The issue of global imbalances is an important global challenge to global economic governance as it affects global financial stability. It was probably an important problem even before World War 1 (De Cecco, 1974). Global imbalances describe the situation where some countries accumulate current account surpluses at the expense of other countries, which ran deficits, because of the interdependence of countries of the world. All other things being equal, the current account deficit of a country indicates the excess of the country’s total domestic investments in capital goods over total domestic savings. This shortfall can only be covered with foreign capital inflows to the extent that countries with current account surpluses are prepared to provide loans. The deficits of debtor countries are therefore the surpluses of lender countries who have current account surpluses and vice versa. It is however intriguing that developing countries have rather provided the surpluses of late and not the industrialized countries (Bernanke, B.S. 2005).
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In the world today, payment imbalances of the US and China make up the greatest proportion of global imbalances, the US being the highest deficit country and China emerging as the highest surplus country and their rivalry in macroeconomic choices as well acceptance of global adjustment responsibilities, have crippled the progress of the IMF and recently the G.20, in resolving the challenge, even though the two multilateral bodies, arguable, are best placed in resolving the challenge (Foot and Walter.2011).
Origins and causes of global imbalances
Andrew Walter identified un-even international economic power and muscle of countries, domestic political orientations and their influences on national macroeconomic policy decisions as well as the delegitimized IMF and its multilateral surveillance system as the main originators of global imbalance (A, Walter. 2010)
Countries of the world are not equally endowed with resources and even the same nation may not possess the same level of resources at all times. Global influences on global affairs, decisions and challenges therefore, differ from time to time. The US and China are, at present, the two main players in the conflict of global imbalances. The US is the heaviest deficit country and the issuer of the major reserve currency and China, emerged quiet recently, as the nation with the biggest stock of trade reserves, overtaking Japan (J, Vestergaad. 2011). The US had the highest GDP (Nominal) of USD 14256 billion and China had the largest population of 1331 billion according to 2009 data ( J, Vestergaad. 2011).
Just after World War 1 the then major surplus countries, France and the United States sought to self-insure themselves by accumulating sterilized reserves. Significant deficit countries such as Britain and Germany saw these activities as unfair to them and uncomplimentary to the then accepted gold standard, which eventually collapsed (Eichengreen. 1992). The need to resolve the clear economic advantage and power of surplus countries over deficit countries in the global economy then became obvious. This informed the Breton Woods Institution (IMF) in their post war deliberations and Keyness, in particular, suggested rules that placed adjustment responsibilities equally between deficit and surplus countries and recommended sanctions for surplus countries which would refuse to accept recommendations for microeconomic expansions or real exchange rate appreciations, through measures that do not require sterilized reserve accumulation (A, Walter. 2010). This, as expected, was not acceptable to the people of the US who seemed convinced that their country would remain the highest surplus country in the world, forever(C, Harrington, 2011). At any rate congress couldn’t have accepted to cede control over microeconomic policy choices of the US, to multilaterals. America, however, saw the need for global adjustment responsibilities to be broadly symmetrical for both deficit and surplus countries, thereby giving hope to the other countries that American would, from then, behave differently (Gardner, N.A. 1980). America did, after this, offer some discriminatory exchange and trade restrictions to some of its allies and even accommodated some significant devaluation, but largely, refused to acknowledge the need to bolster the multilateral surveillance framework, through the International Monetary Fund (A, Walter. 2010).
