At their 26-27 June Summit in Canada, the G20 members will take the first look at their progress on the “Framework for strong, sustainable, and balanced growth,” a concerted effort adopted at the September 2009 Pittsburgh Summit to contain global imbalances.
The timing is opportune. With trade, credit, and commodity prices recovering, the IMF (2010) recently revised its projections of US current-account deficit to 3.3% of GDP in 2010 and 3.4% in 2011. Also UK, Canada, Australia, India, Turkey, France, and southern European nations are projected to run steep trade deficits (Figure 1). The mirroring surplus nations are the familiar China, Japan, emerging East Asia, Germany, and oil producing nations.
Figure 1. Global imbalances 1996-2015
Source: IMF (2010).
The Framework builds on the G20 November 2008 Summit declaration, which blamed both regulatory failures and the drivers of the imbalances (“inconsistent and insufficiently coordinated macroeconomic policies, inadequate structural reforms”) for the global crisis.1 Under the Framework, each G20 member is to subject its economic policies to a peer review managed by the IMF, which, in turn, determines whether the member’s efforts are “collectively consistent” with global growth goals.
But this raises questions: Did the imbalances cause the crisis? Are policies to curb them warranted?
Before the crisis: Alarmists vs. optimists
Recall the pre-crisis years. Imbalances grew in the early 2000s and peaked at 6.5% of US GDP in 2006. Congress threatened steep tariffs against China, and the Bush administration sought various remedies, including an IMF consultation with surplus nations. Academe divided into two camps.
“Alarmists” argued America was in for a sudden stop and hard landing – capital flight followed by collapse of the dollar, rise in interest rates, and decline in output (Mann 1999, 2004, Rubin et al. 2004, Obstfeld and Rogoff 2000, 2005, Summers 2004, Cline 2005ab, 2007, Geithner 2006, IMF 2006, Engler et al. 2007, Bergsten 2007, Feldstein 2008). Concerns were many – declining US private savings, growing budget deficits, rising energy prices, Asia’s focus on tradables, and relative exchange rates. Mainstream analysts placed the “unsustainable” level for the US at a 5%-6% current-account deficit; Obstfeld and Rogoff (2005) suggested that the “hard” landing meant a more than 30% drop in the dollar’s value.
“Optimists” on the other hand saw the imbalances as a symbiotic pattern that channelled surplus nation savings to safe and liquid destinations, which, in turn, enjoyed greater availability of credit (Dooley et al. 2004, Mendoza et al. 2007). In this “Bretton Woods II” world, the US current-account deficit would be near-permanent, and, as long as fiscal deficits were kept in check, they would also be sustainable.2 Cooper (2005, 2007) argued it was much ado about little: formulated in the 1930s, savings measures failed to account for sizable savings in America’s knowledge-based economy. Hausmann and Sturzenegger (2005) argued the large difference between US net assets and debts was “dark matter” that reflected accounting problems, not reality.
In these accounts, landing was neither imminent nor hard, ceteris paribus. Some argued that since capital markets were becoming more flexible, not only would America be able to borrow more, but the world economy would absorb any US adjustment better (Greenspan 2004). Others hypothesised that America’s unique attributes kept it safe from sudden shocks and hard landings.3 For one, the US was arguably too big to fail: US capital markets are so large relative to the world market that departing investors would undermine the world economy and thus their own fortunes (Reinhart and Reinhart 2008). Further, since the US debts are denominated in dollars, depreciation would not, as in ailing emerging markets, cause US liabilities to rise in relative terms.4
Only few analysts took the middle ground. Studying 26 industrialised country adjustments, Freund and Warnock (2007), drawing on Freund (2000), were more cautious. They argued that unwinding from large current account deficits takes a long time and is associated with slow growth, and that consumption and government-driven deficits do lead to deprecation. The aftershocks of smaller, persistent deficits, they found were not associated with slower growth or exchange rate deprecation. Croke et al. (2005), similarly exploring historical data, also argued that a disorderly adjustment may be less likely than the Alarmist group were presuming.
While scholars debated, Capitol Hill felt compelled to action. Simplifying the world, US legislators traced the growing trade deficit to the undervalued Chinese currency and argued that Beijing was unfairly driving US companies out of business.5 Political pressures were magnified by the fact that while at 5-6% of total US GDP, the current-account deficit accounted for an estimated 20% of US traded goods production (Obstfeld and Rogoff 2005). In July 2005, China did agree to a modest revaluation, but the renminbi was again fixed against the dollar in July 2008. This did little to alter trade balances or to placate Congress. The 110th Congress (2007-2009) put forth some dozen China bills, many of which aimed to force an overhaul of China’s exchange rate regime (Roach 2009).
The Bush Administration, meanwhile, struggled to find the right frequency with Beijing (Eichengreen and Irwin 2007). The G7 was a blunt instrument for dealing with the issue, as China was not a member. There also was no appropriate bilateral US-China forum, and Washington’s focus on the currency distanced the Chinese. Multilateral pressure backfired, as the surplus nations agreed that low US savings was the main problem. Taking office in 2007, Treasury Secretary Henry Paulson made China his top priority, creating a new, Cabinet-level US-China “Strategic Economic Dialogue.” But the global crisis would soon engulf the effort – as well as unwind the imbalances.
Imbalances and the crisis: Cause or sideshow?
