Opinion & Commentary
Imbalances essential to global economic system
The federal Treasury’s David Gruen recently told a conference at the University of Western Australia that global imbalances were implicated in the global financial crisis and it was desirable that they become much smaller.
Persistent current account imbalances are in fact a necessary and desirable element of a global economy characterised by free trade in goods and services and open capital markets.
These imbalances only become problematic when governments distort associated capital flows.
National borders are political rather than economic constructs and there is no reason to expect flows of goods, services and capital to conform to these boundaries.
Current account imbalances are merely symptomatic of increased globalisation, with specialisation and the division of labour increasingly spilling across national borders.
People who regard global imbalances as a problem argue that countries such as the US and Australia need to save more to reduce their reliance on foreign saving.
This is equivalent to arguing for a reduction in foreign investment.
The US and Australia enjoy foreign capital inflows because they typically offer higher rates of return to foreign investors.
We would not be better off substituting more expensive domestic for cheaper foreign capital, any more than we would be better off substituting more expensive domestic production for cheaper foreign imports.
The foreign capital inflows that are the flip side of the current account deficit have underpinned growth in Australian living standards throughout its history.
Viewed from this perspective, Australia’s persistent current account deficit should be celebrated rather than lamented. Australia’s dependence on foreign capital is seen by many commentators as a vulnerability, but recent events have shown the Australian economy to be remarkably resilient to even the most severe shock to global capital markets.
Foreign capital inflows to the US have been used less productively because of a massive distortion at the heart of its financial system. The alphabet soup of US government housing programs and related enterprises, such as Freddie Mac, Fannie and Ginnie Mae, channelled domestic and foreign capital into US housing past the point of oversupply.
Peter Wallison of the American Enterprise Institute estimates nearly two-thirds of all bad mortgages in the US were bought by US government agencies or required by government regulation.
Foreign investors, including foreign governments, can hardly be blamed for pouring funds into the debt issued by congressionally mandated and government-sponsored enterprises that offered higher yields than US Treasuries, but were also backed by an implicit (now explicit) US government guarantee.
Imbalances between the US and China are often blamed on China’s managed exchange rate regime, but the exchange rate is not the main driver of China’s current account surplus.
Some see the US as being dangerously dependent on Chinese saving, but it is actually China that is dependent on the US to provide the deep and freely traded capital markets that China has been unwilling or unable to develop domestically.
Like all managed exchange rate regimes, China’s will ultimately come unstuck. As then Reserve Bank governor Ian Macfarlane told the Chinese Academy of Social Sciences in 2005, the combination of rapid economic growth, a fixed exchange rate and persistent current account surpluses is not sustainable in the medium term, and it is in the interests of a country in this situation to adjust its exchange rate.
However, this adjustment won’t do much by itself to alter China’s domestic saving-to-investment imbalance, which is attributable to a much broader range of factors.
China will need to liberalise its capital account and domestic financial markets, moving its economy away from forced saving and unproductive, state-driven investment to a more market-driven system of capital allocation.
In this respect, China and the US have more in common than many Americans would like to think.
The US government will also need to extricate itself from its disastrous politicisation of housing finance and its post-crisis role in the US financial system.
In this regard, the US congress is likely to prove just as resistant to change as the Chinese Communist Party.
A less distorted system of capital allocation in both China and the US would have resulted in the more efficient use of global saving than was evident in the run-up to the global financial crisis. But it is unlikely to make much difference to the forces of globalisation driving persistent global imbalances.
Dr Stephen Kirchner is a Research Fellow with The Centre for Independent Studies.
