The phrase global imbalances refers to the build-up of current account deficits and surpluses in the global economy that began in the 1990s. Five main explanations are offered for this situation. EXPLANATIONS
1. The global savings glut as
Asian economies saved more and invested less after the 1997/8 Asian financial crisis 2. The worsening US budget and BOP deficits and the steep decline in US household savings EXPLANATIONS -TWO 3. Emerging Asias export-led growth model relying on undervalued exchange rates and resulting in the rapid accumulation of huge foreign exchange reserves. 4. The oil price boom and the steep build-up of current account surpluses in oil exporting nations. Explanations - three 5. The attractiveness of U.S. financial assets, owing to their perceived high liquidity and sophisticated investor protection, created sustained demand for U.S. assets.
US ADJUSTS
It was and still is widely feared
that these imbalances would unwind in a disorderly fashion resulting in a run on the US dollar. But even before the onset of the global financial crisis, the US had begun to adjust MAJOR IMPROVEMENT
As US economic growth slowed so
import growth slackened, while the US dollar weakened, resulting in a strong improvement in the balance- of-payments on current account. The deficit in 2010 was less than half of that in 2006 (slide) US CURRENT ACCOUNT DEFICITS $ billions 900 800 700 600 500 400 300 $ billions 200 100 0 GDP GROWTH & the BOP It is important to see how the current account deficit and the The rate of GDP growth move together (slide). As growth accelerates the BOP deficit gets worse and when growth slows the BOP deficit falls. GDP growth (%.p.a.) & BOP Deficit (% of GDP) 7 6 5 4 3 GDP 2 BOP 1 0 -1 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 -2 -3 EXCHANGE RATES The dollar fell also in response to 6 developments: (a) The worsening BOP situation, (b) The subprime financial crisis after mid-2007 and (c) The fall of the US stock market. (d) Quantitative Easing (e) The 2011slowdown since April, and (f) The debt problem and the failure of the Administration and Congress to agree on a workable solution. DOLLAR FALLS
Between 2000 and 2008 the dollar
plunged 22% in real terms (slide). Since then fears that there would be a dollar rout were not realized and from Sept 2008 the dollar rebounded strongly. US$ Index: (1990 = 100) Index 140 120 100 80 60 40 Index 20 0 US$ DEVALUES 46% But the index figure of 84 June 2011 - is one of the lowest since the index series began in 1975. It is also 46% below its peak of 156 reached in 1984. That the US financial crisis became global was NOT the result of these global imbalances. Instead it was that highly leveraged banks in rich countries, some of them in surplus like Switzerland and Germany, as well as France and the UK, invested in so-called toxic (bad) US assets. When the US housing market crashed in 2008 these European banks were adversely affected. This is not to suggest that global imbalances had nothing to do with the subsequent crisis and recession. They did. Global imbalances were part of the global pattern of low interest rates and large capital inflows into U.S. and European banks. These fostered a buildup of leverage, a search for yield, and the creation of riskier assets and house price bubbles in the US and other industrial countries. But the failure of risk management in financial institutions and Weaknesses in financial supervision and regulation Played key roles in the crisis. GLOBAL REBALANCING THE GOOD NEWS The good news is that the financial crisis is contributing to tackling the global imbalance problem in 3 main ways: 1. Private savings are rising in rich countries as the credit and housing bubbles unwind. BUDGET DEFICITS Unfortunately, this welcome trend is being offset by growing public sector deficits. In major advanced countries the average budget deficit will be 8% of GDP in 2011 nearly four times what it was in 2006/7 2. Financial markets have tightened globally due to the massive losses of banks, as a result of which banks are deleveraging and reducing loans. This is also being offset by govts pumping credit into the money markets and rescuing banks. COMMODITY PRICES
3. Although the terms of trade
improved for most industrial countries because commodity prices, especially oil and food, fell relative to prices of manufactured goods, this has reversed in the past 18 months. REVERSAL Commodity prices have risen steeply relative to manufactures so that the terms-of-trade correction has reversed, and The sovereign debt crisis surfaced, starting in Greece as a result of the deterioration of public sector deficits mentioned previously. DEFICITS COME DOWN Oil country BOP surpluses fell steeply which helped to reduce total global imbalances. But this was shortlived and oil prices are have doubled from their low point at the end of 2008. The IMF calculates that global imbalances have fallen from 5.75% of world GDP in 2007 to about 2% percent in 2010 This reflects reduced current account imbalances in the US, oil- exporters and, to a lesser extent, Japan. THE SURPLUS COUNTRIES Nearly 1% is from a group of east Asian countries, led by China. Another percentage point is accounted for by Germany and Japan. The remainder is mostly the oil exporting countries. Asian and Middle East and other EM surpluses that fell during the recession are recovering as export demand and prices rebound. All of which means that the potential US dollar crisis has not gone away. DOLLAR CRISIS? Foreign investors may still not wish