GLOBAL IMBALANCES

GLOBAL 3 - AUGUST 2011

 The phrase global imbalances
refers to the build-up of current
account deficits and surpluses in
the global economy that began in
the 1990s.
Five main explanations are offered
for this situation.
EXPLANATIONS

1. The global savings glut as

Asian economies saved more and
invested less after the 1997/8 Asian
financial crisis
2. The worsening US budget and
BOP deficits and the steep decline
in US household savings
EXPLANATIONS -TWO
3. Emerging Asias export-led
growth model relying on
undervalued exchange rates and
resulting in the rapid accumulation
of huge foreign exchange reserves.
4. The oil price boom and the steep
build-up of current account
surpluses in oil exporting nations.
 Explanations - three
5. The attractiveness of U.S. financial
assets, owing to their perceived high
liquidity and sophisticated investor
protection, created sustained demand
for U.S. assets.

US ADJUSTS

It was and still is widely feared

that these imbalances would
unwind in a disorderly fashion
resulting in a run on the US dollar.
But even before the onset of the
global financial crisis, the US had
begun to adjust
MAJOR IMPROVEMENT

As US economic growth slowed so

import growth slackened, while the
US dollar weakened, resulting in a
strong improvement in the balance-
of-payments on current account.
The deficit in 2010 was less than
half of that in 2006 (slide)
US CURRENT ACCOUNT
DEFICITS
$ billions
900
800
700
600
500
400
300 $ billions
200
100
0
GDP GROWTH & the BOP
It is important to see how the
current account deficit and the
The rate of GDP growth move
together (slide).
As growth accelerates the BOP
deficit gets worse and when growth
slows the BOP deficit falls.
GDP growth (%.p.a.) & BOP
Deficit (% of GDP)
7
6
5
4
3
GDP
2
BOP
1
0
-1 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
-2
-3
EXCHANGE RATES
The dollar fell also in response to 6
developments:
(a) The worsening BOP situation,
(b) The subprime financial crisis
after mid-2007 and
(c) The fall of the US stock market.
(d) Quantitative Easing
 (e) The 2011slowdown since April,
and
(f) The debt problem and the failure
of the Administration and Congress
to agree on a workable solution.
 DOLLAR FALLS

Between 2000 and 2008 the dollar

plunged 22% in real terms (slide).
Since then fears that there would
be a dollar rout were not realized
and from Sept 2008 the dollar
rebounded strongly.
US$ Index: (1990 = 100)
Index
140
120
100
80
60
40 Index
20
0
US$ DEVALUES 46%
But the index figure of 84 June
2011 - is one of the lowest since
the index series began in 1975.
It is also 46% below its peak of 156
reached in 1984.
 That the US financial crisis became
global was NOT the result of these
global imbalances.
Instead it was that highly leveraged
banks in rich countries, some of
them in surplus like Switzerland
and Germany, as well as France
and the UK, invested in so-called
toxic (bad) US assets.
 When the US housing market
crashed in 2008 these European
banks were adversely affected.
This is not to suggest that global
imbalances had nothing to do with
the subsequent crisis and
recession.
They did.
 Global imbalances were part of the
global pattern of low interest rates
and large capital inflows into U.S.
and European banks.
These fostered a buildup of
leverage, a search for yield, and
the creation of riskier assets and
house price bubbles in the US and
other industrial countries.
But the failure of risk management
in financial institutions and
Weaknesses in financial
supervision and regulation
Played key roles in the crisis.
GLOBAL
REBALANCING
THE GOOD NEWS
The good news is that the financial
crisis is contributing to tackling the
global imbalance problem in 3 main
ways:
1. Private savings are rising in rich
countries as the credit and housing
bubbles unwind.
BUDGET DEFICITS
Unfortunately, this welcome trend is
being offset by growing public
sector deficits.
In major advanced countries the
average budget deficit will be 8% of
GDP in 2011 nearly four times
what it was in 2006/7
2. Financial markets have tightened
globally due to the massive losses
of banks, as a result of which banks
are deleveraging and reducing
loans.
This is also being offset by govts
pumping credit into the money
markets and rescuing banks.
COMMODITY PRICES