The initial pegged exchange rate system, and IMF surveillance and recommendations, were to apply equally to all member countries and to restore countries to equilibrium in international payments whenever necessary. However, countries generally found it difficult to accept multilateral oversight responsibility over their fiscal and monetary policy choices, which they seemed to preserve as sovereign decisions (Boughton, J.M. 2002). The IMF’s powers were therefore weakened and were only effective on countries that borrowed from the fund. The IMF, therefore, was unable to insist on equal responsibility for adjustment responsibilities on surplus and deficit countries as well as specific policy responsibilities for reserve currency countries, who also tendered to run huge deficits and for that matter enjoyed substantial economic power and could not be discipline by the IMF (Arghyrou. et al, 2010). Eventually the US lost its position, as the main surplus country of the world to West Germany and the Netherlands, and eventually became a deficit country. Japan came up later and more recently, China emerged as the major surplus country (C, Harrington. 2011). The US, finding itself now as a deficit country, sought to rebalance adjustment responsibilities away from deficit countries, back to surplus countries, by first attempting to strengthen and use the surveillance mechanism of the IMF. The US also introduced special drawing rights (SDR) as a new international reserve asset, and also resorted to bilateral and multilateral negotiations with surplus countries as well as unilateral actions, not excluding the use threat and actual policy sanctions, against recalcitrant surplus countries (A, Walter. 2010). These attempts largely failed because the US, by its own previous actions, had devalued the legitimacy of the IMF and its surveillance mechanism and the French also perceived the SDR as rival to the role of gold as a reserve asset (Boughton, J.M.2002). Arguments raged on at the IMF, the US asking for strict constrains on reserve accumulation of surplus countries and they, in contrast, pushed for greater constrains on the US, as the reserve centre country (Williamson. 1977). American sought and supported two amendments to the IMF’s Articles of agreement in 1977 and 2007. Many thought these amendments were biased in favor of the US, since it imposed no new constrains on their monetary and fiscal policies but rather strengthened the focus on surveillance of exchange rate policies (James. 1996). There was a perception that the IMF was only concentrating on exchange rates to please America and their claim that “the 2007 decision restored exchange rate surveillance position at the core of the IMF’s mandate” (US Treasury. 2009) did not help matters. As expected China did not accept these amendments, further deepening the politicization of the US – China bilateral relations and made worse any prospects, whatsoever, of resolving the global imbalances (A, Walter. 2010). The arguments continued between the US and the surplus countries, who felt that they were being coerced to make the main concessions (Webb, M. 1995) and no lasting consensus on adjustment responsibilities were ever reached. Meanwhile, China’s surpluses escalated and they will not accept any appreciation of the reminbi even when they were invited and persuaded by the G-7 (A, Walter. 2010). The more the US maneuvered the more the surplus countries resented it for unwilling to accept international adjustment responsibilities. Their resort to threats and/or actual use of unilateral sanctions against surplus countries worsened the resentment and Congress did not help by formalizing some of these sanctions and the US – China relationship became worse (Foot and Walter.2011). China did do some modest renminbi appreciations in 2005 but was largely hampered by its own domestic inflation problems (A, Walter. 2010). The US got some temporary victories over surplus countries but could not convince them to accept the Keynesian argument of symmetric adjustment responsibilities for global imbalances (Walter,A.1993) and the legitimacy of the IMF’s surveillance mechanism was totally eroded, contributing in no small way, to the Global economic crisis 2008 – 2009.
Are global current account imbalances a problem?
Imbalances, as open and free market phenomena, could reflect the attraction of markets to investors and vice versa. The US deficit could be the result of “the attractiveness of both the US economy overall and the depth, liquidity and safeguards associated with its capital markets” (Bernanke, B.S. 2007). The truth may be that those market attractions do not only motivate private capital inflows but also official foreign inflows.
Secondly, current account imbalances could give nations the flexibility of spending more or less than their current outputs, in satisfaction of economic needs and demands (Bernanke, B.S. 2007). Countries could therefore procure essential capital items for investment in their growth sectors, in excess of their total domestic savings without overheating their economies and generating excessive inflationary pressures. US trade deficits promoted domestic demand without much pressure for inflation and the Asian countries were able to run surpluses which bolstered their aggregate domestic demand and employment even though their domestic investments had collapsed (Bernanke, B. S. 2007)
Thirdly, imbalances create capacity for sovereign nations to maximize their external investments and for that matter earn more income abroad. At the current levels, US deficits may look unsustainable but their liabilities to foreign investors at present are not putting unbearable burden on their economy and their net international investment position (NIIP),and although at a substantial negative of 19 percent to GDP, it is much smaller than that of several other individual economies(Bernanke,B.S. 2005). The US therefore “continues to earn more on its foreign investments than it pays on its foreign liabilities even after years of current account deficits and corresponding increases in net liabilities” (Bernanke,B.S. 2005). Perhaps the proportions of US assets in foreign portfolios are not excessive relative to the countries importance in the global economy.
However same cannot be said for all other countries. The effect of the Greece debt crisis and the likelihood of default by other weak economy European countries such as Spain and Italy on the stability of the global economy cannot be overemphasized. Since Greece joined and adopted the Euro the country’s debts have escalated out of control. Between 1999-2007 Greece public spending rose dramatically, public sector wages went up 50%, far above any other country in the euro zone and their debts became unsustainable (Nelson, R.M. 2011). The heavy loans they received from the IMF and other European donors, partners and countries such as Germany, France and England rather aggravated matters as the burden of debt service spiraled out of control (Meghir, C. et al. 2010). ” In May, 2010 Greece received a bail- out of 10billion Euros ($140.0bn) from the European Union and early 2012 another 130billion Euros was doled out to themâ€¦â€¦. Their total debts as at Aprail, 2012 stood at $447bn” (P, Acquah. 2012). This level is clearly not sustainable. Investors are uneasy about a possible Greece default though the IMF and the EU have imposed austerity measures (P, Acquah.2012). Greece could set a dangerous precedent if they default. Other weak European economies such as Spain and Italy are also wavering. Investors may buy bonds at extremely high rates or stop buying sovereign bonds. Debtor countries may not be able to pay their creditors and the vicious circle would escalate. The banks may not be spared as they would have to make more provisions and/or write-offs beyond projections thereby weakening them further and jeopardizing confidence in the entire banking system.
