Global Imbalance Redux

From AEI:

Global Imbalance Redux By Philip I. Levy

ForeignPolicy.com

Wednesday, August 25, 2010











In 2009, the Group of 20 nations committed themselves to rebalancing the world economy. Summiteers in London and Pittsburgh resolved that the large trade surpluses and deficits that had characterized the global economy in the lead-up to the financial crisis should no longer be tolerated.



The G-20 leaders were so effective in their proclamations that much of the requisite rebalancing took place in anticipation, before the leaders could even implement any collaborative policies. China's current account surplus of $426 billion in 2008 fell 33 percent to a surplus of $284 billion in 2009. The Middle East, which as a region ran a surplus of $348 billion in 2008, saw it drop 90 percent to just $35 billion in 2009. The United States current account deficit of $706 billion in 2008 shrank by over 40 percent to $418 billion in 2009.



The moral is that trade balances are driven by deep-seated forces within an economy and are difficult to manipulate.Such anticipatory compliance on the part of the world economy would have been most welcome, had it only continued. Yet recent economic data shows it has not. The New York Times summarized the latest numbers:



The United States trade deficit ballooned to $49.9 billion in June, the biggest since October 2008. In July, one month later, China recorded a $28.7 billion trade surplus, the biggest since January 2009. In the first five months of the year, Germany's trade surplus... rose 30 percent compared with 2009, to about $75 billion.



So what does this mean? Before the world's leaders could even assemble, the imbalances shrank, but once they issued their proclamations, the imbalances revived. The moral is that trade balances are driven by deep-seated forces within an economy and are difficult to manipulate. The shock of the housing bust and financial crisis dampened consumption and, thus, imports. Some countries were hit harder than others. U.S. monthly imports peaked at $232 billion in July of 2008. They bottomed out at $151 billion in May of 2009. That 35 percent plunge is a pretty good depiction of economic panic. Over the same period, exports fell by "only" about 24 percent, and they were smaller than imports to begin with (hence the deficit).



Of course, relative consumer confidence around the globe was not the only factor driving these numbers. There were also wild exchange rate swings as investors tried to puzzle out which of the world's major markets posed the least risk.



The point is that none of this was due to the fine-tuning of finance ministers or chancellors of the exchequer. They were all trying everything they could to restore confidence among consumers and investors and to revive economic growth. The standard tools that would be used to manipulate external imbalances were instead directed toward crisis response. This is unlikely to change in the near future. China is much more worried about steering between their Scylla and Charybdis of inflation and unemployment than it is about its trade surplus with the United States. Fed Chairman Ben Bernanke is far more preoccupied with concerns about a double-dip recession and deflation than he is about the value of the dollar. Their moves may end up shrinking global imbalances--significant new quantitative easing by the Fed might depress the dollar-- but this would not be the principal intended effect.



From an economic standpoint, the inability to tackle the imbalances is less worrying than some commentators made it seem. There was a connection between a global savings glut (one aspect of the imbalances) and the U.S. financial crisis, but the latter did not follow inevitably from the former. It took a whole raft of unwise U.S. domestic policies to mishandle the offer of cheap global funds (e.g. offering mortgages with no money down to purchasers of dubious credit was problematic). Similarly, there is no inevitable link between trade deficits and unemployment. Countries with flexible exchange rates and sound policies can adjust to all kinds of external shocks, though the adjustment may be painful.



From a political standpoint, however, the situation may be more dire. Michael Pettis, an astute observer of the Chinese scene, this week concluded that "The world seems to be marching inexorably towards trade war." He argued that the United States will be forced to choose between protection and soaring trade deficits, with the former threatening an ensuing round of global protectionism.



The issue will re-emerge in Washington when Congress returns next month. The Obama administration won a respite from Congressional pressure when China agreed to allow its currency to move in June. Since then, the Chinese yuan has appreciated from a rate of 6.83 to the dollar all the way up to 6.80 to the dollar (less than half a percent). Congressional hearings are already scheduled.



None of this is to argue that it was wrong for the world's major nations to try to address imbalances at their 2009 gatherings, just that the problem is more intractable than they acknowledged. To navigate the economic and political imperatives successfully will require substantially more deft diplomacy.



Philip I. Levy is a resident scholar at AEI.