The debate on “global imbalances” has gone back to the future. The proposal from Tim Geithner, the US Treasury secretary, to target the current account takes us back to the preoccupations of John Maynard Keynes at the Bretton Woods conference of July 1944. Keynes, representing Britain, was obsessed with the dangers of asymmetric adjustment between surplus and deficit countries. The US, then the world’s dominant surplus country, rebuffed calls for a mechanism that would impose pressure on both sides. Now the US is in the other camp.
Might China accept what the US rejected? The answer may be “yes”. The communiqué of the October 23 meeting of the finance ministers and central bank governors of the Group of 20 leading economies in South Korea stated that “persistently large imbalances, assessed against indicative guidelines to be agreed, would warrant an assessment of their nature and the root causes of impediments to adjustment as part of the Mutual Assessment Process, recognising the need to take into account national or regional circumstances, including [those of] large commodity producers.” This ugly sentence was in response to Mr Geithner’s suggestion of 4 per cent of gross domestic product as an indicator for the current account.
So what is the US after? Does its proposal make sense? Can it work?
The US aim is to establish the principle that both surplus and deficit countries have an obligation to adjust. It suggests that there should be an agreed numerical value for the surplus or deficit at which a country should act. This would not be a target. Nor would there be sanctions. The global monetary regime would continue without the automatic mechanisms proposed by Keynes in 1944. In addition, the US hopes to secure appreciation of the currencies of a number of emerging economies, particularly China’s, against those of the high-income countries, particularly the US dollar.
Does the proposal make sense? Rainer Brüderle, Germany’s economy minister, provided the orthodox rejection. He stated that “we should lean toward a market economy process and not on a command economy”. But there are three, in my view, decisive qualifications.
First, today’s huge accumulations of foreign currency reserves are not a market phenomenon: they are the product of government decisions (see chart). They could be justified, initially, as a way of creating insurance against shocks. But these reserves have gone well beyond that, as the modest decline during the crisis of $470bn, or 6 per cent of the total, showed. Second, the repeated evidence that the world economy is unable to use large flows of surplus savings in a safe and effective way cannot be ignored. Finally, the world of today has massive excess capacity. That makes adjustment by deficit countries alone hugely undesirable, as Keynes would surely have argued.
So which G20 countries would be affected by the US indicators? If one adds Spain to the group, the US, South Africa, Turkey and Spain are forecast to have “excessive deficits” this year, and China, Russia, Germany and Saudi Arabia to have “excessive surpluses”. But Russia and Saudi Arabia would presumably be exempt, as “large commodity exporters”. Moreover, if one were to focus on the scale of the surpluses and deficits rather than just shares of GDP, Japan would be among the surplus countries and Italy, Brazil and the UK countries among those with large deficits (see charts).
Such current account indicators can only be a starting point. It is also important to focus only on countries that are systemically significant: Singapore’s current account surplus is forecast at 20 per cent of GDP. But the rest of the world need not care about that. Moreover, for the very biggest countries even 4 per cent of GDP might be far too large. Yet quantitative indicators can at least make the discussion of adjustment far better focused than hitherto.
Finally, can this approach be made to work? There is at least a chance of it. At the annual meetings of the International Monetary Fund and World Bank in Washington, two different Chinese economists informed me that China has already decided to limit its surpluses. So a discussion of this topic should be far more fruitful than a focus on the exchange rate alone. Yet, given the vast scale of its reserves (close to 50 per cent of GDP) and its rapid growth, China should seek external balance, if not a deficit, rather than a surplus of 4 per cent of GDP. Under the latter target, its external surplus might be $400bn by 2015, since its dollar GDP seems likely to double every five years. Unlike the deficit countries that so worried Keynes, the US at least has heavy weaponry at its disposal, not least its ability to issue the world’s principal reserve currency. The rest of the world cannot easily force the US to adjust if it does not wish to do so. Moreover, everybody, including the Chinese, seems frightened of the monetary consequences of further US quantitative easing. Happily, the more successful is the expansion in global demand and adjustment in real exchange rates, the less necessary becomes such a US policy.
The core of any discussion of global adjustment, then, must be between the US and China. Germany will continue to be obstructive. But its victims are its partners in the eurozone: they have chosen to live with Germany’s devastating combination of external competitiveness with domestic restraint, under an irrevocably fixed exchange rate. Japan seems simply unable to deal with its macroeconomic predicament. But China is a very different case, as a burgeoning superpower with a vast population and enormous domestic needs. There is no reason for it to remain a massive capital exporter.
The role of the G20 is to give cover for the needed discussions between the incumbent and prospective superpowers. If China were to set itself the goal of raising demand and so eliminating its current account surpluses, ideally via higher consumption, the Chinese people would be better off and so would the rest of the world. The US should simultaneously commit itself to long-term fiscal consolidation.
Meanwhile, the role of the other heads of governments of the G20, in Korea next week, is to promote the necessary agreement. If they succeed, they will demonstrate one of the biggest benefits of multilateralism: it is a way to manage conflicts between the greatest powers. Mr Geithner has offered an imaginative alternative to endless friction over exchange rates. China’s president should seize the escape the US has offered him.