11

The US-China The US-China Marriage of Convenience: Marriage of Convenience:

Prospects for Global Imbalances Prospects for Global Imbalances and Economic Recoveryand Economic Recovery

Terry McKinleyTerry McKinleyDirector, Centre for Development Policy and Research,Director, Centre for Development Policy and Research,

School of Oriental and African StudiesSchool of Oriental and African Studies Presentation, 29 January 2010, Delhi Conference, Presentation, 29 January 2010, Delhi Conference, ‘‘Recovery or Bubble? The Global Economy Today’Recovery or Bubble? The Global Economy Today’

22

The Starting-Point of The Debate The Starting-Point of The Debate

The US and China remain locked together in The US and China remain locked together in interdependence:interdependence:

China has relied, for some time, on the US as China has relied, for some time, on the US as a market for its exportsa market for its exports

The US now relies on China as the prime The US now relies on China as the prime lender that can continue financing its lender that can continue financing its massive current-account deficitsmassive current-account deficitsIs China equally to blame for global imbalances and Is China equally to blame for global imbalances and the failure to reduce them? the failure to reduce them? Will the US continue to run huge current-account Will the US continue to run huge current-account deficits and undermine the basis for global deficits and undermine the basis for global recovery?recovery?

33

Pinning the Blame on China Pinning the Blame on China for Global Imbalancesfor Global Imbalances

China is often blamed for causing global imbalances, China is often blamed for causing global imbalances, mainly through ‘exchange-rate manipulation’ (US mainly through ‘exchange-rate manipulation’ (US Treasury Secretary Geithner’s early 2009 criticism) Treasury Secretary Geithner’s early 2009 criticism)

China has pegged the value of renminbi to the US China has pegged the value of renminbi to the US dollar (for a while loosely, until 2008)dollar (for a while loosely, until 2008)Martin Wolf, the well-known columnist of the Martin Wolf, the well-known columnist of the Financial TimesFinancial Times, has laid the basis for blaming China , has laid the basis for blaming China in a series of columns on the global crisis:in a series of columns on the global crisis:

““The driving force behind these [global] imbalances The driving force behind these [global] imbalances has been the policies of surplus countries and has been the policies of surplus countries and particularly China” (January 20, 2009)particularly China” (January 20, 2009)

““The world cannot safely absorb the current account The world cannot safely absorb the current account surpluses that [China] is likely to generate under its surpluses that [China] is likely to generate under its current development path” (April 7, 2009)current development path” (April 7, 2009)

44

What Is the Main Source What Is the Main Source of Global Instability?of Global Instability?

The main source of global instability is located not in The main source of global instability is located not in China but in the US, which is the world’s dominant, China but in the US, which is the world’s dominant, reserve-currency country, and its most profligate reserve-currency country, and its most profligate spender:spender:

It has regularly spent beyond its income level, based It has regularly spent beyond its income level, based on borrowing from abroad (e.g., from China!!!)on borrowing from abroad (e.g., from China!!!)

Being the dominant reserve-currency country gives Being the dominant reserve-currency country gives it greater freedom to do so (adjusting at its own it greater freedom to do so (adjusting at its own pace)pace)A Major QuestionA Major Question: Will US current-account deficits : Will US current-account deficits undergo enough adjustment in order to substantially undergo enough adjustment in order to substantially reduce global imbalances and remove the basis for reduce global imbalances and remove the basis for renewed crisis?renewed crisis?

55

The Basis for the US The Basis for the US Over-Consumption BingeOver-Consumption Binge

What were the origins of the US crisis? What were the origins of the US crisis? During the 1990s, current-account deficits were During the 1990s, current-account deficits were substantially increasing and Reagan’s huge fiscal substantially increasing and Reagan’s huge fiscal deficits from the 1980s were being reduced by the deficits from the 1980s were being reduced by the Clinton administrationClinton administrationExternal demand and public-sector demand for External demand and public-sector demand for goods and services were declining. But the biggest goods and services were declining. But the biggest problem was the ballooning current-account deficitsproblem was the ballooning current-account deficitsThis drag implied that the private sector (either This drag implied that the private sector (either households or corporations) had to be the main households or corporations) had to be the main source for supplying additional aggregate demand source for supplying additional aggregate demand to the US economy in order to maintain economic to the US economy in order to maintain economic growthgrowth

