Is the United States at long last getting
serious about global imbalances, or are we risking currency wars that
can end in unmitigated disaster for all? No one knows, though tension
is on the rise with China. This much is certain: any advantage from a
lower currency is a zero-sum gain for the world economy as a whole. At
best, it is about how to distribute the pie, not about growing it.
Until recently, many economists were not sure if global imbalances were
something to be worried about at all. If markets always worked efficiently
as most economists had accepted as an article of faith before the crisis,
there had to be a rational explanation as to why these imbalances were,
if not a blessing in disguise, at least, an innocuous outcome. Clearly
capital was flowing into the United States from the rest of the world
for a reason. Maybe it was the benefits of the deep, highly liquid, and
efficient U.S. financial markets the foreigners were taking advantage
of, or perhaps they were simply trying to invest in the bright future
that was awaiting the United States because of its superior productivity
growth.
Some even argued that the imbalances were simply an illusion created by
poor accounting, a result of the failure to capture the true value of
the financial services the United States was "exporting" to
the rest of the world. These were the optimists, the true believers in
the wisdom of the market, who did not think much, if anything, had to
be done.
Then there were the pessimists who feared that foreign demand for U.S.
financial assets would sooner or later fall short of what was needed to
finance the rapidly growing current account deficit. They differed on
how imminent the danger was and on what shape a hard landing would take,
but, invariably, a run on the dollar and prohibitively high interest rates
were the opening acts in their list of possible bad scenarios. They all
agreed that sooner or later the United States would need to save more
and that it would help if China stopped manipulating the value of its
currency.
Unsurprisingly, the more optimistic arguments began to wear thin as early
as the bursting of the dotcom bubble, only to die out completely after
the financial crisis. The argument that the U.S. stock market boom in
the late 1990s reflected booming productivity growth, and thus rational
expectations about a much higher level of future income in the United
States, was hard to maintain even after the dotcom debacle but yet managed
to survive until after the financial crisis. Likewise, the argument that
the surge in house prices reflected improvement in their quality-the redone
kitchens with Italian marble countertops, etc.-quietly petered out only
after the real estate bubble burst.
But the financial crisis has raised questions for the pessimists as well.
Most notably, the crisis was not triggered by a run on the dollar caused
by a disorderly unravelling of global imbalances as many had feared, but
instead by problems that had to do with the market provision of liquidity
within the financial system itself. For instance, it was hard to discern
a direct connection between the purchase of toxic U.S. mortgage-backed
assets by foreign banks which transmitted the crisis to Europe in its
decisive initial phase and the financing of the U.S. current account deficit.
It hardly seemed to be the case that the crisis would have been prevented
had the major players undertook a coordinated timely policy intervention
targeting global imbalances.
Despite these questions, the pessimists' basic understanding of global
imbalances appears to have survived the crisis intact to become the conventional
view today. The following are its basic tenets:
- imbalances are the ultimate cause of the crisis;
- they are the result of overspending mainly in the United States and exacerbated by the undervalued currencies of East Asian surplus countries;
- one way or another spending has to fall in deficit countries and rise in surplus countries; and,
- taking steps to enhance exchange rate flexibility would help to achieve that end.
None of this is new, of course, but one addition that is missing above
has been the emphasis on the importance of financial regulation. Previously,
overspending used to be blamed on government budget deficits, but after
the crisis another culprit emerged: the failure of financial regulation
to detect and prevent frothing credit growth which made it possible for
households to over-consume.
Imbalances versus Recovery
Now that the finance bill has passed, the Obama administration and the
U.S. Congress seem to be turning their attention to the surplus countries'
role in global imbalances. If only China would let the renminbi appreciate,
they seem to be thinking, China would save less and the United States
would save more, causing global imbalances to shrink. Of course, the pain
that would imply is often ignored. Cutting down global imbalances today
would require cutting down demand in the United States in the midst of
an anaemic recovery, which is clearly counterproductive.
