Two cheers for globalization

Where the economy is concerned, there are two big current realities in the United States. Everyone seems happy that America is finally moving away from what is broadly seen as the at minimum na?ve and at maximum dangerous folly of globalization. At the same time, everyone is also worried about whether America can nail a soft landing from the highest inflation and highest interest rates in decades.

What seems much less widely appreciated is the connection between the two.

Correlation is not causation. But a simple exercise in connecting the dots strongly suggests that, while concerns about job losses and national security risks are real, globalization nonetheless helped promote stable prices and low inflation. Conversely, the current wave of de-globalization will likely bake in higher inflation and interest rates long after we exit our current economic challenges.

So here’s two cheers for the globalization of the past few decades:

• Low inflation: The opening of the American economy to emerging markets reduced the cost of goods and services for American consumers, helping keep prices low and stable
• Low interest rates: The integration of American and international financial markets allowed countries with high savings rates to subsidize American borrowing by buying U.S. debt, helping keep interest rates low

Here’s a plotted four-part economic history of the United States since the last period of high inflation and high interest rates in the early 1980s.

1.?Imports into the U.S. doubled as a percentage of GDP from the depths of the 1980-1982 recession until the 2008-2010 global financial crisis, before falling significantly in the past decade (Source: World Bank).

After the Volcker recession, the Reagan administration (in addition to tax cuts) began systematically to open the U.S. to global trade in the mid-1980s. This opening accelerated in the 1990s under Bill Clinton, first signing the original North American Free Trade Agreement (now called USMCA) in 1993, then championing the creation of the World Trade Organization in 1994, and finally supporting China’s accession to the WTO in 2001. In the decade that followed, American multinational firms as different as Apple and General Motors took advantage of this freer trade to create global supply chains and distribution networks, making things as efficiently as possible and lowering costs for end consumers.

2.?After the double-digits of the early 1980s, U.S. inflation dropped to under 5% by the late 1980s, and stayed well below this level for the next thirty years (Source: U.S. Bureau of Labor Statistics).

For champions of independent central banks, the U.S. Federal Reserve plays a starring role in this remarkable American inflation success story. From this perspective, it was the inflation-fighting credibility established by of the Volcker Fed, forged in the white heat of stagflation (simultaneous double-digit inflation and unemployment), that set the stage for the subsequent decades of price stability.

But the role played by the rise of lower cost products made outside the U.S. but made readily available to American consumers - from clothing and furniture to smartphones and solar panels – deserves more than a bit part in America’s remarkable low inflation success story.

3.?Foreign holdings of U.S. government debt have risen at an ever-accelerating rate from the early 1980s to the early 2020s (Source: Federal Reserve Bank of St. Louis).

The U.S. has long been a country of spenders not savers. Whereas other countries, particularly in Asia and above all China and Japan, save more than they spend. This created a virtuous circle for American interest rates as the U.S. opened its capital account to the rest of the world beginning in the 1980s.

Foreign investors and foreign governments bought U.S. government bonds as a secure way to protect their assets. In turn, this increased demand for American debt lowered interest rates across the board, allowing consumers to borrow money much more cheaply than would otherwise have been possible. Former Fed Chair and Nobel laureate Ben Bernanke called this the “global savings glut” of the 2000s.

4.?U.S. interest rates dropped from nearly 20% in the early 80s to 10% by the end of the decade, then trended down all the way to near zero after well after the global financial crisis (Source: Federal Reserve Bank of St. Louis).

The impact of the global savings glut is clearly evident in U.S. interest rates. Despite the mushrooming public debt from 30% of GDP in the early 1980s to 60% before the financial crisis and to 120% today – which should have put immense upward pressure on U.S. interest rates – the Fed funds rate kept dropping from the 1980s into the 2010s.

There are two simple conclusions from these four graphs. First, the offshoring of goods and services to emerging markets, above all to China, systematically lowered prices in the United States. Second, the integration of financial markets between high-savings countries, led by China and Japan, and low-savings America systematically lowered interest rates in the United States.

Just about the only things Democrats and Republicans agree about today is that they are worried about China and that they want to reduce the U.S.’s economic dependence on other countries. This is invariably framed in terms of creating jobs at home and protecting national security. What is less often said is that this will lower the efficiency – and increase prices – in goods and capital markets.

While concerns about job creation and national security are no doubt well founded, we should not lose sight of the reality that de-globalizing will have real costs, not least in terms of higher inflation and higher interest rates.