66

The Basis for the US The Basis for the US Over-Consumption BingeOver-Consumption Binge

The US household sector began to spend well above The US household sector began to spend well above its income level: its net savings declined from 3% of its income level: its net savings declined from 3% of GNP in the early 1990s to a deficit of -4% of GNP!GNP in the early 1990s to a deficit of -4% of GNP!Households were increasingly borrowing to sustain Households were increasingly borrowing to sustain higher levels of consumption and housing higher levels of consumption and housing investment investment But why did households borrow so heavily? Their But why did households borrow so heavily? Their personal assets (equities and housing stock) personal assets (equities and housing stock) seemed to be inexorably appreciating in value seemed to be inexorably appreciating in value This process was sustainable only as long as asset This process was sustainable only as long as asset appreciation kept pace with the rise of household appreciation kept pace with the rise of household liabilities—and interest rates remained lowliabilities—and interest rates remained low

77

The Basis for the US The Basis for the US Over-Consumption BingeOver-Consumption Binge

But the stock market bubble burst in 2001But the stock market bubble burst in 2001The US government responded with very expansionary fiscal The US government responded with very expansionary fiscal and monetary policies—keeping interest rates low and fuelling, and monetary policies—keeping interest rates low and fuelling, in effect, a larger ensuing financial crisis caused by the real-in effect, a larger ensuing financial crisis caused by the real-estate bubble (exacerbated, indeed, by new complex forms of estate bubble (exacerbated, indeed, by new complex forms of leveraging of risk and lax regulation)leveraging of risk and lax regulation)US current-account deficits began to balloon dramatically in US current-account deficits began to balloon dramatically in the early 2000s, requiring the need for more external the early 2000s, requiring the need for more external borrowing, that is, more purchase of US Treasury Securities by borrowing, that is, more purchase of US Treasury Securities by foreign central banks (such as China’s)foreign central banks (such as China’s)Identifying such purchases of securities by China and other Identifying such purchases of securities by China and other surplus countries—as is often done—as the source of the surplus countries—as is often done—as the source of the global financial crisis misinterprets its origins: global financial crisis misinterprets its origins:

The crisis was due to US over-consumption, not Chinese The crisis was due to US over-consumption, not Chinese excessive savingsexcessive savings

88

Has There Been Has There Been a ‘Global Savings Glut’?a ‘Global Savings Glut’?

Critics of China in the West attribute global Critics of China in the West attribute global imbalances primarily to a so-called ‘Global Savings imbalances primarily to a so-called ‘Global Savings Glut’, which has supposedly made the US borrowing Glut’, which has supposedly made the US borrowing binge much cheaper to financebinge much cheaper to finance

Developing Asia and the Middle East have been the Developing Asia and the Middle East have been the major regions running large current-account major regions running large current-account surpluses and accumulating foreign-exchange surpluses and accumulating foreign-exchange reserves (often in low-interest US Treasury reserves (often in low-interest US Treasury Securities): Securities):

Reserves of Developing Asia in 2009: $ 2.8 trillion projectedReserves of Developing Asia in 2009: $ 2.8 trillion projected Reserves of the Middle East in 2009: $ 870 billion projectedReserves of the Middle East in 2009: $ 870 billion projected These regions have been the major Savers at the global level: These regions have been the major Savers at the global level:

their domestic savings rates significantly exceed their their domestic savings rates significantly exceed their domestic investment rates: they are ‘exporters of savings’domestic investment rates: they are ‘exporters of savings’

99

Stock of Foreign-Exchange ReservesStock of Foreign-Exchange Reserves (US $ Billions)(US $ Billions)

RegionRegion 20012001 20072007 2009 proj.2009 proj.

All DevelopingAll Developing 857857 4,3784,378 5,3235,323

--Africa--Africa 6464 289289 318318

--CIS--CIS 4444 549549 483483

--Developing Asia--Developing Asia 380380 2,1322,132 2,8672,867

ChinaChina 216216 1,5311,531 2,2402,240

--Middle East--Middle East 135135 696696 870870

--W. Hemisphere--W. Hemisphere 159159 445445 517517

1010

Has There Been Has There Been a ‘Global Savings Glut’?a ‘Global Savings Glut’?

