The financial crisis rejuvenated the International Monetary Fund (IMF) and the G20, giving each new roles to play in managing the economic mess. New rules for financial regulation and new financial safety nets to promote stability are being developed. Presumably, when the world economy next looks like it is falling off a cliff, the response will be strong and coordinated. It is harder to get agreement on non-crisis tasks. There is some consensus that large current account imbalances (mirrored by large international capital flows) prolonged the run-up to the crisis and made it worse when it hit. In any case, large imbalances are not indefinitely sustainable, because they lead to unsustainable debt positions for borrowers and tricky portfolio decisions for lending countries.
The US wants targets for current account deficits and surpluses, and agreement on national policies to achieve those targets. Basically, it wants China to revalue its currency. Germany, Japan and China, all running current account surpluses, naturally do not want to be told how to run their national macroeconomic policies. What?s to be done?
Start with the size and shape of the problem. In 2009, according to IMF data, world GDP was about 68 trillion (all figures in US dollars), of which the US accounted for 14 trillion, China and Japan about 5 trillion each, and Germany 3.3 trillion. The latter three countries had current account surpluses of 297, 142 and 163 billion respectively, or a total of 602 billion. The total for all surplus countries was about 1.2 trillion. So the three countries, with 20% of global GDP, contributed about half of the total global surplus. Though several East Asian economies and oil exporters also ran large relative surpluses, one can see why the US tends to focus on the big three. On the other side, the US deficit was 378 billion, with Spain a distant second at 80 billion, followed by Italy and France. The latter three are all in the Eurozone, which was in approximate balance. So global rebalancing on the deficit side is mostly about the US. Note that talk of uniform targets for current account balances as percentages of GDP is a smokescreen in this respect.
There is an asymmetry between surplus and deficit countries. The former have to worry about what to do with their cash, whether to allow it into their domestic economies, or if not, what types of financial assets to hold. Still, these are problems of plenty. Deficit countries have to worry about not being able to pay the bills, which is more serious.
Getting out of debt involves austerity but with a fragile global economy, austerity can be painful. The UK has bitten that bullet but the US is avoiding it for now.
For the US, the ideal is that the big three surplus countries pump up domestic demand, giving the US more room to get its public finances more in balance (starting from a fiscal deficit of 1.4 trillion in 2009) and also increasing foreign demand for US goods, reducing the current account deficit. In particular, it would like to see China revalue its currency, making US goods cheaper. But the Chinese currency has already appreciated by 20% against the dollar since 2005 and the real appreciation (adjusting for higher inflation in China) has been closer to 50% (The Economist, November 4, 2010). The Chinese want to manage any appreciation as part of an overall macroeconomic strategy. Given that China is a large, poor country, one can understand their position.
Economic theory also does not unambiguously support a clear path from currency appreciation to current account surplus reduction.
Still, China seems to know what to do in the medium run. It is less clear what Japan will do, since it is shrinking, aging and allowing its economy to ossify. And Germany is now suffering for failing to provide leadership when the Euro periphery was going wild and violating the conditions of joining the Eurozone, among other policy failures.
This leaves the US, without any strategy of its own. If dollar depreciation is not the answer (and Germany and Japan have run large surpluses with strong currencies), what is? Fiscal consolidation is part of the answer. The other is improving productivity. Barack Obama entered office with a vision of investing in America?s infrastructure, people and innovation. But the country?s dysfunctional, polarised politics have stymied him. Perhaps, like Nixon going to China, it will take a Republican to shore up America?s decaying physical, intellectual and social capital.
Meanwhile, the Chinese are going for the real rebalancing: more decades of high growth based on innovation as well as control of global resources, perhaps a global reserve currency, and ultimately, equal status with today?s global top dog. Brandeis University economist Catherine Mann, tongue-in-cheek, noted that China already holds more than 10% of outstanding US government debt, and so, according to US criteria for controlling FDI stakes, China owns the US, as of now.
?The author is a professor of economics, University of California, Santa Cruz