Why are trade imbalances a concern during global downturns?

Dr. Muhannad Talib Al-Hamdi
 
03/24/2021

Dr. Muhannad Talib Al-Hamdi

Like other crises that preceded it, one of the consequences of the Corona pandemic appears to be the highlighting of the disturbing features of the global economy. Global trade imbalances can be seen as an example. Although it disappeared for a while when the pandemic first struck, it has now recovered. The United States recorded its largest trade deficit in 14 years in August, despite its shift from a large importer of oil to a net exporter at the time. This offsets the US commodity trade deficit neatly and in balance with a renewed Chinese trade surplus. Some temporary factors could be considered a reason for this, such as the increase in China's exports of personal health protection equipment. But there is cause for concern that these entanglements continue to rupture, adding a dangerous element to an already fraught global policy environment .

Global trade imbalances recently reached a peak before the outbreak of the 2007-2009 financial crisis, when the absolute total of current account surpluses and deficits of the world's countries reached more than 5% of global GDP. Current account gaps have widened in part because of what economists have called the "global saving glut", as a result of high oil prices, and the precautionary savings that some emerging economies ’governments have taken to prepare for possible sudden reversals in global risk appetite. The gaps narrowed in the post-crisis decade as oil prices fell and China moved toward rebalancing its economy. However, on the eve of the pandemic's spread, surplus and deficit imbalances remained at around 3% of global GDP, roughly one and a half times the level that prevailed in the early 1990s.

Current account gaps are not inherently bad. A developing economy that needs investment, for example, may consume more than it produces for a period of time as it builds its production capacity, and be able to possess the necessary mechanisms to pay off accumulated external liabilities in the future. But in some cases it can be a source of crisis, if it reflects an accumulation of financial vulnerabilities. These problems become particularly problematic through their increasing connections to the global economy today, particularly in times of low demand. Economies run current account surpluses when they produce more than they consume. When there is a large amount of global demand, it becomes only slightly more inconvenient for deficit economies, which enjoy more consumption than their domestic production capacity alone will allow. However, when demand is scarce, surplus countries drain the purchasing power of their trading partners when they have little to no value than to keep.

In a paper published in 2015, Professor Ricardo Caballero, professor of economics at the Massachusetts Institute of Technology, and Professor Pierre Olivier Gourenshas of the University of California-Berkeley describeAnd Professor Emmanuel Farhey of Harvard University, this effect. Professors frame their argument on the demand side of safe assets. Globally, every surplus must meet a deficit, and saving in one country must be met by borrowing from another. Surplus countries save by buying foreign government bonds. When global interest rates are well above zero, these purchases simply push interest rates down, forcing countries with deficits to borrow and spend more. When interest rates fall to zero, this channel stops working, as interest rates cannot fall any further. Instead, the compensatory increase in borrowing in deficit countries must come through diminishing incomes: a recession .

Since the 2007-2009 financial crisis, interest rates across the rich world have been close to zero, with a few brief exceptions. Parts of the emerging world are close to falling into low prices in 2020. Under these conditions, fiscal expansion, which increases the global stock of government bonds, is an effective way to boost growth, both within and outside the stimulus country. The huge US current account deficit partly reflects the robust consumption of goods produced at home and abroad, supported by stimulus operations. But decisions about monetary easing become more difficult. Part of the boost to growth, especially at lower rates, comes from the devaluation of the currency, which helps exporters get a larger share of trading partners' spending.

Today, bold fiscal stimulus can save the world this fate. But governments are already spending less than they were in Spring 2020. On October 6 last year, former US President Donald Trump ended his talks with congressional leaders about a new round of fiscal stimulus. The day before, Mr. Rishi Sunak, the UK chancellor of the exchequer, spoke of the need to bring public finances under control. If fiscal stimulus packages are curtailed, this leaves monetary easing increasingly like a zero-sum process. A moderate adjustment in the Fed's strategy in August contributed to the dollar's depreciation against the euro, exacerbating the deflationary problem in Europe. For its part, the United States is putting some fiscal surplus countries under fire. On October 2, 2020, the US Treasury Department opened an investigation into possible manipulation of the value of its currency by Vietnam.  A former economist at the US Treasury. US surveillance of China may intensify if trade imbalances remain wide. Although the dollar has fallen against the yuan by about 5% since last May, some evidence indicates that China has acted mischievously to slow its currency's appreciation .

Trade disputes in recent years have been, in many ways, a belated reaction to previous economic conflicts, sparked by persistent current balance of payments imbalances. These trade frictions may diminish, or diminish, if the global economy continues to expand. Instead, the world finds itself tied once again to harsh realities highlighted by depression economics. If trade disputes are not defused by the introduction of enlightened self-interest and cooperation, imbalances can easily become the basis for an exhausting economic struggle.


Professor of Economics and Political Science, Kansas State University, USA.

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