Should we worry about global imbalances?
Martin Wolf thinks we should; sadly I don't have an FT subscription so Wolf's article remains behind the firewall for me. Yet still, the provided teaser is worth a look because what it says is very true.
"Should we stop worrying and learn to love global imbalances? Investors certainly seem to believe this. Even though the US current account deficit reached 7 per cent of gross domestic product in the last quarter of 2005, the real exchange rate has stabilised. But the best time to worry about such trends is when everybody has ceased to do so. Now is such a time.
Why should we remain concerned about global imbalances? The answer is that they are undesirable, cannot continue indefinitely and the longer they last, the bigger and more painful the adjustment will be. Worse still, as recent US congressional threats to China over its "exchange rate manipulation" demonstrate, much damage can be done along the way to the world economy and international relations."
Especially the last part is something which should catch our attention. Because what will indeed be the end game between US and China over the growing US bilateral trade deficits and whether the Yuan really is to blame for the US deficit.
"Yet China's commitment to exchange rate flexibility seems every bit as thin as the Bush Administration's commitment to fiscal sanity and sharing the benefits of growth widely. The RMB's appreciation against the dollar since last July has barely offset ongoing inflation differences. Yes, inflation in the US is higher than inflation in China, so the RMB needs to appreciate a bit just to keep everything (the real bilateral exchange rate that is) the same."
(From the FT)
"But many economists say that even dramatic gestures by China would do surprisingly little to reverse the imbalance. The impact of currency movements on trade flows, they say, has been dwindling because of “local cost” pricing, where companies adjust price tags to keep in line with competitors, rather than according to fluctuations in the exchange rate."
"a revaluation of the renminbi would be ineffective in reducing the US deficit since most of the goods China sells to the US are not widely produced in America."
Contrary to popular -- although not unanimous -- opinion, I do not believe the biggest effect of the revaluation will be on the amount of imports into the U.S., or even the amount of Chinese imports
This is not to say that accelerated Chinese appreciation would have zero impact. In fact, if other East Asian currencies appreciate in line with the Rmb (i.e., if China is a first-mover), then this will mean that acquistion of U.S. Treasury securities will be moderated (...) This is where China's exchange rate policy is important -- not in changing the relative price of Chinese goods, but rather in altering asset prices and hence capital flows.
So returning to the question of what we could do to correct the global imbalances epitomized by the US current account deficit a Chinese revaluation notwithstanding?
"With the US deficit now so large, economists believe that to bring imbalances under control will require a combination of much higher growth outside the US, a big slowdown in the US and a large fall in the dollar. “Any one alone will not be sufficient,” says one economist."
I am not sure I like the two last ones any more than I believe in the first one, but now I am perhaps worrying too much.