Did the meeting of the Group of 20 in London last week put the world economy on the path of sustainable recovery? The answer is no. Such meetings cannot resolve fundamental disagreements over what has gone wrong and how to put it right. As a result, the world is on a path towards an unsustainable recovery, as I argued last week. An unsustainable recovery might be better than none, but it is not good enough.
This summit had two achievements: one broad and one specific.
First, “to jaw-jaw is better than war-war”, as Winston Churchill remarked. Given the intensity of the anger and fear loose upon the world, discussion itself must be good.
Second, the G20 decided to treble resources available to the International Monetary Fund, to $750bn, and to support a $250bn allocation of special drawing rights (SDRs) – the IMF’s reserve asset. If implemented, these decisions should help the worst-hit emerging economies through the crisis. They also mark a return to a big debate: the workings of the international monetary system.
This is the point at which the eyes of countless readers will glaze over. It is easier for most to believe that the explanation for the crisis is solely the deregulation and misregulation of the financial systems of the US, UK and a few other countries. Yet, given the scale of the world’s macroeconomic imbalances, it is far from obvious that higher regulatory standards alone would have saved the world.
This is not just a matter of historical interest. It is also relevant to the sustainability of the recovery. Fiscal deficits are now generally far bigger in countries with structural current account deficits than in those with current account surpluses. This is because the latter can import a substantial part of the stimulus introduced by the former. The Organisation for Economic Co-operation and Development forecasts a jump in US public debt of almost 40 per cent of gross domestic product over three years (see chart). It is quite likely, therefore, that the next crisis will be triggered by what markets see as excessive fiscal debt in countries with large structural current account deficits, notably the US. If so, that could prove a critical moment for the international economic system.
Intriguingly, the country raising these big questions is China. This is, no doubt, for self-serving reasons: China is worried about the value of its foreign currency reserves, most of which are denominated in US dollars; it wants to relieve itself of blame for the crisis; it wishes to preserve as much of its development model as possible; and it is, I suspect, seeking to countervail US pressure on the exchange rate of the renminbi.
Wen Jiabao, the Chinese prime minister, has noted his country’s concern over the value of its vast reserves. At close to $2,000bn, these are almost half of 2008 GDP. Imagine what Americans would say if their government had invested about $7,000bn (the equivalent relative to US GDP) in the liabilities of not altogether friendly governments. The Chinese government is beginning to realise its mistake – too late, alas.
Meanwhile, Governor Zhou Xiaochuan of the People’s Bank of China has produced a remarkable series of speeches and papers on the global financial system, global imbalances and reform of the international monetary system. These are both a statement of the Chinese point of view and a contribution to global debate. One may not agree with all he is saying. Yet the fact that he is speaking out is itself significant.
Governor Zhou argues that the high savings rate of China and other east Asian countries is a reflection of tradition, culture, family structure, demography and the stage of economic development. Furthermore, he adds, they “cannot be adjusted simply by changing the nominal exchange rate”. In addition, he insists, “the high savings ratio and large foreign reserves in the east Asian countries are a result of defensive reactions against predatory speculation”, particularly during the Asian financial crisis of 1997-98.
None of this can be changed swiftly, insists the governor: “Although the US cannot sustain the growth pattern of high consumption and low savings, it is not the right time to raise its saving ratio at this very moment.” In other words, give us US frugality, but not yet. Meanwhile, adds the governor, the Chinese government has produced one of the largest stimulus programmes in the world.
Moreover, the vast accumulations of foreign currency reserves, up by $5,400bn between January 1999 and their peak in July 2008 (see chart), reflect the emerging economies’ demand for safety. But since the US dollar is the world’s main reserve asset, the world depends on US monetary emissions. Moreover, the US tends to run current account deficits, for this reason. The result has been a re-emergence of a weakness discussed in the twilight years of the Bretton Woods system of fixed exchange rates, which broke down in the early 1970s: over-issuance of the key currency. The long-term answer, he adds, is a “super-sovereign reserve currency”.
It is easy to object to many of these arguments. Much of the extraordinary increase in China’s aggregate savings is the result of rising corporate profits (see chart). It would surely be possible to tax and then spend a part of these huge corporate savings. The government could also borrow more: at the 3.6 per cent of GDP forecast by the IMF this year, its deficit remains decidedly modest. It is also hard to believe that a country such as China should be saving half of its GDP or running current account surpluses of close to 10 per cent of GDP.
Similarly, while the international monetary system is indeed defective, this is hardly the sole reason for the world’s vast accumulations of foreign currency reserves. Another is over-reliance on export-led growth. Nevertheless, Governor Zhou is correct that part of the long-term solution of the crisis is a system of reserve creation which allows emerging economies to run current account deficits safely. Issuance of SDRs is a way of achieving this goal, without changing the fundamental character of the global system.
China is seeking to engage the US. That is itself enormously important. However self-seeking its motivation, that is a necessary condition for serious discussion of global reforms. Yet China must also understand an essential point: the world cannot safely absorb the current account surpluses it is likely to generate under its current development path. A country as large as China cannot hope to rely on such large current account surpluses as a source of demand. Spending at home must still rise sharply and sustainably, relative to growth of potential output. It is as simple – and difficult – as that.
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