The Leadership Forum: The World in 2005 December 3rd 2004. London RESEARCH TOOLS Economist.comsuRveYs Reaganomics redux From The Economist print edition Why the world cannot count on a repeat of the 1980s PARALLELS abound between Ronald Reagan and george Bush Like the gipper, dubya is a sun belt conservative with a fondness for his ranch. In all, Mr Reagan spent about one year of his eight-year presidency at his California retreat. Mr Bush has turned his patch of Texan scrub near Crawford into the hottest destination for world leaders cuts and big increases in defence spending. Mr Bush has already cut taxes by as much as Mr+t In economic policy the script, so far, seems eerily similar. Both presidents introduced huge ta Reagan ever did though he has not, as yet, matched the 1980s defence build-up. Both men spilled huge quantities of federal red ink. During Mr Reagan 's first three years the budget deficit rose by 3% of GDP. Mr Bush has doubled that figure, presiding over a deterioration of 6% of GDP in the federal finances since 2000. And under both presidents external imbalances alled. During Mr Reagan's first four-year term, America went from a balanced current account to a deficit of almost 3% of gdP. mr bush inherited a current - account deficit of 4% of GDP. It is now over 5% and rising fast. Critics of the current president make much of these Reagan-Bush parallels. They point out that it took a decade of painful budget discipline in the 1990s to work off the budget deficits built up in the profligate Reagan era. How comforting, then, that the Reagan-era story has a happy ending, at least as far as America's external accounts are concerned Having soared in the early 1980s, the dollar started to fall from 1985. a couple of years later the current-account deficit began to reverse. By 1991 it had disappeared. Though there were nasty scares, notably the 1987 stockmarket crash, there was no global financial meltdown and no global recession However, today's world is very different. a brief detour back to the 1980s will show why Morning in America The Reagan era, like the current Bush presidency began with an economy in recession. But unlike the mild downturn of 2001, the 1981 version was severe, with soaring unemployment and plummeting output. The recovery, however, was quicker and more dramatic. Helped by big tax cuts, America boomed In 1982-84, American domestic demand grew almost 15%, against less than 3% in Europe and 5% in Japan Unlike today interest rates were high, so in 1980-84 the dollar rose by more than 80% against the currencies of its trading partners. The combination of a strong dollar and a strong economy
Reaganomics redux Sep 18th 2003 From The Economist print edition Why the world cannot count on a repeat of the 1980s PARALLELS abound between Ronald Reagan and George Bush. Like the Gipper, Dubya is a sunbelt conservative with a fondness for his ranch. In all, Mr Reagan spent about one year of his eight-year presidency at his California retreat. Mr Bush has turned his patch of Texan scrub near Crawford into the hottest destination for world leaders. In economic policy, the script, so far, seems eerily similar. Both presidents introduced huge tax cuts and big increases in defence spending. Mr Bush has already cut taxes by as much as Mr Reagan ever did, though he has not, as yet, matched the 1980s defence build-up. Both men spilled huge quantities of federal red ink. During Mr Reagan's first three years the budget deficit rose by 3% of GDP. Mr Bush has doubled that figure, presiding over a deterioration of 6% of GDP in the federal finances since 2000. And under both presidents external imbalances spiralled. During Mr Reagan's first four-year term, America went from a balanced current account to a deficit of almost 3% of GDP. Mr Bush inherited a current-account deficit of 4% of GDP. It is now over 5% and rising fast. Critics of the current president make much of these Reagan-Bush parallels. They point out that it took a decade of painful budget discipline in the 1990s to work off the budget deficits built up in the profligate Reagan era. How comforting, then, that the Reagan-era story has a happy ending, at least as far as America's external accounts are concerned. Having soared in the early 1980s, the dollar started to fall from 1985. A couple of years later the current-account deficit began to reverse. By 1991 it had disappeared. Though there were nasty scares, notably the 1987 stockmarket crash, there was no global financial meltdown and no global recession. However, today's world is very different. A brief detour back to the 1980s will show why. Morning in America The Reagan era, like the current Bush presidency, began with an economy in recession. But unlike the mild downturn of 2001, the 1981 version was severe, with soaring unemployment and plummeting output. The recovery, however, was quicker and more dramatic. Helped by big tax cuts, America boomed. In 1982-84, American domestic demand grew almost 15%, against less than 3% in Europe and 5% in Japan. Unlike today, interest rates were high, so in 1980-84 the dollar rose by more than 80% against the currencies of its trading partners. The combination of a strong dollar and a strong economy
