Global Imbalances

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Michael Pettis has written an interesting article on the significance of the global imbalances between US and Chinese economies: "The last chance to avoid a global trade war".

I've recently constructed graphs on global current account deficits and surpluses to show just how important the US deficit is in counterbalancing the surpluses of China, Germany and Japan. The graphs show the percentage each of the top 11 countries have of total world deficits and surpluses.

The data is from the IMF WEO Database for April 2010.

Pettis argues expanding US trade deficits (the US current account deficit is mainly a trade deficit, unlike Australia which is mainly an income deficit) could lead to a global trade war:

The world seems to be marching inexorably towards trade war. The US trade deficit is surging, for reasons that have nothing to do with domestic consumption and everything to do with policies and events abroad. In the months ahead, the US will be forced to choose either protection or soaring trade deficits with rising unemployment. It will almost certainly choose the former but if it overreacts, which is likely, it could unleash another round of global protectionism – which will especially hurt trade-surplus countries.

He says arguments that the currently growing US deficit is the result of unbridled consumerism are wrong:

As it continues rising there will be renewed criticism about US consumers embarking on another ill-judged buying spree, but this time the finger-waggers will be wrong. The surge in the trade deficit is the automatic consequence of a shift in global trade imbalances.

Five countries or regions have largely driven these imbalances in the past decade. Three of them – China, Germany and Japan – run huge trade surpluses on which they are dependent for domestic employment growth.

Counterbalancing them have been the two trade-deficit champions – the US and trade-deficit Europe, dominated by Spain, Italy and Greece

The problem is that deficit countries are generally lowering their debt levels, which makes them less able to maintain "the excess demand they provide to the rest of the world". But trade surplus countries have resisted making appropriate adjustments and have instead pushed to increase their surpluses.

The combination of a collapsing euro and German fiscal constraint will raise Germany’s trade surplus sharply and generate rapid growth. Any rise in the value of the renminbi has been more than offset by a surge in cheap credit to Chinese manufacturers, increasing their competitiveness, so China’s surplus is also rising. Recent strength in the yen has set off alarm bells and Tokyo, too, will do what it can to maintain its trade surplus.

But rising surpluses require rising deficits elsewhere, and here the situation is dire. The crisis has made it all but impossible for most of the trade-deficit countries in Europe to raise new financing – Spain, Italy, Greece and many of the other trade-deficit countries of Europe will see their capital account surpluses contract rapidly. Since current account deficits are the obverse of capital account surpluses, their current account deficits will automatically contract too.

The obvious dilemma here is the obvious fact that global trade must balance:

The rest of the world will have to absorb, with rising trade deficits, the combination of rising surpluses among surplus champions and declining deficits in trade-deficit Europe. Given its openness and financial flexibility, the US will, in practice, absorb most of the adjustment, its trade deficit rising inexorably – until Congress implements vigorous anti-trade policies. The US lacks the industrial, currency intervention and interest-rate management policies available to the main trade-surplus countries, and so will be forced to use other forms of trade protection – tariffs and import quotas.

This should not be allowed to happen. Instead of supporting policies that shift the adjustment elsewhere, the other main economies must agree to absorb a large share of the European shock. If they do not, they will force the US to retaliate. It is up to the surplus countries to ensure their urgent dependence on foreign demand does not result in a collapse in the willingness of deficit countries to continue providing that demand.

Perhaps it is already too late. Trade-deficit Europe has no choice but to adjust quickly. Opposition from uncomprehending domestic constituencies in the trade-surplus champions will prevent them from taking steps to adjust. Meanwhile, US anger over trade is rising quickly and has made bashing foreigners an easy and obvious vote-getter.

Responsible leaders must nonetheless make every effort to rebalance trade in a less disruptive way. Trying to avoid sharing the cost of the necessary global adjustment is how the major economies reacted in the 1930s, and those policies are widely and correctly referred to as beggar-thy-neighbour. We know how that game ends.

To make the matter potentially worse is the growing possibility of a double-dip recession in the US will make it even more difficult for the Obama administration to resist protectionist pressures.