to hold US dollars China has several times expressed concern over this resulting in a run on the dollar. There are two reasons for thinking that this is unlikely 1. What is the alternative to the dollar Yen, Euro, gold? The answer is that at this stage - there is no viable alternative, and 2. Large holders of dollars do not want to sell into a falling market and thereby lose value. HOME BIAS STRENGTHENS? It could be that home bias will strengthen globally so that cross- border capital flows decline. This would make it even harder for the US to finance its deficit, while Many EMs and developing countries would also be unable to finance their deficits. IS CHINA REBALANCING? HOW? Theory holds that China must rebalance its economy by reducing its savings, investment and exports, and Importing and consuming more. Is that happening? TRADE SURPLUS FALLS China insists it is pointing to a 7% decline in its trade surplus in 2010 and The steep drop in the current account surplus, from 11% of GDP in 2007 to just short of 6% in 2010. But this 6% surplus is much larger than Japans 4% surplus in the 1980s which caused severe political and economic problems. Worse, there is no sign of any increase in Chinese consumption spending. In 2010 consumption made its lowest contribution to growth since 2003 and Also continued to decline as a share of overall spending. Growth in urban incomes, which was in double figures in 2009, fell to 7.5% in 2010. PARADOX This is the paradox of Chinas economy: Demand for modern consumer goods is rising sharply as urban Chinese get richer, but Consumption as a whole plays a smaller role than in any other large economy. MAKING CHOICES If it wants its economy to be export- driven then China has no choice but to accumulate dollars that have doubtful long-term value. The solution is to stop buying dollars and allow the Renminbi to rise in value. But this would mean that export-led growth would be much more difficult because the strong Renminbi would mean lower exports and higher imports. THE WAY FORWARD Three key components
There are three key components to
global imbalances: 1. The US deficit on both the budget (10% of GDP) and in the balance of payments (3%). 2. Chinas BOP surplus (5% of GDP in 2011), and 3. Oil exporter surpluses (0.5%) 1. The US Deficit For decades US economic growth has been consumer-led, driven by rising asset prices which made people think they were richer and By easy access to bank loans and other types of credit - Credit cards or buying cars on very cheap lease agreements SAVINGS SLUMP Consumer credit and residential investment (house-buying) rose from two-thirds of GDP in 1980 to three-quarters in 2007. Household saving rates collapsed from 10% of disposable (after tax) income in 1980 to virtually zero in 2007 DEFICIT PEAKS Household debt doubled from 67% of disposable income (1980) to 132% by 2007. As the US spent more than it earned so the current account BOP balance went from + 0.4% of GDP in 1980 to minus 6% (deficit) in 2006 which was the peak. Consumers are poorer
Following the destruction of $13
trillion in consumer wealth (collapse in house prices and equity prices) and The implosion of the banks, which used to supply much of the credit Americans have been forced to start saving with the latest figure back to 5% or 6% of disposable income. As a result some gloomy forecasts suggest that US consumer spending could drop from 70% to 63% of GDP or even lower. What would that mean?
The US would import less, especially
from China and other surplus economies; The dollar would - gradually strengthen; There would be a huge gap in the US economy that would have to be made up by investment plus exports The consumption collapse has changed the US economy radically, but while private saving has risen the budget deficit will still be 9% of GDP this year, implying massive dissaving by the public sector. GLOBAL ASPECT From a global imbalance view the US will no longer add to global growth but subtract from it, because of the steep decline in consumer spending. Surplus countries would have to fill the gap left by falling exports in their economies. So China, Germany and Japan must boost their own domestic demand to fill the gap created by the decline in the US demand. However this is not happening in either China or Japan, while the US is printing money to boost consumption. Japan tried the same tactic when its economy slowed in 1990; It boosted demand for a decade to replace the steep fall in domestic spending. But because - unlike Japan in the 1990s the US is already overborrowed. This means that public sector support will have to gradually withdrawn, but what will then replace it? One estimate is that consumer demand is going to grow at 2% a year far short of the average of 3.4% annually between 1993-2007. The lesson is that the US economy must rely more on exports and investment for its growth and much less on domestic consumer spending. But while this may happen it will take a long time and as a result the US economy faces a long period of slow growth with very high unemployment. There is a very real danger that the US will move towards greater protection to help its industries adjust to the new normal. DEFLATION ? Already analysts are saying that the signs are that the US recovery is going to be production-led, not demand-led. So who will buy what is produced? It is this that raises the spectre of deflation. Will firms have to cut prices - and jobs and wages so that they can sell their products at home and abroad? This could well happen and it would be a re-run of the 1930s all over again. THE 1930s