sent America's trade deficit soaring. During Mr Reagan 's first term officials cared little about the strong dollar or the rising external imbalances. Like the current Bush team they argued that a bigger external deficit simply reflected the attractiveness to outsiders of investing i America. The tone was defiant, even boastful. In Europe theyre calling it the American miracle," Mr Reagan said in early 1985. Day by day we are shattering accepted notions of what is possible Within months, however, the mood in Washington had changed sharply. By the summer of 1985, the domestic political pressures from a strong dollar and rising trade deficit were becoming hard to contain Congress was in a militant, protectionist mood Japan was the scapegoat, blamed for hollowing out American manufacturing industry. Almost 100 trade bills were drawn up in 1985, each one of them protectionist James Baker, Mr Reagan's new Treasury secretary realised that something had to be done to stem the protectionist tide. Over months of secret diplomacy he put together a plan to secure international economic co-operation and currency intervention to push the dollar down on September 22nd 1985, finance ministers from the worlds five biggest economies-America Japan, West Germany france and Britain-announced the plaza accord at the eponymous New York hotel Each country made specific promises on economic policy America pledged to cut the federal deficit Japan Controlled crash promised a looser monetary policy and a range of financial-sector reforms, and germany proposed tax Dollar against the yen and the D-mark cuts. All countries agreed to intervene in currency D/5 markets as necessary to get the dollar down. Perhaps not surprisingly, not all the promises were kept (least of 320 all America's on deficit-cutting), but even so the plan turned out to be spectacularly successful. By the end of240 1987, the dollar had fallen by 54% against both the d- mark and the yen from its peak in February 1985(see chart 8). 4L⊥⊥⊥⊥⊥⊥⊥⊥⊥季 19808284868890 Keep it up Source: Thomson Datastream This sharp drop led to a new fear: of an uncontrolled dollar plunge. So in 1987 another bis.s international plan, the Louvre Accord, was hatched to stabilise the dollar. Again specific policy pledges were made (america to tighten fiscal policy, Japan to loosen monetary policy). agai the participants promised currency intervention if major currencies moved outside an agreed, but unpublished, set of ranges. Heavy foreign-exchange market intervention in 1987 did stabilise the dollar. Meanwhile America' s external deficit began to shrink sharply helped by the big depreciation but even more by relatively faster growth abroad. In the late 1980s, domestic demand slowed in America but remained strong in Germany and boomed in bubble-era Japan. By 1990 America's current account deficit was down to 1%of GDP. A year later, after America's modest 1991 recession, it was in surplus. The story of the Reagan era helps explain why the current Bush team is keeping so calm about America's external imbalances. serious as they seemed at the time the excesses of the mid
sent America's trade deficit soaring. During Mr Reagan's first term, officials cared little about the strong dollar or the rising external imbalances. Like the current Bush team, they argued that a bigger external deficit simply reflected the attractiveness to outsiders of investing in America. The tone was defiant, even boastful. “In Europe they're calling it the American miracle,” Mr Reagan said in early 1985. “Day by day we are shattering accepted notions of what is possible.” Within months, however, the mood in Washington had changed sharply. By the summer of 1985, the domestic political pressures from a strong dollar and rising trade deficit were becoming hard to contain. Congress was in a militant, protectionist mood. Japan was the scapegoat, blamed for hollowing out American manufacturing industry. Almost 100 trade bills were drawn up in 1985, each one of them protectionist. James Baker, Mr Reagan's new Treasury secretary, realised that something had to be done to stem the protectionist tide. Over months of secret diplomacy, he put together a plan to secure international economic co-operation and currency intervention to push the dollar down. On September 22nd 1985, finance ministers from the world's five biggest economies—America, Japan, West Germany, France and Britain—announced the Plaza Accord at the eponymous New York hotel. Each country made specific promises on economic policy: America pledged to cut the federal deficit, Japan promised a looser monetary policy and a range of financial-sector reforms, and Germany proposed tax cuts. All countries agreed to intervene in currency markets as necessary to get the dollar down. Perhaps not surprisingly, not all the promises were kept (least of all America's on deficit-cutting), but even so the plan turned out to be spectacularly successful. By the end of 1987, the dollar had fallen by 54% against both the Dmark and the yen from its peak in February 1985 (see chart 8). Keep it up This sharp drop led to a new fear: of an uncontrolled dollar plunge. So in 