The US-China
Marriage of Convenience:
Prospects for Global Imbalances
and Economic Recovery
Terry McKinley
Director, Centre for Development Policy and Research,
School of Oriental and African Studies
Presentation, 29 January 2010, Delhi Conference,
‘Recovery or Bubble? The Global Economy Today’
1
The Starting-Point of The Debate
The US and China remain locked together in
interdependence:
 China has relied, for some time, on the US as
a market for its exports
 The US now relies on China as the prime
lender that can continue financing its
massive current-account deficits
Is China equally to blame for global imbalances and
the failure to reduce them?
Will the US continue to run huge current-account
deficits and undermine the basis for global
recovery?
2
Pinning the Blame on China
for Global Imbalances
China is often blamed for causing global imbalances,
mainly through ‘exchange-rate manipulation’ (US
Treasury Secretary Geithner’s early 2009 criticism)
 China has pegged the value of renminbi to the US
dollar (for a while loosely, until 2008)
Martin Wolf, the well-known columnist of the
Financial Times, has laid the basis for blaming China
in a series of columns on the global crisis:
 “The driving force behind these [global] imbalances
has been the policies of surplus countries and
particularly China” (January 20, 2009)
 “The world cannot safely absorb the current account
surpluses that [China] is likely to generate under its
current development path” (April 7, 2009)
3
What Is the Main Source
of Global Instability?
The main source of global instability is located not in
China but in the US, which is the world’s dominant,
reserve-currency country, and its most profligate
spender:
 It has regularly spent beyond its income level, based
on borrowing from abroad (e.g., from China!!!)
 Being the dominant reserve-currency country gives
it greater freedom to do so (adjusting at its own
pace)
A Major Question: Will US current-account deficits
undergo enough adjustment in order to substantially
reduce global imbalances and remove the basis for
renewed crisis?
4
The Basis for the US
Over-Consumption Binge
What were the origins of the US crisis?
During the 1990s, current-account deficits were
substantially increasing and Reagan’s huge fiscal
deficits from the 1980s were being reduced by the
Clinton administration
External demand and public-sector demand for
goods and services were declining. But the biggest
problem was the ballooning current-account deficits
This drag implied that the private sector (either
households or corporations) had to be the main
source for supplying additional aggregate demand to
the US economy in order to maintain economic
growth
5
The Basis for the US
Over-Consumption Binge
The US household sector began to spend well above
its income level: its net savings declined from 3% of
GNP in the early 1990s to a deficit of -4% of GNP!
Households were increasingly borrowing to sustain
higher levels of consumption and housing
investment
But why did households borrow so heavily? Their
personal assets (equities and housing stock)
seemed to be inexorably appreciating in value
This process was sustainable only as long as asset
appreciation kept pace with the rise of household
liabilities—and interest rates remained low
6
The Basis for the US
Over-Consumption Binge
But the stock market bubble burst in 2001
The US government responded with very expansionary fiscal
and monetary policies—keeping interest rates low and fuelling,
in effect, a larger ensuing financial crisis caused by the realestate bubble (exacerbated, indeed, by new complex forms of
leveraging of risk and lax regulation)
US current-account deficits began to balloon dramatically in
the early 2000s, requiring the need for more external borrowing,
that is, more purchase of US Treasury Securities by foreign
central banks (such as China’s)
Identifying such purchases of securities by China and other
surplus countries—as is often done—as the source of the
global financial crisis misinterprets its origins:
 The crisis was due to US over-consumption, not Chinese
excessive savings
7
Has There Been
a ‘Global Savings Glut’?
Critics of China in the West attribute global
imbalances primarily to a so-called ‘Global Savings
Glut’, which has supposedly made the US borrowing
binge much cheaper to finance
 Developing Asia and the Middle East have been the
major regions running large current-account
surpluses and accumulating foreign-exchange
reserves (often in low-interest US Treasury
Securities):
 Reserves of Developing Asia in 2009: $ 2.8 trillion projected
 Reserves of the Middle East in 2009: $ 870 billion projected
 These regions have been the major Savers at the global level:
their domestic savings rates significantly exceed their
domestic investment rates: they are ‘exporters of savings’
8
Stock of Foreign-Exchange Reserves
(US $ Billions)
Region
2001
2007
2009 proj.
All Developing
857
4,378
5,323
--Africa
64
289
318
--CIS
44
549
483
380
2,132
2,867
216
1,531
2,240
--Middle East
135
696
870
--W. Hemisphere
159
445
517
--Developing Asia
China
9
Has There Been
a ‘Global Savings Glut’?
