The start of 2014 marks ten years since we began fretting about global imbalances, and specifically about the chronic trade and current-account imbalances of the United States and China. A decade later, we can happily declare that the era of global imbalances is over. So now is the time to draw the right lessons from that period.
America's current-account deficit, which was an alarming 5.8 per cent of GDP as recently as 2006, has now shrunk to just 2.7 per cent of GDP — a level that the US can easily finance from its royalty income and returns on prior foreign investments without incurring additional foreign debt. Even more impressive, China's current-account surplus, which reached an extraordinary 10 per cent of GDP in 2007, is now barely 2.5 per cent of national income.
There are still a few countries with worrisomely large surpluses and deficits. Germany and Turkey stand out. But Germany's 6 per cent-of-GDP surplus is mainly a problem for Europe, while Turkey's 7.4 per cent deficit is mainly a problem for Turkey. In other words, theirs are not global problems.
Back in 2004, there were two schools of thought on global imbalances.
The Dr. Pangloss school dismissed them as benign — a mere reflection of emerging economies' demand for dollar reserves, which only the US could provide, and American consumers' insatiable appetite for cheap merchandise imports. Trading safe assets for cheap merchandise was the best of all worlds. It was a happy equilibrium that could last indefinitely.
By contrast, adherents of the Dr. Doom school warned that global imbalances were an accident waiting to happen. At some point, emerging-market demand for US assets would be sated.
Worse, emerging markets would conclude that US assets were no longer safe. Financing for America's current-account deficit would dry up. The dollar would crash. Financial institutions would be caught wrong-footed, and a crisis would result.
We now know that both views were wrong. Global imbalances did not continue indefinitely. As China satisfied its demand for safe assets, it turned to riskier foreign investments. It began rebalancing its economy from saving to consumption and from exports to domestic demand.
The US, meanwhile, acknowledged the dangers of excessive debt and leverage. It began taking steps to reduce its indebtedness and increase its savings. To accommodate this change in spending patterns, the dollar weakened, enabling the US to export more. The renminbi, meanwhile, strengthened, reflecting Chinese residents' increased desire to consume.
There was a crisis, to be sure, but it was not a crisis of global imbalances. Although the US had plenty of financial problems, financing its external deficit was not one of them. On the contrary, the dollar was one of the few clear beneficiaries of the crisis, as foreign investors, desperate for liquidity, piled into US Treasury bonds.
The principal culprits in the crisis were, rather, lax supervision and regulation of US financial institutions and markets, which allowed unsound practices and financial excesses to build up. China did not cause the financial crisis; America did (with help from other advanced economies).
This is not to deny the enabling role of international capital flows.
But the flows that mattered were not the net flows of capital from the rest of the world that financed America's current-account deficit. Rather, they were the gross flows of finance from the US to Europe that allowed European banks to leverage their balance sheets, and the large, matching flows of money from European banks into toxic US subprime-linked securities. Both critics and defenders of global imbalances almost entirely overlooked these gross flows in both directions across the North Atlantic.
The next time that global imbalances develop, analysts will — we must hope — know to look beneath their surface. But will there be a next time?
A couple of years ago, forecasters were confident that global imbalances would re-emerge once the crisis passed. That now seems unlikely: Neither the US nor China is going back to its pre-crisis growth rate or spending pattern.
Nor are earlier trade balances about to re-emerge. America's trade position will be strengthened by the shale-gas revolution, which promises energy self-sufficiency, increase productivity that will auger further re-shoring of manufacturing production.