By running a huge current-account surplus, China By running a huge current-account surplus, China has allegedly been contributing to a ‘global savings has allegedly been contributing to a ‘global savings glut’glut’This assumption is endorsed by a wide range of mainstream This assumption is endorsed by a wide range of mainstream economists, Martin Wolf, Ben Bernanke and Lawrence economists, Martin Wolf, Ben Bernanke and Lawrence Summers—and been used to shift global blame onto ChinaSummers—and been used to shift global blame onto China

Although widely embraced, does this assumption Although widely embraced, does this assumption make any sense? make any sense? At the global level, total savings At the global level, total savings must equalmust equal, by , by accounting definition, global investment (unless accounting definition, global investment (unless there are errors in estimation)there are errors in estimation)In other words, In other words, excess savingsexcess savings in one grouping of in one grouping of countries, such as Asia, must be balanced out by countries, such as Asia, must be balanced out by deficient savingsdeficient savings in another part of the world, such in another part of the world, such as the USas the US

1111

Has There Been Has There Been a ‘Global Savings Glut’?a ‘Global Savings Glut’?

Another interpretation of the ‘savings glut’ is that Another interpretation of the ‘savings glut’ is that global savings has been rising relative to global global savings has been rising relative to global incomeincomeThe table shows that broad averages since the late The table shows that broad averages since the late 1980s do not support such a claim1980s do not support such a claimAs a ratio to global income, savings has been As a ratio to global income, savings has been relatively stable, at 22-23%relatively stable, at 22-23%So there has been no pronounced upward savings So there has been no pronounced upward savings trend, no evidence of a ‘savings glut’trend, no evidence of a ‘savings glut’But there has been a marked downward trend in the But there has been a marked downward trend in the savings of Advanced Economies, which has been savings of Advanced Economies, which has been compensated by a substantial rise in the savings of compensated by a substantial rise in the savings of Emerging and Developing EconomiesEmerging and Developing Economies

1212

Savings as a Ratio to GDP (%)Savings as a Ratio to GDP (%)

  1986-1993 1994-2001 2002-2008

Global 22.7 22.1 22.7

  Advanced Economies 22.2 21.6 19.8

  USA 16.3 17.0 13.9

Emerging and Developing Economies 24.3 24.2 31.1

  Middle East 17.6 25.5 38.7

 Developing Asia (including

China) 28.8 32.7 41.2

1313

What Is the Main Source What Is the Main Source of Global Instability of Global Instability NowNow??

The US is currently trying to The US is currently trying to replacereplace huge private- huge private-sector spending deficits (mainly of households) with sector spending deficits (mainly of households) with massive public deficits in order to stimulate massive public deficits in order to stimulate economic recoveryeconomic recovery

The 2009 US fiscal deficit is projected by the IMF to The 2009 US fiscal deficit is projected by the IMF to reach 12.5% of GDP (and to still be 10% in 2010)reach 12.5% of GDP (and to still be 10% in 2010)

Such a fiscal deficit tends to enlarge the current-Such a fiscal deficit tends to enlarge the current-account deficit: increased domestic spending spills account deficit: increased domestic spending spills over into increased importsover into increased imports

The alternative is to devalue the US dollar, making The alternative is to devalue the US dollar, making its exports cheaper—and thereby reduce the US its exports cheaper—and thereby reduce the US current-account deficitcurrent-account deficit

1414

The Impact of The Impact of a Depreciated US Dollara Depreciated US Dollar

When this option is taken, relative to the US dollar, When this option is taken, relative to the US dollar, the currencies of many other countries will the currencies of many other countries will appreciate, worsening their trade balancesappreciate, worsening their trade balancesJust as importantly, the US will lower the relative Just as importantly, the US will lower the relative value of its external debt value of its external debt

The US can effectively ‘inflate away’ its external debt The US can effectively ‘inflate away’ its external debt by printing more dollars (the internationally reserve by printing more dollars (the internationally reserve currency, for which there remains a global demand)currency, for which there remains a global demand)

Countries holding their reserves in US Treasury Countries holding their reserves in US Treasury Securities will find their value reduced in their own Securities will find their value reduced in their own currencies (will suffer a loss of asset value)currencies (will suffer a loss of asset value)

To some degree, the US remains in the ‘driver’s seat’To some degree, the US remains in the ‘driver’s seat’

