Political Economist

The widening gap between the rich and middle-class Americans is undermining political support for free trade in the US, the president of the Federal Reserve Bank of New York, warned on Thursday.

Tim Geithner told the Council on Foreign Relations that the “political challenge” of sustaining support for further global economic integration “may be the most important economic challenge of our time”.

The New York Fed chief also warned that the inflow of surplus savings from abroad could be distorting US asset prices and keeping risk premiums artificially low across financial markets.

His comments were made amid growing concern in US political and business circles over the risk of a populist backlash against free trade caused by rising inequality and a protracted period of stagnation in median wages – the wages earned by the average US worker.

While recent data show real wage growth has at last picked up, many economists fear this could be short-lived.

Mr Geithner said maintaining support for open markets would be made more difficult “because of what has happened to the distribution of income and economic insecurity”.

He cited as big political problems the “long-term increase in income inequality”, the “slow pace of growth in real wages for the middle quintiles of the population”, increased volatility in income and the greater exposure of families to risks involved in financing retirement and healthcare.

Echoing views expressed by Larry Summers, his former boss as Treasury secretary in the Clinton administration, Mr Geithner said it was “not enough to explain that globalisation is inevitable” and protectionist policies were self-defeating.

Better education and an improved safety net were a “necessary part of the solution to this challenge”. But, he warned, “these reforms will have a long fuse and they may not yield the hoped-for increase in support”.

Mr Geithner cautioned that the low level of risk premiums across asset markets was “unusual” and might not prove lasting.

He said there were many sound reasons why risk premiums might be low, including better monetary policy, strong underlying productivity growth and better risk-sharing across more globally integrated financial markets.

But he warned that the inflow of surplus savings from abroad – including “very substantial official accumulation of dollar reserves” by countries seeking to maintain fixed exchange rates – could be distorting asset prices, sending the wrong signals to savers and investors.

Mr Geithner said these forces were “surely transitory” but could “mask or dampen the effect on risk premiums in financial markets that we might otherwise expect”, given the huge US trade deficit and its long- term fiscal challenges.