Wednesday, 24 October 2007

IMF on Global Imbalances: What Next?

Simon Johnson of the IMF has a new blog that, as you can imagine, never strays too far away from issues related to China.

In today's post he talks about the impact of Global Imbalances and how they might be corrected. The blog has started well and I hope Simon Johnson can keep it this level of blogging productivity. Given his lofty position one can not help wondering whether he shouldn't have more important things to do. However, putting a cheery face on the IMF could be considered good public relations.

This is a well argued post that I agree with almost entirely.

Global Imbalances: What Next?

I took part in a frank discussion over global imbalances very early Sunday morning, organized by Anton Brender and Florence Pisani of Dexia. The topic was their book on this issue and -- most important -- what could follow, particularly after the summer's financial turbulence.

My main argument was that the first phase of global imbalances is likely over. In this phase, the primary imbalance was between the US current account deficit on the one hand and current account surpluses in oil producing countries, Japan, China and few other places. The main issue, which Anton and Florence make clear in their book, was one of flows, i.e., how to get capital from countries that were saving "too much" (or at least more than they wanted to invest) to the US, which was saving "too little" (or less than it was investing.)

We should of course keep in mind that during this first phase, a number of things changed. For example, initially -- in the late 1990s -- US firms invested more than they saved and this accounted for most of the US side of the imbalance. More recently, since around 2000-2001, US firms have saved more than they invested but US households have reduced their savings. So things change in the nature of this imbalance, and it has in the past been dangerous to make predictions about behavior.

Still, it now appears likely that US households will save more -- after all, few now expect property prices to continue to rise and other asset prices might also be regarded as high. This doesn't have to be a big, rapid or disruptive change, but it will likely raise savings in the US and help take the current account down to 5 1/2 percent (or smaller?) in 2008.

But if the US current account deficit is smaller, what does that imply for other countries' current accounts? Remember, that savings and investment have to add up around the world. So if the US has a smaller deficit and we want to sustain broadly the same level of world growth, either someone else has to come up with a deficit (which is large enough to make a difference) or the surplus countries have to reduce their surpluses.

But oil prices are now unexpectedly high and oil producers, who are trying hard to spend, will almost certainly have large surpluses in the near term than previously thought. Japan has zero or close to zero inflation and growth is not so very strong, so its interest rates remain appropriately low. This will likely prove consistent with a continued surplus -- although this has been driven by high savings in the corporate sector; they have reduced debt levels over the past 10 years so they are now very similar to other OECD countries, but it is not clear that they will now go out and spend more.

Now, contrary to some impressions, China is actually experiencing an appreciation in its real exchange rate -- mostly due to high inflation. In its Multilateral Consultation plan, China expressed the intention of rebalancing the economy more broadly (away from investment and exports and towards consumption), but including exchange rate flexibility. Even so, based on what we have seen in the past few months, a robust Chinese current account surplus is the foreseeable future. This is based on very strong performances, profits and savings in the corporate sector -- really the results of successful development. But still, in the near term, this part of the global imbalances is not getting smaller.

So again, if the US current account deficit goes down, and the surpluses do not go down, whose deficit will go up? This is the very big question of the day. How this question is answered is likely to have a first order impact on global growth.


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