1515

The Depreciation The Depreciation of the US Dollarof the US Dollar

Generally, the US dollar has been depreciating since Generally, the US dollar has been depreciating since February 2002 (because of current account deficits): February 2002 (because of current account deficits): about 21%, overall, in nominal termsabout 21%, overall, in nominal termsIts value hit a low point in April 2008, having fallen in Its value hit a low point in April 2008, having fallen in nominal terms by 26% since 2002nominal terms by 26% since 2002But the dollar appreciated between roughly April But the dollar appreciated between roughly April 2008 and April 2009 as money flooded, seemingly 2008 and April 2009 as money flooded, seemingly perversely, into US securities as a ‘safe haven’ perversely, into US securities as a ‘safe haven’

As global economic conditions worsen (including US As global economic conditions worsen (including US recession), the US dollar becomes more valued!!recession), the US dollar becomes more valued!!

Along with global recovery, the US dollar should depreciate Along with global recovery, the US dollar should depreciate further, but currently it has been holding fairly steady as further, but currently it has been holding fairly steady as prospects for a speedy recovery remain uncertain. prospects for a speedy recovery remain uncertain. FigureFigure

1616

Depreciation of the US DollarDepreciation of the US DollarNominal Broad Index, Jan. 2002 – Jan. 2010Nominal Broad Index, Jan. 2002 – Jan. 2010

0

20

40

60

80

100

120

140

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

1717

Who Gains from Depreciation Who Gains from Depreciation of the US Dollar?of the US Dollar?

Continued depreciation of the US dollar is necessary Continued depreciation of the US dollar is necessary in order to reduce global imbalances but its reserve-in order to reduce global imbalances but its reserve-currency status impedes this adjustmentcurrency status impedes this adjustmentBut if depreciation of the US dollar proceeds too far But if depreciation of the US dollar proceeds too far and too fast, interest rates on US securities will have and too fast, interest rates on US securities will have to rise to compensate foreign investors in its to rise to compensate foreign investors in its securities, possibly choking off recovery from securities, possibly choking off recovery from recession, and jeopardizing global recoveryrecession, and jeopardizing global recoveryIf China too quickly shifts its foreign-exchange If China too quickly shifts its foreign-exchange reserves out of US securities, the US dollar will reserves out of US securities, the US dollar will depreciate faster, and more dangerously: depreciate faster, and more dangerously:

Thus there is a continuing uneasy strategic Thus there is a continuing uneasy strategic Marriage of Convenience!Marriage of Convenience!

1818

Capital Has Been Flowing UphillCapital Has Been Flowing Uphill

As a result, China, along with other Low-income and middle-As a result, China, along with other Low-income and middle-income countries, have ended up exporting huge quantities of income countries, have ended up exporting huge quantities of capital to the richest countries (primarily the US) capital to the richest countries (primarily the US) This is not only inequitable but also inefficient globally:This is not only inequitable but also inefficient globally:

Emerging and developing economies have mounted a Emerging and developing economies have mounted a massive massive ‘foreign aid program’ to the US‘foreign aid program’ to the US since they have to borrow from since they have to borrow from the US at high interest rates but lend their reserves to it at very the US at high interest rates but lend their reserves to it at very low rateslow rates

Large Current Account Deficits, % of GDP 2007:Large Current Account Deficits, % of GDP 2007:US -5.2%, UK -2.7%, Spain -10.0%, Australia -6.3%US -5.2%, UK -2.7%, Spain -10.0%, Australia -6.3%

Large Current Account Surpluses, % of GDP 2007:Large Current Account Surpluses, % of GDP 2007:Developing Asia 7.0% (China 11.0%) Developing Asia 7.0% (China 11.0%) Middle East 18.1% (Saudi Arabia 24.3%)Middle East 18.1% (Saudi Arabia 24.3%)CIS 4.2% (Russia 5.9%)CIS 4.2% (Russia 5.9%)Africa 2.9% (Nigeria 18.8%)Africa 2.9% (Nigeria 18.8%)

1919

Why Has China (and East & Southeast Why Has China (and East & Southeast Asia) Adopted Export-Led Growth?Asia) Adopted Export-Led Growth?

