Handling the market
How transatlantic squabbles over the war threaten economic cooperation across the globe.
The increasingly bad-tempered political rows between ‘old Europe’ and America over the Iraq war have attracted widespread attention. But the impact of the growing rift on an already unbalanced world economy is less well understood.
Discussions about the economic implications of the transatlantic split tend to focus on the issue of consumer boycotts – the campaign in America to rename ‘French fries’ to ‘freedom fries’, or the attempt in Paris to boycott McDonald’s.
But the stakes are much higher than these consumer boycotts. The system of economic cooperation that has been painstakingly developed since the 1970s looks like it could be undermined. Increasingly intemperate relations between the Western powers threaten to make it more difficult to operate.
No country is deliberately out to destroy a network of institutions that has given the world economy far more resilience than it would otherwise have had. It is more the case that the countries involved are so preoccupied with their political disputes that they risk losing sight of the benefits of economic cooperation.
Although it is rarely discussed or understood outside of specialist circles, the system of international cooperation is extremely elaborate. There are numerous ways in which Western countries are prepared to sacrifice their short-term economic interests in exchange for longer terms benefits.
One of the most important areas is monetary policy. The central banks of the world’s largest economies are in constant contact with each other. If a problem emerges in one country the others are normally quick to lend support.
This was most strikingly illustrated after the terrorist attacks on 11 September 2001. Soon afterwards, the world’s main central banks all cut interest rates at the same time. This coordinated action meant in effect that a huge amount of cheap money was pumped into the world economy. One result was that the world’s stockmarkets recovered after several days of steep falls.
Coordinated monetary policy can also have other short-term and long-term benefits. For example, if one currency suffers a sudden and unexpected fall, the other central banks will normally move to prop it up. Alternatively, during the 1980s the Japanese authorities kept interest rates artificially low to help bolster a sluggish world economy. At the time, Japan was the most dynamic of the large economies and so in a position to try to promote global growth.
There is also an understanding between the world’s main economies to keep trade barriers in check. Although there is not ‘free trade’ in the way it is often understood – keeping protectionism to a minimum – the big powers have managed to avoid the bitter trade wars that characterised the 1930s.
Such collaborative mechanisms are the result of painstaking work by several generations of the world’s top economic policymakers. They have not arisen naturally from the operation of the market.
Many of the key institutions, such as the International Monetary Fund (IMF), were founded at the end of the Second World War. But it was really in the 1970s, with the onset of the first serious post-war economic crisis, that cooperation took off. The regular G7 summits of the world’s top leaders, one of the most visible forms of collaboration, started at that time.
Yet it is far easier to undermine this system of collaboration than it was to create it. The resentment that has recently come to the fore with the Iraq war is already making it harder to operate. For example, it was striking that on the weekend of 12 April, just days after US forces marched into Baghdad, that the European Central Bank (ECB) – that operates monetary policy for the 12 euro-zone countries – publicly rejected calls from America and the IMF to cut interest rates. The gist of the ECB response was that it knew what it was doing so America should stop trying to boss it around (1).
In some circumstances the weakening of international economic cooperation would not matter too much. If the world economy were running smoothly then it would not be a serious problem.
But at present there are huge ‘imbalances’ between the world’s main economic blocs. Basically what is happening is that Asia, and to a lesser extent Europe, are providing huge subsidies to keep the American economy going.
In more technical language the USA is running a current account deficit – importing more than it is exporting – of an unprecedented five percent of gross domestic product (GDP). The only reason it can afford to do this is that other countries are willing to invest in the USA and so effectively lend it the money to suck up imports.
Most of this money comes from Asian governments. According to a recent estimate in the Financial Times, the central banks of China, Hong Kong, Japan, Taiwan and Singapore alone have accumulated $1100billion (£703billion) of official reserves, most of which is in American government debt (2). The author goes on to argue, with some justification, that in effect it was Asian governments that paid for the war against Iraq.
Naturally, Asian governments are not acting out of pure altruism – even though in many cases they could get a better return on their investment at home. They understand that without their support the dollar is likely to weaken considerably. And if it does it will make Asian exports less competitive relative to their American counterparts.
But the huge American current account deficit is ultimately likely to prove unsustainable. Asia and Europe are unlikely to be willing to prop up the American economy for ever; particularly if they believe it is at their expense.
The real question is whether the deficit will unwind in a slow smooth process or in a sharper reversal. Optimists are hoping that it will happen gradually, in a similar way to the late 1980s – although America’s deficit was not as high then as it is now. Concerted policy cooperation between the main powers would certainly make such a benign outcome more likely.
But the greater the tensions between the main economic powers the more likely such cooperation is to be undermined. As a result, the adjustment process could be far more painful: with a sharp fall in the dollar and higher interest rates in America. Within the USA this would mean a painful restructuring, with weaker businesses struggling and consumers finding it harder to repay debt.
Outside America there would also be problems, as firms from other countries would find it hard to compete with more competitive US products. Overall, global economic growth would probably be even more sluggish than it is now.
The system of international economic cooperation that evolved in recent decades was far from perfect. But the consequences of its demise are likely to be felt way beyond the confines of the small number of people involved in the process.
Daniel Ben-Ami is the author of Cowardly Capitalism: The Myth of the Global Financial Casino, John Wiley and Sons, 2001 (buy this book from Amazon (UK) or Amazon (USA)). He is also a contributor to Cultural Difference, Media Memories: Anglo-American Images of Japan, Continuum International Publishing Group, 1997 (buy this book from Amazon (UK) or Amazon (USA)).
spiked-issue: War on Iraq
(1) ‘Europe resists G7 pressure to loosen rate policy’, The Times, 14 April 2003
(2) ‘The sinews of war are Asian’, Financial Times, 21 March 2003
To enquire about republishing spiked’s content, a right to reply or to request a correction, please contact the managing editor, Viv Regan.