Peterson Institute Director Warns of Trade Imbalances

C. Fred Bergsten, director of the Peterson Institute for International Economics, issued a dire warning May 19 that the U.S. trade and deficit imbalances, which he said underpinned the current economic crisis, could contribute to future crises if not corrected. He spoke at Biz Breakfast meeting at the Club.

He said that the U.S. trade deficit, financed by inflow of capital from trade surplus countries, laid the groundwork for the crisis by enabling looser monetary policy and lower interest rates than would otherwise have occurred. This condition, he added, not only made it “easy to make mistakes, but in fact encouraged them.” The mistakes were risky loans and investments. The continued willingness of foreigners to hold American assets - including the treasury notes that finance the budget deficit - in exchange for goods gave us “enough rope to hang ourselves,” he said.

The largest capital inflows came from China, the largest surplus country in the international system of trade imbalances. Bergsten used the term “Chimerica” to describe the skewed world trading system that, he believes, led to the crisis. However, the system was weakening as the crisis approached, he noted. China and other countries’ nervousness about their large holdings of dollars weakened the dollar, which fell 26 percent from 2002 to the start of the crisis.

Surprisingly, he said, the dollar has strengthened during the crisis because it is still perceived as a “safe haven” in the financial storm. Also, countries keeping their currencies undervalued do so by buying dollars, adding to demand for them. This situation enables the United States to finance the current budget deficits but poses a danger for the future, Bergsten said. Continuing the imbalances could make the next crisis worse because the option of having other countries finance deficits for stimulus packages in the future probably would not be available, he said.

Bergsten prescribed trade sanctions under the World Trade Organization for countries that systematically undervalue their currencies to maintain trade surpluses.

Bergsten presented a policy prescription for the United States of bringing the budget deficit down as economic recovery takes place. His first target would be Social Security reform in three steps: continuing to lift the retirement age, changing the cost of living adjustment to be price-based rather than wage-based, and taxing high income recipients steeply. He also addressed the need for an overhaul of the financial regulation system, which, he said, had lagged behind the evolution of the system.