The historical roots of the Export-led Model are in The historical roots of the Export-led Model are in the successes of Japan and the East Asian Tigers, the successes of Japan and the East Asian Tigers, and in the bitter lessons of the Asia Financial Crisisand in the bitter lessons of the Asia Financial CrisisThe countries that had hastily liberalized their trade The countries that had hastily liberalized their trade and capital flows (based on IMF advice) learned from and capital flows (based on IMF advice) learned from the 1997-98 Crisis that they must avoid, at all costs, the 1997-98 Crisis that they must avoid, at all costs, current-account deficits (especially if those deficits current-account deficits (especially if those deficits are financed by short-term external loans)are financed by short-term external loans)They were subjected to speculative attacks on their They were subjected to speculative attacks on their currencies and sharp painful recessions—attacks on currencies and sharp painful recessions—attacks on otherwise sound economies otherwise sound economies They were forced to endure a heavy and humiliating They were forced to endure a heavy and humiliating burden of IMF conditionalities (an experience that burden of IMF conditionalities (an experience that they wished never to repeat)they wished never to repeat)

2020

Why East & Southeast Asia Why East & Southeast Asia Adopted Export-Led GrowthAdopted Export-Led Growth

Afterwards, East and Southeast Asian countries Afterwards, East and Southeast Asian countries began to run sizeable yearly current-account began to run sizeable yearly current-account surpluses, amassing large stocks of foreign-surpluses, amassing large stocks of foreign-exchange reservesexchange reserves

The reserves were seen as a necessary form of The reserves were seen as a necessary form of ‘precautionary’ savings designed to deal with any ‘precautionary’ savings designed to deal with any attacks on their currenciesattacks on their currencies

Is it necessary to invest a country’s reserves in low-Is it necessary to invest a country’s reserves in low-yielding, risky foreign assets, such as US T-bills?yielding, risky foreign assets, such as US T-bills?

Is it necessary to amass such large stockpiles of Is it necessary to amass such large stockpiles of reserves—beyond precaution? reserves—beyond precaution?

Does this stockpiling have a deflationary global Does this stockpiling have a deflationary global impact, diverting funds from more productive impact, diverting funds from more productive outlets?outlets?

2121

Does China Save Too Much? Does China Save Too Much?

If a country’s current-account balance is in surplus, If a country’s current-account balance is in surplus, then macroeconomic accounting will show that its then macroeconomic accounting will show that its total domestic savings exceeds its domestic total domestic savings exceeds its domestic investment: it saves too much or invests too little investment: it saves too much or invests too little The country is recorded as having ‘Excess Savings’ The country is recorded as having ‘Excess Savings’ (adding to its overall savings rate)(adding to its overall savings rate)Has China been investing too little? Its Gross Capital Has China been investing too little? Its Gross Capital Formation approached 40% of GDP during 1990-2004 Formation approached 40% of GDP during 1990-2004 and more recently has approached 45%. Figureand more recently has approached 45%. FigureChina has an exceptionally high savings rate, i.e., China has an exceptionally high savings rate, i.e., over 50% of GDP in recent years; and the gap over 50% of GDP in recent years; and the gap between savings and investment has widened between savings and investment has widened ominously: savings have become misaligned with ominously: savings have become misaligned with investmentinvestment

2222

Investment and Savings in ChinaInvestment and Savings in China1990-2007 (% of GDP)1990-2007 (% of GDP)

  1990-1994

1995-1999

2000-2004

2005-2007

Gross Domestic Savings

41.2 42.0 41.1 52.4

Gross Capital Formation

39.5 38.8 38.7 44.1

Difference between the Two

1.7 3.2 2.4 8.3

2323

Savings, Investment and Savings, Investment and Current-Account SurplusesCurrent-Account Surpluses

China has been a high-savings, high-investment China has been a high-savings, high-investment economy for a long time, growing rapidly and economy for a long time, growing rapidly and channelling its huge rural labour surplus into the channelling its huge rural labour surplus into the production of higher-productivity tradables, i.e., it production of higher-productivity tradables, i.e., it has been ‘developing’has been ‘developing’Its current fiscal stimulus (5% of GDP), mostly in Its current fiscal stimulus (5% of GDP), mostly in investment, is designed to continue this momentum investment, is designed to continue this momentum during the global recessionduring the global recessionIt has ample ‘fiscal space’ to expand domestic It has ample ‘fiscal space’ to expand domestic demand without creating unsustainable public debtdemand without creating unsustainable public debtCritics argue that China should boost domestic Critics argue that China should boost domestic consumption (and thus imports) to rebalance its consumption (and thus imports) to rebalance its economy (and the global economy)economy (and the global economy)Would this improve China’s economic conditions?Would this improve China’s economic conditions?

