Martin Wolf：the endgame for the global imbalances

Martin Wolf, in today’s Financial Times, comes to a similar conclusion:


With businesses uninterested in spending more on investment than their retained earnings, and households cutting back, despite easy monetary policy, fiscal deficits are exploding. Even so, deficits have not been large enough to sustain growth in line with potential. So deliberate fiscal boosts are also being undertaken…

This then is the endgame for the global imbalances. On the one hand are the surplus countries. On the other are these huge fiscal deficits. So deficits aimed at sustaining demand will be piled on top of the fiscal costs of rescuing banking systems bankrupted in the rush to finance excess spending by uncreditworthy households via securitised lending against overpriced houses.

This is not a durable solution to the challenge of sustaining global demand. Sooner or later….willingness to absorb government paper and the liabilities of central banks will reach a limit. At that point crisis will come. To avoid that dire outcome the private sector of these economies must be able and willing to borrow; or the economy must be rebalanced, with stronger external balances as the counterpart of smaller domestic deficits. Given the overhang of private debt, the first outcome looks not so much unlikely as lethal. So it must be the latter.

In normal times, current account surpluses of countries that are either structurally mercantilist – that is, have a chronic excess of output over spending, like Germany and Japan – or follow mercantilist policies – that is, keep exchange rates down through huge foreign currency intervention, like China – are even useful. In a crisis of deficient demand, however, they are dangerously contractionary.

Countries with large external surpluses import demand from the rest of the world. In a deep recession, this is a “beggar-my-neighbour” policy. It makes impossible the necessary combination of global rebalancing with sustained aggregate demand. John Maynard Keynes argued just this when negotiating the post-second world war order.

In short, if the world economy is to get through this crisis in reasonable shape, creditworthy surplus countries must expand domestic demand relative to potential output. How they achieve this outcome is up to them. But only in this way can the deficit countries realistically hope to avoid spending themselves into bankruptcy.

The UK is closer to the endgame than the US, so it is easier for them to perceive the risks (Willem Buiter has detailed the parallels between the UK and Iceland). The US, with the advantage of its deep Treasury markets and the reserve currency, has more rope with which to hang itself and its hapless creditors.