1987 another big international plan, the Louvre Accord, was hatched to stabilise the dollar. Again specific policy pledges were made (America to tighten fiscal policy, Japan to loosen monetary policy). Again the participants promised currency intervention if major currencies moved outside an agreed, but unpublished, set of ranges. Heavy foreign-exchange market intervention in 1987 did stabilise the dollar. Meanwhile, America's external deficit began to shrink sharply, helped by the big depreciation but even more by relatively faster growth abroad. In the late 1980s, domestic demand slowed in America but remained strong in Germany and boomed in bubble-era Japan. By 1990 America's currentaccount deficit was down to 1% of GDP. A year later, after America's modest 1991 recession, it was in surplus. The story of the Reagan era helps explain why the current Bush team is keeping so calm about America's external imbalances. Serious as they seemed at the time, the excesses of the mid-
1980s were purged with relative ease. But behind the superficial similarities, America's situation now is quite different from that in the mid-1980s. the imbal are bigger; the internationa economic environment is more complex; and America's trading partners are weaker. All these factors suggest that the adjustment will be riskier and more painful Start with the size of the problem. When Mr Reagan took office, America was still the world's biggest creditor. The current-account deficit at its peak in 1987 reached 3. 4% of GDP. Mr Bush in contrast, inherited an economy that was already the world' s biggest debtor and a current account deficit that was already bigger than at its peak under Mr Reagan Besides in the 1980s the current-account deficit had been rising for only four years before the Reagan team took action It also had a clear cause: an investment boom after the 1981 recession, coupled with a collapse in saving as the budget deficit ballooned which together pushed the dollar sky-high Today's deficit, in contrast, has been rising for over a decade. It was started by an investment boom in the mid-1990s then fuelled by a dramatic drop in private savings as Americans splurged in the late 1990s; and is now being sustained by a drop in public saving. An external imbalance that has gone on for so long with so many disparate causes, is likely to be much harder to turn around oreover, today,'s larger problem must be resolved in a global economic environment that is far more fragile than that of the mid-1980s. The world economy is still working through the aftermath of a huge asset-price and investment bubble. Inflation is much lower than it was in he mid-1980s. Deflation is already a reality in several countries and hovers threateningly over many others. a drop in the dollar will put extra deflationary pressure on those countries whose currencies appreciate against it. No appetite for action Despite the world economy's greater fragility, global policymakers are showing much less appetite for 1980s-style international policy Co-ordination. Not everyone views the plaza an Louvre accords as a great success. Japan, in particular, blames the monetary easing agreed on at the time for the development of its bubble economy in the late 1980s, and hence as the root cause of today's problems. Europeans tend to see both accords as clever American tricks in which the Reagan officials pushed the burden of dealing with their past profligacy on to others Even if the Japanese and the europeans could be persuaded to overcome their suspicions of repeat it is not clear that the 1980s remedies would work this time. Co-ordination is much harder these days because of the way policy is made particularly given the rise of independent central banks. Back in the 1980s, the governments of Germany and Japan could tell their central banks what to do. Now both the Bank of Japan and the European Central Bank jealously guard their independence. Both in Japan and in the euro zone, central bankers see themselves as guardians of discipline against spendthrift politicians. That makes domestic fiscal and monetary Co-ordination difficult enough, never mind any international efforts oreover, the huge growth in capital markets has rendered currency intervention much less effective. With over $1 trillion in foreign exchange crossing borders every day, up from less than $200 billion in 1985, most economists now think that official currency intervention works at best at the margin, and then only if it is used to reinforce existing economic trends
