:: OP-ED

Global imbalances

By Jayati Ghosh

Oct 20 : The US economy has been running large current account deficits for several decades now, but they were typically offset by surpluses of other developed countries like Japan and Germany, as well as by oil-exporting countries of West Asia. In the most recent period, that picture has changed in a significant way. The huge US balance of payments deficit is now being substantially financed by developing countries and not largely by the surpluses of other developed countries or the surpluses in the oil exporting countries.

For example, in 2007 Japan and Germany accounted only for 30 per cent of the aggregate surplus of all surplus earners, and Germany’s surplus tends to be counterbalanced by deficits in other countries of the Euro area. Meanwhile, developing countries and countries in transition became important sources of surpluses to finance the US deficit. The aggregate surplus of the top ten developing and transition economies accounted for 95 per cent of the US deficit. The top 10 among non-oil surplus developing countries accounted for 72 per cent of the US deficit. China’s surplus was equal to 51.1 per cent of the US deficit.

The transformation of the developing world’s current account deficits into surpluses occurred in the mid-1990s. While this was true initially of a set of countries in Asia, they have since been joined by countries in West Asia, Africa and Latin America, though not Central and Eastern Europe. However, developing and emerging market countries outside developing Asia have also been recording a surplus as a group, because of the contribution made by oil exporters in West Asia.

As a consequence, the bulk of the increase in the US current account deficit was balanced by changes in the current account positions of developing countries, which moved from a collective deficit of $109 billion to a surplus of $492 billion — a net change of $601 billion — between 1996 and 2007.

There are two sources of accretion of surpluses in the balance of payments of the developing countries, epitomised by China and India. In China’s case, these surpluses have been substantially "earned" in the sense that they reflect its export success and a surplus on the current account of its balance of payments. This has been added to with inflows of foreign direct investment, and more recently foreign portfolio investment. In the case of India on the other hand, its surpluses have been "borrowed", in the sense that they accrue because small deficits or small surpluses on the current account of its balance of payments in recent years have been accompanied by huge inflows of capital, especially portfolio capital. If capital inflows are largely borrowed and are of the portfolio kind, the pressure to accumulate reserves is greater, because of the danger that these flows could be reversed, as happened in Southeast Asia in late 1990s.

There is another reason why a significant, even if not dominant part of the recycling of these surpluses to the US occurred through the central banks of these countries. Under liberalised exchange rate regimes, large dollar inflows (whether due to surpluses on the current or capital account) exert an upward pressure on the domestic currency of the countries that receive those foreign exchange inflows, raising the value of the domestic currency against the reserve currency. To prevent such appreciation and shore up the competitiveness of the recipient country’s exports, the central bank steps in to stabilise the currency to buy and mop up the excess foreign exchange. This results in the accumulation of large reserves. Data from the US Federal Reserve relating to US government agency bonds held by foreign official institutions shows that they increased by $119 billion in 2007, although in the wake of the crisis in 2008 they fell by $31 billion. In the first seven months of 2009, they fell by another $31 billion.

However, not only was the contribution of non-oil exporting Asian countries even more significant, it actually continued to be positive even in 2008. Thus, Asian holding of US public bonds increased by $131.6 billion in 2007 and $32.4 billion in 2008, while the corresponding figures for China and Hong Kong taken together were $103.7 billion and $40.3 billion. Even in the first seven months of 2009, total Asian holding of US government bonds remained largely stable, with a small increase of $2.3 billion by West Asian oil exporters and a small decline of $2.5 billion for all other Asian countries.

So, while US profligacy results in the huge deficit on its balance of payments, it does not need to make the adjustment to correct for global imbalance. Instead, in a remarkable reversal of past experience of other countries, the countries accumulating surpluses, whether "earned" or "borrowed", are the ones making the adjustment. They continue to invest their surpluses in safe and liquid international securities among which US Treasury securities predominate. And that adjustment is not without cost. Large reserves create huge problems for monetary management, and central bank efforts to sterilise foreign exchange reserves to manage money supply have adverse implications for fiscal policy. Moreover, the returns received on reserves invested by central banks are much less than the returns earned by those who bring the foreign exchange into these countries in the first place.

This is quite directly related to the shift in policy regime in favour of less regulated, more market-friendly and obsessively export-oriented regimes across the world. When successful exporters record current account surpluses, this threatens an appreciation of their currencies that could reduce export competitiveness. To prevent this, they accumulate foreign exchange reserves to prevent appreciation, in turn necessitating the investment of these surpluses in safe assets. Much of this investment moves to the home of the reserve currency, where the value of the assets is presumed to be more stable.

Meanwhile, neo-liberal fiscal reform imposes fiscal conservatism and deflationary fiscal practices, which have balance of payments effects that imply either a reduction of current account deficits or the emergence or increase of current account surpluses. Capital account liberalisation can lead to inflows that cause currency appreciation. It also increases the pressure to accumulate reserves to guard against the reversal of capital flows that could follow any surge in inflows.

These consequences of liberalisation contribute in no small measure to the global imbalance that is otherwise rooted in the uneven development characteristic of capitalism. Perversely, they also strengthen the position of the reserve currency, by creates an influential global constituency against the depreciation of the US dollar.