stops. Since the global game of trade cannot stop, the winner has both an exorbitant privilege (of being funded by the others) and an exorbitant curse (of bearing the loss if the others won’t pay). To keep the game going, the winner has to give or lend the chips back to the other players, who play with the hope of winning the next round.
The game can be enlarged if the winner issues more chips (defined as a reserve currency), which the others are more than willing to borrow and play.
In the current situation, the winners are the four countries with reserve currencies, the dollar, euro, yen and sterling, all of which have near-zero or negative interest rates. Until recently, the winners blamed China and the oil-producing countries for having too high current account surpluses. But, after the huge European cutback in expenditure, Europe as a whole is the world’s largest current account surplus group, of nearly 5 per cent of GDP.
Herein lies the winner’s curse. The emerging markets should be able to stimulate global growth, but are unwilling to run larger current account deficits because they cannot get financing. The richer economies can stimulate global growth, but are unwilling to do so, because they either feel they already have too much debt or because they worry that stimulus would lead to inflation.
However, reserve currency countries have an advantage. As long as they are willing to run current account deficits, there will be little inflation because the world economy has huge excess capacity and surplus savings. If emerging markets run higher current account deficits, their currencies will have to depreciate, which is exactly what Brazil, South Africa and others have done.
The winner’s curse is that if Europe is now unwilling to reflate and spend, the world will continue to slow. Indeed, in a world of greater geopolitical risk, money is fleeing to the dollar and the yen, causing both to appreciate.
What these capital flows into the reserve currencies imply is that the dollar and the yen play the deflationary role of gold in the 1930s. As more and more mahjong players hold gold and don’t spend, the global trade and growth game slows further. The Mahjong Winner’s Curse requires the winners to stimulate and spend, bearing higher credit risks. That’s the privilege and responsibility of winners in the global game. If not, look out for more global secular deflation.
Andrew Sheng writes on global issues from an Asian perspective