3. Although the terms of trade

improved for most industrial
countries because commodity
prices, especially oil and food, fell
relative to prices of manufactured
goods, this has reversed in the past
18 months.
REVERSAL
Commodity prices have risen
steeply relative to manufactures so
that the terms-of-trade correction
has reversed, and
The sovereign debt crisis surfaced,
starting in Greece as a result of the
deterioration of public sector
deficits mentioned previously.
DEFICITS COME DOWN
Oil country BOP surpluses fell
steeply which helped to reduce
total global imbalances.
But this was shortlived and oil
prices are have doubled from their
low point at the end of 2008.
 The IMF calculates that global
imbalances have fallen from 5.75%
of world GDP in 2007 to about 2%
percent in 2010
This reflects reduced current
account imbalances in the US, oil-
exporters and, to a lesser extent,
Japan.
THE SURPLUS COUNTRIES
Nearly 1% is from a group of east
Asian countries, led by China.
Another percentage point is
accounted for by Germany and
Japan.
The remainder is mostly the oil
exporting countries.
 Asian and Middle East and other
EM surpluses that fell during the
recession are recovering as export
demand and prices rebound.
All of which means that the
potential US dollar crisis has not
gone away.
DOLLAR CRISIS?
Foreign investors may still not wish
to hold US dollars China has
several times expressed concern
over this resulting in a run on the
dollar.
There are two reasons for thinking
that this is unlikely
1. What is the alternative to the dollar
Yen, Euro, gold?
The answer is that at this stage -
there is no viable alternative, and
2. Large holders of dollars do not
want to sell into a falling market
and thereby lose value.
HOME BIAS STRENGTHENS?
It could be that home bias will
strengthen globally so that cross-
border capital flows decline.
This would make it even harder for
the US to finance its deficit, while
Many EMs and developing
countries would also be unable to
finance their deficits.
IS CHINA
REBALANCING?
HOW?
Theory holds that China must
rebalance its economy by reducing
its savings, investment and exports,
and
Importing and consuming more.
Is that happening?
TRADE SURPLUS FALLS
China insists it is pointing to a 7%
decline in its trade surplus in 2010
and
The steep drop in the current
account surplus, from 11% of GDP
in 2007 to just short of 6% in 2010.
 But this 6% surplus is much larger
than Japans 4% surplus in the
1980s which caused severe
political and economic problems.
Worse, there is no sign of any
increase in Chinese consumption
spending.
 In 2010 consumption made its lowest
contribution to growth since 2003 and
Also continued to decline as a share
of overall spending.
Growth in urban incomes, which was
in double figures in 2009, fell to 7.5%
in 2010.
PARADOX
This is the paradox of Chinas
economy:
Demand for modern consumer
goods is rising sharply as urban
Chinese get richer, but
Consumption as a whole plays a
smaller role than in any other large
economy.
MAKING CHOICES
If it wants its economy to be export-
driven then China has no choice
but to accumulate dollars that have
doubtful long-term value.
The solution is to stop buying
dollars and allow the Renminbi to
rise in value.
 But this would mean that export-led
growth would be much more
difficult because the strong
Renminbi would mean lower
exports and higher imports.
THE WAY FORWARD
Three key components

There are three key components to

global imbalances:
1. The US deficit on both the budget
(10% of GDP) and in the balance of
payments (3%).
2. Chinas BOP surplus (5% of GDP in
2011), and
3. Oil exporter surpluses (0.5%)
1. The US Deficit
For decades US economic growth
has been consumer-led, driven by
rising asset prices which made
people think they were richer and
By easy access to bank loans and
other types of credit - Credit cards or
buying cars on very cheap lease
agreements
SAVINGS SLUMP
Consumer credit and residential
investment (house-buying) rose
from two-thirds of GDP in 1980 to
three-quarters in 2007.
Household saving rates collapsed
from 10% of disposable (after tax)
income in 1980 to virtually zero in
2007
DEFICIT PEAKS
Household debt doubled from 67%
of disposable income (1980) to
132% by 2007.
As the US spent more than it
earned so the current account
BOP balance went from + 0.4% of
GDP in 1980 to minus 6% (deficit)
in 2006 which was the peak.
Consumers are poorer

Following the destruction of $13

trillion in consumer wealth (collapse
in house prices and equity prices)
and
The implosion of the banks, which
used to supply much of the credit
 Americans have been forced to start
saving with the latest figure back to
5% or 6% of disposable income.
As a result some gloomy forecasts
suggest that US consumer spending
could drop from 70% to 63% of GDP
or even lower.
 What would that mean?

The US would import less, especially

from China and other surplus
economies;
The dollar would - gradually
strengthen;
There would be a huge gap in the US
economy that would have to be made
up by investment plus exports
 The consumption collapse has
changed the US economy radically,
but while private saving has risen the
budget deficit will still be 9% of GDP
this year, implying massive dissaving
by the public sector.
GLOBAL ASPECT
From a global imbalance view the
US will no longer add to global
growth but subtract from it,
because of the steep decline in
consumer spending.
Surplus countries would have to fill
the gap left by falling exports in
their economies.
 So China, Germany and Japan
must boost their own domestic
demand to fill the gap created by
the decline in the US demand.
However this is not happening in
either China or Japan, while the US
is printing money to boost
consumption.
 Japan tried the same tactic when its
economy slowed in 1990;
It boosted demand for a decade to
replace the steep fall in domestic
spending.
But because - unlike Japan in the
1990s the US is already
overborrowed.
 This means that public sector
support will have to gradually
withdrawn, but what will then replace
it?
One estimate is that consumer
demand is going to grow at 2% a
year far short of the average of
3.4% annually between 1993-2007.
 The lesson is that the US economy
must rely more on exports and
investment for its growth and much
less on domestic consumer
spending.
 But while this may happen it will take
a long time and as a result the US
economy faces a long period of slow
growth with very high unemployment.
There is a very real danger that the
US will move towards greater
protection to help its industries adjust
to the new normal.
DEFLATION ?
Already analysts are saying that the
signs are that the US recovery is
going to be production-led, not
demand-led.
So who will buy what is produced?
It is this that raises the spectre of
deflation.
 Will firms have to cut prices - and
jobs and wages so that they can
sell their products at home and
abroad?
This could well happen and it would
be a re-run of the 1930s all over
again.
THE 1930s

