A V Rajwade: The politics of 'global imbalances'

It seems the real cause of 'global imbalances' is more US over-consumption than anything else.

It is politically incorrect to refer to the biggest threat to international financial stability, namely the United States' galloping and unsustainable current account deficit, by that name: the politically correct description is "global imbalances". Whatever the name, the deficit keeps rising inexorably. It reached $225 bn, or 7% of GDP in the last quarter of 2005. There are two ways of looking at the deficit""as the difference between current earnings from and expenditure incurred on the rest of the world through exports and imports, or as the difference between domestic savings and domestic investments. If savings are more than investments, the economy records a surplus on the current account, and vice-versa.

The largest bilateral deficit is with China. At $200 bn, it is also the politically most sensitive. As President Hu Jintao prepares for a state visit to Washington next week, there is enormous political pressure on the Chinese authorities to adopt a "more flexible" exchange rate regime""a euphemism for an upward valuation of the Chinese yuan""to reduce its bilateral surplus. Since the Chinese abandoned the dollar peg last July, the currency has so far appreciated around 3% against the dollar.

American politicians believe that it is the undervalued yuan and its "manipulated" exchange rate that are the root causes of the problem. The Chinese counter that by saying it is the structural savings-investment gap in the United States. Who is right? Is the root cause the yuan's exchange rate or the excess consumption in the United States? Martin Wolf, of the Financial Times, blames Asian savings, arguing that, "the driving force behind the global imbalances is Asia's structural savings surplus ... [the] US cannot safely diminish its excess spending if others do not diminish their excess saving at the same time" (March 29, 2006). Does Mr Wolf suggest that through its excess spending, the US is obliging Asia, by absorbing its excess savings?

Analysing the US savings-investment picture, one sees that while the corporate sector is a net saver, both the government and the household sectors are huge net dis-savers. As for the government sector, the two big drivers of the fiscal deficit have been Mr Bush's gargantuan tax cuts for the rich and the half a trillion dollars spent on the foolish wars in Iraq and Afghanistan. It is difficult to believe that, at the heart of these decisions, was the idea to help the Asian saver""what else would the poor fellow do with his savings, if the US did not cut taxes for the rich or start wars? To be sure, Chinese reserves, now exceeding $850 bn and the world's largest, are used to buy US treasuries which finance the fiscal deficits""so do those of other Asian countries.

As for the household sector, the excess consumption, which has led to record high credit card and mortgage loans, is partly a cultural factor, the race "to keep up with the Joneses", to satisfy ever more wants created by a clever advertising industry. (At least some of the excess consumption in the form of food has swelled into the world's first obese nation.) Once again it is difficult to believe that the American consumer is overspending and consuming even at the cost of his/her health, in order to help absorb Asian savings. In any case, the average American is innocent of much interest beyond his locality""just look at how locality-centric so much of US media coverage is!

What about the alleged, manipulated undervaluation of the Asian currencies, particularly the yuan? The issue is interesting for students of international finance, particularly in comparison with what happened a couple of decades back. A few points are worth making:

If the other currencies are undervalued, the dollar must be overvalued. By any basic economic logic, this should have a deflationary impact on the US economy, like slowing growth, if not a recession, rising unemployment, etc. (Indeed, this was the case in the background of which the Plaza Accord between the major economies was signed, back in 1985, aimed at a sharp fall of the US dollar""it is, of course, politically incorrect to refer to the Plaza Accord as a manipulation of exchange rates. Indeed, it was held as an act of great political and economic statesmanship.) The situation today is totally different. The economy is growing at above its long-term trend line and unemployment is at a five-year low.

Again, take the case of the EU surplus with the United States. It has almost doubled over the last five years, over which the euro has appreciated 50% from its lows of June 2001.

On balance, it seems to me that the real cause of "global imbalances" is not so much "manipulated" exchange rates or Asian savings as US over-consumption. But, politically, it is so much more convenient to blame the Chinese than ask the Americans to tighten their belts! To come back to Mr Wolf's argument, US over-consumption is not aimed at helping Asian savers; but it is undeniable that it creates Asian jobs and growth, albeit by taking a big risk""a hard landing through a sharp fall of the dollar, which would cut growth and the value of the reserves.

Tailpiece: In 2001, a Chinese steel company purchased the closed-down steel plant of ThyssenKrupp, one of the icons of German industrial might. A thousand Chinese workers came to Dortmund to dismantle the plant, document the place of every piece of hardware down to nuts and screws, and ship it back to China for re-assembly. The job took a year less than what the Chinese had estimated""and two years less than the German company's estimate. And, when the workers went back, the temporary living accommodation they were using was left spotlessly clean. Once fully operational, the plant is expected to give three million tonnes more output than what the Germans got.

Those who believe that Chinese competitiveness comes primarily from cheap labour, and an undervalued currency, are overlooking the superb, meticulous organisation of work""from supply chains to customer relationships.

avrco@vsnl.com