Sovereign is he who successfully insists he is exceptional

This is another peeve post spurred by a customary irritant—trade policy and the alleged impact of free trade on developed countries. But it will also go into something I’ve been thinking a bit about over the last year or —the US and its notions of sovereignty.

Anyway the trigger here was a post (Bloot?) by Michael Pettis arguing, along lines already set out by Dani Rodrik in the early 2000s — that globalization had led to a loss of economic sovereignty in the US. As Pettis describes it, countries pursuing persistent trade surpluses are shipping both their surplus goods and their surplus of savings into the US, effectively making the US less sovereign in terms of the economic policies it might pursue.  This is a natural consequence of his well-known belief that the size of the US trade deficit is not determined by US policies but by policy choices regarding the balance of between consumption and savings elsewhere in the world. For my part, I have remarked that this argument is a) inferring causation from an accounting identity and b) conflating the ABSENCE of an external financing constraint on the US with the IMPOSITION of a positive constraint to react passively to other countries’ choices.

I have long had many issues with this argument above and have expounded upon them at greater length but let me just make some quick points regarding the types of economic sovereignty the US does retain in the face of large and putatively undesirable inflows into US markets.

The US can intervene in FX markets to prevent dollar appreciation, not just via the Exchange Stabilization Fund, but potentially through the Fed, which could at various times cite its employment mandate; its inflation mandate in the event of excessive imported disinflation; or its financial stability mandate if such inflows are causing a risk of excesses in pockets of the markets

It could use the dampening of domestic interest rates increases —presumably the corollary in bond markets to an undesired appreciation of the dollar  in currency markets— to engage in fiscal policy measures that might increase the sophistication of certain portions of the tradeable manufactures mix, thus reducing their FX-sensitivity.

It could use such inflows to finance fiscally-led improvements in the US’s most problematic non-tradeable sectors such as housing, healthcare, or working conditions for low-wage non-tradeable services. This might not alleviate concentrated political backlash in those portions of the tradeable sector most exposed to import competition, but would at least improve the lives of the considerably larger number of households engaged in nontradeable activites in what is the least open of the big 3 economies.

As Brad Setser tirelessly reminds us, it could rewrite the Tax Code to limit not just transfer-pricing tax arbitrage but also the offshoring of jobs that goes with it. For my part, despite my appreciation of the enormously beneficial global impacts of ULC arbitrage as a development strategy, I’m less troubled in this particular instance because the tax arbitrage is vexing, and employment/tech convergence effects probably hits developed countries like Ireland (perhaps the biggest beneficiary) less hard than real EM.

It could/could have taken the occasion of the drop in energy prices in the mid-2010s to impose an economy-wide carbon tax (much as countries like India and Indonesia took that as an opportunity to withdraw fuel subsidies). This would have accomplished a couple of things —First, it might have changed incentive structures in the automotive sector in the direction of not just greater fuel efficiency, but also of convergence with automotive preference in the rest of the world, leaving the US less of a Cenozoic Continent when the EV revolution came around. Second, it would avoid the embarrassment of having to explain to the WTO why a country without a countrywide national carbon pricing mechanism is imposing a carbon-adjustment mechanism at its border. Not that the latter matters—the US will maintain its sovereign right to ignore any ruling and face no consequences for this, having already blown up the Appellate Body.

As the last bit of snark suggests, it might well be the case that any or all of the remedies/adjustment mechanisms above are politically tricky (or impossible), but that really ought not to be confused with an erosion of sovereignty. Because for real erosions of economic sovereignty, we must look elsewhere—in emerging markets or possibly (and more trickily) in the Eurozone.

And I am trying to make two points here. The first is that it would be foolish to believe that all countries are equally sovereign in the face of pressures that come either from countries in the international system or from global financial markets. Soem are just most “sovereign” than others, which in turn might affect how one thinks about Rodrik’s “Globalization, Democracy, Sovereignty” Trilemma. Or as Kris Kristofferson sang (in the song that was apparently a favorite of Abdurrahman Wahid — Suharto’s successor after the Indonesian etape of the Asian Financial Crisis) — Freedom is another word for nothin’ left to lose.

The second point is that short of being invaded and occupied, there are few things that are more destructive of a country’s sovereignty than being a deficit area that runs into balance of payments difficulties and then needs concessional assistance from the IMF or other IFIs. (Glad I already worked my Suharto reference into the previous paragraph).  But such assistance is only available on the basis of conditionality. The good thing is that the conditionality might be somewhat less exigent than what markets belatedly demand—the IMF typically asks for things next year that furious investors (whether the trapped kind or the “got out by the skin of their teeth” kind) belatedly realize they should have probably have asked for last year.

