The upcoming G20 summit takes place at a pivotal moment. The halo of the G20?s response to the financial crisis in 2009 has faded, and it is receiving a lot of flak for not getting things done. In my last column (November 1), I argued that the G20 has an important potential role to play as a manager of current and emerging global risks, including those of climate change as well as financial volatility. For the moment, though, the focus is on global imbalances?the large current account surpluses and deficits that major members of the G20 are running. These imbalances were less of an issue (though still a concern) when the world economy was growing rapidly, and the US, in particular, was booming. The change in US circumstances is therefore a major cause of the new frictions.
One way to think of the global imbalance is that developing countries are saving more than ever, and more than they can invest effectively at home. These excess savings have to be put somewhere, and the US provided the best source of safe financial assets. China is the prime example of this pattern, with household consumption only 40% of GDP, and foreign reserves exceeding $2.5 trillion. The problem with this pattern was that the US created financial assets that were not as safe as they were made out to be: hence the financial crisis and its recessionary aftermath.
The financial crisis reduced US wealth, and left its banks with bad property loans and indebted households with credit constraints, uncertain employment prospects and the need to save more than they had been doing. Meanwhile, the government had been borrowing heavily in good times, leaving it little room for spending more to make up for the drop in private demand. The US Federal Reserve, trying to get the economy back on its feet, is creating money through a second round of quantitative easing (QE2), hoping to increase borrowing and lending, thus fuelling aggregate domestic (and global) demand.
From the US perspective, it would be so much nicer if China were to increase its contribution to global demand, buying more US goods and services in the process, and helping along the US recovery. Here, appreciating China?s currency is an enabler, increasing Chinese demand for foreign goods. But the real issue is increasing demand. For that, other changes have to take place in the Chinese economy. The situation of two other major surplus countries backs up this view. Germany and Japan are not manipulating their exchange rates, but still running current account surpluses. The US would be happier if they spend more as well. Meanwhile, QE2 is leading to dollar depreciation, making China work harder to keep its exchange rate pegged where it wants.
China?s response has been revealing, in various speeches by its leaders. There has been some criticism of QE2, but much less shrill than that of Germany. At the same time, the Chinese are acknowledging that the US is in a tough spot. So this is where things stand before the G20 summit. China, poor but frugal, is in a position to be magnanimous to the rich but profligate US. It is laying the groundwork for increasing domestic demand, but that will take time. It will slowly allow the renminbi to appreciate. It will do these things to demonstrate its global leadership and its rising power. It can do so because it has the cash and the room to manoeuvre.
What the G20 summit should do is to allow this adjustment to happen gracefully. The US needs to save face, and the Chinese understand that concept well. So does Japan. The Europeans need to get on board too. The G20 is the right place for this kind of face-saving exercise. There will be exterior harmony, but also another slow step in the process of the real rebalancing that is taking place, the rise of Asia, led by China.
Meanwhile, there is much else the G20 should do at the coming summit. It needs to keep moving forward on reforming the international regulatory architecture of finance, where it can just bless what the specialists are doing. It can reiterate the gradual but significant reform of the international financial institutions, nudging things along. And it can begin defining what a global financial safety net will look like. These efforts can do two things?contribute to reducing global imbalances (by making excessive international reserve accumulation less compelling) as well as having protections in place when things go wrong (because of the global imbalances or otherwise).
There is much else on the Seoul Summit agenda: trade, development, climate change, energy and anti-corruption measures will all be subjects of plenary sessions. The Koreans will also have a Business Summit, which presumably will promote Korea Inc. In these matters, the G20 has to feel its way, and may seem ineffective in the short run. But the core issue will be what one might call the global economic architecture. China needs the US economy to be healthy for it to keep growing, and that should drive the outcome.
The coda to this line of thought is India?s position in all this. The US, in President Obama?s visit and elsewhere, sees India as a counterweight to China. But China is important to India as well. The Seoul Summit is a chance for India to be a friend to both sides, offering sage advice and a sympathetic ear.
?The author is professor of economics, University of California, Santa Cruz