The world is dangerously imbalanced — the G7 must act

Global imbalances are the central theme of the G7 summit in Évian-les-Bains in June. Under the French presidency, the aim is to restore the G7 to its original purpose as a forum addressing major economic challenges.

One of the biggest is global imbalances, reflecting large and persistent current account deficits and surpluses.

The timing is apt. It will be 20 years since the International Monetary Fund hosted the first Multilateral Consultation on Global Imbalances in June 2006. Ahead of the 2008 crisis, trade and savings imbalances provided a warning of deeper problems ahead.

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Then, the focus was on China, the euro area, Japan, Saudi Arabia and the US. The aim was an orderly unwinding of imbalances to support growth.

Imbalances narrowed after the financial crisis but since 2018 they have widened again, becoming large and persistent. The US now runs a large current account deficit while China and the euro area run large surpluses. This means global growth is again becoming dangerously imbalanced.

The concern is twofold. First, such imbalances reflect deep structural challenges within the US, China and euro area. Second, they risk fuelling protectionism, national security concerns and financial instability.

Countries running persistent deficits consume more than they produce, save too little and rely on foreign capital inflows to finance the gap, building up liabilities over time. In contrast, surplus countries save too much, depend excessively on exports and accumulate overseas assets.

Over time, the policy prescriptions to address imbalances have become well known. These include the burden of adjustment not just falling on deficit countries; surplus countries should act too.

For surplus countries, that means saving less, spending more and letting their currencies appreciate. Deficit countries, meanwhile, should spend less, save more and see weaker currencies. Structural reforms are also essential. A key role is for the General Agreement on Tariffs and Trade and the World Trade Organisation to prevent sectoral trade tensions escalating. Globally, however, there has been a shift towards interventionist policies, increased subsidies and regulatory barriers.

Yet while policymakers often talk about coordination they usually act only when national self-interest demands it.

That was true before the 2008 crisis. Coordination came only afterwards, notably at the 2009 London G20 Summit with fiscal stimulus and ultra-loose monetary policy.

The high point of international coordination remains the 1985 Plaza Accord, when the G5 agreed to weaken the dollar.

A lesson is that while currency moves may be necessary, they are rarely sufficient. Other changes are needed.

Another takeaway provides support for those who do not want to be pushed into domestic action by global events. That’s the view that the policies Japan adopted after the Plaza Accord, with a strong yen and low interest rates, fed its bubble economy, which then burst.

No one should raise their hopes of coordinated policy action from this G7. If countries are going to act it will be for domestic reasons. Even if growth is imbalanced, it may be seen as better than the alternative if that means weaker growth now. Instead, the trend is towards fragmentation, protectionism and state intervention. National security concerns increasingly shape economic policy.

At the same time the global financial backdrop has become more fragile. Deleveraging has seen private sector borrowing moderate since 2008, but public debt has surged. A global sovereign debt problem is building.

Regulatory changes following the 2008 crisis mean banks globally are now in good shape, well capitalised and liquid. But, in turn, shadow banks, outside of the regulatory spotlight, have more assets than banks. Often, they are opaque, leveraged and now hold vast swathes of government bonds. Although yields have been rising for government debt, there are fears that markets are not pricing fully for risk, with compressed risk premia.

The growth outlook is contingent upon the war and energy prices. But what would it take to rebalance global growth?

Unfortunately, global rebalancing requires things that will take time, such as China’s consumption rising sharply, the euro area addressing its competitiveness issues and the US curbing its budget deficit.

China has accounted for one third of global growth in recent years but its economy is imbalanced. It needs to raise consumption as a share of GDP, a key focus of its new 15th Five-Year Plan. This is a huge opportunity for the UK as a future market to sell into, given its expertise in services. China is only the 13th largest services trading partner of the UK, accounting for 1.9 per cent of UK services trade.

China’s vast trade surplus reflects a hyper-efficient export machine, a competitive currency and involution, which is intense competition across its industrial sector. This is keeping prices low and adding to global competition. High-quality Chinese exports such as electric cars are set to gain market share across the UK and western Europe.

Germany has been a persistent source of imbalance with a large trade surplus. But its industrial engine has stalled, leading last year to the abandonment of its debt brake and its new-found enthusiasm for government debt. Defence spending may provide a temporary lift but will not solve its deeper competitiveness problem.

More broadly, the EU’s large surplus reflects weak investment opportunities and excessive savings. Without structural reform and implementation of the Draghi report, it may drift towards protectionism.

The lesson for the US is to address its large budget deficit, while its worsening net liability position may add to downward pressure on the dollar.

The UK, like the US, has run current account deficits for half a century. That leaves the UK reliant on foreign investors to finance both its trade deficit and government borrowing. Credible policies are needed to reassure the markets.

The G7 needs to persuade countries to address their domestic structural challenges in the global interest. If the G7 fails to restore more balanced global growth, the spotlight will fall more sharply on Britain’s own domestic imbalance of high public debt.

Dr Gerard Lyons is chief economist at Netwealth