Future history books, depending on where they are written, will take one of two approaches when they assign blame for the world’s current financial and economic crisis.
One approach will blame lax regulation, accommodating monetary policy and inadequate savings in the US. The other, already being pushed by economists like former chairman of the US Federal Reserve Alan Greenspan and incumbent Chairman Ben Bernanke, will blame the immense pool of liquidity generated by high-savings countries in East Asia and the Middle East.
All that liquidity, they will argue, had to go somewhere. Its logical destination was the country with the deepest financial markets, the US, where it raised asset prices to unsustainable heights.
Note the one thing on which members of both camps agree: The global savings imbalance — low savings in the US and high savings in China and other emerging markets — played a key role in the crisis by allowing Americans to live beyond their means. It encouraged financiers desperate to earn a return on abundant funds to put them to more speculative use. If there is a consensus on one issue, it is the impossibility of understanding the bubble and the crash without considering the role of global imbalances.
Preventing future crises similar to this one therefore requires resolving the problem of global imbalances. Here, the early signs are reassuring. US households are saving again.
The most recent data show US trade deficit has declined from US$60 billion a month to just US$26 billion. As a matter of simple arithmetic, we know that the rest of the world is running correspondingly smaller surpluses.
But once US households rebuild their retirement accounts, they may return to their profligate ways. Indeed, the Obama administration and the Federal Reserve are doing all they can to pump up US spending. The only reason the US trade deficit is falling is that the country remains in a severe recession, causing US imports and exports to collapse in parallel.
With recovery, both may recover to previous levels, and the 6 percent-of-GDP US external deficit will be back. In fact, there has been no change in relative prices or depreciation of the US dollar of a magnitude that would augur a permanent shift in trade and spending patterns.
Whether there is a permanent reduction in global imbalances will depend mainly on decisions taken outside the US, specifically in countries like China. One’s forecast of those decisions hinges, in turn, on why these other countries came to run such large surpluses in the first place.
One view is that their surpluses were a corollary of the policies favoring export-led growth that worked so well for so long. China’s leaders are understandably reluctant to abandon a tried-and-true model.
They can’t restructure their economy instantaneously. They can’t move workers from painting children’s toys in Guangdong Province to building schools in western China overnight.
They need time to build a social safety net capable of encouraging Chinese households to reduce their precautionary saving. If this view is correct, we can expect to see global imbalances re-emerge once the recession is over and to unwind only slowly thereafter.
The other view is that China contributed to global imbalances not through its merchandise exports, but through its capital exports. What China lacked was not demand for consumption goods, but a supply of high-quality financial assets. It found these in the US, mainly in the form Treasury and other government-backed securities, in turn pushing other investors into more speculative investments.
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