Macro focus: are today’s global imbalances a problem?

France, which holds the presidency of the G7 this year, wishes to “return to the original purpose of the group and make this forum a space for dialogue between major economic powers”, and describes imbalances as “profound”. Such imbalances threaten the stability of the global economy and encourage protectionist tendencies, to the detriment of shared growth.

Global current account imbalances, even really large ones, are not a new phenomenon, and to be expected in our global and open financial system. Since global industrialisation began accelerating over the latter part of the 19th century, as world trade and commerce rapidly increased, big deficits and surpluses have come and gone while economies industrialised and grew, and the world order changed rapidly, with some nations powering ahead and others falling back.

Fast growing ‘new’ economies, like the US, Canada, Australia, Argentina, needed to import huge amounts of capital for investment, far more than their domestics savings could supply, for building railroads, ports, bridges, housing and more. Consequently, these economies ran persistent and often large current account deficits.

‘Old world’ capital-rich nations like France, the Netherlands, or Belgium, on the other hand, tended to run surplus current accounts over that period, with Britain enjoying a particularly large surplus of around 4 to 5% from the 1870s through to the onset of the First World War. 

Macroeconomic factors are the main drivers of persistent imbalances. The IMF categorises these factors into three categories: fundamental factors, such as demographics, overall level of economic development, and natural resources like oil; cyclical conditions, driven by the business cycle; policy settings, such as fiscal policy, health and welfare spending, although the IMF does not currently include industrial policy in its categorisation.

The IMF also labels current account balances as ‘appropriate’ or ‘excessive’, by gauging if policy settings are, in the judgement of IMF staff analyses, published in the annual External Balance Assessment, appropriate for the moment. Although some imbalances are certainly excessive, it is also true that not all excessive balances end in chaos or economic pain as they are unwound.

Long-standing issue

Towards the end of the 19th century, the huge imbalances built up during the global industrialisation period were a lot less problematic than in later times. This is possibly because lenders were more careful in seeking actual investment prospects before loans were agreed, or because governments were so much smaller, or indeed because government fiscal policies were in no way activist. Strict adherence to the gold standard, as opposed to societal well-being, was the driving force for policy makers.

However, the unwinding of imbalances after 1918 was very painful for many economies. With the US now being the dominant surplus nation, capital was transferred not only for ongoing industrialisation and largely still to resource-rich economies including Latin American governments and municipalities, but also for the huge post war reparations and reconstruction needed in Europe.

When the Fed raised rates in 1928, however, several US banks collapsed and lending dried up, forcing borrowers into recessions, while in Europe tensions were rising and money transfers jeopardised which sent first Austria, then Germany and others into ruinous financial crises. 

After the Second World War, US current account surplus recycling enjoyed another golden age, as the US became a hugely successful exporter of capital goods to Western Europe as well as being active with grants and loans. Geopolitics played a large part too, as the advent of the Cold War became another significant motivator for the US to maintain strong links with its allies in the West. The US surplus steadily declined and then moved into deficit, not least due to spending on the Vietnam war, while Germany and Japan had moved into significant surpluses.

Over the last 50 years, the unwinding of large imbalances has often culminated in, or at least coincided with, some very volatile and destructive crises. The enormous surpluses of the OPEC countries in the 1970s and 80s – Saudi Arabia’s surplus averaged 28% of GDP during this time, for example – spurred a gargantuan lending splurge across Latin America. Perhaps not too surprisingly, after Paul Volcker’s Fed dramatically hiked US rates in response to very high inflation, that spending spree ended with Mexico defaulting, followed by others, with years of economic hardship across the region. 

Though not necessarily the root cause of the post-2008 financial crisis, the huge and rapidly increasing global imbalances, which had peaked a couple of years before the crisis began, were a key topic of economic research. Attention focused on the potential for some sort of disorderly and dangerous re-adjustment. Also in the early 2000s, alongside the growing current account deficit of the world’s largest economy, was the arrival of China attaining world’s biggest exporter status. 

Although US manufacturing has declined significantly over the decades, the attractiveness of US financial markets to world capital has remained undiminished. Today, the net international investment position, meaning the claims of the US on the rest of the world minus the world’s claims on the US, is estimated at a negative $21.3trn, which equates to around -70% of US GDP. 

Failed promises

The commitments of the G20 summit back in 2009 agreed by world leaders, chastened by the pain wreaked in the crisis, have not been maintained. Certain currencies, like the Chinese yuan, remain chronically misvalued, the US is still over-consuming and has been unable to reign in its ballooning fiscal deficit, while China has thus far not succeeded in shifting its economy from investment- to consumption-led, and is thus still over-investing and over-producing and still flooding world markets with cheaper products.

Historically, any onus to reduce wide imbalances has tended to lie with deficit economies, on fears that a country in deficit could, in a crisis, likely endure huge and potentially very destabilising outflows. Ideally, all sides would do their part together, though it is possible that China, looking at Japan’s uncomfortable experiences after agreeing to the 1985 Plaza Accord, has concluded that macro policy coordination might not mean China’s economic pain would be matched equally by the US. 

At present, the only certainty seems to be that these imbalances are growing. Whether or not they become the triggers for the next global crisis, it seems clear that the bigger they become, the higher the degree of damage that could ensue.