As its power declines, the U.S. pays the price
Economic policy isn’t just a domestic issue anymore. That is the conclusion we should draw from the market volatility this week, including the shift by Standard & Poor’s to a negative outlook for U.S. government debt, and the meeting last weekend of the International Monetary Fund and World Bank.
This is a familiar fact for smaller countries. The emerging market nations have long understood that judgments made on Wall Street or at the IMF headquarters in Washington often had more power to shape their economic policy than the proposals of their own ministers of finance and central bankers. More recently, that is a lesson that fiscally weak Western countries like Greece, Ireland and Portugal have been learning, too.
Now, as the relative power of the United States in the global economy declines, it is a fact of life that Americans need to get used to, too. That is one of the important messages of the S&P decision at the beginning of this week to put the United States on a negative outlook – essentially a warning that the ratings agency is no longer certain the United States will maintain its AAA rating.
There are a lot of reasons the S&P call should be taken with a grain of salt. For one thing, the ratings agencies hardly covered themselves with glory in the run-up to the financial crisis, and surely no longer deserve oracular status – if they ever did.
For another, the S&P warning wasn’t new news. With a 10.6 percent budget deficit last year and with gross national debt at 91.6 percent of gross domestic product, it has been obvious for some time that the United States’ public finances are a mess. Nor has that concern been limited to the wonks. The debt and deficit have become a Main Street issue – witness the rise of the Tea Party movement – and have dominated the political debate in Washington for the past six months.
But there is one good reason the S&P’s negative outlook attracted so many headlines. It was a reminder that U.S. economic policy was no longer just about debates in Washington or what plays in the Iowa caucuses. U.S. economic policy needs to pass muster with global markets and with foreign lenders, too.
That is an old story for every other country in the world. But the United States has been accustomed to being the world’s dominant economy and to owning the printing press of its reserve currency. Both are still true, but less so than before. Moreover, for all its size, the United States’ massive debt means it is already dependent on the confidence of foreign buyers of U.S. Treasury securities, including governments running massive surpluses, like China.
That means national economic decisions, like the level of government spending, or the rate of taxation, aren’t purely national issues any more. In the proud days of the so-called Washington Consensus after the collapse of the Berlin Wall and the triumph of Western capitalism, U.S. pundits and policy-makers got used to issuing edicts from Washington about how emerging markets should run their economies. The reverse is not yet true, but the S&P move is a sign that the United States will need to start thinking about how its economic policy moves play in Beijing and Dubai, as well as in the Beltway and New Hampshire.
It is not just the debt and deficit that are making economic policy a matter of international concern. As the IMF and World Bank meetings revealed, one of the consequences of globalization has been to give national economic decisions a more powerful international wallop.
This isn’t an entirely novel notion for the United States. U.S. complaints about China’s exchange-rate policy and its strategy of export-driven growth are a vivid example of the public’s conviction that one country’s domestic economic strategy is a legitimate – indeed central – issue for international debate.
Now the rest of the world is starting to take the same view of the United States. In Washington last week, the Brazilian finance minister, Guido Mantega, complained that the policies of the Federal Reserve, designed to help the United States recover from the gravest financial crisis since the Great Depression, were having unintended and malign consequences in other parts of the world.
Low interest rates in countries like the United States, Mr. Mantega warned, were the “primary trigger of many of today’s economic woes.”
“Domestic political constraints have been too easily invoked by reserve currency-issuing countries as a reason for adopting ultra-expansionary monetary policies,” he said in a statement to the IMF’s policy steering committee. “But this does not change the fact that these policies generate spillovers that have made life difficult for other countries.”
Mr. Mantega isn’t the only one who is worried. In a panel discussion at Bretton Woods I moderated a few weeks ago, Andres Velasco, the former finance minister of Chile, warned: “So, if you are Brazil today or if you are many of these countries in the rest of the world, you look out the window and what you see is a tremendous tsunami of wealth coming your way. And this, which once upon a time might have been welcomed, I view and many of the people in these countries view as a terrifying sight indeed. Why? Because this tsunami is going to make your politics very difficult, your life if you are a minister very unpleasant and your macro trade-offs very sharp indeed.”
When we think about the thorny questions in foreign policy, we think first about the rocky intervention in Libya or the agonizing war in Afghanistan. But the really big challenge in managing relations between nations is the problem pointed to by Mr. Velasco, Mr. Mantega and S.&P.: managing a world in which my domestic economic policy solution is your foreign economic tsunami.