2424

Rebalancing China’s GrowthRebalancing China’s Growth

Rebalancing China’s growth model by stimulating Rebalancing China’s growth model by stimulating more domestic consumption is certainly feasible more domestic consumption is certainly feasible since its domestic market is large since its domestic market is large Its consumption has continued to grow rapidly (9.3% Its consumption has continued to grow rapidly (9.3% in 2009) but its investment has still been growing in 2009) but its investment has still been growing faster (14.8%)faster (14.8%)

Striving for ‘consumption-led’ growth makes no sense for an Striving for ‘consumption-led’ growth makes no sense for an underdeveloped economy, especially since China’s equity and underdeveloped economy, especially since China’s equity and housing markets are showing signs of an incipient bubblehousing markets are showing signs of an incipient bubble

The transition to a Chinese growth model based more on The transition to a Chinese growth model based more on domestic demand (particularly household consumption) would domestic demand (particularly household consumption) would necessarily be a protracted process, in any case, based on necessarily be a protracted process, in any case, based on fundamental restructuring of the economyfundamental restructuring of the economy

In the meantime, China is operating as an engine of growth for In the meantime, China is operating as an engine of growth for the rest of Asia, whose exports to China are now boomingthe rest of Asia, whose exports to China are now booming

2525

Rebalancing China’s GrowthRebalancing China’s Growth Global imbalances have recently diminished: The US current-Global imbalances have recently diminished: The US current-

account deficit is expected to decline to -2.2% of GDP in 2010 account deficit is expected to decline to -2.2% of GDP in 2010 and China’s current-account surplus to decline to 8.6% (IMF and China’s current-account surplus to decline to 8.6% (IMF World Economic Outlook) World Economic Outlook) China will continue, for a while, to rely on the export of China will continue, for a while, to rely on the export of manufactured exports as the engine of rising productivity and manufactured exports as the engine of rising productivity and growth—but probably to more diversified marketsgrowth—but probably to more diversified markets

China does need to shift from low-return and risky China does need to shift from low-return and risky reserve accumulation to higher yielding direct reserve accumulation to higher yielding direct foreign investment in other developing countriesforeign investment in other developing countriesSuch a shift already appears to be happening as the Such a shift already appears to be happening as the previous surplus on its capital account is previous surplus on its capital account is diminishingdiminishingBut, like Brazil and India, China still faces the But, like Brazil and India, China still faces the problem of increased inflows of speculative capitalproblem of increased inflows of speculative capital

2626

China’s Trade DiversificationChina’s Trade Diversification China’s trade has been diversifying for some timeChina’s trade has been diversifying for some time Since only 16% of China’s exports were directed to Since only 16% of China’s exports were directed to

the US market in 2007 (with a falling trend), pegging the US market in 2007 (with a falling trend), pegging strictly to the US dollar does not necessarily make strictly to the US dollar does not necessarily make sensesense

China should continue managing the exchange rate China should continue managing the exchange rate but could peg the renminbi to a more diversified set but could peg the renminbi to a more diversified set of major currencies since its trade is becoming of major currencies since its trade is becoming increasingly diversifiedincreasingly diversified

But pegging to the dollar makes more sense But pegging to the dollar makes more sense precisely for maintaining the renminbi value of its precisely for maintaining the renminbi value of its dollar-denominated foreign-exchange reservesdollar-denominated foreign-exchange reserves

Otherwise, China would incur huge book-value Otherwise, China would incur huge book-value losses on these assets as the US dollar depreciateslosses on these assets as the US dollar depreciates

2727

The Direction of China's Exports The Direction of China's Exports 2000-2007 (% of total)2000-2007 (% of total)

33

16

20

1614

33

7

16 15

29

0

5

10

15

20

25

30

35

DevelopingAsia

Japan United States EuropeanUnion

Other

% o

f Tot

al E

xpor

ts

2000 2007

2828

Widening Fault-Lines in Widening Fault-Lines in The International Monetary SystemThe International Monetary System

The constraints on China’s reliance on Export-Led The constraints on China’s reliance on Export-Led Growth: the US Dollar no longer appears to be a Growth: the US Dollar no longer appears to be a reliable ‘store of value’ reliable ‘store of value’ How can it continue How can it continue functioning as the world’s prime Reserve Currency?functioning as the world’s prime Reserve Currency?

