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Focus on Jackson Hole should be directed toward a G-20 stimulus deal

Janet Yellen (C) , chair of the U.S. Federal Reserve, arrives at the Jackson Hole economic symposium.
David Paul Morris | Bloomberg | Getty Images
Janet Yellen (C) , chair of the U.S. Federal Reserve, arrives at the Jackson Hole economic symposium.

The Fed's policy message from Jackson Hole, Wyoming, last week was entirely reasonable in the absence of any reliable indication of the fiscal and structural economic measures of America's next administration.

It, therefore, seems that the weakening U.S. bond market read too much last Friday into the Fed's view that the current inflation indicators and labor market conditions had strengthened the case for an interest rate increase – most probably another 25 basis-point pinprick.

At the moment, however, there is nothing even so mildly threatening on the horizon.

The last report on reserve movements, dated August 17, showed that the Fed's monetary base was only 4 percent below its average year-earlier level, and the effective federal funds rate closed on Friday 9 basis points below its official target.

Arguably, that's the way it should be. As a matter of sound monetary management, and a modicum of Beltway comity, the Fed is right to wait for the new administration to show its hand with respect to fiscal and structural policies it intends to implement. The Fed has strong evidence to demonstrate, if need be, to the new legislative and executive authorities that the monetary policy alone cannot carry the entire burden of economic stabilization.

Don't do it alone – it's a G20 issue

Only a careful evaluation of the new fiscal and structural policies will allow the Fed to properly calibrate its action to support the economy, maintain price stability and ensure the soundness of the financial system.

These are matters of delicate fine-tuning, because the new fiscal policy (a mix of tax changes and public spending) will have a limited room to maneuver. Rearrangements of national priorities will be required to keep the budget deficit and the gross national debt around 4 percent and 114 percent of GDP respectively.

It is unfortunate that the cheap funding provided by the Fed's extraordinarily easy policies did not lead to a greater improvement of America's fiscal position. Net debt interest payments remain roughly unchanged at about 3 percent of GDP, and the primary budget deficit (budget balances before interest charges on public debt) is still close to 1 percent of GDP.

Under these circumstances, and assuming rising interest rates in the years ahead, it will be a big challenge to stabilize and reduce national debt, because the primary budget would have to start generating large and sustainable surpluses.

At any rate, America's future fiscal easing should be closely coordinated with similar policies in Europe and China. Otherwise, if Washington does a solo stimulus number, its impact will promptly leak out through sharply rising imports from countries that are waiting for Uncle Sam to do the heavy lifting. If that happens, rapidly climbing trade deficits will hit U.S. jobs and income, while adding to net foreign liabilities currently standing at $7.5 trillion.

The forthcoming G20 summit in Hangzhou, China, on September 4-5, is the right forum to address a coordinated economic stimulus in accordance with the well-established – but never respected – rules of international trade adjustment.

What are these rules? They are simple and they differ for surplus and deficit countries.

Governments running external surpluses, balanced public sector accounts and stable prices are expected to stimulate their domestic demand. The opposite applies to governments experiencing external and internal deficits and accelerating inflation.

Call out the free-riders

Notice the symmetry in adjustment obligations. In practice, however, these rules are never applied because the IMF - the referee, and Washington, its major shareholder - look the other way. As a result of that, deficit countries have to adjust because they run out of money, and surplus countries get a pat on the back for "virtuously" living off the rest of the world.

But the truth is that the perennial surplus countries are equally responsible for creating an unstable and unbalanced world economy. At one point, surplus countries were liable for penalties if they failed to follow trade adjustment rules.

So, who are the major culprits according to those rules?

China, the country hosting the G20 summit, is one of the prima facie suspects, because of its current account surplus of about 3 percent of GDP and an inflation rate of 1.8 percent. That would put China in a group of countries that should stimulate domestic demand, were it not for an increasing budget deficit likely to hit 3.5-4.0 percent of GDP by the end of this year – a significant worsening compared with the deficit of 2.4 percent of GDP in 2015.

China, therefore, could get a pass, with a rider enjoining Zhongnanhai mandarins to generate more growth from domestic demand, and to keep their markets open to foreign trade, direct investments and international capital flows.

Germany is a much tougher case. With its huge trade surpluses, Berlin not only lives nicely off the rest of the world, but it also continues to push fiscal austerity on its euro partners and keeps calling on the European Central Bank (ECB) to throw away the life jacket of euro area's recessionary economies. Pretty cruel, isn't it?

But there is more. These German policies are also shrinking the markets for 22.5 percent of U.S. exports. In the first half of this year, America's trade deficit with Europe was running at an annual rate of $156.4 billion, or 22 percent of the total trade gap. Nearly half of that was accounted for by the U.S. trade deficit with Germany.

And here is how much Germany is a perfect candidate for trade adjustment: Its current account surplus is a whopping 9 percent of GDP, its budget was running a surplus of 18.5 billion euros in the first half of this year, and its inflation rate last month was 0.4 percent. Even the German healthcare system – the envy of the Western world – just reported a surplus of 600 million euros in the first half of this year.

Take that Obamacare (aka, Affordable Care Act)!

One of the highly respected German magazines was screaming last week: "Down with taxes!" The paper claimed that public coffers were overflowing with money, but the government still wanted to bleed the taxpayers.

Worryingly, Berlin is doing more than that: It has just declared an emergency, head-for-the-hills, situation, urging people to stock food and water. Even the mundane task of relocating a few fighter planes and small personnel from Turkey to another NATO base is called a "national nightmare."

Investment thoughts

The Fed is right in its apparent intention to postpone major policy changes until it gets clear indications of fiscal and structural policies the new administration intends to pursue.

Despite the current interregnum, Washington should insist on a coordinated fiscal (and monetary, where appropriate) stimulus with Europe and China. A failure to achieve that, and having to do it alone, would be (a) a major political setback, (b) a huge gift to trade freeloaders, (c) a growing trade deficit (and hence a drag on growth) and (d) a new surge in America's net foreign liabilities toward $8 trillion, and counting.

So far, only one of the declared U.S. presidential candidates is ready to go to bat for vitally important trade issues.

The G-20 summit in China, starting next Sunday, is an excellent opportunity to set the stage for ministerial expert groups to work on an urgent and coordinated global economic stimulus in accordance with the rules of international trade adjustment.

Washington would also be well advised to have a serious talk with Germany – unless it wants to lose Europe. That's the kind of talk the members of the Visegrad Group (Poland, Hungary, the Czech Republic and Slovakia) had with Germany last Friday in Warsaw, Poland, to defend their own economic and security interests. The British tried, failed and left. The U.S. may not wish to follow the same path.

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