Rethinking global rebalancing

Persistent global imbalances are a manifestation of all that is wrong with an increasingly interdependent world economy. They are an outgrowth of the excesses that gave rise to the Great Crisis and Recession of 2008-09. They are hobbling a post-crisis healing. And they have sparked the early skirmishes of a “currency war,” which could push the world down the very slippery slope of trade frictions and protectionism. A failure to take major steps on the road of global rebalancing poses the distinct possibility of a relapse and another crisis.

Morgan Stanley Asia Chairman
Stephen S. Roach

By Stephen S. Roach

Persistent global imbalances are a manifestation of all that is wrong with an increasingly interdependent world economy. They are an outgrowth of the excesses that gave rise to the Great Crisis and Recession of 2008-09. They are hobbling a post-crisis healing. And they have sparked the early skirmishes of a “currency war,” which could push the world down the very slippery slope of trade frictions and protectionism. A failure to take major steps on the road of global rebalancing poses the distinct possibility of a relapse and another crisis.

That’s the bad news. The good news is that the G20 finally appears to get it. A recent proposal by U.S. Treasury Secretary Timothy Geithner has the potential to be a game changer in the global rebalancing debate. It shifts the onus of the adjustment process away from a dubious and circuitous currency realignment toward a direct assault on the world’s underlying current account and saving disparities. Its strength lies in its practicality. By focusing directly in the imbalances themselves, the Geithner approach, as endorsed by G20 finance ministers meeting in Gyeongju, South Korea on October 23, forces individual countries to address the structural characteristics of their economies that have led to destabilizing excesses.

Take the United States ― by far, the biggest problem on the deficit side of the global current account and saving equations. America’s saving shortfall is unprecedented in the annals of the modern global era ― a net national saving rate (depreciation-adjusted saving of households, businesses, and the government sector) that fell into negative territory in 2008 and plunged further to -2.3 per cent of national income in 2008. At work were two related developments ― consumers who saved increasingly out of asset bubbles and thereby squandered their income-based saving, as well as outsized Federal budget deficits that arose when the government had to arrest the freefall of personal consumption that stemmed from the bursting of those bubbles. For America to save again, it must tackle both of these tough issues.

Or take China ― the most rapidly growing source of instability on the surplus side of the global imbalance equation. China’s outsize domestic saving rate ― fully 54 percent of GDP in 2009 ― is the mirror image of a major deficiency of internal private consumption, whose share currently stands at just 36% of GDP. Lacking in a well-funded social safety net ― social security, private pensions, medical and unemployment insurance ― Chinese families save increasingly out of fear. That puts the onus on exports and fixed investment as major sources of output and employment growth. In a post-crisis era of persistently high unemployment in the developed world, this growth model ― together with a tightly managed currency ― finds China on a collision course with the rest of the world. If China charts a new course, that collision can be avoided.

Under a current-account rebalancing framework, both the United States and China will be forced to rethink their growth strategies and address the root causes of their saving imbalances. For the U.S., that implies a deleveraging by asset-dependent consumers and a disciplined exit strategy from outsize government budget deficits. Similarly, China will be required to address its deficiency of internal private consumption head on, putting policies in place that would not only reduce its propensity to save but would also broaden the footprint of job creation into services and raise the income levels of rural Chinese families. If China achieves traction in stimulating private consumption, it would provide a new and important source of external demand for exporters in the growth-starved West.

In other words, the current account adjustment framework for global rebalancing allows individual nations the leeway to craft adjustment policies that are tailor-made to fit their own problems and systems, while at the same time, benefiting the broader global economy. Such an approach ― preferably focusing on directional targets rather than on precise numerical thresholds ― is likely to be far more effective than a currency realignment, which forces all adjustments through the same blunt mechanism. The presumption of such a one-size-fits-all remedy – irrespective of whether nations are market or non-market economies, or developing or developed – is one of the biggest flaws of the so-called currency fix.

At best, the currency-realignment prescription offers a very circuitous means for global rebalancing. As was the case in the aftermath of the sharp revaluation of the yen in the aftermath of the Plaza Accord on 1985, when the outsize Japanese current account surplus barely budged, there are no guarantees that currency realignments will lead to sustained improvements of global imbalances. Indeed, the 24% drop in the inflation-adjusted broad trade-weighed dollar index over the past 8 ½ years has done next to nothing to narrow America’s seemingly chronic trade deficit.

Nor do the econometricians have much of a clue on the currency valuation front ― that is in determining how much a particular currency needs to move in order to spark shifts in trade and current account imbalances. Back in 2005, when Washington first started to focus on the Chinese currency problem, the experts maintained that the renminbi was undervalued by about 25 per cent relative to the dollar. Since then, the bilateral cross-rate has moved up by 24 percent and yet the so-called experts are stuck on the same verdict ― maintaining that the RMB is still 25 percent below its fair value.

Similarly, back-of-the envelope calculations of prominent pundits suggesting that Chinese currency manipulation is costing America between 500,000 and 1.4 million jobs don’t appear to be worth the paper they are scribbled on. A multi-county econometric model designed by Yale Professor Ray Fair, that allows for a full range of global feedback effects, puts the net US jobs impact at closer to 41,000 in response to a 25% increase in the value of the renminbi versus the dollar. In short, the evidence in favor of a currency fix ― especially a “bilateral fix” that singles out China as the cure for the world’s “multi-lateral” imbalances ― is highly problematic. Rather than operate through the theoretical channels of a relative price adjustment, it makes far better practical sense to rely on a current-account targeting approach that directly attacks the world’s imbalances.

As always, the devil will be in the detail ― as well as in the political will of individual nations to act in the collective interest of an unbalanced world. But failure is no longer an option in this still precarious post-crisis climate The world needs and deserves a much better plan than a poorly conceived and misdirected currency fix. Hopefully, the G20 stays with the new approach hammered out in Gyeongju and follows through on IMF-driven accountability and enforcement mechanisms. If so, meaningful and long overdue progress in resolving global imbalances might finally be at hand.

Mr. Roach, a member of the faculty at Yale University, is also non-executive chairman of Morgan Stanley Asia and author of The Next Asia (Wiley 2009).