Does supplying the ‘world’s monetary needs’ imply Does supplying the ‘world’s monetary needs’ imply that the US has to run a current-account deficit?that the US has to run a current-account deficit?

The US has tended to run such deficits since the The US has tended to run such deficits since the break-up of the Bretton Woods system: it has almost break-up of the Bretton Woods system: it has almost invariably run deficits since the early 1980s. Figureinvariably run deficits since the early 1980s. Figure

Its current-account deficits ballooned beginning in Its current-account deficits ballooned beginning in the early 1990s, reaching a floor of -6% of its GDP in the early 1990s, reaching a floor of -6% of its GDP in 2006—before recovering modestly, to -5.2% in 2007 2006—before recovering modestly, to -5.2% in 2007 and -4.9% in 2008and -4.9% in 2008

2929

US Current-Account DeficitsUS Current-Account Deficits$ Billion, 1980-2008$ Billion, 1980-2008

-850-800-750-700-650-600-550-500-450-400-350-300-250-200-150-100

-500

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

US

$ b

illio

ns

3030

Widening Fault-Lines in Widening Fault-Lines in The International Monetary SystemThe International Monetary SystemBecause the US current-account deficits remain Because the US current-account deficits remain large and recent US domestic counter-cyclical large and recent US domestic counter-cyclical monetary and fiscal policies have added pressure, monetary and fiscal policies have added pressure, the main question is not whether the US dollar will the main question is not whether the US dollar will depreciate. It is: how fast will it depreciate?depreciate. It is: how fast will it depreciate?When the US administration states that it favours a When the US administration states that it favours a ‘strong dollar’, this means that it favours gradual ‘strong dollar’, this means that it favours gradual depreciation (any prolonged appreciation is depreciation (any prolonged appreciation is unrealistic)unrealistic)Holders of US-denominated reserves, such as China, Holders of US-denominated reserves, such as China, are already suffering losses. And if they significantly are already suffering losses. And if they significantly withdrew such investment, the value of the dollar withdrew such investment, the value of the dollar would drop even furtherwould drop even furtherThe ProblemThe Problem: This is an inherently unstable : This is an inherently unstable situation, which could trigger future crisessituation, which could trigger future crises

3131

Why Does China Continue Why Does China Continue Investing in US Reserves?Investing in US Reserves?

In a way, China was obliged to invest its foreign-In a way, China was obliged to invest its foreign-exchange reserves in US T-Billsexchange reserves in US T-BillsThe Central Bank had to sterilize the large and The Central Bank had to sterilize the large and recurrent monetary impact of recurrent monetary impact of bothboth current-account current-account and capital-account surpluses (foreign investment)and capital-account surpluses (foreign investment)It had to build up reserves: otherwise the injection of additional It had to build up reserves: otherwise the injection of additional money into the economy would have driven up imports, and money into the economy would have driven up imports, and wiped out net exportswiped out net exportsThere were very few highly liquid financial markets in which There were very few highly liquid financial markets in which such a large yearly stock of reserves could be parkedsuch a large yearly stock of reserves could be parkedHuge US current-account deficits conveniently created just Huge US current-account deficits conveniently created just such a market. However, there remains a such a market. However, there remains a clear continuing clear continuing downside riskdownside risk

3232

Will Global Imbalances Will Global Imbalances Now Disappear?Now Disappear?

The IMF projects the US current-account deficit to decline to The IMF projects the US current-account deficit to decline to US$ -325 billion in 2010 but to rise back up to US$ -475 by 2014US$ -325 billion in 2010 but to rise back up to US$ -475 by 2014

The US fiscal deficit is still projected to be -6.7% of GDP in 2014 The US fiscal deficit is still projected to be -6.7% of GDP in 2014 and thus there should be continuous global marketing of US and thus there should be continuous global marketing of US Treasury SecuritiesTreasury Securities

Hence, there is likely to be recurrent pressure for depreciation Hence, there is likely to be recurrent pressure for depreciation of the US dollarof the US dollar

Developing Asia is projected to run a current-account surplus Developing Asia is projected to run a current-account surplus of US$ 677 billion and the Middle East a surplus of US$ 307 of US$ 677 billion and the Middle East a surplus of US$ 307 billion in 2014billion in 2014