Fourth, the imbalances cannot persist indefinitely. The ability of the US to service its large current account deficits and the willingness of foreigners to hold US assets in their portfolios are limited (Bernanke, B.S. 2007). Eventually, there must be adjustment with its consequences. This could involve releasing resources to the manufacturing sector to bolster production of US goods for export in preference of demand for imports of foreign goods. Similarly, China will have to shift resources from manufacturing for exports into production for home consumption. The greater the magnitude of these resource shifts for adjustment, the more potentially disruptive and costly they may be and the earlier they are done the less rapid and smaller the scale (Bernanke, B.S. 2007).
Then also the longer these imbalances persist and the more foreign investors hold dollar assets, the higher the probability of these investors becoming satiated with dollar assets and, all other things being equal, the more difficult the deficit financing, at reasonable costs(A, Walter. 2010). “Earlier reduction of global imbalances would reduce the potential strains associated with financing a large quantity of international liabilities and likely allow a smoother adjustment in financial markets” (A, Walter, 2010).
Time has also come for the developing world which tended to contribute financial capital to the industrialized nations also to receive capital. Labor is abundant in the developing world, relative to financial capital and technology and therefore there exists high potential returns for prospective investors and their host countries (Bernanke, B.S. 2007).
After the financial crisis:
The global financial crisis completely blew out the G7 and brought on the need for a new grouping reflecting the “new multipolarity” (Dadust and Stancil, 2010) and in September, 2009 at Pittsburgh, the G-20 leaders “designated the G-20 to be the pressure forum for international economic corporation” (G-20. 2009), thereby subordinating the IMF and other international standard setting bodies, and the G-20 was thought to be the most likely body to provide a reasonable balance between representativeness and efficiency (Carin. et al, 2010). However, there emerged doubts as to the ability of the G-20 to achieve adequate consensus to be effective. Its composition and perceived unrepresentativeness cast shadows over its legitimacy. “The process by which countries were selected for these purposes was of questionable legitimacy, a reflex of G-7 world” (Wade. 2009). However, the G-20 agreed a new “framework for strong, sustainable and balanced growth” which had “more balanced current account” as one of its objectives (G-20. 2009). The G-20 members also subscribed to a “mutual assessment process” (MAP), with IMF assistance to promote convergence of macroeconomic policies of member countries (IMF. 2009). It was further agreed that these peer assessments should address “all salient policy commitments as well as projections for key economic variables (IMF. 2009). Both China and the US accepted the objectives and President Obama remarked that achieving the objective would mean “in the United State â€¦.. Saving more and spending less, reforming our financial system and reducing our long-term deficit” (Johnson, S.2010). In fact, in a joint statement issued in November 17, 2009 both countries indicated their acceptance of symmetric responsibilities, as the major surplus and deficit countries (Johnson, S.2010). The IMF also found its voice and in a report stated that “credible fiscal consolidation over the medium term, underpinned by high-quality measures of sufficient magnitude, should be a top priority in advanced deficit economies” and in “emerging surplus economies, policy should aim at enhancing social safety nets, reforming corporate governance and developing financial markets, supported by greater exchange rate flexibility to facilitate a rebalancing of demand towards domestic sources” (IMF, 2010b). The US was urged to reduce its fiscal deficit by three percentage points, over five years, above the projections of the Obama administration (Foot and Walter.2011). However, domestic constrains did not allow the nations much progress and they kept accusing each other. The US Treasury Secretary, Geithner, argued that “the IMF must strengthen its surveillance of exchange rate policies and reserve accumulation practices “(A, Walter.2010), when Wen Jiabao had earlier remarked that “we will not yield to any pressure of any form to appreciate” (A, Walter.2010) and China kept arguing that America’s own extremely loose monetary and fiscal policies were what was destabilizing the world economy (A, Walter. 2010). unsurprisingly most vital new initiative failed to achieve any progress.
Why have global imbalances been persistent?