By running a huge current-account surplus, China
has allegedly been contributing to a ‘global savings
glut’
This assumption is endorsed by a wide range of mainstream
economists, Martin Wolf, Ben Bernanke and Lawrence
Summers—and been used to shift global blame onto China
Although widely embraced, does this assumption
make any sense?
At the global level, total savings must equal, by
accounting definition, global investment (unless
there are errors in estimation)
In other words, excess savings in one grouping of
countries, such as Asia, must be balanced out by
deficient savings in another part of the world, such
as the US
10
Has There Been
a ‘Global Savings Glut’?
Another interpretation of the ‘savings glut’ is that
global savings has been rising relative to global
income
The table shows that broad averages since the late
1980s do not support such a claim
As a ratio to global income, savings has been
relatively stable, at 22-23%
So there has been no pronounced upward savings
trend, no evidence of a ‘savings glut’
But there has been a marked downward trend in the
savings of Advanced Economies, which has been
compensated by a substantial rise in the savings of
Emerging and Developing Economies
11
Savings as a Ratio to GDP (%)
1986-1993 1994-2001 2002-2008
Global
22.7
22.1
22.7
Advanced Economies
22.2
21.6
19.8
USA
16.3
17.0
13.9
24.3
24.2
31.1
Middle East
17.6
25.5
38.7
Developing Asia (including
China)
28.8
32.7
41.2
Emerging and Developing
Economies
12
What Is the Main Source
of Global Instability Now?
The US is currently trying to replace huge privatesector spending deficits (mainly of households) with
massive public deficits in order to stimulate
economic recovery
 The 2009 US fiscal deficit is projected by the IMF to
reach 12.5% of GDP (and to still be 10% in 2010)
 Such a fiscal deficit tends to enlarge the currentaccount deficit: increased domestic spending spills
over into increased imports
 The alternative is to devalue the US dollar, making its
exports cheaper—and thereby reduce the US
current-account deficit
13
The Impact of
a Depreciated US Dollar
When this option is taken, relative to the US dollar,
the currencies of many other countries will
appreciate, worsening their trade balances
Just as importantly, the US will lower the relative
value of its external debt
 The US can effectively ‘inflate away’ its external debt
by printing more dollars (the internationally reserve
currency, for which there remains a global demand)
 Countries holding their reserves in US Treasury
Securities will find their value reduced in their own
currencies (will suffer a loss of asset value)
 To some degree, the US remains in the ‘driver’s seat’
14
The Depreciation
of the US Dollar
Generally, the US dollar has been depreciating since
February 2002 (because of current account deficits):
about 21%, overall, in nominal terms
Its value hit a low point in April 2008, having fallen in
nominal terms by 26% since 2002
But the dollar appreciated between roughly April
2008 and April 2009 as money flooded, seemingly
perversely, into US securities as a ‘safe haven’
 As global economic conditions worsen (including US
recession), the US dollar becomes more valued!!
 Along with global recovery, the US dollar should depreciate
further, but currently it has been holding fairly steady as
prospects for a speedy recovery remain uncertain. Figure
15
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Depreciation of the US Dollar
Nominal Broad Index, Jan. 2002 – Jan. 2010
140
120
100
80
60
40
20
0
16
Who Gains from Depreciation
of the US Dollar?
Continued depreciation of the US dollar is necessary
in order to reduce global imbalances but its reservecurrency status impedes this adjustment
But if depreciation of the US dollar proceeds too far
and too fast, interest rates on US securities will have
to rise to compensate foreign investors in its
securities, possibly choking off recovery from
recession, and jeopardizing global recovery
If China too quickly shifts its foreign-exchange
reserves out of US securities, the US dollar will
depreciate faster, and more dangerously:
Thus there is a continuing uneasy strategic
Marriage of Convenience!
17
Capital Has Been Flowing Uphill
As a result, China, along with other Low-income and middleincome countries, have ended up exporting huge quantities of
capital to the richest countries (primarily the US)
This is not only inequitable but also inefficient globally:
 Emerging and developing economies have mounted a massive
‘foreign aid program’ to the US since they have to borrow from
the US at high interest rates but lend their reserves to it at very
low rates
 Large Current Account Deficits, % of GDP 2007:
US -5.2%, UK -2.7%, Spain -10.0%, Australia -6.3%
 Large Current Account Surpluses, % of GDP 2007:
Developing Asia 7.0% (China 11.0%)
Middle East 18.1% (Saudi Arabia 24.3%)
CIS 4.2% (Russia 5.9%)
Africa 2.9% (Nigeria 18.8%)
18
Why Has China (and East & Southeast
Asia) Adopted Export-Led Growth?
