by Joseph Joyce
The global economic contraction following the pandemic has led to a massive fiscal response. Governments have acknowledged the need to increase spending in order to offset the declines in consumption and investment. The decreases in public savings can lead to rising current account deficits that offset the capital inflows needed to cover the gap between savings and investment. But will these measures generate a return to the global imbalances that preceded the global financial crisis?
The IMF’s External Sector Report for 2020, subtitled Global Imbalances and the COVID-19 Crisis, appeared in August (see a summary here). The analysis was based on data from 2019 when the global current account imbalance (the absolute sum of all surpluses and deficits) fell by 0.2 of a percentage point to 2.9% of global GDP. But the report’s authors also considered the impact of the pandemic on countries’ balance of payments.
The IMF’s analysis suggested that about 40% of the 2019 current account positions were excessive. Larger than warranted surpluses were registered by Germany and the Netherlands, while deficits were larger than warranted in Canada, the U.K. and the U.S. China’s external position was in line with its fundamentals and policies.
In the report, the IMF anticipated that in 2020 the U.S. would report a current account deficit equal to 0.5% of world GDP. Canada and the U.K.’s deficits were each projected to be equal in value to about 0.1% of global output. China was expected to register a surplus of about 0.2% of world GDP, as were Germany and Japan. These forecasts come with a large degree of uncertainty, and the report’s authors acknowledge that global financial stress could lead to more capital flow reversals and larger imbalances.
More recent data show clearly that the U.S. and China are running the largest current account imbalances in absolute terms. Brad Setser of the Council on Foreign Relations points out that Chinese firms have benefitted from the demand for electronic goods as workers stay at home, as well as the need for personal protective equipment. Moreover, the Chinese government has supported its firms that export, with less direct support for households. The U.S. has provided more direct support to households.
The fiscal responses of the two countries to the pandemic also differ. The Economist estimates that the 2020 U.S. budget balance will show a deficit equal to 15.3% of its GDP, while China’s deficit is estimated at 5.6% of GDP. Part of the U.S. fiscal deficit will be offset by household savings, which increased last spring to over 30% of disposable income. The savings rate has slowly come down since then, while households attempt to plan their spending in a world of uncertainty. If the recovery in the U.S. stalls and there is no additional fiscal stimulus, then households will be forced to dip into their savings.
The IMF’s current account forecasts are consistent with the analysis of Matthew Klein and Michael Pettis in their recent book, Trade Wars Are Class Wars: How Rising Inequality Distorts the Global Economy and Threatens International Peace. The authors claim that these imbalances reflect domestic policies that privilege the more affluent members of a country. The trade wars that divide nations reflect divisions within these countries between asset owners and workers.
Klein and Pettis attribute China’s surpluses, for example, to government decisions in the 1990s to foster development through investments and exports while suppressing Chinese consumption in order to generate savings. The government has since acknowledged this imbalance and sought to rebalance domestic spending, in part by promoting consumption expenditures while curbing shadow banking. But whenever economic growth has slowed, the government has responded by encouraging new investment, including housing, and total credit to the private sector has grown to 216% of GDP.
Similarly, Germany’s current account surpluses reflect its policies designed to encourage growth after the decade of the 1990s, when the costs of reunification weighed down the economy. There was a conscious decision to encourage savings, a shift that benefited capital owners at the expense of labor. Until this year the government took pride in its balanced budgets, despite a need for infrastructure spending. The high personal savings rate reflects in part a high degree of income inequality, with most gains going to those households more likely to save them. There was also an emphasis on the country’s external position, and wage increases were limited in order to hold down costs.
The increases in foreign savings were matched by capital flows to the U.S. These reflected the U.S. position as the financial hegemon, with the most liquid financial markets. Moreover, the U.S. provided something of great value: safe assets. U.S. Treasury bonds have been the preferred asset of central banks and European savers, although before the 2008-09 financial crisis mortgage backed securities with AAA ratings were seen as acceptable substitutes. The financial sector within the U.S. benefitted from the increase in domestic and foreign financial activity. But the capital inflows appreciated the dollar, which undermined the export sector. In the years leading up to the global financial crisis the Federal Reserve kept interest rates low in order to boost spending. A weak recovery after that crisis caused the Federal Reserve to continue its low interest rate policy.
The pandemic has brought a return to past conditions. Whether or not the most recent increase in the Chinese trade surplus is a transitory phenomenon, its current account is on track to record a surplus for the year (although at a much lower level than before the global financial crisis). Similarly, while Germany’s budget balance is forecast to show a deficit of 7.2% of its GDP for the year, its current account is expected to register a surplus equal in value to almost 6% of its GDP. The U.S. current account deficit, which peaked at 6% of GDP in 2005, was equal in value to 3.5% of GDP in the second quarter of this year.
Klein and Pettis write that past global imbalances reflected a complementarity of interests between American financiers and Chinese and German industrialists, and reinforced inequality. To change these patterns requires policy reorientations within these countries that will allow more income to be transferred to households. They admit that this is a difficult task, but point out that a new system was devised by the Allied nations at Bretton Woods in 1944 in order to guarantee living standards. The upheaval produced by the pandemic is global in nature and has the potential to bring about another policy transformation. The one necessary element that will be contested by those who profit from current arrangements is the political will.