But these countries still have to put up with quarterly reviews on a huge range of macroeconomic, microeconomic and institutional targets. Sometimes they can plead extenuating circumstances or appeal ot geopolitical reasons to get off easier, but still it’s a pain. And acceding to conditionality is a task that is usually devolved to non-party technocratic PM or Finance Minister reliant on support from a multiparty majority whose components are torn between the specter of economic disaster now or political disaster at the next election. And that’s the lucky ones that eventual graduate from the program and return to the markets instead of exploding into full-on civil strife.

That dramatic exposition —which will nevertheless be familiar to anyone who has been around EM or the Eurozone in the last 25 years — is meant to do two things. First, to show complainers in the US what a real loss of economic sovereignty looks like. And secondly to reiterate a point that I have made repeatedly—it is precisely to avoid such balance of payments crises and the attendant loss of sovereignty that countries do the things that Pettis complains about as reducing American economic sovereignty.

This typically includes efforts to run persistent trade surpluses;  engage in reserve accumulation that might come alongside an “undervalued” currency; use ULC arbitrage to entice foreign firms onshore in order to gain productive plant closer to the technological frontier and achieve an export mix with high exchange-rate sensitivity. Or as I like to say—the Pettis Paradox is that any remotely competent EM policymaker who has read The Volatility Machine will naturally take the measures that lead to the world he and Matt Klein describe (complain about) in Trade Wars Are Class Wars. In other words, developing countries that have successfully negotiated Globalization 2.0, have not lost sovereignty in the international economic and financial order, they have gained it through the process.

Note that the travails cited a couple of paragraphs above typically happen to emerging countries running deficits. But they don’t happen to developed countries (that time when Truss lost market support was extremely amusing, but really doesn’t count IMO, even if I did make a joke at the time that the UK was a Kwasi-EM). And they certainly don’t happen to the world’s largest external debtor, the US.

And here it might be time to consider how little sovereignty the current international monetary, financial, and trading system costs the US at least in comparison with every other country on the planet. As Jacques Rueff pointed out almost 60 years ago, the ability to settle persistent deficits in a numeraire the US can produce at will allows it to run ‘deficits without tears” at least at an aggregate level (in terms of tears), if not at the level of single sectors on the wrong side of an import surge. And the sheer-size of the US market means that episodes of dollar weakness typically lead to lower inflation passthrough than in other countries because exporters would rather absorb a portion of the loss in their domestic-currency margins than lose market share.

But beyond this, because the US produces the world’s dominant numeraire for both trade and cross border liability issuance, it gets to control much of the access to concessional financing in USD by deciding on conditionality behind IMF programs and Fed Swap Lines. Its gets to surveil USD transactions anywhere in the world, and to impose primary and potentially secondary sanctions (i.e., not just on certain suspect users but also on those servicing said users). And these sanctions don’t even have to be triggered by USD-usage in the first instance—anyone transacting in any currency with a sanctioned entity is at threat of finding themselves cut off from the USD system.

Now one might argue that this is an extraordinary power and the US has by and large used it for good. Be that as it may (And I Have Questions About Some Of This), my point here is about sovereignty. And it seems extraordinarily clear-cut to me that the extent to which the current international, monetary, financial and trading system intrudes on or constrains the sovereignty of the US is utterly dwarfed by the extent to which said system not only constrains the sovereignty of most other countries but even allows the US to intrude on such sovereignty. There can  be little doubt that in terms of “net sovereignty” which one might think of as “doing unto others minus other doing unto you,” the US is far and away the most sovereign sovereign on the planet.

And although this asymmetry in sovereignty is most evident in the economic sphere, it is true elsewhere. I’ve tweeted here that one of the interesting things about the US role in the international system is that it’s domestic political system is extraordinarily jealous of ANY intrusion on its sovereignty. It is not a signatory to the Law of the Sea: not a member of the ICJ or the ICC; has insisted to a greater degree than others that the Article XXI National Security Exemption of the WTO is entirely self-judging; and so on. The thing to note here is that the US claims to be the upholder of the Rule Based International Order, but at the same time its domestic political culture is extremely careful to ensure that US adhesion to the RBIO in most circumstances is discretionary and de facto, rather than de jure (which might bind too much).

Like the Hobbesian sovereign the argument seems to be that in order to uphold the law, it must be above it. This will lead to all kinds of geopolitical/legal excursions that I’m not inclined to go on right now. But purely in terms of international economics, I want to say — stop already with this “free trade is reducing our sovereignty” boo-hoo.

Check your (Exorbitant) privilege.