The historical roots of the Export-led Model are in
the successes of Japan and the East Asian Tigers,
and in the bitter lessons of the Asia Financial Crisis
The countries that had hastily liberalized their trade
and capital flows (based on IMF advice) learned from
the 1997-98 Crisis that they must avoid, at all costs,
current-account deficits (especially if those deficits
are financed by short-term external loans)
They were subjected to speculative attacks on their
currencies and sharp painful recessions—attacks on
otherwise sound economies
They were forced to endure a heavy and humiliating
burden of IMF conditionalities (an experience that
they wished never to repeat)
19
Why East & Southeast Asia
Adopted Export-Led Growth




Afterwards, East and Southeast Asian countries
began to run sizeable yearly current-account
surpluses, amassing large stocks of foreignexchange reserves
The reserves were seen as a necessary form of
‘precautionary’ savings designed to deal with any
attacks on their currencies
Is it necessary to invest a country’s reserves in lowyielding, risky foreign assets, such as US T-bills?
Is it necessary to amass such large stockpiles of
reserves—beyond precaution?
Does this stockpiling have a deflationary global
impact, diverting funds from more productive
outlets?
20
Does China Save Too Much?
If a country’s current-account balance is in surplus,
then macroeconomic accounting will show that its
total domestic savings exceeds its domestic
investment: it saves too much or invests too little
The country is recorded as having ‘Excess Savings’
(adding to its overall savings rate)
Has China been investing too little? Its Gross Capital
Formation approached 40% of GDP during 1990-2004
and more recently has approached 45%. Figure
China has an exceptionally high savings rate, i.e.,
over 50% of GDP in recent years; and the gap
between savings and investment has widened
ominously: savings have become misaligned with
investment
21
Investment and Savings in China
1990-2007 (% of GDP)
Gross
Domestic
Savings
Gross Capital
Formation
Difference
between the
Two
1990-1994
1995-1999
2000-2004
2005-2007
41.2
42.0
41.1
52.4
39.5
38.8
38.7
44.1
1.7
3.2
2.4
8.3
22
Savings, Investment and
Current-Account Surpluses
China has been a high-savings, high-investment
economy for a long time, growing rapidly and
channelling its huge rural labour surplus into the
production of higher-productivity tradables, i.e., it
has been ‘developing’
Its current fiscal stimulus (5% of GDP), mostly in
investment, is designed to continue this momentum
during the global recession
It has ample ‘fiscal space’ to expand domestic
demand without creating unsustainable public debt
Critics argue that China should boost domestic
consumption (and thus imports) to rebalance its
economy (and the global economy)
Would this improve China’s economic conditions?
23
Rebalancing China’s Growth
Rebalancing China’s growth model by stimulating
more domestic consumption is certainly feasible
since its domestic market is large
Its consumption has continued to grow rapidly (9.3%
in 2009) but its investment has still been growing
faster (14.8%)
 Striving for ‘consumption-led’ growth makes no sense for an
underdeveloped economy, especially since China’s equity and
housing markets are showing signs of an incipient bubble
 The transition to a Chinese growth model based more on
domestic demand (particularly household consumption) would
necessarily be a protracted process, in any case, based on
fundamental restructuring of the economy
 In the meantime, China is operating as an engine of growth for
the rest of Asia, whose exports to China are now booming
24
Rebalancing China’s Growth
 Global imbalances have recently diminished: The US current-
account deficit is expected to decline to -2.2% of GDP in 2010
and China’s current-account surplus to decline to 8.6% (IMF
World Economic Outlook)
China will continue, for a while, to rely on the export of
manufactured exports as the engine of rising productivity and
growth—but probably to more diversified markets
China does need to shift from low-return and risky
reserve accumulation to higher yielding direct
foreign investment in other developing countries
Such a shift already appears to be happening as the
previous surplus on its capital account is
diminishing
But, like Brazil and India, China still faces the
problem of increased inflows of speculative capital
25
China’s Trade Diversification
 China’s trade has been diversifying for some time
 Since only 16% of China’s exports were directed to
the US market in 2007 (with a falling trend), pegging
strictly to the US dollar does not necessarily make
sense
 China should continue managing the exchange rate
but could peg the renminbi to a more diversified set
of major currencies since its trade is becoming
increasingly diversified
 But pegging to the dollar makes more sense
precisely for maintaining the renminbi value of its
dollar-denominated foreign-exchange reserves
 Otherwise, China would incur huge book-value
losses on these assets as the US dollar depreciates
26
The Direction of China's Exports
2000-2007 (% of total)
35
33
33
29
30
% of Total Exports
25
20
20
16
16
16
15
15
10
14
7
5
0
Developing
Asia
Japan
United States
2000
2007
European
Union
Other
27
Widening Fault-Lines in
The International Monetary System
The constraints on China’s reliance on Export-Led
Growth: the US Dollar no longer appears to be a
reliable ‘store of value’  How can it continue
functioning as the world’s prime Reserve Currency?