What happened then was that

world trade fell sharply and
countries retreated behind tariff
barriers to shut imports out of their
markets, while
Devaluing their currencies to win
and maintain export markets.
 Recall:
Y = C + I + G + (X M)
So a fall in C, which was
compensated in 2009 by a rise in G
could also be replaced by higher I or
By an increase in net exports X
rising while M falls.
 Since the US govt will find it very
difficult to increase G and I is
unlikely to rise unless it does for
export markets
The answer lies as already
suggested in higher net exports.
 To achieve this the US must
improve its productivity and
competitiveness, possibly also
allow the dollar to devalue.
CHINA
 2. Chinas contribution to
rebalancing the global economy is
two-fold
(i) It must expand consumption
because its exports are unlikely to
recover to previous levels, AND
(b) It must allow its exchange rate to
appreciate strengthen.
 In 2008 the Chinese surplus was
some $400 billion or 10% of GDP
which is unsustainable because it
means other countries must be
running deficits of the same
amount.
 Adjustment is already occurring
with the surplus halving between
2007 and 2010 to 4.7% of GDP
(from 10.6% in 2007) and forecast
at 5% in 2011.
Another way of looking at this is the
net export balance.
ADJUSTMENT UNDERWAY

In 2008 net exports (X M)

accounted for 2.6% of Chinas
7.5% growth roughly a third.
In 2009 net exports are estimated
to have reduced growth by about
4%.
 Exports which were 35% of GDP in
2007 were around 25% in 2009.
But this is only part of the story
because the balance between
consumption and investment in
China is skewed and becoming
even more so.
 In 2007 private consumption was
35% of GDP (70% in the US 50%
to 60% in most other Asian
economies and 80% in Zimbabwe).
In China it was very much higher
50% - in 1990
 Investment already high at 35% of
GDP has since risen strongly to 70%.
Most of this is going into real estate
and some to infrastructure with the
result that China is developing excess
capacity in housing and infrastructure
as well as in its factories.
 Consumption is low because
savings are high
The household savings rate is 28%
of disposable income up from
20% ten years ago.
But consumption is low also
because a smaller share of national
income is going to households.
WHY?
(1) Partly because as here in
Zimbabwe the share of wages in
GDP has fallen while that of profits
has risen sharply.
One reason for this is Chinas
industry is becoming increasingly
capital-intensive, so that a lot of
investment generates relatively few
jobs, but lots of machines.
LOW INTEREST RATES

(2) Capital-intensive factories are

partly the result of very low interest
rates that encourage firms to
substitute machines for workers.
Also, state-owned firms do not pay
dividends so all their profits are
available for reinvestment.
Undervalued exchange rate

(3) A third point is that by holding

down the exchange rate, the govt
encourages manufacturing, which
is capital-intensive, relative to
services which are employment-
intensive.
 REVALUATION

Obviously, part of the solution from a

global imbalance viewpoint is to allow
the exchange rate to appreciate.
China would then export less and
import more.
In 2005, China abandoned its fixed
exchange rate peg of the Yuan to the
US dollar.
 By February 2009, the had
appreciated by more than a quarter
But then the govt panicked and re-
pegged the currency to the dollar
which has since fallen
As a result, the currency (the RMB)
fell along with the dollar.
OVERVALUATION

At this level, a US study estimated

that RMB is between 15% and 25%
undervalued.
However over the last six months
its exchange rate has started to
strengthen rising some 4.5% in
real terms.
STRUCTURAL REFORMS
However this needs to be put into
perspective.
Since mid-2009 the rate has
depreciated (fallen) some 6% in
real terms.
China also needs to implement
social and structural reforms.
SOCIAL SPENDING
China spends only 6% of GDP on
education, health, social welfare
and pensions compared with 25%
in OECD countries.
This helps explain why the
household savings rate is high
people save to meet social welfare
costs, especially pensions.
REFORMS
On the structural side banking
legislation needs to be liberalized
so that state-owned companies are
forced to borrow at market, not
subsidized interest rates.
The tax system that favours
manufacturing against services
should be reformed
ELIMINATE SUBSIDIES

Along with laws that ban private

sector participation from some
service industries.
Industrial inputs should not be
subsidized and state firms should
pay dividends from their profits.
BLAME THE US

It is easy enough to say what the

Chinese Govt ought to do, but there
is very little likelihood that it will
take much notice.
Instead, the signs are that China
will continue to point fingers at
large deficit countries like US.
TWO WAY STREET
China argues that it not the
responsibility of surplus countries to
adjust but of deficit states.
The latter reply by saying that they
are adjusting faster and further than
China, and that
Adjustment is a two-way street
 3.With the steep fall in the oil price,
the third problem that of oil
surpluses largely fell away.
But as a group oil exporters
remain in strong surplus and with
the recovery on the oil price those
surpluses will grow over the next
year or two.