by Joseph E. Gagnon, Peterson Institute for International Economics
Op-ed in Bloomberg. Reposted with permission.
February 4, 2013
The United States isn't expected to return to full employment for at least six more years, and the consensus in Washington seems to be that President Barack Obama's administration has no options to improve that dreary outlook.
The debate over tax increases and spending cuts, as well as the latest statement from the Federal Reserve, proves that additional fiscal and monetary stimulus won't be coming unless the economy turns even worse. But there's one weapon the Obama administration can fire to get a more satisfactory recovery in employment: taking action to narrow the longstanding deficit in international trade. Millions of jobs are at stake.
As it happens, the International Monetary Fund (IMF) recently gave a green light to measures the administration could use to reduce the trade deficit in a formal statement of its "institutional view" on the management of capital flows.
Capital flows directed by a number of foreign governments into the United States have grown to unprecedented levels in recent years. These flows keep foreign exports artificially cheap and make US exports artificially expensive to foreign buyers; they are the main reason the United States has a large trade deficit right now. The country should take heed of the IMF's recommendations and act forcefully to damp these distortionary capital inflows and to restore balance in international trade.
For countries in the position of the United States, the IMF doctrine recommends policy measures be taken in the following order. Each successive step should be taken only if the previous ones have been pursued aggressively and proved insufficient.
First, ease monetary policy if inflation isn't a problem.
Second, use expansionary fiscal policy to sustain growth if government debt isn't excessive.
Third, accumulate more foreign-exchange reserves to weaken the currency.
Fourth, impose controls on capital inflows.
The United States has pursued the first two steps aggressively but growth has remained too weak. It's time to move on to stage three: large-scale purchases of foreign-currency reserves. At only $52 billion, US reserves are far below the conventional metric for adequate reserves of three months of imports, which would imply reserves of almost $700 billion.
US reserves are denominated in euros and yen. With both the euro area and Japanese economies already stagnating, leaders of these countries would surely criticize official purchases that put upward pressure on their currencies and downward pressure on their exports.
The obvious alternative is to buy the Chinese renminbi, but China forbids foreign investment in its currency except through strictly limited channels. No other single currency has markets deep enough to make purchases practicable in the amounts required.
However, as I recently proposed with my colleague C. Fred Bergsten, the United States should purchase reserves in a range of currencies from countries that manipulate their exchange rates, namely Denmark, Hong Kong, Malaysia, Singapore, South Korea, Switzerland, and Taiwan. And the United States should communicate clearly to Japan that any future intervention by the Japanese to weaken the yen would be fully offset by US purchases of yen.
Further measures are needed, however. The country should prepare to impose taxes or restrictions on capital inflows, especially against countries such as China that manipulate exchange rates and that don't allow reciprocal purchases of their own currencies by foreigners.
And the IMF should examine whether the large purchases of foreign assets by governments in oil-exporting countries exceed a reasonable level, especially in light of the negative effects of such purchases on global economic activity during a time of widespread underemployment.
These policies would add millions of jobs in the United States. As the leaders of the Group of 20 have urged, governments in countries with trade surpluses should be encouraged to boost consumption and investment at home. Returning international trade to balance would strengthen global growth and make it more sustainable, a good outcome for the whole world.
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