Uncertainty Shifts to China

As long as imbalances of world trade and capital flows unwind slowly and smoothly, the magnitude of global economic distress should be relatively small. However, under two plausible scenarios – both concerning China – the unwinding of global imbalances could cause regional if not global depression.

Now that the dollar has dropped 43% from its high against the euro, the process of global financial rebalancing is seriously underway. The United States’ trade and current account deficits have begun to shrink relative to American and world GDP. Asian current account surpluses are about to start to shrink as well, especially if growth slows markedly in America in the aftermath of the end of its housing boom.

At the moment, Europe is feeling most of the pain, as the euro’s value has risen furthest and fastest against the dollar. But Latin America and Asia will start to feel distress as well, as the decade-long US role as the global economy’s importer of last resort comes to an end.

As long as imbalances of world trade and capital flows unwind slowly and smoothly, the magnitude of any global economic distress should be relatively small. Of course, it will not seem small to exporters and their workers who lose their American markets, or to Americans who lose access to cheap capital provided by foreigners. But the next few years are certain to bring up a more threatening and more serious political-economic problem than the unwinding of global imbalances.

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