As America and China square up, the chancellor is ignoring the bigger picture with his ill-advised spending review
Those who run the International Monetary Fund are supreme financial diplomats. They talk the opaque language of financial final communiques, the honed compromises between the great economic powers.
So when Dominique Strauss-Kahn, the IMF managing director, acknowledged that the language of a recent IMF summit communique was "ineffective", that the time for "real action" had come and that he feared "a race to the bottom" as the major countries began to outdo each other in beggar-my-neighbour currency wars, you should sit up and listen. The problem is that we can talk and talk and talk, he said, but in the end something has to happen – and it has not. If countries chose not to co-operate in unravelling the problems facing the world economy, we all faced disaster.
The United States blames China for the impasse, saying it was manipulating its currency to export unemployment to stagnation-stricken America. China blames the US for flooding the world with dollars and taking no responsibility as the hegemonic power for the fiscal and monetary discipline necessary to underpin the world's key currency. Fears are growing that next month's G20 meeting in Seoul will reveal the lack of co-operation.
It was the collapse of collaboration at the London summit in 1931 that launched the trade and currency policies that prolonged depression. Will history repeat itself? The US is preparing to declare unilateral economic war on China by further swelling the flood of dollars when next month it adopts an American form of quantitative easing to boost anaemic levels of bank lending. China will be swamped by yet more dollars displaced from the US, but is determined, as the governor of the Bank of China, Zhou Xiaochuan, repeated, to move with extreme gradualism on its currency, if it moves at all. Both, as in the early 1930s, imagine they can get better results by going it alone. And if they square up to each other, the rest of the world has no option but to protect itself, the dynamic that caused the competitive devaluations and trade protection of the 1930s.
This is the background to this week's statement by chancellor George Osborne in which he will announce the fastest, deepest cuts in public spending ever mounted by a government in modern times. Given the risks, the right policy would have been to embed flexibility in Britain's spending, taxing and borrowing plans so the government could move fast to adjust to whatever happens. It is not what will be announced.
There was no need for such haste. Just as we took a decade to solve our problems after the crises of the mid-1970s and early 1990s, so we could have done the same today – aggressively cutting the deficit only when recovery is more assured. After all, it has never been easier to sell government debt. Equally, if more of the burden of deficit reduction had been shouldered by planned tax increases, they could have been quickly deferred or abandoned to boost the economy if world economic prospects darkened. The haste to cut so blindly and so crudely, unless we are very lucky, will be seen by future historians as one of the great acts of economic folly.
Optimists insist China and the US will draw back from economic war and that the risks are manageable. The Chinese have let the yuan go up by 2% over the last two months, and are pledged to lower their trade surplus. After all, with foreign exchange reserves of $2.6 trillion, the highest of any country in history, the only way China can carry on acquiring reserves on this scale without risking massive inflation is through even more draconian controls on its banking system.
Change would seem rational. On Friday, President Obama deferred for another 90 days the launch of another weapon in the US's economic arsenal – naming China as a currency manipulator and unilaterally imposing American tariffs on Chinese imports – in the hope that China was retreating. There could yet be a deal in Korea.
But China's economic model is built on sky-high saving and phenomenal export growth, especially to the US. Only last month, the US recorded its second-biggest monthly trade deficit; more than half was with China. Any bargain that makes sense requires China to spend more, save and export less and the US to spend less and export more.
A US in the grip of the rising Tea party movement is hardly likely to embark on the reforms required to make the US a more compatible trade and currency partner. It will do whatever it needs to protect American growth and jobs – and the rest of the world can adjust to it. This, after all, is what the pre-Tea party US did to Japan in the late 1980s, forcing the yen to rise sharply, triggering a profound financial and banking crisis that delivered nearly two decades of economic stagnation. Now the Chinese fear that an even more aggressive US wants to do the same to them and that US quantitative easing is its chosen weapon.
The Chinese Communist party could not survive two decades of Japanese-style stagnation, nor could it survive an upsurge in inflation. Its legitimacy is based on its capacity to deliver economically, not on bankrupt communist ideology. Nor can it easily boost Chinese consumer spending without establishing property rights and proper welfare with the accompanying rise in taxes, an existential threat to the regime.
In any case, we do not live in multilateral, international deal-making times. The Doha round of trade talks has been deadlocked for a decade. There is no agreement on climate change. Effective nuclear nonproliferation remains elusive. In the EU, member states take their cue from Eurosceptics jealously protecting national sovereignty. Unless something changes dramatically, it is hard to see how China and the US can do anything else but remain, at best, deadlocked, at worst, sliding towards economic war.
Britain should be doing all in its power to avoid this disaster and to have a plan B to protect itself if disaster strikes. We should be offering to play our full part in any world deal to buy time for the US and China to change, while making sure we can act fast and flexibly to respond to a climate of beggar-my-neighbour trade and currency policies. The spending review should have been framed to allow Britain to play its part in boosting world demand, help the world arrive at the compromises necessary to sustain economic order and make our recovery more secure. It will not be. The coalition has many admirable aims and that two political parties can work together so effectively is refreshing. But everything is being put at risk by once again kowtowing to the gods of financial orthodoxy. That was always wrong in the past. It is no less wrong today.
Copyright Speakers Corner 2017