1980s were purged with relative ease. But behind the superficial similarities, America's situation now is quite different from that in the mid-1980s. The imbalances are bigger; the international economic environment is more complex; and America's trading partners are weaker. All these factors suggest that the adjustment will be riskier and more painful. Start with the size of the problem. When Mr Reagan took office, America was still the world's biggest creditor. The current-account deficit at its peak in 1987 reached 3.4% of GDP. Mr Bush, in contrast, inherited an economy that was already the world's biggest debtor, and a currentaccount deficit that was already bigger than at its peak under Mr Reagan. Besides, in the 1980s the current-account deficit had been rising for only four years before the Reagan team took action. It also had a clear cause: an investment boom after the 1981 recession, coupled with a collapse in saving as the budget deficit ballooned, which together pushed the dollar sky-high. Today's deficit, in contrast, has been rising for over a decade. It was started by an investment boom in the mid-1990s; then fuelled by a dramatic drop in private savings as Americans splurged in the late 1990s; and is now being sustained by a drop in public saving. An external imbalance that has gone on for so long, with so many disparate causes, is likely to be much harder to turn around. Moreover, today's larger problem must be resolved in a global economic environment that is far more fragile than that of the mid-1980s. The world economy is still working through the aftermath of a huge asset-price and investment bubble. Inflation is much lower than it was in the mid-1980s. Deflation is already a reality in several countries, and hovers threateningly over many others. A drop in the dollar will put extra deflationary pressure on those countries whose currencies appreciate against it. No appetite for action Despite the world economy's greater fragility, global policymakers are showing much less appetite for 1980s-style international policy co-ordination. Not everyone views the Plaza and Louvre accords as a great success. Japan, in particular, blames the monetary easing agreed on at the time for the development of its bubble economy in the late 1980s, and hence as the root cause of today's problems. Europeans tend to see both accords as clever American tricks in which the Reagan officials pushed the burden of dealing with their past profligacy on to others. Even if the Japanese and the Europeans could be persuaded to overcome their suspicions of a repeat, it is not clear that the 1980s remedies would work this time. Co-ordination is much harder these days because of the way policy is made, particularly given the rise of independent central banks. Back in the 1980s, the governments of Germany and Japan could tell their central banks what to do. Now both the Bank of Japan and the European Central Bank jealously guard their independence. Both in Japan and in the euro zone, central bankers see themselves as guardians of discipline against spendthrift politicians. That makes domestic fiscal and monetary co-ordination difficult enough, never mind any international efforts. Moreover, the huge growth in capital markets has rendered currency intervention much less effective. With over $1 trillion in foreign exchange crossing borders every day, up from less than $200 billion in 1985, most economists now think that official currency intervention works at best at the margin, and then only if it is used to reinforce existing economic trends
Lastly, big changes in the structure of America's trade patterns mean that more countries would have to be involved in any adjustment process. In 1985, Japan accounted for 16% of America's trade; now that share is down to 9%o. Meanwhile Mexico, China and some other Asian countries have become much more important partners. a round of financial diplomacy involving policymakers in only five countries would no longer do the trick But the main difference between today and the mid-1980s is that the adjustment paths used last time round-a big shift in demand away from America towards Japan and germany together with a substantial but orderly drop in the dollar-are blocked As the next two sections will argue, both Japan and germany face big hurdles and wrenching economic reforms before orderly depreciation of the dollar. That makes the prospects a lot grimmer than before aa ount either can become an engine of global growth in demand; and Asian countries which acco for a third of America's trade are refusing to let their currencies appreciate ruling out Copyright 2004 The Economist Newspaper and The Economist Group. All rights reserved
Lastly, big changes in the structure of America's trade patterns mean that more countries would have to be involved in any adjustment process. In 1985, Japan accounted for 16% of America's trade; now that share is down to 9%. Meanwhile Mexico, China and some other Asian countries have become much more important partners. A round of financial diplomacy involving policymakers in only five countries would no longer do the trick. But the main difference between today and the mid-1980s is that the adjustment paths used last time round—a big shift in demand away from America towards Japan and Germany, together with a substantial but orderly drop in the dollar—are blocked. As the next two sections will argue, both Japan and Germany face big hurdles and wrenching economic reforms before either can become an engine of global growth in demand; and Asian countries, which account for a third of America's trade, are refusing to let their currencies appreciate, ruling out an orderly depreciation of the dollar. That makes the prospects a lot grimmer than before. Copyright © 2004 The Economist Newspaper and The Economist Group. All rights reserved
