Here's post #2 on the current account imbalances issue. Martin Feldstein thinks these imbalances will, for the most part, take care of themselves, without any grand international plan to fix them. He leads off his paper this way:
The high level of current account imbalances has been a major focus of international concern for a considerable number of years. In these remarks I will suggest why public and private actions in the United States and China are now likely to cause the current account imbalances in those countries to shrink and perhaps even to disappear in the next few years. If that happens, it will eliminate the largest current account imbalances in the global economy. ...
Although natural market forces should resolve such imbalances without the need for specific government policies, the government actions in both countries have actually contributed to their persistence and prevented market forces from correcting the problem. That may be about to change.
He then sets out some details:
What Needs to Be Done
There is no mystery about what has to be done to shrink or eliminate current account imbalances. The basic national income accounting identity tells us that a countryʼs current account surplus is the difference between national saving and national investment. Countries with current account surpluses can reduce those surpluses only by reducing public and private saving and/or increasing investment. Similarly, countries with current account deficits can shrink those deficits only by increasing national saving and/or reducing national investment.
So, it's mostly about savings and investment levels. But what about exchange rates?
That is true regardless of what happens to exchange rates. The saving investment imbalance is fundamental and it alone determines a countryʼs current account deficit or surplus.
But changes in the current account deficit or surplus must be accompanied by changes in the countryʼs real exchange rate in order to maintain domestic macroeconomic balance -- i.e., noninflationary full employment. ...
For the United States, the shift to increased exports and reduced imports needed to maintain aggregate demand while raising national saving requires a decline in the value of the dollar relative to the currencies of our trading partners. The natural market forces that would cause the dollar to decline relative to our major trading partners is prevented by the Chinese policy of managing the exchange rate between the Chinese renminbi and the dollar.
For a country with a current account surplus, a rise in private consumption or in government spending designed to reduce that surplus will create inflationary pressures unless the exchange rate adjusts to reduce exports or increase imports. An increase in private or public spending matched by an equal reduction in exports or increase in imports would prevent such an inflationary increase in domestic demand. That reduction in exports or increase in imports generally requires a rise in the value of the currency to make exports less attractive to foreign buyers and imports less costly and therefore more attractive to domestic buyers.
Turning now to what caused the problems to begin with, he says:
Government Policies vs. Market Forces
The persistence of large current account imbalances reflects government policies that alter the savings-investment balances in both the United States and China.
The large current account deficit of the United States reflects the combination of large budget deficits (negative government saving) and very low household saving rates. ...
In contrast, Chinaʼs large current account surplus reflects the worldʼs highest saving rate at some 45 percent of GDP. Some of this high national saving is caused by the very high retained earnings of state-owned enterprises. Chinese households are also high savers because the country lacks reliable social insurance programs for retirement, health care and unemployment.
The Chinese maintain aggregate demand and growing urban employment by channeling these savings into public and private investment and by encouraging high levels of exports by preventing an appreciation of the renminbi.
The result of this combination of policies in the U.S. and China is large current account deficits in the United States and large current accountsurpluses in China. ...
So it's a mix of government and market forces to blame, in his view.
What about other proposed solutions:
Attempts at International Policies to Limit Current Imbalances
Reducing these large current account imbalances has been a focus of international negotiations and of the activities of the International Monetary Fund. The United States and China have had bilateral discussions about policy changes, including changes in Chinaʼs exchange rate policy. These have focused too much attention on the exchange rate rather than on Chinaʼs saving and investment policies. They did not succeed in changing those policies and may have caused China to resist an exchange rate adjustment more strongly to avoid the impression that China was forced by the U.S. to alter its policy.
The International Monetary Fund has tried in several ways to persuade China to reduce its current account surplus. Chinaʼs large trade and current account surplus has been a subject of the IMFʼs annual article four review with the Chinese government. In 2006 the IMF launched a series of discussions focused on the five countries with the largest current account imbalances. When that failed to produce results, the IMF shifted to a policy that it labeled a “multilateral surveillance process” in which countries were supposed to collectively monitor each otherʼs behavior. That also failed to produce any effects on the policies and current account imbalances of either China or the United States.
More recently, the action has shifted from policies explicitly directed by the IMF to policies developed by the G20 countries at their periodic meetings on the theory that, for domestic political reasons, countries might be more willing to make changes that they had designed themselves rather than policies that appeared to be imposed by the IMF. The United States government came to the November 2010 meeting of the G20 in Seoul with a proposal that would require countries to agree to limit current account surpluses to no more than 4 percent of their GDP. This policy was rejected by China and Germany and was not adopted by the G20.