The 2008-09 crisis seemed to vindicate the optimists. As the crisis globalised, money flowed to the US, escaping turbulence elsewhere.6 The crisis expected by the alarmists just did not occur (DeLong 2008, Dooley and Garber 2009, IMF 2009). A somewhat contentious and occasionally politicised debate emerged to explain the role of the imbalances in the crisis; it was a three-sided argument.
Some pre-crisis optimists and a number of others regard the imbalances as a sideshow, even as an innocent bystander, to the crisis (DeLong 2008, Dooley and Garber 2009, Backus and Cooley 2010, Whelan 2010, Truman 2010, Greenspan 2010), and, instead, blame financial regulations and supervision and moral hazard.7 Contrary to Bernanke (2008) and Greenspan (2010), Taylor (2008) posits the crisis originated in the Federal Reserve’s loose monetary policy. Bibow (2008) also points to the post-9/11 expansionary monetary and fiscal policies as the trigger for the global boom.
At the other extreme, Portes (2009) argues that while the imbalances interacted with problems in the financial sector, they were the leading cause of the crisis due to having resulted in a low cost of financing.
Most analysts view the imbalances as a “handmaiden” to the crisis – as a more or less central contributor to the crisis. In a standard account, imbalances relaxed America’s credit constraint and perpetuated low US real interest rates that, in turn, stoked borrowing and the housing bubble (Setser 2008, Paulson 2008, Wolf 2008, Bini Smaghi 2008, Bernanke 2008, Caballero et al. 2008, Dunaway 2009, Obstfeld and Rogoff 2009, IMF 2009, Caballero and Krishnamurthy 2009, Blanchard and Milesi-Ferretti 2009, Roubini 2009, Kohn 2010).8
“Imbalances” in these accounts is often short-hand for their drivers. Among the favoured determinants are low US savings (stressed especially by Feldstein 2008, 2009), Asia’s export-led growth strategy, reserve build-up, and exchange rate policies (discussed by many, including Bibow 2008, Obstfeld and Rogoff 2009,), and Asian “savings glut” (highlighted by Bernanke 2005, 2007, 2008, Bini Smaghi 2008, Wolf 2008, Greenspan 2010).
Why would developments in Asia affect the US in particular?
Ben Bernanke (2005) argued that the US became the main deficit nation because of its service as global safe haven and reserve currency issuer, and because of the rapid growth in US household wealth from stock market gains and housing appreciation. The wealth effect arguably kept savings low, perpetuating foreign borrowing.9 Similar factors, Bernanke argues, were at play in the other current-account deficit nations, but not in Germany or Japan. The flow of money into housing rather equipment or, say, software was linked to regulatory and supervisory gaps in mortgage underwriting and securitisation (Johnson and Kwak 2009).
To date studies on the exact contribution of global imbalances or their drivers to the crisis are inconclusive. More hard evidence is needed to answer the question in the title: Did global imbalances cause the crisis? Meanwhile, positions are changing. Many observers, including Ben Bernanke, now prioritise regulatory failures as the leading cause for the crisis (Rampell 2010).
But arguing that the imbalances played a sideshow in 2008-09 is not to claim that they are innocuous. They could still perpetrate the crisis predicted by the alarmists. As a matter of prudence, policies to contain them could still be warranted. The US fiscal deficit is a game changer in the debate, and it is already bridging the divisions between imbalance analysts. Policy options going forward will be the topic of a column for a future date.
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1 The Declaration states, under the heading “Root Causes of the Current Crisis”, that “During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system. Policy-makers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions.
"4. Major underlying factors to the current situation were, among others, inconsistent and insufficiently coordinated macroeconomic policies, inadequate structural reforms, which led to unsustainable global macroeconomic outcomes. These developments, together, contributed to excesses and ultimately resulted in severe market disruption.” Declaration Summit on Financial Markets and the World Economy, 15 November 2008.
2 See Dooley et al. (2004) for the term “Bretton Woods II”. On the US fiscal deficits, they note that “as USA debts cumulate, US willingness to repay both Asia and Europe comes more naturally onto the radar screen, so the system that was previously stable could run into trouble.”
3 For a discussion, see Cline (2005b).
4 Eichengreen and Adalet (2005) maintained that cross-country comparisons are futile because the effects of current account deficits vary widely across countries. For a review of drivers, see also Freund (2000).
5 In 2003, veteran Senators Charles Schumer of New York and Leslie Graham of North Carolina threatened 27.5 percent blanket tariff against China unless Beijing revalued the renminbi; the 109th Congress, in office in 2005-2007, introduced 27 pieces of anti-China trade legislation. See Scheve and Slaughter (2007).
6 Treasuries gained 14% in 2008, and net purchases of US government notes and bonds soared to $100.5 billion in June 2009, a historic monthly high. For an assessment of America’s attractiveness for investment, see Forbes (2009).
7 Truman (2010) is somewhat less adamant, arguing the imbalances “at most played a minor role in the crisis.”
8 Caballero et al. (2008) argued that the sub-prime crisis exacerbated the shortage of safe assets in the world economy, which triggered a bubble in commodities and new petrodollars, which, in turn, kept the US economy going and perpetuated borrowing.
9 Evidence on wealth effect cuts many ways. While some argue that the health of the stock market and financial wealth are the leading determinants of saving rates, others have found that particularly in America, government savings and demographics are key. For summaries, see for example, Marquisn (2002) and Feldstein (2009).