SUDDENLY, the tectonic plates of the world economy have shifted. The weekend’s tremors felt in Washington at the spring gatherings of the International Monetary Fund and finance ministers of the world’s key economic powers were slight, but they seemed to have the potential, at least, to herald some significant upheavals to come.
The much-vaunted problems of “global economic imbalances”, which were a central focus of the talks in the US capital, can certainly be compared to the formidable geological pressures that accumulate under the Earth’s crust.
Like tectonic forces, the imbalances are vast and, to most, unfathomable. They are the product of the action of fundamental forces between the world’s big geographical blocs — in this case huge international flows of goods and capital. The imbalances, too, harbour the potential to unleash a devastating “quake” if stresses reach a critical point — the shockwave in this case being most likely to come in the form of a slump in the dollar.
The crucial difference, though, between the geological dangers and the economic ones that threaten the global economy is that we can do something to mitigate the economic threats. The problem of the global imbalances is well diagnosed, the scary prognoses are well known and the prescriptions to forestall disaster have been spelled out repeatedly by experts, not least the IMF’s — but to little effect.
All of this remained the case as the world’s finance ministers and central bank governors arrived in Washington. On Wednesday, the IMF’s twice-yearly World Economic Outlook again clearly detailed the symptoms, causes and possible solutions of the imbalances.
The United States is consuming and borrowing too much, and saving too little, resulting in a current account deficit heading for 7 per cent of national income this year. America’s addiction to consumption is underpinned by low market interest rates, which are suppressed by huge purchases of US Treasury bonds by Asian nations, especially China.
These are carried out to keep their currencies super-competitive and to help them to sell cheap goods to US consumers. In turn, Asia has built up vast current account surpluses and foreign exchange reserves. In Europe, weak domestic demand leaves nations too dependent on trade and growing at a lacklustre pace that deprives the global economy of an alternative engine for growth.
The dangers are well known. If markets suddenly decide that the US current account deficit is unsustainable, then the imbalances could abruptly unwind, sending the dollar into freefall and propelling the American and world economies into recession. To try to avert this, policymakers could seek to boost US domestic saving; stimulate domestic demand and push through structural reforms in Europe; and move to more flexible exchange rate regimes in Asia.
Yet last week Raghuram Rajan, the IMF’s chief economist, was gloomy over the willingness of leaders to act: “Far too little is being done far too late.”
After years of warnings, this despair is understandable. Leaders’ lack of resolve is easily explained, since the measures needed would be politically difficult.
By yesterday, though, things looked just a little more optimistic. A sudden shift in mood seemed to have taken place at the Washington talks, which coupled increased apprehension over the growing risks with a greater readiness to act.
This shift manifested itself in two ways. First, the Group of Seven leading economies ended talks understood to have included discussion of IMF simulations of the risks from a sharp dollar depreciation by publishing a special statement on the global imbalances. Secondly, both the G7 and the IMF’s ruling committee, chaired by Gordon Brown, agreed to move more rapidly than expected to give the Fund important new powers to foster action on the imbalances. Under the IMF’s new role, it will be able to police the way in which individual big economies affect each other through “spillover effects”, and will also be able to bring nations together on an ad hoc basis to try to thrash out ways to address instabilities from inappropriate fiscal, monetary and exchange rate policies.
Rodrigo de Rato, the IMF’s managing director, who deserves some applause for forcefully pushing ahead with plans for this new role for the Fund, is expected to move quickly to put the new powers to use. Mr Brown suggested that the first fruits could emerge in time for the IMF’s next annual meeting in Singapore in September.
Will this really come to anything? There are big question marks.
John Maynard Keynes, the economic giant of the postwar period and the IMF’s founding father, whose death was 60 years ago this weekend, wanted it to be a body that would pursue “ruthless truth-telling” and give “grandfatherly” guidance to force countries collectively to resolve imbalances such as those we now face. Nowadays, though, while the IMF can try to knock heads together, it has no powers to compel them to co-operate or to act. And the actions that many of the key players must take will still remain economically and politically painful to implement. It is hard to be confident that they will not continue to turn a deaf ear to unpalatable advice.
Still, some subtle change in mood does seem to have occurred. The plates have shifted. If measures are to be attempted, the moment is as propitious as it can be, with the world economy in the midst of what Mr Rajan called a "purple patch" of four years of booming growth.
Siren voices will continue to urge inaction, with perennial optimists on Wall Street and elsewhere arguing that the risks from imbalances are overdone and that they can unwind over a long stretch in an orderly way. Maybe so. But as Mr. Rajan also observed, "the optimists have to be right every day, while the pessimists need to be right only once".
Since the imbalances will, inevitably, adjust, it is clear that Lord Keynes himself would have urged precautionary action now. That should be incentive enough for those who take the decisions.
