Ignoring the Biggest Mistake
Schmieding, Holger, Newsweek International
Byline: Holger Schmieding; Schmieding is European economist at Bank of America Securities Merrill Lynch.
The main threat to commerce is not old-fashioned tariffs or subsidies. It's that stricken banks are bringing money home.
Eighty years ago, three major policy mistakes turned the stock-market crash of 1929 into the Great Depression of the 1930s: a tight monetary policy, a restrictive fiscal stance and a wave of protectionism that paralyzed the world's greatest wealth-creation machine, the exchange of goods and capital across national borders. This time, central bankers and politicians around the world are deftly avoiding the first two mistakes.
However, there is a rising risk that a collapse in cross-border commerce could critically deepen and prolong the downturn. Countries are not shutting their borders to trade in the old-fashioned way through tariffs, import quotas or other such instruments of economic torture. Even the approaching avalanche of national subsidies to national producers, which can distort global competition as badly as tariffs do, is not the major threat to watch. At least in Europe, the key risk stems from an abrupt reversal of financial globalization. As stricken banks strive to bring money home, some of the cross-border flows of liquidity that grease the global production process are drying up.
To understand the issue, look at Europe's biggest economy, Germany. Household debt is low by international standards, and corporate balance sheets are healthy, with the ratio of corporate debt to annual gross value added at 204 percent, close to that of the United States (180 percent in 2007) and far below that of the euro-zone average, 243 percent. At first glance, Germany should not have been vulnerable to a credit crunch. Yet the German economy fell off a cliff in the final quarter of 2008, with the total value of goods and services produced contracting at an annualized rate of 8.2 percent, versus drops of 3.8 percent in the United States and some 5 percent in the euro zone outside Germany. Moreover, Germany exports just more than half of what it produces, and in December exports of goods had fallen by 14 percent below their average for the July-through-September period. Judging by the 24 percent plunge in export orders during the same period, worse is to come.
This is happening in Germany and other export-oriented nations because trade is intricately linked to finance. At the simplest level, some institution has to provide a financial bridge for the period between the production of a good in one country and the point in time when it is sold somewhere else. In normal times, and between countries and firms with a solid reputation, the financial side of such transactions hardly ever poses a problem. But times are not normal. …