[Mb-civic] US deficit's aren't just China's problem _ Martin Wolff

Tue Apr 19 14:34:23 PDT 2005

Martin Wolff is a very serious commentator. His solution to the imbalance between the world's creditors (Asia) and debtors (USA, Argentina, Bangladesh etc) seems simple and elegant. Unfortunately he also seems to think that the Bush administration's economic policies are the most catastrophic in living memory so there are no guarantees that intelligence will prevail, rather the opposite.
Al Baraka

US deficits aren’t just China's problem 
>By Martin Wolf
>Published: April 19 2005 20:47 | Last updated: April 19 2005 20:47
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"If you owe your bank a hundred pounds, you have a problem. But if you owe a million, it has." John Maynard Keynes

If Keynes was right, the world's creditor countries have a huge problem and the US none at all. Yet the assumption that the creditors should be more terrified than the debtor is wrong if the latter needs to continue borrowing. If creditors face an endless stream of additional borrowing and a good chance of default at the end of it, they should refuse to throw good money after bad. They will then impose huge costs on the debtor.

This balance of financial terror, as it has been called, characterises the current huge flows of finance to the US. Carefully thought through economic policy is needed if the world is to extricate itself from this predicament. Alas, we can rely on the administration of George W. Bush not to provide it.

So it proved at this weekend's meeting of the Group of Seven leading industrial countries. The communiqué remarked that "we emphasise that more flexibility in exchange rates is desirable for major countries and areas that lack such flexibility". If anyone was in doubt about what that meant, John Snow, the US treasury secretary, insisted that China should embrace a looser exchange rate immediately. Mr Snow is not the organ-grinder of US economic policy but the monkey. But he accurately reflected the "China-bashing" now sweeping across US politics, so painfully reminiscent of the Japan-bashing of past decades.

As Nouriel Roubini of New York University promptly responded, the US attack on one of its principal creditors is playing with fire. In the past two years, he argues, three quarters of the US fiscal deficit has been financed by foreign central banks, 100 per cent of the fiscal deficit has been financed from abroad and about 80 per cent of the current account deficit has been financed by foreign central banks.* Biting the hand that feeds one is folly.

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According to the International Monetary Fund, the US general government fiscal deficit this year will be 4.4 per cent of gross domestic product, while the current account deficit is forecast to be 5.8 per cent of GDP. At present, therefore, the American people are able to consume and invest as if the fiscal deficits did not exist. The treasury secretary of what is arguably the most fiscally irresponsible US administration since the second world war should fall down on his knees in thanks rather than indulge in complaints.

Prof Roubini is also right to note the economic disruption that would ensue if the flow of official international credit were cut off. The consequences would almost certainly include a dollar collapse, higher domestic prices, a jump in interest rates, a fall in prices of housing, a steep rise in household bankruptcies and, not least, a sharp US recession. The bigger and swifter the adjustment in the external accounts, the more drastic those impacts would be. The landing would be hard.

Nevertheless, it is in US long-run interests to avoid an explosive build-up of net external liabilities. However big the crisis if a sudden correction were to occur now, it would be nothing compared with what would happen after another decade of rising net liabilities. Better still, instead of choosing between a sudden correction now and a still more brutal sudden correction later, why not go for a smoother correction that starts now?

The requirements for such a correction are clear. There needs to be a reduction of spending, in relation to potential output, in the US and an increase in spending in its creditors. A reduction in the US structural fiscal deficit will be required. Exchange rate movement will be needed as well, to facilitate adjustment.

Where then does China fit into this? The answer is suggested by the charts, which show the current and capital accounts of all emerging market economies, of Asian emerging economies and of China itself since 1996, the year before the devastating Asian financial crisis. From these, one can draw four important conclusions.

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First, in 2004, the emerging market economies ran an aggregate current account surplus of $336bn, just over half of the counterpart of the US deficit of $666bn. Asian emerging market economies ran a surplus of $193bn.

Second, these current surpluses emerged after the financial crises. This is particularly visible for Asian emerging countries, which ran a current account deficit of $40bn in 1996 and a surplus of $114bn in 1998.

Third, the private sector has been trying to push emerging market economies into current account deficit. In 2004, the combination of current account surpluses and net capital inflows forced emerging market economies to accumulate $519bn in reserves. The corresponding figure for Asian emerging economies was $344bn.

Fourth, China is a significant player. Its current account surplus was 18 per cent of the emerging market total in 2004, its net inward direct investment was 28 per cent and its reserve accumulation was 40 per cent.

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In short, it will be impossible to achieve a significant adjustment of the US current account deficit without a big adjustment by emerging market economies. These are the world's natural deficit countries. Moreover, given present levels of reserves, running current account deficits at least equal to the inflow of FDI is both perfectly safe and obviously sensible.

If the emerging market economies had run such current account deficits last year, the total would have been $186bn. The difference between the actual surplus and this deficit would have been $523bn, sufficient to eliminate most of the US deficit. Even China on its own is significant. Last year, the sum of its current account surplus and net inflow of FDI was 7 per cent of GDP. If it had run a current account deficit equal to inward FDI, instead, it would have run a deficit of $52bn. This would have made a difference of $111bn.

The huge reserve accumulations of emerging market economies are by now senseless. These are not only wasteful investments but also prevent the global adjustment that the private sector rightly wishes to make. Emerging market economies should run current account deficits equal to inward FDI. Hectoring China on the exchange rate alone is folly. But a serious discussion of policies to deliver a better global balance is not. That discussion must begin now.

* Global Economics Blog, April 17 2005, www.rgemonitor.com

martin.wolf at ft.com

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