Since the onset of global financial crisis in 2008, there have been civil, plodding, and ineffectual efforts to rebalance the global economy. These talks have involved many of the world’s major economies, but have centered around the United States and China. The United States needed to address its persistent current account deficits and excessive consumption; China needed to address its ballooning foreign exchange reserves and excessive dependence on exports. Little came of the discussions. When last checked, they were entangled in intricate debates about how to recognize an objectionable imbalance if we were to see one, all held under the auspices of the G-20 and the IMF.
The trudging pace of efforts to achieve global rebalancing can be explained by at least three factors:
1. In the wake of the crisis, the urgency of reform abated; the trade and financial imbalances shrank.
2. The remedies for these imbalances are politically difficult. In the United States, consumption cuts are painful for obvious reasons. In China, rebalancing implies transferring resources from favored corporate sectors to households.
3. Little value has been placed on reaching a cooperative solution. This has been much less true of the United States than of China. While the U.S. Treasury was a strong advocate of seeking a new global consensus on rules governing imbalances, China has been an exceedingly reluctant participant in those talks.
In recent weeks, though, we may have stumbled upon several catalysts to spark a sense of urgency and potentially spur progress. The contentious debate in the United States over raising the debt ceiling drew alarmed reactions from China.
Given China’s substantial holdings of U.S. Treasury obligations, its leaders were particularly concerned by any suggestion that the United States might not make good on those debts.
Then, in early August, just after the debt ceiling standoff was resolved, the U.S. Federal Reserve announced that it intended to maintain “exceptionally low levels for the federal funds rate at least through mid-2013.” This did not draw the anguished international response that the Fed’s earlier quantitative expansion (QE2) provoked, but the policies are likely to have similar effects. An expansionary monetary policy will, in general, drive down the value of the U.S. dollar and undercut the value of large bond holdings.
Finally, in the same week, China announced its largest monthly trade surplus in two years and the United States announced its largest monthly trade deficit since late 2008. The spectre of large imbalances had returned.
While the sense of urgency may have returned to global rebalancing, the political challenge has not gotten any easier. Quite the opposite: the difficulties have grown over time. In the United States, calls for moderating consumption confront a slack economic environment with persistent high unemployment. Proponents of austerity face off against Keynesians, whose advocacy of new fiscal stimulus recalls Saint Augustine’s plea: “Lord make me chaste, but not yet.”
China’s export sector has only expanded in recent years and its stock of foreign exchange reserves now weighs in around $3.2 trillion. That magnifies the potential losses China will face should it appreciate its exchange rate – a critical component of any serious plan for economic rebalancing.
Chinese commentators have variously called for actions to safeguard Chinese investments in the United States, a new diversification of Chinese foreign exchange reserves, or even an abrupt abandonment of China’s policy of containing the value of the RMB.
Mounting economic pressures will force both the United States and China to address their imbalances; the question is whether the two countries will do so in a spirit of conflict or cooperation.
Chinese reaction to the U.S. debt ceiling debate was strikingly dismissive in tone. That was a shame, since there were some relevant lessons to emerge from the episode. While it is possible to view the debt ceiling as a farce, it can also be seen as an example of how difficult economic questions are resolved when there are sharp differences of opinion in the populace and a government of limited and divided powers.
China faces just such challenges: as the United States cannot continue racking up debt, China cannot continue stockpiling the bonds that constitute that debt. As the United States must undertake painful adjustment to temper its consumption, China must undertake painful adjustment to deemphasize the low-cost export industries that have played a critical role in China’s remarkable growth of recent decades.
A conflictual approach would entail each country scapegoating the other for its problems and would surely work in both directions. China has indulged in such rhetoric in recent weeks. Such rhetoric has abated in recent months in the United States, but is likely to reemerge in the U.S. election campaign and in Congressional debates on perennially popular China currency bills. Paradoxically, perhaps, the United States would have an advantage in such a scenario: it can and will pursue a self-interested monetary policy, per the Fed’s mandate. China would have little recourse. There are no good alternative markets into which it could diversify its massive foreign exchange reserves and any attempt to stop buying them would simply accelerate RMB appreciation.
In a more cooperative scenario, both countries would help lead a discussion among key global actors about new rules governing global imbalances and adjustment. Each could temper the political pain of necessary adjustments by pointing to “concessions” arduously won from the other country that would address long-standing concerns.
While a cooperative approach would not render adjustment painless, it would have some important benefits. It could restore faith in the functioning of the global economic system and it could avoid poisoning the key Sino-U.S. relationship in other, non-economic realms of discourse.
Given percolating economic pressures, the post-crisis period of amiable but empty discussions of global rebalancing plans may be drawing to a close. It will be replaced either by a period of concerted joint efforts for change, or by a period of recriminations and naked self-interest.
Phillip Levy is a Resident Scholar in International Economics at the American Enterprise Institute for Public Policy Research