But let us not forget one fundamental issue which lies at the heart of our problems. Over a period of years, persistent and growing global imbalances fueled a dramatic increase in capital flows, low interest rates, excessive risk taking and a global search for return. Those excesses cannot be attributed to any single nation. There is no doubt that low U.S. savings are a significant factor, but the lack of consumption and accumulation of reserves in Asia and oil-exporting countries and structural issues in Europe have also fed the imbalances.
If we only address particular regulatory issues – as critical as they are – without addressing the global imbalances that fueled recent excesses, we will have missed an opportunity to dramatically improve the foundation for global markets and economic vitality going forward. The pressure from global imbalances will simply build up again until it finds another outlet.
"Global imbalances" are a symptom of weak aggregate demand, relative to productive capacity. Or, what the Left has historically called a 'crisis of over-production'.
Asia's "lack of consumption" is caused by the need to suppress wages, as various countries compete to maintain export-oriented industries, and support new investment. Indeed, when China passed its most stringent labor law in 2007 (now unenforced), they were scolded by the US-China Business Council, who warned, "The Draft Law may … reduce employment opportunities for PRC workers and negatively impact PRC's competitiveness and appeal as a destination for foreign investment." Many of these industries are labor intensive, and important in keeping unemployment from rising.
This is the paradox of capitalism when it runs into a technological or geographic wall - wages must be supressed to maintain profit, which simultaneously destroys demand. Meanwhile, capacity is overextended as companies fight for increased market share. And capital becomes increasingly speculative, as productive sources of profit dwindle.
Update (6/3/09): Despite the recent rise in the markets, stimulus is not structural reform. It can merely buy time. Simon Johnson asks "Is Mr. Geithner trying to persuade China to reflate a new version of our financial bubble ?" The answer seem to be yes.
The US has liquidated more of its domestic overcapacity during this recession than many countries. This is less the case in China, Japan, and other countries where employment is part of the social contract. As the U.S. consumer wilts during this liquidation (expressed through unemployment), stimulus through global government spending is maintaining worldwide capacity. Social crisis is being averted through extreme increases in deficit spending. This, when governments are faced with capital that is more liquid and difficult to tax than ever before. Resolutions within the traditional nation-state framework seem difficult.
More than anything, capitalism requires expansion in order to remain healthy. The expansion of capitalism into China's vast interior heartland is a often mentioned possibility, usually worded as the need to increase China's domestic consumption. This expansion would also carry the risk of social chaos and instability, as it would require modernizing the agricultural sector, and pushing a new group of people off the land and into the cities.
If stimulus does not follow with a structural increase in aggregate private demand, "global imbalances" mean either years of economic stagnation, or a worldwide liquidation of capacity that will have calamitous consequences.
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