Americas Quarterly - Spring 2009

1929. Fiscal and monetary policies are as expansionary as anybody would have thought imaginable, so as to err on the other side of Hoover. But what are the likely mistakes of 2009 that policymakers and economists during the next crisis will be trying to avoid?

One possible candidate is the fact that the recapitalization and reflation is planned mainly for the U.S. domestic economy, while the problem and the borrowed resources are global. The current strategy constitutes an attempt to restart the global economy through a widening of the U.S. external deficit. Clearly, this is not the best way forward because it tries to solve one problem by aggravating another. It may cushion the fall now, but it will slow down the recovery later.

AP Photo/RicARdo MoRAes

If current trends continue, by 2011, the U.S. balance sheet will look pretty weak, given all the additional debt. Tax rates will need to go up, as is currently planned through the expiration of the Bush tax cuts. If by then the recession is not over, investors will feel much less sanguine about U.S. Treasuries and the super-borrower power may evaporate.

It seems reasonable to assume that if the crisis is global, the solution must also have a global character, even if the world has just a few super-borrower nations. A more sustainable alternative is to use the

super-borrower capacity to reflate the global economy and to re-establish financial links globally.

This would imply using the capacity to borrow to buy financial assets abroad, thus allowing other countries to expand their spending and investment. Through this approach, the balance sheet of the U.S. does not get worse: the additional debt is balanced by additional claims on foreigners, and the interest-rate differential will make the U.S. taxpayer better off. The additional foreign spending would seep into the U.S. through higher American exports, thus stimulating the economy in a more sustainable manner.

How To Get It Done

Global reflation can be accomplished in several ways. First, multilateral development banks should be recapitalized by having countries subscribe to new issues of callable capital (i.e., de facto guarantees). This will allow the IFIs to raise funds in global capital markets, which they can then lend to the credit-starved developing world. For Latin America, this would imply a recapitalized World Bank and Inter-American Development Bank (IDB).