Global Imbalances and the Financial System
Savings Gluts and Deficits Must Be Corrected for Sustainable Growth
Sep 27, 2009
Despite what the experts may tell you, economics is not a science. Science implies finite rules and outcomes, theories and laws. Unfortunately, the fundamental “laws” of economics have been called into question numerous times in the history of the modern economic system, most recently with the collapse of the financial system that began about a year ago with the formal bankruptcy of Lehman Brothers. The financial crisis was precipitated by the growing global imbalances in trade, savings, and expenditure. Advanced economies like the United States had grown accustomed to spending beyond their means, whereas developing countries had amassed savings surpluses, in an effort to absorb excess capital from export-reliant domestic economic structures and keep exchange rates low.
Export-led Growth and the Savings Glut
In the 1970s, a still-recovering Japan began to increase its exports abroad, largely penetrating the US markets. By the 1980s, this model of export-led growth had caught on throughout Asia, with developing countries seeking to replicate the success of the Japanese. Many of these countries still rely on their exports to foreign markets to provide sustained economic growth and attract investment into the domestic economy, bringing with it expertise, technology, and capital. However, as these economies have expanded and their wealth has grown, there has also been corresponding pressure for currency appreciation.
An appreciated currency will have a negative effect on export-led growth as the appreciation causes the exported good to become more expensive for the importer. In order to offset this effect, many Asian states began to roll their wealth into savings and sovereign wealth funds, effectively intervening in the exchange rate by controlling the money supply. This led to the creation of a savings glut in Asian economies, and climbing oil prices led to a similar effect in some Middle Eastern states.
The Advanced Economies’ Response to the Savings Glut
The savings glut in developing countries necessitated an outlet for this excess capital. Advanced economies were only too happy to oblige. Most of these economies had low savings rates and were spending in excess of their annual GDP. In order to meet consumer habits and finance federal projects these economies – notably to US – had to borrow heavily from abroad. This satisfied the savings-glut countries’ need for an investment destination and the deficit countries’ penchant for spending. The frailty of this system was exposed when the US sub-prime mortgage crisis led to disastrous effects globally.
The Recovery
Now that the financial crisis appears to be over and the world economy is moving toward recovery, it is important that these global imbalances are rectified and prevented in the future. In order to rectify the global imbalances, two things must happen. First, deficit countries must rebuild their national savings rates. The negative effect of this will be slower economic growth for a period of time, but will offer great economic stability in the long run. Second, countries with savings glut must increase their domestic consumption. As Martin Wolf, chief economic commentator for The Financial Times, noted, this means that citizens within those countries must start living better – and how much of a hardship is that really?
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