 Does supplying the ‘world’s monetary needs’ imply
that the US has to run a current-account deficit?
 The US has tended to run such deficits since the
break-up of the Bretton Woods system: it has almost
invariably run deficits since the early 1980s. Figure
 Its current-account deficits ballooned beginning in
the early 1990s, reaching a floor of -6% of its GDP in
2006—before recovering modestly, to -5.2% in 2007
and -4.9% in 2008
28
US $ billions
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
US Current-Account Deficits
$ Billion, 1980-2008
0
-50
-100
-150
-200
-250
-300
-350
-400
-450
-500
-550
-600
-650
-700
-750
-800
-850
29
Widening Fault-Lines in
The International Monetary System
Because the US current-account deficits remain
large and recent US domestic counter-cyclical
monetary and fiscal policies have added pressure,
the main question is not whether the US dollar will
depreciate. It is: how fast will it depreciate?
When the US administration states that it favours a
‘strong dollar’, this means that it favours gradual
depreciation (any prolonged appreciation is
unrealistic)
Holders of US-denominated reserves, such as China,
are already suffering losses. And if they significantly
withdrew such investment, the value of the dollar
would drop even further
The Problem: This is an inherently unstable
situation, which could trigger future crises
30
Why Does China Continue
Investing in US Reserves?
In a way, China was obliged to invest its foreignexchange reserves in US T-Bills
The Central Bank had to sterilize the large and
recurrent monetary impact of both current-account
and capital-account surpluses (foreign investment)
It had to build up reserves: otherwise the injection of additional
money into the economy would have driven up imports, and
wiped out net exports
There were very few highly liquid financial markets in which
such a large yearly stock of reserves could be parked
Huge US current-account deficits conveniently created just
such a market. However, there remains a clear continuing
downside risk
31
Will Global Imbalances
Now Disappear?
The IMF projects the US current-account deficit to decline to
US$ -325 billion in 2010 but to rise back up to US$ -475 by 2014
The US fiscal deficit is still projected to be -6.7% of GDP in 2014
and thus there should be continuous global marketing of US
Treasury Securities
Hence, there is likely to be recurrent pressure for depreciation
of the US dollar
Developing Asia is projected to run a current-account surplus
of US$ 677 billion and the Middle East a surplus of US$ 307
billion in 2014
The gargantuan global imbalances of recent years might have
been modestly diminished in the recent period but the basis for
recurrent global imbalances and instability will likely remain
32
Resultant Calls for
International Monetary Reform
A 2008 paper by Bruce Greenwald and Joe Stiglitz has provided
a Keynesian perspective on reserve accumulation, viewing it as
a subtraction from global purchasing power (‘A Modest
Proposal for International Monetary Reform’)
As the US increasingly absorbs the reserves of surplus
countries (by borrowing to finance its growing current-account
deficits), the world becomes increasingly flooded with dollars
But the world economy is also subjected to a deflationary bias,
they claim, because of the unnecessary stockpiling of reserves
by individual countries
 Some precautionary savings is necessary but the recent build-up has
been excessive (this is wasted investment)
US debt-fuelled consumption and government deficit spending
have merely counteracted this deflationary bias without
providing a sustainable basis for global growth
While the continuous threat of dollar depreciation still poses a
destabilizing threat to the global economy
33
Modest Reform of the
International Monetary System
Their ‘Modest Proposal’: Issue Special Drawing Rights on a
substantial and regular basis
 SDRs could be a stable store of value linked to a diversified set of
convertible currencies
Reserves could be credited to the IMF accounts of member
countries in proportion to their IMF funding positions
Each country would no longer have to ‘bury in the ground’
some of its purchasing power by the precautionary
accumulation of its own reserves
Any country could run a deficit (enjoy net imports of more real
resources), which would be equal to its mandated receipts of
new reserves from the IMF
Countries would not have to worry so much about pressure on
their currency and recurrent financial crises associated with
global imbalances
34
How Realistic and Equitable
Are Such Monetary Reforms?
Current imbalances are based on a dynamic under which the
richest country in the world continues to spend beyond its
means in order to prop up global aggregate demand
The US remains in a stronger position to do so than any other
country or grouping of countries (e.g., Europe): it can force
adjustment onto other countries
There is no immediate alternative to the US dollar—not even
the Euro (which accounts for about 30% of all reserves)
Emerging and developing countries are not yet in a strong
enough position to negotiate a new international monetary
system that would be in their own interests
 Note the disadvantages of current reform proposals: 1) they
centre on the IMF (without fundamental governance reforms)
and 2) they allocate international reserves according to
measures such as GDP (namely, not equitably)
35