Inviting the Avoidable

Maybe it is excessive skittishness, or perhaps it is the result of global financial volatility in recent years – crises in Mexico in 1994-5, East Asia in 1997-98, Russia in 1998, and then in Brazil, Turkey, and Argentina – but we economists are more concerned about monetary affairs and possible future disasters than we have been in many decades.

This month, the Switzerland-based Bank for International Settlements (BIS) was the latest to worry aloud about the financial risks that the world seems to be building into its future. “[A]ll the countries hit by financial crisis... experience[d] a very sharp slowdown,” the BIS says of the recent past. It then cites “global current account imbalances,” particularly “the US external deficit,” describing it as “unprecedented for a reserve currency country to have a current account deficit of such magnitude.” In short, the world has become “increasingly prone to financial turbulence.”

The BIS hints at the possibility of a financial crisis that, with the US at its center, would dwarf by at least an order of magnitude all crises that have occurred since 1933. Yet, in response to this risk, the BIS issues the standard textbook recommendations. Countries whose policies and economies are out of balance should change their policies, thereby restoring balance: “deficit countries should reduce the rate of growth of domestic spending below that of domestic production. Allowing their currencies to depreciate in real terms would make their products more competitive, and also provide an incentive for production to shift out of non-tradables into tradables.”

This is economists’ polite code for the message that the US must gradually cut its budget deficit, while other countries – like China and Japan – must gradually let the value of the dollar fall and that of their own currencies rise. So the BIS proposes nothing new or particularly attention-grabbing.