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Fixing global economic imbalances

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In Brief

The G20 Finance Ministers' meeting in Paris over the weekend clinched a deal on the indicators that will be used to evaluate and to tackle the economic imbalances, said to be at the heart of managing recovery from the global crisis.

Importantly, China signed on to the deal, the announcement of which reports that trade balance and investment flows will be monitored 'taking due consideration of exchange rate, fiscal, monetary and other policies.'

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This suggests that exchange rates will be considered only in a wider policy context, something that Beijing has always insisted should be the case in response to Western criticism. The accord marks an important first step towards dealing with the imbalance problem and putting the global economy on track towards more viable growth and prosperity.

Everyone these days seems to be trying to get out of the global financial trough by pushing exports. The United States’ huge current account deficit behoves it to lift exports and spend within in its international means. China’s current account surpluses persist, and are the focus of US congressional ire and draft legislation that seeks to impose penalties for ‘undervaluation’ of the Chinese currency, the RMB. While the debt-burdened European economies, from Ireland to Greece, are constrained by commitment to the Euro, all are striving to get growth through exports. And Germany, in holding back on domestic demand expansion, has become more and more competitive within the EU and its increasingly competitive position is lifting its export surplus both within Europe and with the rest of the world.

Something has got to give, David Vines argues in this week’s lead essay, to resolve these inconsistent macroeconomic policy strategies. Not all countries can have export-led growth, if that is defined to mean a faster growth of exports over imports in all major economies. This is what has made the focus on the need for currency re-alignment, and on China as the country that needs to lift its exchange rate, so intense.

After the collapse of the US and European economies in the global financial crisis, a new and urgent priority is to restore industrial country growth and absorb the unemployment it created. Before the crisis, Vines argues, real exchange rates (set in East Asia) and real interest rates (set in New York) underpinned strong growth both in East Asia and the industrial world. But it also gave rise to global imbalances. It created the financial fragility, and the vulnerability to financial crisis, that led to the global financial crisis.

The US can lift growth in the short run if it continues to over-spend relative to its long run capacity. The signs are that it is having some success with this strategy. But this growth trajectory will only be sustained, the argument runs, if global imbalances worsen again — if the current account surpluses in China (and Germany) expand and the US current account deteriorates further. In this trajectory there are large risks, at some point in the medium term, of a collapse of the US dollar. If that happened, there is the risk of a dollar crisis. As Vines explains, this risk is real because the carry trade is so highly leveraged that, once the dollar begins to fall, the holders of dollar assets will have to sell lots more of them. There is also a risk that the US Federal Reserve will continue with a quantitative easing strategy to push the dollar down. If the dollar falls against the Euro, European nations (notably Germany), themselves set on export-led growth, will resort to quantitative easing (QE) of money supply to push the Euro down against the dollar. This is the kind of currency war, Vines reckons, that the global prisoner’s dilemma scenario he describes could spark.

These policy strategies will push the world towards another low-interest-rate bubble. That will be bad for China, and for East Asia generally, for whom the current level of interest rates is clearly too low, and for whom QE is undesirable. And, Vines says, we haven’t got strong enough international regulation yet to protect against the fall-out from that.

These are the policy dilemmas that face the G20 this year. They were put on the table in Seoul last November and the G20 has begun to confront them. G20 finance officials and the IMF are putting in place a G20 Mutual Assessment Process, or ‘G20-MAP,’ the aim of which is to ensure that national policy strategies are integrated and become more sensitive to the global outcomes they might deliver. This is a just a work-in-progress but one that has now moved forward in Paris. More important in the meantime is commitment by national leaders to re-jig policy strategies so as to take the pressure out of the strains in the international economy about which Vines worries. The Chinese leadership openly accepts that change is required in the exchange rate regime but argues, with some justification, that nominal exchange rate change alone will not prevent the re-emergence of the imbalance problem. The outcome in Paris over the weekend respects this position. China is therefore committed to putting in place structural reforms that are essential to delivering a domestic demand-led model of growth. There are complementary commitments in America and Europe that will also take time to deliver. The question is whether there is enough political will to deliver on these commitments all ways round. And how much time have we got?

The G20 has opened the space and the beginnings of a cooperative process that can deliver the global policy coordination we now so desperately need. If it works, as Vines says, the process will institutionalise, globally, a new shared responsibility for managing the global macro-economy.

2 responses to “Fixing global economic imbalances”

  1. The effort of G20 nations towards better economic cooperation is a key step for better understanding of each one’s needs and necessities. Until recently, East Asian Economies have become the model of successful economic development. High growth is achieved largely by getting the basics right. This success is often thought within the framework of traditional trade theory in which both competitiveness and external trade, which are the keys of rapid economic growth and stability, are achieved through economic liberalization. The orthodox interpretation of East Asian economic miracle often conceals many country specific characteristics. Although, there is a little disagreement regarding the role of competitiveness and trade in fostering growth, it also clear that many highly relevant facts particularly from the perspective of micro economic agents are still waiting to be explored. The G20 nations have to look for the success stories of East Asian economic stability, particularly the Indian order of economic issues.

  2. Re: ….China’s current account surpluses persist, and are the focus of US congressional ire and draft legislation that seeks to impose penalties for ‘undervaluation’ of the Chinese currency, the RMB….

    I am not a scholar and simply retired with time to roam the internet with an open mind.

    The era of US hegemony has been a period of chronic current account surpluses.
    During the colonial era and post WWII the West enjoyed current account surpluses and the “Southern hemisphere” chronic deficits.
    The rise of the so called BRIC Within The US Hegemonic System reversed the pattern whereby BRIC nations acquired current account surpluses and the US and Western nations deficits as well as unsustainable debts and consequent prospective sovereign risk etc.

    London and New York became the world’s financial centre recycling the surpluses from the Middle East and newly industrialized nations benefiting the West in which economic and financial concepts were largely invented in Washington and Chicago.

    In summary, the US created the present GFC because it owned the hegemonic system which compelled the world to operate within.

    It seems to me the hullabaloo about China’s current account surpluses versus US deficits misses the point because its focus on a symptom does not solve GFC and is designed for political intent – given the above observations.
    Of course, the global imbalance is unsustainable but it is not the cause of GFC.

    No GFC solution will be realized until the US solves its private and public debt burden, balances its budget, re-industrializes, re-constitutes its insolvent FIRE sector (Finance, Insurance and Real Estate), forgets about empire and reduces its unaffordable global military hegemony and relinquishes its role as the global US dollar transaction reserve currency role. US money printing is useless and destructive and does not solve the underlying problem.

    The US is the reason why the secular classless Middle East masses have demanded regime change and redistribution of societal wealth and democracy.
    China needs to continue its economic transformation from an export FDI dependent economy into a domestic market model.
    Europe has to decide if it wants to survive as EU by creating as Fiscal Union or break up and regardless to its economic union solve its private and public debt.
    Japan has to change its deficit budgetary habits and re-examine its dependence on current export practices because the US and Europe markets will be anemic for at least a decade.

    The world has changed and the way Aljazeera has informed on the Middle East compared to western media generally (particularly US media) is symbolical of how out of touch our paradigms have become.
    Concepts and narratives follow the ascendant.

    Ascendancy and influence in a multi-polar world is caused by state of mind in touch of reality and confidence.

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