National Debt and Global Order

 Harold James

PRINCETON – As we entered the new year, all indications pointed to a remaking of the global order. Donald Trump was inaugurated as President of the United States, Chinese President Xi Jinping delivered a defense of globalization at Davos, and far-right leaders such as Marine Le Pen and Geert Wilders held an “alternative European summit” in the German city of Koblenz.

Trump and his populist allies in Europe have denounced globalization, while Xi now stands as its principal defender. But Trump’s message, in particular, is conflicted: pursuing strictly national economic interests may require less international cooperation, but bolstering security requires more.

The nationalist thrust of Trump’s inaugural address echoed the isolationism championed by the racist aviator Charles Lindbergh, who, as a spokesman for the America First Committee, lobbied to keep the US out of World War II. And now Trump, blaming previous US leaders for the economic hardships confronting many Americans, has renounced the country’s historical role in creating and sustaining the post-war order. While his objection to “global America” is not new, hearing it from a US president certainly is.

Trump’s vision is centered on the politics of debt. Having overseen a large debt-financed real-estate business, his intuition is that debt renegotiation can be used to win back for America what “other countries” have supposedly taken from it. He has focused on China and Germany, because they maintain large bilateral trade surpluses with the US – totaling $366 billion and $74 billion, respectively, in 2015. Just before the inauguration, he suggested that he might impose high tariffs on imported German cars, singling out BMW with particular relish.

With their accumulated current-account surpluses, both countries have built up large claims on the US, in the form of government debt for China and a wide variety of securitized assets for Germany. While China’s foreign reserves are now rapidly falling, Germany’s are rising. But, in both cases, immediately eliminating America’s bilateral deficits would simply make Americans poorer. It would be no different than if Greece suddenly eliminated its large deficits with the rest of Europe.

In the past, US policymakers have tried to spur domestic job creation by getting the surplus countries to run budget deficits or loosen their monetary policy, so that they could grow faster and buy more American goods. Former US Presidents Jimmy Carter and Ronald Reagan took this tack in the late 1970s and 1980s, and President Barack Obama did so again in the middle of the euro crisis that began in 2009.

This is the classic form of adjustment in the international economic system, and past US administrations pursued this method by applying bilateral pressure, and by working through international institutions such as the G7 and the International Monetary Fund. But these negotiations have always had rather mixed outcomes. Inevitably, neither side is satisfied, and the process comes to be seen as flawed.

Trump thinks that this old process failed because the surplus countries cheated. According to this view, China deliberately held down its exchange rate in the years prior to 2015, subsidized Chinese businesses, and restricted foreign ownership rights; and Germany manipulated its currency as well, first within Europe’s hard exchange-rate system after 1979, and then within the eurozone after 1999. The European Union and the eurozone, Trump has concluded, are simply mechanisms to protect German interests and extend German power.

There are two alternatives to the classical adjustment approach. The first, more plausible option is to strike bilateral deals. There are some historical precedents for this, such as when Japan, in the 1980s, “voluntarily” agreed to limit the number of cars it sold in the US. Consequently, Japan stopped selling cheap cars and quickly moved up the value chain.

Then there is a more radical alternative. Trump may pursue a nationalist version of what is typically a leftist demand: a debt jubilee or write-off. And his strategic reasoning might entail letting China’s own high levels of internal debt, and the unresolved debt issues in the eurozone, blow up.

British Prime Minister Theresa May’s meeting with Trump in Washington, DC, on January 27, has stirred much excitement about a new security arrangement based on “Anglo-American capitalism.” The old style of Anglo-American capitalism was built on manufacturing; but the new style rests on debt – particularly home ownership – to maintain consumption and high standards of living.

May’s government could play a decisive role in the current international reordering. But while she has indicated that the UK will pursue a “hard Brexit” – a clean separation from the EU – she has also emphasized how important both the EU and NATO are to the European and global security framework.

If May can convince Trump that security is more important than a gamble on leveraged debt, she will have undermined a key part of his domestic strategy, while rescuing some of the old spirit of mutual defense. It’s worth remembering that the only other US president to promote the phrase “America first” was Woodrow Wilson, who ended up trying to build an elaborate international system based on shared security and cooperation./Project Syndicate