Global Imbalances: In Midstream? By Olivier Blanchard and Gian Maria Milesi-Ferretti IMF Staff Position Note No. SPN/09/29
The phrase “Global Imbalances” has been in vogue for several years now and is shorthand for describing a lopsided world economy where the US and a handful of other countries consume while countries such as China produce. The dollars earned by the export-driven countries of East Asia are reinvested in the US, financing its massive current account deficit and keeping interest rates low in the US, helping consumers to borrow more and import more.
For a while, the system served both the US and China very well, but many economists have been drawing attention for years to the dangers of a “disorderly unwinding of global imbalances”. For how long would Asian countries continue to put their foreign exchange reserves in US treasurys when the dollar was rapidly depreciating? And was the big rise in the indebtedness of the US consumer sustainable? These worries about the global economy had prompted many dire warnings before the financial crisis.
But now that US current account deficits have come down and US savings have increased as a result of the crisis, does it not indicate a rebalancing of the global economy? That is the question that IMF chief economist Olivier Blanchard and Gian Maria Milesi-Ferretti try to answer in their recent paper on “Global Imbalances: In Midstream?”
The authors first take a look at the evolution of the imbalances. They point out that while the US current account deficit has been widening since the mid-1990s, the reason has been different at different times. Between 1996 and 2000, the deficit increased because US investment increased more than the rise in US saving, which was driven by fiscal consolidation. The deficit was financed by foreign direct investment and portfolio inflows. Between 2001 and 2004, US investment declined after the collapse of the dot-com bubble, but savings declined even more. The financing of the deficit during this period was through foreign purchases of US bonds. And finally, during the boom years of 2005-08, while the US current account deficit continued to deteriorate, China instead of Japan became the main creditor country. With rising oil prices, the oil exporters also had sizeable surpluses.
Blanchard and Milesi-Ferretti say global imbalances are forecast to decline to a significant extent in 2009 on account of several factors. These include: 1. A substantial decline in oil prices, implying a very large contraction in the surplus of oil exporters and a corresponding improvement in the current account balance of oil-importing countries; 2. Asset price busts, leading to a sharp contraction in domestic demand and thus a substantial improvement in the current account of a number of deficit countries severely affected by the crisis and; 3. a sharp contraction in exports of investment goods, affecting a number of surplus countries, in particular Germany and Japan, and leading to a large reduction in their current account surplus.
Some of the changes will be long-lasting. These include higher private saving in the US, lower investment rates as tighter regulation increases the cost of capital as well as the desire for emerging markets to accumulate reserves as insurance for the kind of meltdown we saw in the last quarter of 2008.
The authors say that “one important adjustment—the increase in U.S. private saving—is under way. However, other parts of the global external adjustment process are not in place yet: In response to the crisis, US fiscal deficits have increased significantly, and will need to decline substantially in the future; current account adjustment in China, while significant in 2009, may turn out to be largely temporary, particularly if the renminbi is not allowed to appreciate; and a number of other emerging market countries are still running surpluses and accumulating foreign reserves.” In other words, we are now in midstream so far as the resolution of the global imbalances are concerned. China will have to allow its currency to appreciate and increase domestic demand.
In short, two more adjustments need to be implemented—lower fiscal deficits in the US, and lower current account surpluses in China and a number of other emerging market countries.
The authors say that “If these do not take place, there is a high risk that the recovery will be weak and unbalanced. Staying in midstream is dangerous.”
Illustration by Jayachandran /Mint
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