Any such plan to limit current account surpluses and deficits to a specific percent of GDP cannot be an operational policy because governments do not control their current account balances in the short term or even in the medium term. Shifts in the world price of oil and food cause substantial shifts in the values of imports and exports. When that happens, these external forces cause a temporary change in domestic saving and investment. For example, a rise in import prices can cause an increase in a current account deficit by causing a reduction in domestic saving, something that happened in the United States in 2007. Large market driven fluctuations in exchange rates of countries that do not actively manage their exchange rate can also produce large unintended fluctuations of the value of imports and exports. Spontaneous decisions of household sand firms to change saving and investment will also lead to changes inimports and exports that are not due to changes in government policies.
The result of the most recent G20 summit meeting was therefore a rather vague statement that the individual G20 countries would “commit” to specific policies that would shrink current imbalances. The role of the IMF would be limited to assessing the global compatibility of these national policies and suggesting ways in which individual countries might benefit from taking into account the policy commitments of other countries.My judgement is that such “commitments” to change domestic policies in the context of G20 negotiations are not likely to have any significant effects. The president of the United States cannot really commit to changes inpolicies that alter national saving since he cannot control the actions of theCongress or of the Federal Reserve.
In a nutshell, he doesn't think these types of approaches will have much impact.
Finally, how will the savings/investment adjustment solution work?
If the saving rate now continues to rise from todayʼs 6 percent of after tax income to 9 percent, that would raise national saving by about two percent of GDP. That is not a prediction but current conditions and past history indicate that it is a change that might very well happen.
The fiscal deficit is now 8 percent of GDP and is projected on the basis of current policy to decline to between 5 percent and 6 percent of GDP. That would raise the national saving rate by two percent of GDP. While political forecasting is even more difficult than economic forecasting, my crystal ball indicates that budget deficits are likely to decline even more than that. A fiscal deficit of five percent of GDP would cause the national debt to rise from the current 60 percent of GDP to a politically unacceptable 100 percent by the end of the decade, a ratio not seen since the end of World War II. To stabilize the debt at todayʼs 60 percent of GDP -- a much higher ratio than we have experienced in recent decades -- would require reducing the deficit to three percent of GDP.
I am optimistic that that is likely to be achieved or even bettered. The recent election and public opinion polls indicate a substantial increase in public concern about the size of the deficit and the growing national debt. The crisis in Europe associated with excessive deficits has increased that concern in the United States. In the recent report of the fiscal commission appointed by President Obama, a bipartisan group of senior political figures most of whom are current members of Congress, proposed very bold policies to reduce the budget deficit in the current decade by cutting specific government outlays and by radical reductions in tax expenditures.
...
The implied fall in public and private consumption would depress aggregate demand and prevent a return to full employment if it is not accompanied by a fall in the relative value of the dollar that causes a shift to increased spending on American made goods and services. An important part of that exchange rate adjustment is under way because of the rise of the real value of the renminbi. The next several years may also see a return of the euro to its previous higher level once the current eurozone crisis is resolved.
...
The reduction of the U.S. current account deficit implies that the current account surplus of the rest of the world must also decrease. While this need not mean a lower current account surplus in China, I believe that the policies that the Chinese have outlined for their new five year plan are likely to have that effect. These include raising the share of household income in GDP, requiring state owned enterprises to increase their dividends, and increasing government spending on consumption services like health care, education and housing. It is important that these policies are motivated by domestic considerations as China seeks to raise the standard of living of the population more rapidly that the moderating growth rate of GDP.
Basically, savings and investment will rise in the U.S. and decline in China, for the reasons he sets out. This, he says, should fix the imbalance:
It is not hard to imagine that a few years from now the current account imbalances of the US and China will be very much smaller than they are today or even totally gone.
I have a harder time imagining all this then he does. Some of the savings/investment changes might happen in the coming years, but I'm skeptical they will be as significant as he expects. In the U.S., the debt may come down slightly, and people may save a bit more than they used to. But barring some new economic catastrophe, I don't see the coming changes as substantial enough to get rid of the imbalances by themselves. Similarly, in China, some of what he predicts may happen, but I'm just not sure the pace will be as fast as he expects.
As to the various proposals mentioned in the last post, my guess is that actions will be taken to reduce tensions before any such proposals are fully implemented.
My prediction: Five years from now we will still be talking about solutions to the problem, the extent of the problem, whether there is a problem, etc.
