Unwinding the global imbalance

Fred Bergstein and Arvind Subramanian of the Peterson Institute for International Economics recently expressed their concerns in an article on FT.com how the global imbalances (huge US current account deficits and China's large current account surpluses) will rectify itself over time:

The Obama administration is increasingly signalling that the US will not continue to be the world’s consumer and importer of last resort. Larry Summers recently said: The US must become an export-oriented rather than a consumption-based economy and must rely on real engineering rather than financial wizardry.

The logic of this new US position is not just economic. It is also strategic. Mr Summers has previously remarked on the tension between superpower status and net foreign indebtedness. US influence can be compromised if it is dependent on foreign investors to bail out its financial sector (as in the early part of this crisis) or to finance its fiscal profligacy (as China and other surplus countries have been doing for a long time). The US undoubtedly also recognises that it might not be able to finance large external deficits in the future at an acceptable price so to some extent it is making a virtue of necessity.

This long-run vision for US growth entails greater exports and probably a smaller current account deficit than where it is now (about 3 per cent of gross domestic product). Although Mr Summers did not and could not say so, the vision will require an end to the remaining overvaluation of the dollar.

In the short run, US recovery from the recession requires that the fiscal and monetary stimulus programmes be effective. In turn, that calls for domestic and foreign investors to absorb smoothly and trustingly the voluminous amounts of IOUs being offered by the US government. Hence it is essential to avoid perceptions that the dollar is about to fall, at least by very much, and that the US authorities are pushing it down.

But Mr Summers’ long-run structural targets will come into play once the economy is out of the woods. Redirecting resources away from finance and consumption towards exports and investment will require relative price shifts, for which the dollar has to move down. So a stronger rate for the dollar now and a more sustainable rate once the recovery has taken hold can reconcile the short-run imperative and the medium-term goal.

What are the implications of this vision for America’s trading partners? To the extent it is credible, it is a warning shot to the rest of the world. If the US will not run large and persistent current account deficits, countries such as China, and probably Germany and Japan, will not be able to run large and persistent current account surpluses. They will not be able to rely on export-led growth. They will have to find ways to expand domestic demand on a lasting and substantial basis.

Progress is already being made in reducing global imbalances. The US current account deficit has come down from a peak of more than 6 per cent of GDP to about 3 per cent. China’s current account surplus has declined from 11 per cent of GDP to about 9.8 per cent and is expected to decline much further this year.

Mr Summers has stated that China can no longer behave like China because the US intends to behave much more like China. The world economy cannot have two, or even one-and-a-half, Chinese growth strategies from its two most important economies. Which will prevail?