Willem Buiter: Mismangement by the Officialdom Can Produce a Depression

To be fair, Willem Buiter’s latest post strives for a bit of gallows humor via its title, “YES WE CAN!! have a global depression if we really continue to work at it…,” before getting down to serious business, namely, that the powers that be risk missing the opportunity to salvage the global economy.

What makes Buiter worth reading, aside from his refreshing bluntness, is that he is largely but not entirely an orthodox economist. He accepts the notion, for instance, that Kenyesian stimulus would be a very good thing, but concludes, heretically, that a lot of the main economic actors can’t go very far down that path.

Aside from arguing that point (as he has previously) Buiter also warns against the dangers of growing protectionism. That is conventional but well expressed nevertheless.

It seems that a collective sour mood has developed, as the ugly reality reveals itself: the economic crisis is going to take quite a bit of time to resolve itself. Countries with overlevered, dud banks and overextended consumers are nearly certain to suffer a permanent hit to their standard of living. The highest profile incidents at Davos were either outbursts or harsh criticisms of the financial order once aggressively promoted by the US. But as telling were journalists’ comments about widespread anger (not just gloom), which does not bode well for cooperation.

The reason that the talk of protectionism now is unfortunate is that it is ill timed. The juncture for the US to have made noise about China’s currency peg was after the Asian crisis had clearly passed and China (which only took a glancing blow) had built up a buffer of FX reserves. Conceptually, an artificially low currency is no different than an across the board export subsidy. But being able to borrow cheaply had certain advantages to the US. Even though the Bush crowd was quite wiling to alienate most of the rest of the world on Iraq, it was craven in its dealings with China (and other countries running dollar pegs).

The entire post is worth reading, and includes a very good discussion of how the ECB is behind the eight ball (with useful legal and operational detail). Key sections:

There is little doubt that if the Buy American provisions of the Economic Stimulus Package were to become law, this would amount to an economic declaration of war on the rest of the world. The response of the assembled non-US finance ministers in Davos made this clear. Retaliation from the EU countries and the rest of the world would follow swiftly. Because this disastrous US Congressional actions follows so closely on Treasury Secretary Geithner’s declaration that China is manipulating its currency, it is essential that the Obama administration draw a clear line in the sand. If anything like the Buy American clause inserted by the House survives in the bill president Obama gets on his desk, he must veto it. The questionable value of the fiscal stimulus is overwhelmed by the unquestionable domestic and global harm caused by the Buy American clause. If president Obama fails to veto a protectionism-laced bill, it will be clear that we have a wuss in the White House. If such is the case, God help us all….

Yves here, I am convinced Obama IS a wuss, and would be delighted to be proven wrong. Back to the post;

Financial protectionism is on the rise everywhere. This is partly the inevitable result of the belated discovery of the truth that cross-border banking must be severely restricted as long as regulation, supervision and tax-payer-financed bail-out support for banks is arranged at the national level. The post-crisis world will no longer have cross-border branch banking, with the foreign branches controlled by the parent, its depositors guaranteed by the parent, home country regulation and supervision and no independent capitalisation. Instead we will have just independently capitalised and financially ring-fenced subsidiaries (no Lehman UK last-minute raid by the failing parent on the local kitty), with host country regulation and supervision, deposit guarantees provided by the host country and with fiscal bail-out support provided by the host country Treasury or by no-one….

Effective fiscal stimuli involving increased government deficits can only be provided by governments with fiscal credibility, that is, governments that can cut taxes and increase public spending now and credibly commit themselves to future tax increases and public spending cuts of equal magnitude. The relentlessly procyclical behaviour of most fiscal authorities in Europe and North America during the past decade means that in the north Atlantic region, at the beginning of the crisis, only Germany and Spain had any significant fiscal credibility and spare capacity. As far as I can tell, the US and the UK have little if any. In the emerging market universe, China and Brazil have some fiscal elbow room. Few other countries do. This means that the contribution of fiscal policy to the recovery of global demand will (a) be limited and (b) have to be modulated according to national fiscal spare capacity. That means little if any fiscal stimulus in the USA and the UK and a large fiscal stimulus in Germany and China. Germany is being dragged, reluctantly, towards the Halls of Reason. The US and the UK seem intent on expansionary fiscal actions that are likely to more than exhaust their government’s credibility capital. These fiscal actions by the US and the UK will also re-invigorate the underlying global imbalances that provided some of the combustible material that caught fire on August 9, 2007.

It is refreshing to see an economist dispute the idea that we can return to status quo ante. But at the moment, no one in authority wants to hear that.


Originally published at Naked Capitalism and reproduced here with the author’s permission.