What happened then was that
world trade fell sharply and countries retreated behind tariff barriers to shut imports out of their markets, while Devaluing their currencies to win and maintain export markets. Recall: Y = C + I + G + (X M) So a fall in C, which was compensated in 2009 by a rise in G could also be replaced by higher I or By an increase in net exports X rising while M falls. Since the US govt will find it very difficult to increase G and I is unlikely to rise unless it does for export markets The answer lies as already suggested in higher net exports. To achieve this the US must improve its productivity and competitiveness, possibly also allow the dollar to devalue. CHINA 2. Chinas contribution to rebalancing the global economy is two-fold (i) It must expand consumption because its exports are unlikely to recover to previous levels, AND (b) It must allow its exchange rate to appreciate strengthen. In 2008 the Chinese surplus was some $400 billion or 10% of GDP which is unsustainable because it means other countries must be running deficits of the same amount. Adjustment is already occurring with the surplus halving between 2007 and 2010 to 4.7% of GDP (from 10.6% in 2007) and forecast at 5% in 2011. Another way of looking at this is the net export balance. ADJUSTMENT UNDERWAY
In 2008 net exports (X M)
accounted for 2.6% of Chinas 7.5% growth roughly a third. In 2009 net exports are estimated to have reduced growth by about 4%. Exports which were 35% of GDP in 2007 were around 25% in 2009. But this is only part of the story because the balance between consumption and investment in China is skewed and becoming even more so. In 2007 private consumption was 35% of GDP (70% in the US 50% to 60% in most other Asian economies and 80% in Zimbabwe). In China it was very much higher 50% - in 1990 Investment already high at 35% of GDP has since risen strongly to 70%. Most of this is going into real estate and some to infrastructure with the result that China is developing excess capacity in housing and infrastructure as well as in its factories. Consumption is low because savings are high The household savings rate is 28% of disposable income up from 20% ten years ago. But consumption is low also because a smaller share of national income is going to households. WHY? (1) Partly because as here in Zimbabwe the share of wages in GDP has fallen while that of profits has risen sharply. One reason for this is Chinas industry is becoming increasingly capital-intensive, so that a lot of investment generates relatively few jobs, but lots of machines. LOW INTEREST RATES
(2) Capital-intensive factories are
partly the result of very low interest rates that encourage firms to substitute machines for workers. Also, state-owned firms do not pay dividends so all their profits are available for reinvestment. Undervalued exchange rate
(3) A third point is that by holding
down the exchange rate, the govt encourages manufacturing, which is capital-intensive, relative to services which are employment- intensive. REVALUATION
Obviously, part of the solution from a
global imbalance viewpoint is to allow the exchange rate to appreciate. China would then export less and import more. In 2005, China abandoned its fixed exchange rate peg of the Yuan to the US dollar. By February 2009, the had appreciated by more than a quarter But then the govt panicked and re- pegged the currency to the dollar which has since fallen As a result, the currency (the RMB) fell along with the dollar. OVERVALUATION
At this level, a US study estimated
that RMB is between 15% and 25% undervalued. However over the last six months its exchange rate has started to strengthen rising some 4.5% in real terms. STRUCTURAL REFORMS However this needs to be put into perspective. Since mid-2009 the rate has depreciated (fallen) some 6% in real terms. China also needs to implement social and structural reforms. SOCIAL SPENDING China spends only 6% of GDP on education, health, social welfare and pensions compared with 25% in OECD countries. This helps explain why the household savings rate is high people save to meet social welfare costs, especially pensions. REFORMS On the structural side banking legislation needs to be liberalized so that state-owned companies are forced to borrow at market, not subsidized interest rates. The tax system that favours manufacturing against services should be reformed ELIMINATE SUBSIDIES
Along with laws that ban private
sector participation from some service industries. Industrial inputs should not be subsidized and state firms should pay dividends from their profits. BLAME THE US
It is easy enough to say what the
Chinese Govt ought to do, but there is very little likelihood that it will take much notice. Instead, the signs are that China will continue to point fingers at large deficit countries like US. TWO WAY STREET China argues that it not the responsibility of surplus countries to adjust but of deficit states. The latter reply by saying that they are adjusting faster and further than China, and that Adjustment is a two-way street 3.With the steep fall in the oil price, the third problem that of oil surpluses largely fell away. But as a group oil exporters remain in strong surplus and with the recovery on the oil price those surpluses will grow over the next year or two.
House Hearing, 110TH Congress - An Overview of The Compact of Free Association Between The United States and The Republic of The Marshall Islands: Are Changes Needed?