Economists often talk from both sides of their mouth to deal with the
problem: raising spending is advisable in the short run to revive growth
when in a slump, but needs to be curtailed in the long run when growth
is restored. The trouble is that the short-run fix takes us further away
from the long-run target, without any clear idea how we are to go from
the former to the latter. For instance, during the thick of the crisis,
there has been a significant reduction in the size of global imbalances
along with a drastic, steep contraction in world trade. Yet, with the
partial revival of trade since the recovery, global imbalances have begun
to widen again. Does it then follow that the world is farther from a solution
to its structural ills today than when it was at the bottom of its slump?
Arguably, the conventional view offers little policy guidance for here
and now.
It is possible that the conventional view also fails at a deeper level,
for it assumes a world that no longer exists. It implicitly presupposes
an international economy consisting of distinct national economies with
their own separate systems of financial intermediation that are tied to
each other mainly through trade. In other words, it assumes a world where
financial assets are traded to move the goods; a world where central banks
control credit growth; a world where the current account rules the roost.
None of this of course is consistent with the increasingly transnational
world we now inhabit. The expansion of cross-border financial transactions
began to outstrip the expansion of goods trade as early as the 1970s,
but their increase with the rapid acceleration of financial globalization
since the 1990s has simply been spectacular. In this new world, it is
misleading to assume that the asset trade is still auxiliary to the goods
trade.
All of this suggests another way of looking at global imbalances which
can give a very different understanding of the nature of the problem we
face. Think of Bernanke's "savings-glut" thesis-and, ignore
its frequent Pollyanna-ish use. It basically says that the U.S. credit
boom that led to overconsumption, and thus the ballooning trade deficits,
was in turn caused by money flowing into the United States from the rest
of the world through its capital account. In other words, it was ultimately
the capital inflow that fuelled the credit expansion and brought long-term
interest rates down, making it possible for U.S. households to overspend
and thereby be the engine of world growth.
Note that in this view what needs to be done to restore world growth is
not as obvious as in the conventional view. Here, the overspending in
the United States, along with the trade deficit it gave rise to, appear
as a "solution" to a deeper problem involving excessive savings
in the global economy. Thus, one could even say that the real estate boom
in the United States was perversely functional in creating a source of
demand that forestalled the deflationary effect of excess savings for
as long as possible. In other words, the trouble was not with global imbalances
per se, but the unsustainable way they were being recycled and what they
were used to finance.
Because U.S. households and banks continue to face an ongoing threat of
insolvency, personal saving has been rising markedly since the crisis.
The adverse effect of this on aggregate demand has so far been partially
offset by a sharp increase in public spending (or dis-saving). Now that
recovery is supposedly well underway, the conventional view calls for
cutting public dis-saving so that the U.S. trade deficit can be reduced.
Yet, that is a recipe for disaster-it risks much higher levels of unemployment
than what we have now. It also aims at returning to a world as it was
before globalization, which probably cannot be achieved if at all without
first going through a global slump comparable only to the Great Depression
in its length and depth.
There is Another Way
Yet soldiering on with more public stimulus to "jump-start"
the economy that only widens the twin deficits is not really a viable
option either. Even if the fears about a sovereign debt crisis in the
U.S. are wildly overblown, the fear is real and will impair the effectiveness
of continued use of public stimulus. As is often the case, fear is rarely
overcome by arguing that it is unjustified. More importantly, it is futile
to jump-start U.S. overconsumption to lead the world economy out of its
doldrums. Even if it works in the short run it simply will not be sustainable.
What other alternative is there if we don't bite the bullet and shrink
our economy, deglobalizing in the process if need be?
The alternative is to ask how the problem of global excess savings can
be addressed in the first place. In other words, what if anything can
take the place of U.S. overspending in offsetting the deflationary effect
of global excess savings today? Once the question is posed thus, the real
policy challenge today can, for instance, be defined as figuring out how
to put to use the U.S. financial system to recycle large dollar reserves
abroad to finance development in poor countries, which will benefit everyone
including the rich. The corollary of that is also the question of how
to restore the system of global financial intermediation on sound footing
rather than getting rid of it.