L.IKE OTHER In the previous crises, Covid-19 appears to have been designed to highlight problematic features of the global economy. Take global imbalances. Although these were briefly suppressed when the pandemic first broke out, they have now recovered. America recorded its largest trade deficit in 14 years in August, despite having grown from a large oil importer to a net exporter during that time. The goods deficit is being offset by a resurgent surplus in China. Temporary factors such as an increase in Chinese exports of personal protective equipment are partly to blame. However, there is cause for concern that these lines of error will persist and add a dangerous element to an already tense global political environment.
Global imbalances reached a modern high shortly before the 2007-09 financial crisis, when the absolute sum of countries’ current account surpluses and deficits exceeded 5% of the world GDP. The current account gaps have been widened in part by what economists have called the “global savings glut,” the result of soaring oil prices and precautionary savings by emerging market governments prepared for sudden reversals in global risk appetite. The gaps narrowed in the post-crisis decade when oil prices fell and China focused on balancing its economy. However, on the eve of the pandemic, imbalances still remained at around 3% of global imbalances GDP, about one and a half times what it was in the early 1990s. And in some places yawning trade gaps have opened since then. America’s current account deficit of 2% GDP At the end of 2019, it had jumped to 3.5% GDP six months later. China’s current account balance assumed a surplus of 1.1% GDP At the end of 2019 to a deficit in Q1 2020 before falling back to a surplus of 3.1% GDP in this second.
Current account gaps are not inherently bad. For example, a developing economy in need of investment could consume more than it temporarily produces as it builds up its production capacity – and what it needs to repay accumulated foreign liabilities in the future. However, in some cases they can be a source of crisis if they reflect an accumulation of financial weaknesses. And especially for today’s global economy, they are particularly problematic in times of weak demand. Economies run current account surpluses when they produce more than they consume. If there is enough global demand, it will be at most a minor inconvenience to deficit economies that consume more than their domestic production capacity alone allows. But when demand is low, surplus countries siphon off the purchasing power of trading partners when they have little to spare.
Ricardo Caballero from the Massachusetts Institute of Technology, Pierre-Olivier Gourinchas from the University of California at Berkeley and Emmanuel Farhi, also at Berkeley at the time, described this effect in an article published in 2015. The authors justify their argument with the demand for safe assets. Globally, any surplus must go hand in hand with a deficit, and saving in one place must be met by borrowing in another. Surplus countries save by buying foreign government bonds. When global interest rates are well above zero, these purchases simply push interest rates down and cause deficit countries to borrow and spend more. However, when interest rates drop to zero, that channel will stop working because interest rates cannot continue to fall. Instead, the offsetting increase in borrowing in the deficit countries must come from squashed incomes – a recession.
With few exceptions, interest rates in the rich world have been close to zero since the financial crisis. And parts of the emerging markets have moved closer to the low-interest swamp this year. In these circumstances, fiscal expansion, which increases the global holdings of government bonds, is an effective means of stimulating growth both within the stimulating country and beyond. America’s large current account deficit partly reflects the strong consumption of domestically and internationally produced goods, which is supported by incentives. However, decisions about monetary easing are becoming more difficult. Some of the boost, especially when interest rates are low, is due to currency depreciation, which helps exporters get a larger share of trading partners’ spending. In the 1930s, countries that were at the end of this demand set up tariff barriers, leading to escalating protectionism and the collapse of world trade.
There goes the neighborhood
Today, bold fiscal incentives could save the world from that fate. But the governments are already spending less freely than in the spring. On October 6, President Donald Trump ended talks on a new round of incentives. The day before, Rishi Sunak, the British Chancellor of the Exchequer, spoke of the need to bring public finances under control. When fiscal stimulus is scaled back, monetary easing looks increasingly like zero sum. A dizzying change in strategy by the Federal Reserve in August contributed to the dollar’s decline against the euro and exacerbated a deflation problem in Europe. America, for its part, is targeting some surplus countries. On October 2, it launched an investigation into Vietnam’s currency manipulation. The rapid growth of foreign exchange reserves in a number of excess Asian economies suggests governments are stepping in to depress their currencies, says Brad Setser of the Council on Foreign Relations, a think tank. American control over China could also tighten if the imbalances persist. Although the dollar has fallen around 5% against the yuan since May, some evidence suggests that China has acted smartly to slow the pace of its currency appreciation.
Trade relations over the past few years have in many ways been a delayed response to previous economic ills caused by persistent imbalances. Had global expansion continued, they might have failed. Instead, the world is tied back to the harsh realities of the depression economy. Unless they are defused through enlightened self-interest and cooperation, imbalances could easily become the basis of debilitating economic conflicts. ■
This article appeared in the Finance & Economics section of the print edition under the heading “Beggar Banquet”