Wed, Apr 28, 2010 - Page 9 News List

Avoiding deep global payment imbalances

By Jose Antonio Ocampo

Two troubling features of the ongoing economic recovery are the depressed nature of world trade and the early revival of international global payment imbalances. Estimates by the IMF and the UN indicate that the volume of international trade this year will still be 7 percent to 8 percent below its 2008 peak, while many or most countries, including industrial nations, are seeking to boost their current accounts.

Indeed, if we believe the IMF’s projections, the world economy’s accumulated current-account surpluses would increase by almost US$1 trillion between last year and 2012. This is, of course, impossible, as surpluses and deficits must be in balance for the world economy as a whole. It simply reflects the recessionary (or deflationary) force of weak global demand hanging over the world economy.

Under these conditions, export-led growth by major economies is a threat to the world economy. This is true for China, Germany (as French finance minister Christine Lagarde has consistently reminded her neighbor), Japan and the US. Countries running surpluses must adopt expansionary policies and appreciate their currencies. More broadly, to the extent that major emerging-market countries will continue to lead the global recovery, they should reduce their current-account surpluses or even generate deficits to help, through increased imports, spread the benefits of their growth worldwide.

While that implies that emerging-market currencies must strengthen, disorderly appreciations would do more harm than good. To use an American saying, it might mean throwing out the baby (economic growth) with the bathwater (exchange rate appreciation).

Consider China, which accounts for the largest share by far of world trade among emerging economies. Real appreciation of the yuan is necessary for a balanced world economic recovery but disorderly appreciation may seriously affect China’s economic growth by disrupting its export industries, which would generate major adverse effects on all of East Asia. China needs a major internal restructuring from exports and investments, its two engines of growth in past decades, to personal and government consumption (education, health and social protection in the latter case). However, this restructuring will tend to reduce, not increase, import demand, as exports and investment are much more import-intensive than consumption.

Moreover, a sharp appreciation of the yuan could risk domestic deflation and a financial crisis. Chinese authorities certainly seem to have that interpretation of the roots of Japan’s malaise in mind as they seek to avoid rapid revaluation.

The only desirable scenario, therefore, is a Chinese economy that transmits its stimulus to the rest of the world mainly through rising imports generated by rapid economic growth (ie, the income effect on import demand), rather than by exchange-rate appreciation (the substitution effect). This requires maintaining rapid growth while undertaking a major but necessarily gradual domestic restructuring, for which a smooth appreciation is much better suited.

Now consider other major emerging markets. Here, currency appreciation is already taking place, pushed by massive capital inflows since the second quarter of last year, and in some cases it can already be said to be excessive (for example, in Brazil).

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