Global Imbalances

The NY Times recently had an op-ed piece by Nouriel Roubini on the global imbalances (GIs) - an issue I've been following for years due to my interest in current account deficits (yes dull I know).

Nouriel Roubini achieved fame as the man who predicted the global financial crisis and there is no doubt that his speech in 2006 to the IMF was generally dismissed because Roubini was like a few others a permanent negative vibe merchant or prophet of doom. The financial markets call such commentators permabears. The NY Times' Stephen Mihm ran a profile in August 2008 titled Dr Doom:

On Sept. 7, 2006, Nouriel Roubini, an economics professor at New York University, stood before an audience of economists at the International Monetary Fund and announced that a crisis was brewing. In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession. He laid out a bleak sequence of events: homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt. These developments, he went on, could cripple or destroy hedge funds, investment banks and other major financial institutions like Fannie Mae and Freddie Mac.

The audience seemed skeptical, even dismissive. As Roubini stepped down from the lectern after his talk, the moderator of the event quipped, “I think perhaps we will need a stiff drink after that.” People laughed — and not without reason. At the time, unemployment and inflation remained low, and the economy, while weak, was still growing, despite rising oil prices and a softening housing market. And then there was the espouser of doom himself: Roubini was known to be a perpetual pessimist, what economists call a “permabear.” When the economist Anirvan Banerji delivered his response to Roubini’s talk, he noted that Roubini’s predictions did not make use of mathematical models and dismissed his hunches as those of a career naysayer.

(See also David Hirst's piece in The Age in August 2009)

Since then, however, Roubini's predictions have been seemingly less accurate, especially on the US economy and stock market in 2009. And he continues to attract criticism. The US stock market has done better than most imagined and the US economy just recorded annualised growth of 3.5 % (In Australia we record growth for the quarter ... so US growth was roughly 0.9 % in Australian terms). [While writing this I'm fittingly listening to Albinoni's adagio in G Minor]. There is still a chance that the end result of 2009 will be worse than is now being predicted. I, for example, remain a negative vibe merchant about the prospects for sustained growth in the short-to-medium-term (1-2 years).

In his op-ed piece Roubini defines the GIs as:

Global imbalances — roughly defined, the different emphasis the world’s leading economies place on savings, spending and debt — is a phrase much used and little acted upon.

He then notes that they have been on the international policy agenda for quite some time. This is true, while writing my book I was intrigued by the literature that increasingly argued that there was no real problem with the huge imbalances. (see Chapter 3)

While there has been some narrowing of the GIs over 2009 partly due to the recession in the US and the huge stimulus in China and the collapse of Chinese exports, the GIs remain a problem.

the financial crisis has contributed to a significant narrowing of global economic imbalances. Consumers in so-called “deficit countries” — states like the U.S., Britain, Spain and the countries of Eastern Europe that have huge trade deficits — are saving more as the crisis has exposed the dangerous extent of their indebtedness. Meanwhile, in China and other large export-driven economies, fiscal stimulus spending and some other policy moves have encouraged more domestic consumption.

As Roubini points out changing ingrained habits - too much saving in Asia (particularly China) and too much debt-fuelled spending in the US (and Australia) - is very difficult.  And so the idea that the GIS will naturally lessen as a result of market forces is a dangerous assumption. While US consumers have been forced to tighten their belts to an extent, it's difficult to make people in China save less and spend more. Even the stimulus has not been sufficiently aimed at consumption to change habits. Roubini argues that the rebalancing is temporary "the result of reactive policy measures among exporters and retrenchment among the profligate."

China, the world’s sovereign wealth machine over the past decade, is a case in point. My colleague, Rachel Ziemba, projects China’s current account surplus will likely narrow to $350-370 billion depending on the import trajectory, down from a record $420 billion in 2008. China’s trade surplus was just under $100 billion in the first half of 2009. A trade surplus of about $30 billion in the third quarter of this year is expected, which is well below 2008 levels. Increased spending at home rather than savings could further reduce the surplus. Yet with China reluctant to allow currency appreciation, reserve accumulation has resumed at a strong pace.

Although the export-oriented growth model has been shaken by the crisis, many countries seem reluctant to recalibrate. The beginning of inventory restocking has buoyed Asia significantly, as companies that cut back sharply have now increased output. Avoiding currency appreciation will exacerbate this trend, adding to reserve accumulation and distortions.

The question becomes who will take up the slack of Chinese surpluses in the absence of the US continuing its status as the 'buyer of last resort' par excellence. Roubini notes that the IMF suggests a diffusion of the GIs.

where surpluses of Germany and Japan will remain in shrinking mode even in 2010, while the deficits of Canada and Australia, as well as emerging economies like Brazil, will offset the growth of China’s surplus.

Roubini points out that the GIs are back on the policy agenda of the G20 but probably can't be solved by communiqué. What is required instead is a organisation with teeth to force adjustment. This is an idea of long standing going back to Keyes view in the Bretton Woods negotiations that both deficit and surplus countries should be made to adjust.

Global imbalances are back on the policy agenda with the G-20 agreeing to create a peer review of macroeconomic policies including imbalances to avoid another crisis. The details are limited so far, but focus once again on an agreement that the U.S. will consume less and save more; Japan, Germany and China will spend more and will reallocate investment away from the export sector.

These are the right goals, to be sure. But a joint communiqué from a nascent international organization isn’t much to hang the world’s hat upon. The I.M.F. needs teeth, perhaps along the lines of the W.T.O.’s authority to prod member states toward “out of court” settlements, in order to enforce these difficult political and economic goals.

Basically there is no chance of this happening unless there was another severe economic downturn and even then it is unlikely that countries would agree on the causes of the crisis, thus negating a sound solution (just think of the many and varied views on what caused the current crisis.

The problem is that the GIs provide an impetus for the creation of crisis and bubbles. While Roubini correctly points out that the GIs did not cause the crisis they did provide the liquidity backing for it and are part of the crisis equation.

While imbalances did not cause the current financial crisis — I believe lax regulation bears a far greater onus — these imbalances certainly helped create the conditions for this crisis. Easy money and low long-term interest rates created an incentive to invest in seemingly-safe high-yield assets. An orderly unwinding of imbalances might put a lid on global growth during the adjustment, but is fundamental to achieve sustainable global growth.