Global imbalances have tended to persist probably because of “a limited technical consensus amongst economists about the course of and solutions to imbalance; the high degree of domestic sensibility to policies that probably contribute most to global imbalances, and international power imbalances and associated dilemmas” (A, Walter. 2010). Some economists have also argued that global imbalances are caused by persistent savings-investment balance differences across different countries, while others blame it on changes in real exchange rates but others are still doubtful about the ability of real exchange rate changes to correct imbalances (McKinnon, R. 2010). However, most “have accepted that US fiscal and taxation policies on one hand and Chinese exchange rate, energy, corporate taxation and financial policies were all contributors, to global imbalance” (A, Walter. 2010). Second has been the politicization of domestic policy changes that could resolve the problem. “Demanding that foreign governments accept exchange rate appreciation has been easier for US politicians than raising taxes, reducing subsidies to home owners, and controlling public spending on health and other entitlement programs” (A, Walter. 2010). For surplus countries such as China, their penchant for export led growth and policies that encourage investment for exports at the expense of domestic consumption have sustained the imbalances (Rajan, A. 2010). China achieved sustained rapid growth without incurring current account deficits, massive inflow of private capital and serious financial crisis (Rodrik, D. 2008). Their exchange rates were undervalued, interest rates repressed and un-naturally low production costs, including energy costs, yet the political Influence on these choices was well known to the IMF which actually acknowledged that domestic microeconomic policy choices were issues of national sovereignty and for that matter should not be on the table(A,Walter.2010).
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Substantial differences in the international economic power of countries have also entrenched the problem. Some countries have the economic and political muscle to shift adjustment responsibilities onto others thereby discrediting the legitimacy of the multinational surveillance system as well as the Keynesian prescription of symmetrical adjustment responsibilities (A, Walter. 2010). The rapid rise of china as the major surplus country even made matters more contentious as the big difference in their common understanding of the challenges with America has worsened the problem, hence the belief of some economics in the emergence of a “G-2” platform (Harrington, C. 2011).
A US – China G-2 platform may not be sufficient for the resolution of the persistent and urgent global challenge of excessive payments imbalances even though imbalances between these two nations make up the biggest proportion of the global imbalances. The total elimination of other equally important countries like Japan, Germany and blocks like the European Union and probably Africa could obscure the effort. Domestic political orientations of both countries such as the authoritarian political regime of China and the vibrant democracy of the US and their effects on microeconomic choices cannot be easily discounted. However, issues such as the looming demographic challenges make it imperative for these two countries to collaborate. The aging population of the US and the ‘one child policy of China’ are all pointers to serious future challenges which they must begin to address today, by considering alternative policy choices.
The actions and inaction of the two countries over the years have also frustrated and delegitimized the efforts and surveillance mechanisms of the IMF and the G-20 grouping and time has come for them both to collaborate and behave in the general good of the global economy.
Addressing the challenge of global imbalances must begin by identifying the origins of the problem, which could be found in the diverse political orientations of nations and their influences on domestic microeconomic policy choices and the effects of international economic and political muscle of different countries and their eventual delegimization of the IMF and its multilateral surveillance processes.
Internal political influences cannot be wished away, but progress requires close and effective economic coordination among countries and regions probably through the IMF and the G-20. Cooper (2010) rightly posits that the concern for bridging the global trade imbalances so as to deal with the collapse of the financial system must place emphasis on restricting the international flow of capital and find means to control the level of globalizing the world economy since the freedom of continuous capital movements combined with other demographic dynamisms entail a pill-up of international assets and liabilities of countries.
To forestall a future break-up, low-savings countries must reduce their net borrowing from abroad and decrease their ever-increasing trade deficits by finding ways to increase their domestic savings. To maintain levels of economic activity, high-savings countries must also expand domestic demand and allow their trade surpluses to shrink. This requires changes in prices and most obviously in real exchange rates through either nominal exchange rates or domestic price levels.
China’s responses in recent weeks have been much obvious. On July 5, 2012, the central bank of China reduced its benchmark interest rates from 6.31% to 6% and deposit rates from 3.25% to 3% (P, Acquah. 2012). This was a second cut in rates in 2 months. There were no cuts since 2008. The reductions were to halt declining economic growth and bolster domestic demand. “China’s first quarter economic growth of 8.1% p.a in 2012 was the slowest in 3 years. Export growth fell as demand for Chinese exports declined on the US and Europe markets due to the global debt crises” (P, Acquah.2012).
North Korea similarly reduced their cost of borrowing by 25 basis points to 3% p.a on July 12, 2012. They intend to stimulate domestic demand in response to the slowing effect of the European debt crises on exports (BBC. june18,2012).
The challenge of global current account imbalances is and must therefore be of concern to all countries, who must collaborate to resolve it, for the mutual benefit of all, the earlier, the easier the adjustment responsibilities for all.