Congressional Testimony on the Global Crisis

Testifiying before the Subcommittee on Terrorism, Nonproliferation and Trade on the subject of “U.S. Foreign Economic Policy in the Global Crisis” were Simon Johnson, Ph.D., Peter Morici, Ph.D., C. Fred Bergsten, Ph.D., Philip I. Levy, Ph.D., Lori Wallach, Esq.

The webcast can be found at here

Written testimony for each:

Simon Johnson
Peter Morici
C. Fred Bergsten
Philip I. Levy
Lori Wallach

The analysis of the crisis varies among the experts. I offer a precis of only two, offering more of my limited space to Professor Morici. Readers would do well to read all the testimony and sort out for themselves the root causes of the crisis in which the world now finds itself.

Simon Johnson sees the problem in terms of the weakness of balance sheets in the private sector.

Households did not save much since the mid-1990s and reduced their savings further this decade, in part because of the increase in house prices; this was the counterpart of the large increase in the US current account deficit. Desired household saving is now increasing, at the same time that the corporate sector is cutting back on investments. The main dynamic is a fall in credit demand rather than constraints on credit supply in the US. Even entities with deep pockets, strong balance sheets and long investment horizons (e.g., universities, private equity) are cutting back on spending and trying to strengthen their balance sheets. This desire to save is creating the economic contraction we see all around us.

He finds the February stimulus package he sees as far too small to do much.

Besides politics, the main constraint on fiscal stimulus is the US balance sheet. The US balance sheet is strong relative to most other industrialized countries – private sector holdings of government debt are around 40% of GDP – and US government debt remains the ultimate safe haven. But with increasing Social Security and Medicare payments in the medium term, the national debt will only increase for the foreseeable future. The underlying problem is that fiscal policy was not sufficiently counter-cyclical during the boom.

Peter Morici sees the problem as a result of confluence of issues, specifically the twin U.S. deficits:

Most fundamentally, the recession, which may now become a depression without more effective policy responses, has origins in the interaction of changes in our banking and financial systems, energy policies and trade policies, and in the actions of foreign governments.

The largest and most dangerous issue is that of trade imbalances:

Some critics warned of the dangers of such large deficits, while others argued that the resulting inflows of capital represented investments in the United States and confidence in quality of economic policy and future growth of the U.S. economy.
The fact is most of the money was raised by borrowing or selling off fixed assets and was not new productive investments. Much was used to prop up consumption, and some was used to leverage investment schemes that proved more speculative than productive. Much was provided by sovereigns and near sovereigns who were merely looking for hard currency parking places for cash and safe political environments in the event political conditions changed elsewhere in the world.

The largest components of these deficits were net imports of oil, principally to fuel automobiles, and a growing trade deficit with China. In 2008, those components alone totaled 96 percent of the trade deficit.

The trade deficit on oil was the result of domestic policies that neglected domestic oil and gas development and that failed to fully exploit alternatives to conventional fuels and build out energy-conserving technologies.

Those policies maximized dependence on foreign sources of oil. Coupled with rapid growth and fuel subsidies in the developing countries of Asia, U.S. energy policies helped push up global crude oil prices and the U.S. petroleum trade deficit.

China controls foreign exchange transactions and manages the value of its currency. It set the yuan-dollar exchange rate at an artificially low value in 1994 and fixed that rate from 1995 to 2005. From mid-2005 to mid-2008, China permitted some modest revaluation of the yuan; however, this was not nearly enough, and the yuan remains significantly undervalued.

Since July 2008, the value of the yuan has not changed much.

The undervalued yuan provides Chinese manufacturers with a huge export subsidy and a hidden tariff on imports.

China is using its currency as a development tool, but this victimizes otherwise competitive businesses and their employees in the United States. In response to the recession, China has again frozen the level of the yuan and laid on additional export subsidies, seeking to export its recession in the worst tradition of Smoot-Hawley. In addition, China maintains high explicit import tariffs. Through these and other regulations, it essentially requires foreign manufacturers to locate in China to service its market and for their suppliers to relocate to China, further accelerating the decline in U.S.manufacturing.

This creates a pattern of international trade, specialization and production that confounds expectations for trade based on comparative advantage—the kind of trade that was expected to follow from China’s accession to the WTO in 2001.