Right Diagnosis is needed for global economic imbalance （Jiang Shixue）

When somebody is sick, say, with a high fever, the doctor needs to correctly diagnose the cause(s) of the illness before he can prescribe the right medicine. Otherwise, the patient may not recover. For many years the world economy has been sick with a symptom called imbalance. Some economists say that this imbalance resulted in the global financial crisis, from which the world has yet to fully rebound.

The notion of this global economic imbalance was first put forward by the International Monetary Fund (IMF) in its report titled World Economic Outlook (September 2002). The IMF defined the imbalance as current account surpluses in Japan, the Euro area and (in the late 1990s) emerging markets, and deficits elsewhere, most notably in the United States. It believed that this imbalance across major trading regions rose steadily during the 1990s, driven by movements in current trade accounts.

What has caused the global economic imbalance? Different economists have different opinions. Some contend that China's huge foreign exchange reserves and low-valued Renminbi are villains causing the global economic imbalance. Over the years, China has been pressured, particularly by the United States, to raise the value of its currency so as to curtail the accumulation of its foreign exchange reserves.

This diagnosis is not correct. First, China is not the only country that has accumulated a great amount of foreign exchange reserves. Second, almost two-thirds of China’s trade surplus is created by foreign investment. Its accumulation of foreign exchange reserves is a win-win outcome for both China and foreign investors. Third, there are other countries that have maintained a trade surplus for a prolonged period of time. For instance, Germany has kept this surplus for 58 years and Japan for 29 years. China has had it only since 1994.

We argue that the United States should be blamed for creating the global economic imbalance. To put it simply, the U.S. spends more than it saves, thus generating an enormous gap of capital need. As the United States is the largest economy in the world, the multiple effects of this gap are extremely great.

The United States can print money as much as it wishes. So, in a broad perspective, the current international monetary system, dominated by the US dollar, is also to blame for the global economic imbalance.

In the discussion of global economic imbalance, China's high savings rate is often considered as another factor. This is also a wrong diagnosis. Influenced by its cultural traditions, Chinese people tend to "break a penny into two before spending". Thrift, along with some other reasons, can explain why China's savings rate is so high. But this high savings rate only leads to a high investment rate, not the global economic imbalance.

Global economic imbalance has become an issue of concern for the G20. It was reported that the G20 meeting of finance ministers and central bank governors in Paris during February 18-19, 2011, would have included exchange rates and currency reserves into a set of indicators to monitor and adjust global economic imbalances. It was reported that, due to China's opposition, exchange rates and currency reserves were not included in the indicators. As the communiqué of the G20 meeting reads, the finance ministers and central bank governors "agreed on a set of indicators that will allow us to focus, through an integrated two-step process, on those persistently large imbalances which require policy actions…While not targets, these indicative guidelines will be used to assess the following indicators: (i) public debt and fiscal deficits; and private savings rate and private debt (ii) and the external imbalance composed of the trade balance and net investment income flows and transfers, taking due consideration of exchange rate, fiscal, monetary and other policies."

The communiqué seems to be a victory for China. However, excluding the exchange rates and currency reserves from the set of indicators does not mean that China will not make its own contributions to maintain the stability of the world economy. Nor does it imply that China will make no efforts to stimulate its domestic demand or reform the exchange rate system.

Chinese leaders have promised to proceed further with the reform of the Renminbi exchange rate regime to enhance exchange rate flexibility. But this process should be implemented in a gradual way. In a press briefing during the annual meetings of the IMF and the World Bank in Washington D.C., on October 8, 2010, Zhou Xiaochuan, the governor of the People's Bank of China, vividly described China's policy position regarding the exchange rate issue: "Westerners prefer Western medication method that is quick but drastic, while Chinese people prefer traditional Chinese medication that is slower and gives time for different herbs to take effect."

The author is a columnist with China.org.cn For more information please visit

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http://www.china.org.cn/opinion/2011-02/28/content_22021192.htm