Sunday, November 23, 2014

A Requiem for Global Imbalances

BERKELEY – The start of 2014 marks ten years since we began fretting about global imbalances, and specifically about the chronic trade and current-account imbalances of the United States and China. A decade later, we can happily declare that the era of global imbalances is over. So now is the time to draw the right lessons from that period.

America’s current-account deficit, which was an alarming 5.8% of GDP as recently as 2006, has now shrunk to just 2.7% of GDP – a level that the US can easily finance from its royalty income and returns on prior foreign investments without incurring additional foreign debt. Even more impressive, China’s current-account surplus, which reached an extraordinary 10% of GDP in 2007, is now barely 2.5% of national income.

There are still a few countries with worrisomely large surpluses and deficits. Germany and Turkey stand out. But Germany’s 6%-of-GDP surplus is mainly a problem for Europe, while Turkey’s 7.4% deficit is mainly a problem for Turkey. In other words, theirs are not global problems.

Back in 2004, there were two schools of thought on global imbalances. The Dr. Pangloss school dismissed them as benign – a mere reflection of emerging economies’ demand for dollar reserves, which only the US could provide, and American consumers’ insatiable appetite for cheap merchandise imports. Trading safe assets for cheap merchandise was the best of all worlds. It was a happy equilibrium that could last indefinitely.

By contrast, adherents of the Dr. Doom school warned that global imbalances were an accident waiting to happen. At some point, emerging-market demand for US assets would be sated. Worse, emerging markets would conclude that US assets were no longer safe. Financing for America’s current-account deficit would dry up. The dollar would crash. Financial institutions would be caught wrong-footed, and a crisis would result.

We now know that both views were wrong. Global imbalances did not continue indefinitely. As China satisfied its demand for safe assets, it turned to riskier foreign investments. It began rebalancing its economy from saving to consumption and from exports to domestic demand.

The US, meanwhile, acknowledged the dangers of excessive debt and leverage. It began taking steps to reduce its indebtedness and increase its savings. To accommodate this change in spending patterns, the dollar weakened, enabling the US to export more. The renminbi, meanwhile, strengthened, reflecting Chinese residents’ increased desire to consume.

There was a crisis, to be sure, but it was not a crisis of global imbalances. Although the US had plenty of financial problems, financing its external deficit was not one of them. On the contrary, the dollar was one of the few clear beneficiaries of the crisis, as foreign investors, desperate for liquidity, piled into US Treasury bonds.

The principal culprits in the crisis were, rather, lax supervision and regulation of US financial institutions and markets, which allowed unsound practices and financial excesses to build up. China did not cause the financial crisis; America did (with help from other advanced economies).

This is not to deny the enabling role of international capital flows. But the flows that mattered were not the net flows of capital from the rest of the world that financed America’s current-account deficit. Rather, they were the gross flows of finance from the US to Europe that allowed European banks to leverage their balance sheets, and the large, matching flows of money from European banks into toxic US subprime-linked securities. Both critics and defenders of global imbalances almost entirely overlooked these gross flows in both directions across the North Atlantic.

The next time that global imbalances develop, analysts will – we must hope – know to look beneath their surface. But will there be a next time? A couple of years ago, forecasters were confident that global imbalances would reemerge once the crisis passed. That now seems unlikely: Neither the US nor China is going back to its pre-crisis growth rate or spending pattern.

Nor are earlier trade balances about to reemerge. America’s trade position will be strengthened by the shale-gas revolution, which promises energy self-sufficiency, and by increases in productivity that auger further re-shoring of manufacturing production.

Emerging markets, for their part, have learned that export surpluses are no guarantee of rapid growth. Nor do large international reserves guarantee financial stability. There are better ways to enhance stability, from strengthening prudential supervision to taxing and controlling destabilizing capital flows and letting the exchange rate adjust.

All of this suggests that the accumulation of foreign reserves by emerging and developing countries – another phenomenon over which much ink has been spilled – may be about to peak. Then it will be just another problem laid to rest.

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    1. CommentedGerald Silverberg

      What Eichengreen neglects to mention is that the Eurozone, through its policy of internal devaluation and austerity since the Greek crisis 2010, has moved from a balanced current account to an almost 3% surplus while contracting imports in aggregate. This policy of exporting deflation introduces a new element in the imbalance equation, which thus has not gone away, just changed character from a China+EM/US imbalance to a EZ/EM one.

