China Global Imbalances, Reserve Currency and Global Economic

Global imbalances, Reserve currency, and Global economic governance The accepted hypotheses for the root cause of global economic imbalances are: 1)East Asian economies’ export-led growth: recently the integration with international markets leads to an import and export expansion making the trade surpluses in EA dramatically increase. It had a great success in EA producing higher living standards and poverty rates declining. This cannot be the main cause for the emergence of large global imbalances in 2000 and thereafter since before 2000 EA economies’ TB were roughly balances. )Self-insurance motivation for foreign currency reserve accumulation: after the financial crises in the late 1990s, emerging market economies in EA increased their CA surpluses substantially, and they experienced rising international reserves. After 2005 Chinese surpluses and reserves are too large to be justified by the self-insurance motivation. 3)China’s exchange rate policy: the g. i. started to grow in 2002 and China has been accused of causing the imbalance sustaining a large undervaluation of its real exchange rate since 2003, but it is not true because: •China trade surplus did not become large until 2005 RMB appreciated against US$ by 20% in 2005-2008 but the global imbalances continued to grow •Most other developing countries also increased their CA surpluses in the same period (if exchange rate was the cause, the other countries that compete with China would have experience declining trade surpluses and reserves) >The need for an alternative hypothesis: these hypotheses imply that the EA economies are driving the g. i. but is not consistent with the basic statistics.

While the US trade deficits with China did increase substantially, the share of the US trade deficit due to EA economies as a region actually declined significantly. The three hypotheses surely contributed but they cannot be the main cause of the global imbalances. >An alternative hypothesis consistent with the data: it views the g. i. as a result of the status of the US $ as the major global reserve currency, combined with: •The lack of appropriate financial sector regulation due to deregulation in the 1980s. The federal reserve’s low interest rate policy following the burst of the “dotcom” bubble in 2001. These policy changes led to excessive risk-taking and higher leverage, producing excess liquidity and “bubbles” in the US markets, which enabled the US overconsumption that increased the US CA deficit. As China had become the major producer of labor-intensive processed consumer goods by 2000, the US ran a large deficit with China, which ran trade deficits with the EA economies that provided intermediate products to China.

The excess liquidity also led to the large outflow of capital to developing countries, which enhance their investment and consequently in large trade surpluses in capital-goods exporting countries and natural resources exporting countries. Since the US is the reserve currency issuing country, the foreign reserves accumulated through trade/capital account surpluses in other countries would return to the US leading to the US CA surplus. >Why did China stand out in the global imbalances? : the large CA surplus in China reflects high domestic savings.

There are several commonly accepted hypotheses about China’s high households saving rate: such as the lack of well-developed social safety net and the demographics of an aging population. But the uniqueness of China’s savings is the large share of corporate savings, which are driven by the excessive concentration of the financial system that serves the big firms, low taxation on natural resources, and monopolies in some sectors. Reforms are required for removing these distortions and increasing consumption. The role of the reserve currency in global imbalances: the status of the $ as the major global reserve currency, combined with the financial deregulation of the 1980s and the low interest rate policy of the 2000s, led to the emergence of global imbalances. To prevent their recurrence, the ultimate solution is to replace national currencies as global reserve currencies with a new global currency, but US is unlikely to give up its reserve-issuing privilege to a global body (IMF).

A more likely scenario is the emergence of a basket of reserve currencies with some changes in the basket’s consumption and weights. >A win-win solution for the global recovery: the most urgent challenges are high unemployment and the large excess capacity in high-income industrialized countries. Win-win solutions for the global recovery and long-term growth could be based on new international financial arrangements along with structural reforms in both high-income and developing countries.

On the financial front it could be created a global recovery fund (supported by hard-currency countries and large-reserve countries and managed by multilateral development banks) to finance investments to release bottlenecks and enhance productivity in developing countries. These investments would increase the demand for capital goods produced in high-income countries, reduce their unemployment now, and enhance the developing countries’ growth in the future. The fund could be complemented by structural reforms in high-income and developing countries to create space for investment and to improve the efficiency of investment.