Global Imbalances without Tears

CAMBRIDGE – Doctors have long known that it is not just how much you eat, but what you eat, that contributes to or diminishes your health. Likewise, economists have long noted that for countries gorging on capital inflows, there is a big difference between debt instruments and equity-like investments, including both stocks and foreign direct investment.

So, with policymakers and pundits railing against sustained oversized trade imbalances, we need to recognize that the real problems are rooted in excessive concentrations of debt. If G-20 governments stood back and asked themselves how to channel a much larger share of the imbalances into equity-like instruments, the global financial system that emerged just might be a lot more robust than the crisis-prone system that we have now.

Unfortunately, we are very far from the idealized world in which financial markets efficiently share risk. Of the roughly $200 trillion in global financial assets today, almost three-quarters are in some kind of debt instrument, including bank loans, corporate bonds, and government securities. The derivatives market certainly helps spread risk more widely than this superficial calculation implies, but the basic point stands.

Certainly, there are some good economic reasons why lenders have such an insatiable appetite for debt. Imperfect information and difficulties in monitoring firms pose significant obstacles to idealized risk-sharing instruments.