Global Imbalances: Another Crisis Round the Corner?

To keep the global economy on the growth track, balancing the global imbalances is need of the hour. If not there will be a weak world recovery; at worst, the seeds of the next financial crisis will be sown.

The outline of the Group of 20 nation’s summit of financial leaders in Paris limited both optimistic and pessimistic views on global economic recovery. The two-day financial summit issued a statement on February 19, 2011 saying that economic recovery was strengthening, but is still uneven, although there was a “persistent misalignment" of exchange rates. Given that, the G20 finance ministers have arrived at a cooperation deal to correct global economic imbalances while expressing concern over excessive commodity price volatility impacting the world food security, an issue pressed by India. The world’s mighty group, The G20 was formed in 1999 and accounts for 85% of worldwide trade.

One of the main reasons behind threatening global imbalances is: as major economies are rationally pursuing their own self interest, these actions had collective consequences which threaten the sustainability of the recovery in global demand. Mervyn King, Bank of England’s Governor, has warned that a failure in addressing this issue will lead to another crisis. He suggests that policymakers should reach in an agreement on the right speed of adjustment to the real pattern of spending and should take many policies in addition to exchange rate changes.

 It is often said that the key cause of the global financial crisis is regulatory failure in the mortgage and finance industry. However, along with regulatory failure there was a large global imbalance between East (mainly China and rest of Asia) and West (mainly US and UK) caused, or at least exacerbated, by the financial crisis in the recent past. The graph on current account balances of different countries clearly explains this dichotomy. Economists say the persistency of global imbalances is mainly the policies of the US economy. The world’s largest economy is depending on capital inflows to sustain its ever-rising current account deficits mainly because the rest of the world is dependent on the US market and its buoyancy for growth.

China’s Connection

During the last decade, both advanced and developing nations have grown in fundamentally different ways. The trade and financial relationship between China and America (the consumer of last resort) has been best illustrated for growing global imbalances. China invests a large portion of its surplus in the US debt, implying that it essentially lends to America the capital to buy Chinese exports. This results into the enduring imbalance between the two and also involves a trade imbalance and an imbalance of financial flows. Thus, the dragon has an excess of savings after investing in its burgeoning economy, while the US national debt has grown to about $14 trillion, equivalent to about 100% of its GDP. Similar imbalances are then replicated as many countries such as the UK and Spain run deficits, and Japan, Germany and the major oil-producer countries run surpluses. Thus the growing imbalances between nations have come to be seen as particularly taxing because of their role in the financial crisis.

Rebalancing or Restructuring?

Thus rebalancing is one of the key concerns that global policy makers are facing today. Most emerging nations blame the advanced world’s slow recovery from the financial crisis, on the other hand, the US criticizes China’s yuan policy. But on the whole, there seems little commitment to make the necessary restructuring changes. Against this context, economists suggest that it would be better to have the aim of restructuring and rebuilding rather than rebalancing. And through these efforts a more balanced economy is likely to emerge soon.

Jany, Chief Economist