Asia could solve America's debt trap Author: Martin Wolf
It takes two to tango. This has been one of the twin themes of my recent columns on global current account imbalances (November 24 and December 1 and 8). The huge deficits being run by the US are the mirror image of the surplus savings of the rest of the world. But the dance is becoming ever wilder. That has been my second theme. It is necessary to call a halt before serious injury occurs. The "blame game" among policymakers is idiotic: they have created the problem together and must solve it together.
The aim is to reduce the rest of the world's reliance on the spillover of excess demand from the US and from a few other high-income countries (particularly the UK, Spain and Australia), while sustaining global economic activity. To achieve this, we need two changes: a reduction in aggregate demand, relative to potential supply, in deficit countries (and offsetting increases in surplus ones); and a depreciation of the real exchange rate in deficit countries, to switch output towards - and demand from - tradeable goods and services.
How difficult would the needed adjustments be? The first step towards an answer is deciding what a sustainable US current account deficit might be. In a recent column (FT, December 15), Raghuram Rajan, the chief economist of the International Monetary Fund, argues that the US could sustain a current account deficit of 3 per cent of gross domestic product (half the current level) indefinitely. Given US potential growth, net external liabilities would stabilise at 50 per cent of GDP, against roughly 30 per cent today. Given the chronic savings surplus of Japan and several other high-income countries, such deficits and liabilities seem reasonable for the world's biggest and most dynamic advanced economy.
Suppose, then, that the current account deficit were to be reduced from 6 per cent to 3 per cent of GDP over half a dozen years. With potential growth of supply at 3½ per cent a year, real domestic demand would then need to grow at around 3 per cent. Between 1996 and 2005, real demand will have grown 0.4 percentage points a year faster than output . So, overall, real domestic demand would be growing about a percentage point a year more slowly than it has over the past decade. That would be noticeable, but not agonising.
The corresponding reduction in the rest of the world's current account surplus would be about 1 per cent of its combined GDP. This seems quite modest. But the eurozone and Japan, which account for over a third of global GDP at market prices, would need to expand demand relative to supply. This would represent a marked reversal of the past decade's trends .
Now turn to the required changes in real exchange rates. To achieve a fall in the current account deficit, at full employment, of 3 per cent of GDP, the increased domestic supply - and reduced domestic demand - for tradeable goods and services in the US would amount to about an eighth of current output in this sector. Some analysts suggest that the needed overall real exchange rate adjustment could be close to 30 per cent from the peak three years ago. This would imply a further depreciation nearly as large as the one so far.
If a halving of the current account deficit, in relation to GDP, and a 30 per cent overall fall in the real exchange rate from the peak in early 2002 is the adjustment we seek, will the market deliver? The answer is: only if it is allowed to do so.
As economists at Deutsche Bank have argued, a new informal dollar area has emerged that contains countries that either run fixed exchange rates against the dollar (notably China) or at least intervene heavily in foreign currency markets. This new dollar area contains over half the world economy. But it will also run an overall deficit of about $260bn (£133bn) in 2004. It is not surprising the dollar area's currencies have been declining against the rest.
As the pain grows, argues Deutsche Bank, the eurozone may also embark on foreign exchange interventions and so join the informal dollar area, even in the teeth of opposition from the European Central Bank. Most of the world would then be underwriting the US external (and domestic) financial deficits. That would be a nirvana for US policymakers in the short term. But it would also postpone - and exacerbate - needed adjustments.
There is a better way: all round adjustment. The pivotal players here will be the Asian developing countries. Under almost any circumstances, Japan will run current account surpluses for years. The same is true for continental Europe. Both are regions with a natural tendency to save more than they can invest. But non-Japan Asia contains the world's fastest growing economies and biggest populations. These are the countries that would normally be expected to run current account deficits, financed by long-term capital inflows.
Yet that has not happened, largely because exchange rate intervention and monetary sterilisation are thwarting the natural adjustment. The result has been an astonishing accumulation of foreign currency reserves (see chart). By any conceivable standards, these countries have more reserves than they need. China, for example, holds reserves equal to a third of GDP, up from a sixth just four years ago. What is the point of exporting real goods in return for pieces of paper whose value will tumble when the Chinese seek to cash them in? It would be far more sensible to tolerate current account deficits equal at least to the inflow of foreign direct investment.
The world will only dispense with its dependence on the accumulation of mountainous US liabilities if non-Japan Asia - above all, China - play the role to be expected of the world's fastest growing and most populous countries. Continent-sized countries should not go on playing the mercantilist game of piling up reserves indefinitely.
Non-Japan Asia needs to become a large net importer of capital. Aggregate current account deficits of at least $150bn a year, in today's prices, would be very helpful. Facilitating the emergence of the efficient capital markets and dynamic consumer demand needed for this is much the highest priority in global macroeconomic policy. Such reforms not only offer the only durable escape from the US debt trap. They are also exactly the changes Asia needs for its own long-term development.