    2. CommentedJonathan Lam

      Gamesmith94134@ The Anatomy of Global Economic Uncertainty
      In the search of the optimal paradigm for the four dynamics as in economic and financial or social and political, after the lender and debtor placed in growth and development we can see the clear distinctions on globalization, profitability, and balance of payments are pretty extreme; especially when the basis of the exchange in its value of currencies or durable goods like the real estate, or resources like oil changes. They do created the uncertainty on how we saw in the historical values integrated with change on the status from the globalization, profitability, and balances of payment. Perhaps, when we observe the deleveraging on the value of the economical advances or the currencies after the liquidity turned to solvency problems; and the exchange rate on the currencies made sit worsen on the restoring the historical values-----uncertainty on the value of the currencies made the foundation of the present exchange system collapsible even after the Libor rate principle is no longer relevant from the changes in globalization, profitability and the balance of payments.
      At first, we would question the title of the “Consumer of the World’, America and the merging of the European Union after the 92’. It sounds as the game of monopoly in the stock and commodity markets. It was the price market that most emerging market nations attempt to catch up with the economical growth by offering its labors and cheaper currencies; and the economical giants like US and EU were taking advantages of the profitability; but they gave up the industries that utilized its human resources by prompt on the raising salaries on the high end industries they sustained, and the government themselves shared their profits with government workers like teacher, policeman and fireman, and the growth push the cost of living standard forward the most labors were benefited from the surge. When their high end jobs missed their competitions from the emerging market nations, the balance of payment was default with deficits. Since the Western world is short on the political will to adjust and deprive the inflation, the liquidity traps were set in the quantitative easing with more bonds to sell.
      Perhaps, the key point was the excessiveness of the funds created after the issuance of the bonds with less of equity backings. Then, they accompanied with the financial establishment like banks boomed with the inflated pricing, hoping the emerging market nations accept its inflation by raising its currencies rates to exchange instead of harvesting the surpluses. Consequently, these issues were not purchased by investments of its people nor corresponded by the revenues of its government. Thus, it created the sovereignty debt that the foreigners must pay as the bearer of the issuance of these bonds. It went on to build up the price on stock or commodity; but the interest rate was mutated by its anemic growth in the developed nations; and inflation hit the emerging market nations with hike on the labor cost. Then, in due process, sovereignties are separated in the globalization after the fact on the political ends; while the debtor nations shirked with its debt, and the emerging market nations restricted the floating rate from inflation. It is why globalization was not a part of free trade in the sake of sovereignty under its protectionism.
      However, the bond issuers had applied the liquidity instead of solvency to the deficits or create growth, in reverse, they also developed the bubble in the stock and commodity market and the exchanges rates with their suppression of the interest rate to growth variation that the funds were created had no basis for growth, and its currencies were devalued. Then profitability was questionable on the displacement of time and value as it were; when the interest rate was under the spell of monopoly, that neither dollar nor Euro was the only alternative in storage of value in free will either. Soon as the deficit surface, the secondary storage, like real estate or commodity does not reflect the value of the future. The market collapsed on the demand of the appropriate compensation with hike of interest rate. With lesser success to improve the exchange in the bonds, the credits dragged on to the financial, that most medium business structure suffered most of the credit crunch. Then, profitability is limited on the established business and the medium business lost its profitability from the cash it must store or raise more to survive rather to gain. Since the anemic growth will continue globally and inflation hit harder to the labor cost for those exposed to the profitable nations and developed establishments. ..then, the credit crunch set in for the ordinary working class too in amending the balance of payment, from his credit card to home mortgage. Eventually, his job is hanging by a thread due to the eroding job market and the other is fighting inflation with low rising income or wages.
      Perhaps, we are identifying a limited set of explanatory variables in what statisticians call “a reduced-form equation”, from the changes in the value line that flip flap in the merging globalization how each is sensitive to inflation and deflation; or, how profitable is each investment we are involved whether it is stocks, commodities or bonds may not be depended on the outcome but how it would evolved relatively to others like the exchange of the currencies; or it is more depandable on the reveiws on the balance of payments from the soveriegnties, and from average working class as well, since the present political environment is much vulnarable to change whether it was keynesian or socialististic. It is hard to tell how we value on the currencies or the government is soaked in the welfare state, and is coming to drown itself. Finally, I am looking forward in the next years in the settlement of the Euro and its sovereignty debts; and how the Western world looking at the globalization by fending off China or reminbi which had already set from the watermark of the global economy, and it is not going away. However, I would expect another new world order that is much stabler than the Euro-dollar rule, in the multi-speed, and multi-currencies Zones mode, which will extended its protection on its sovereignty power and currencies in running its domestic financial and global financial; so, monopoly or hegmony is no longer relevant in our civilized community and financial world.
      May the Buddha bless you?

    3. CommentedJose araujo

      I think there is still a strong view in economic politics and in the public mind that favors Imbalances that led recently to the resurgence of mercantilism.

      The idea that growth is a zero sum game, and that in order for a country to develop other country has to suffer, is very powerful and isn’t going away soon.

      The current economic mindset favors this mercantilist views. We are bombarded almost every day with the need to lower wages in order to keep our countries competitive to reduce internal demand so we can balance our accounts and accumulate more “gold”.

      IMHO we are very far away from having a “normal” discussion about this views. How free trade and free capital flows can hinder the development of a nation, how regulation is needed, not only for market stabilization but for development guidance.