The gargantuan global imbalances of recent years might have The gargantuan global imbalances of recent years might have been modestly diminished in the recent period but the basis for been modestly diminished in the recent period but the basis for recurrent global imbalances and instability will likely remainrecurrent global imbalances and instability will likely remain

3333

Resultant Calls for Resultant Calls for International Monetary ReformInternational Monetary ReformA 2008 paper by Bruce Greenwald and Joe Stiglitz has provided A 2008 paper by Bruce Greenwald and Joe Stiglitz has provided a Keynesian perspective on reserve accumulation, viewing it as a Keynesian perspective on reserve accumulation, viewing it as a subtraction from global purchasing power (‘A Modest a subtraction from global purchasing power (‘A Modest Proposal for International Monetary Reform’)Proposal for International Monetary Reform’)As the US increasingly absorbs the reserves of surplus As the US increasingly absorbs the reserves of surplus countries (by borrowing to finance its growing current-account countries (by borrowing to finance its growing current-account deficits), the world becomes increasingly flooded with dollarsdeficits), the world becomes increasingly flooded with dollarsBut the world economy is also subjected to a deflationary bias, But the world economy is also subjected to a deflationary bias, they claim, because of the unnecessary stockpiling of reserves they claim, because of the unnecessary stockpiling of reserves by individual countriesby individual countries

Some precautionary savings is necessary but the recent build-up has Some precautionary savings is necessary but the recent build-up has been excessive (this is wasted investment)been excessive (this is wasted investment)US debt-fuelled consumption and government deficit spending US debt-fuelled consumption and government deficit spending have merely counteracted this deflationary bias without have merely counteracted this deflationary bias without providing a sustainable basis for global growth providing a sustainable basis for global growth While the continuous threat of dollar depreciation still poses a While the continuous threat of dollar depreciation still poses a destabilizing threat to the global economydestabilizing threat to the global economy

3434

Modest Reform of the Modest Reform of the International Monetary SystemInternational Monetary SystemTheir ‘Modest Proposal’Their ‘Modest Proposal’: Issue : Issue Special Drawing RightsSpecial Drawing Rights on a on a substantial and regular basis substantial and regular basis

SDRs could be a stable store of value linked to a diversified set of SDRs could be a stable store of value linked to a diversified set of convertible currenciesconvertible currenciesReserves could be credited to the IMF accounts of member Reserves could be credited to the IMF accounts of member countries in proportion to their IMF funding positions countries in proportion to their IMF funding positions Each country would no longer have to ‘bury in the ground’ Each country would no longer have to ‘bury in the ground’ some of its purchasing power by the some of its purchasing power by the precautionary precautionary accumulation of its own reservesaccumulation of its own reservesAny country could run a deficit (enjoy net imports of more real Any country could run a deficit (enjoy net imports of more real resources), which would be equal to its mandated receipts of resources), which would be equal to its mandated receipts of new reserves from the IMFnew reserves from the IMFCountries would not have to worry so much about pressure on Countries would not have to worry so much about pressure on their currency and recurrent financial crises associated with their currency and recurrent financial crises associated with global imbalancesglobal imbalances

3535

How Realistic and Equitable How Realistic and Equitable Are Such Monetary Reforms?Are Such Monetary Reforms?

Current imbalances are based on a dynamic under which the Current imbalances are based on a dynamic under which the richest country in the world continues to spend beyond its richest country in the world continues to spend beyond its means in order to prop up global aggregate demandmeans in order to prop up global aggregate demandThe US remains in a stronger position to do so than any other The US remains in a stronger position to do so than any other country or grouping of countries (e.g., Europe): it can force country or grouping of countries (e.g., Europe): it can force adjustment onto other countriesadjustment onto other countriesThere is no immediate alternative to the US dollar—not even There is no immediate alternative to the US dollar—not even the Euro (which accounts for about 30% of all reserves)the Euro (which accounts for about 30% of all reserves)Emerging and developing countries are not yet in a strong Emerging and developing countries are not yet in a strong enough position to negotiate a new international monetary enough position to negotiate a new international monetary system that would be in their own interestssystem that would be in their own interests

Note the disadvantages of current reform proposals: 1) they Note the disadvantages of current reform proposals: 1) they centre on the IMF (without fundamental governance reforms) centre on the IMF (without fundamental governance reforms) and 2) they allocate international reserves according to and 2) they allocate international reserves according to measures such as GDP (namely, not equitably)measures such as GDP (namely, not equitably)