| "Global imbalances" have become a hardy perennial on the international conference circuit for senior finance mandarins of governments and international financial institutions, as well as academic economists. For several years, a majority of both sets of attendees have issued dire warnings for the world economy if the imbalances are not moderated. Yet the world economy continues to power ahead at 5 per cent per year, while the imbalances continue to increase. What's going on? On the strength of participation in one of these international seminars on the subject (typically in salubrious locales: this one was at a Cape Cod resort in Massachusetts), let me share a few thoughts. |
| What's the problem of "global imbalances"? The most prominent symptom or yardstick is the steadily increasing current account deficit in the balance of payments of the United States, which has risen from $114 billion (or 1.5 per cent of GDP) in 1995 to $805 billion (or 6.4 per cent of GDP) in 2005 and is projected to rise further in 2006. This scale of sustained and rising deficits has never before been experienced by the US (or any significant industrial nation). Just think. In 2005 the world's biggest and richest economy took in $800 billion of savings by the rest of the world. In the five years 2001-05, the foreign savings absorbed was nearly $3 trillion, turning the globe's single superpower into a significant debtor nation. This outcome is quite contrary to what textbooks predict (savings will flow from capital-heavy, rich countries to capital-starved, poor ones) and to the Pax Brittanica decades, when imperial Britain was a major net creditor channelling savings to the empire. The present, unprecedented foreign savings inflow into the US has been described as the largest programme of "external assistance" in history, with the notable flaw that the recipient is the most powerful economy on earth! |
| Associated (but not congruent) with this peculiar phenomenon of capital "flowing up the hill" is the increasingly lopsided pattern of international reserve holding. In the past four years, global foreign exchange reserve holdings have increased by over $2 trillion, of which China alone accounted for nearly $600 billion and the rest of "emerging Asia" and Japan for about $400 billion each. The bulk of international reserves are held in the form of US government treasury bills and bonds with pretty low yields. Thus poor Asian countries (and Japan and some oil exporters) are working hard to generate surpluses, which they are "investing" in low-return US government liabilities. Again, an odd outcome, to put it mildly. |
| Aside from being very peculiar, the recent trajectory of global finances is also fraught with serious risks. First, almost everyone recognises that the pattern of large and growing US current account deficits cannot go on for ever. Sooner or later, there has to be "adjustment", brought about through some combination of higher US savings (or lower investment), higher investment (or lower saving) outside the US and a real depreciation of the dollar versus other currencies (equivalently a real appreciation of non-dollar currencies). The issue is whether it will be a "hard" or "soft" landing for the US and the world. Very likely, the longer the unprecedented trajectory of imbalances persists, the higher the risks of a disruptive hard landing, which could be triggered by a number of factors in world financial or real markets, not to mention war or pandemics. For example, a significant rise in US inflation could induce portfolio shifts away from dollar assets by foreign holders, thereby raising US and global interest rates, causing overshooting in currency adjustments and disrupting global production and trade. Second, the continued stickiness in China's real exchange rate, despite large and rising external account surpluses and reserves, could provoke US trade restrictions on China's imports and thus trigger a major trade war to the detriment of all. |
| A more sanguine view of these imbalances is offered by some reputable economists (like Richard Cooper of Harvard), who focus on the surplus side of the imbalances. They emphasise that the US current account deficit has to be matched by surpluses elsewhere (barring an irritating statistical discrepancy). They note that in 2005, Japan and China each ran current account surpluses of about $160 billion, while oil exporters accounted for about $350 billion. Although the euro area was close to balance, Germany plus neighbouring Switzerland and the Netherlands boasted a surplus of $200 billion. These surpluses were driven by a combination of factors, including high oil prices, the tendency for high savings in aging societies (Japan and "Germany plus"), mercantilist trade policy (China) and relatively weak domestic systems for financial intermediation (China, Japan and oil exporters). In this view, the surpluses are the driving force behind global imbalances (remember Ben Bernanke's "savings glut"?). Moreover, the surpluses could persist (if not grow) for a few more years, after which market forces will bring about a "soft landing" adjustment. |
| Well, may be. But I recall Larry Summers' warning in his L K Jha memorial lecture earlier this year: "the moment of maximum risk comes precisely when those concerned about sustainability lose confidence in their views as their warnings prove to have been premature and when rationalizations come to the forefront". To me, there seems to be both merit and safety in the more mainstream advocacy of a set of policies which look sensible (in themselves) for key country groupings and which also gradually reduce global imbalances. What are these policies? First is a reduction in the US budget deficit, which would improve US macro balances and help reduce the current account deficit. Second is a shift in favour of domestic demand (and away from exports) in China brought about by some combination of an appreciation of the renminbi and higher domestic consumption. Third is the standard IMF recommendation for structural reforms in Europe, which would stimulate higher investment, growth and external deficits. Fourth is a range of energy policies to encourage higher conservation and faster development of non-oil substitutes. Last is a call for policies to strengthen systems of financial intermediation in all major countries (outside the US) and especially in the "structural surplus" countries, so that more of national savings "gluts" are productively deployed within national boundaries. |
| The author is Honorary Professor at ICRIER and former Chief Economic Adviser to the Government of India. The views expressed are personal |
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