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Crude Calls on Global Imbalances
(Caixin Online) Splashed across the pages of every financial periodical recently, global imbalances have become a focal point of interest for investment research houses and leading lights of the academic community. In past months, the issue has crystallized in the form of raucous political debate over the value of the Chinese renminbi.
The common refrain to the average investor plays out as a scenario of living on borrowed time – the U.S. and other developed countries have been propping up their spending with cheap foreign funds at low interest rates. The emerging bloc, and in particular, China, has artificially weak consumption demand and has essentially supported growth by selling goods to the advanced world, keeping exchange rates cynically pegged at an undervalued rate in the process. Heavy central bank intervention is the lubricant that holds this pernicious system together, as ever-increasing surpluses are recycled directly back into the developed world to finance rising export purchases.
The U.S. and European economies can stabilize, but can't begin to grow until the emerging world stops living at their own expense and starts pulling its own weight. This entails a wrenching change in the growth model, where sharp currency appreciation is the singular answer to removing distortions that prevent domestic consumption. Otherwise, the rising weight of never-ending surpluses and intervention risks will lead to bubbles. Then, collapse. Fate stares straight into the eyes of the global economy.
A Plight Fantastic
These imbalances have been exaggerated. First, imbalances were never as large as commonly believed – and they're even smaller now. There was a clear widening in emerging market surpluses and developed-country deficits from 2000-06, but one that probably only accounted for a small fraction of growth and consumption. Since 2007, those gaps have narrowed visibly, and as of 2010, we are not far off from our best estimate of historical "balance."
Secondly, it's mostly about oil prices. China did see a sharp rise in its own surplus balance over the past decade, but mainland surpluses never contributed more than one-quarter to the total emerging market increase. Rather, by far the single most important factor was oil and fuel, which accounted for over half of cumulative imbalance.
Lastly, the main drivers of rising surpluses were supply shocks. Everyone points to low emerging consumption ratios, but on a structural basis these are almost exactly the same as in the advanced world. And the more recent fall was not due to weak consumer spending but rather to a sudden supply-driven expansion in the GDP denominator. Among oil exporters, this reflected the impact of rising commodity prices, and in China this was due to the rapid rise of steel and other heavy industrial capacity.
If we take these views as a guide to future trends, they suggest that the global imbalances – when viewed from the perspective of the emerging world – will likely stabilize and then continue to subside going forward; this is clearly what stable fuel prices and relative emerging market growth decoupling would imply, even in the absence of major changes in economic strategy. But for China, this is not necessarily true. Much depends on the current pace of new industrial capacity creation and future policy decisions on the renminbi exchange rate.
The Din on China
Partitions are typically drawn between US deficits on one side and, Chinese and Asian surpluses on the other. But the gap between the "emerging" and "developed" regions as a whole are neglected. So even if imbalances don't look particularly onerous for the world economy in the aggregate, don't we have a much bigger problem if we just concentrate on the troubled "trans-Pacific" axis?
Crawling even further into this tunnel, if the bulk of the increase in emerging market surpluses was driven by acute imbalances in China, can't we say that the recent improvement in relative current account positions is all "just temporary" because of the role of massive mainland fiscal and monetary stimulus policies, which kept domestic demand strong in the face of falling exports? In other words, once export markets stabilize and the Chinese government reverses its unusually expansionary stance, won't surpluses jump right back to previous highs?
The answer to these questions would be mostly "no." The U.S. does loom overwhelmingly large in explaining developed deficits – but the same is not true for China. Despite all the hand-wringing over the renminbi exchange rate, by far the biggest driver of emerging surpluses has in fact been oil prices.
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| (Chart 1) |
If you look at the breakdown of the emerging current account balance in Chart 1, China was not even close to being the biggest contributor to the 1999-2006 upsurge – that honor goes to emerging market oil and fuel exporters, who accounted for more than half of the total increase. In fact, at no time during that period did China account for more than one-quarter of the cumulative adjustment from the 1990s average (roughly the same contribution as for other non-fuel emerging markets, see Chart 2).
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| (Chart 2) |
Nor did China have much to do with the reversal of the past few years; once again, the main driver here was the sharp drop in oil prices in 2008-09.
This is not to say that the mainland economy didn't play any role at all; from the charts, it clearly did. But the most significant factor behind the dramatic rise and more recent decline was nonetheless oil prices. And even if Chinese surpluses were to jump back to previous highs (which, we should add, is not the base case scenario), the impact on the overall EM balance would be minimal.
But aren't oil prices really just another proxy for China? The usual perception is that the mainland is now the sole determinant of commodity prices, so can't we say that EM surpluses really are mostly about China after all?
Not according to the numbers. On the one hand, if we look at China's role in the steel market, for example, we find that mainland consumption rose from 15 percent of global consumption in 1999 to nearly 33 percent in 2006 – accounting for a stunning two-thirds of the overall increase in consumption during the same period (and much more today, see Chart 3); clearly China was the marginal driver of demand and pricing here.
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| (Chart 3) |
However, as we saw in Charts 1 and 2, the main force behind emerging imbalances was not general commodity and materials exporters – it was just oil and fuel exporters. And China accounted for only slightly more than 5 percent of total oil consumption in 1999 and still just 8 percent seven years later, which puts the marginal contribution at around one-quarter of annual new demand (Chart 4). In other words, it's much more difficult to argue that the mainland was "driving" markets here in the same sense; and in fact from the chart it's immediately evident that other emerging markets had a more important impact on marginal demand in aggregate.
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| (Chart 4) |
Now, to return to the initial point above, it's clear from the data that the U.S. economy was virtually the sole contributor to developed deficits. As you can see from Chart 5 below, the U.S. current account balance fell dramatically for 15 years between 1990 and 2006, while the rest of the advanced world actually had a rising surplus position over the same period.
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| (Chart 5) |
However, when we look at the bilateral composition of the U.S. goods and services trade deficit (a close proxy for the current account deficit) in Chart 6, the story is essentially the same as before. Looking at the movements from the late 1990s through 2006, when the overall U.S. deficit worsened from 2 percent of GDP to nearly 7 percent of GDP at the trough, a full three percentage points of that adjustment came from other advanced economies and from fuel imports; only two percentage points came from China and other non-fuel emerging markets. And the recent drop in the U.S. deficit had almost nothing to do with China; again, it was oil prices and developed trade that explains the entire swing over the past 18 months.
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| (Chart 6) |
So whether we look at global aggregates or just the U.S. in particular, there is little evidence to suggest that Chinese surpluses have played "the" leading role.
Jonathan Anderson is head of Asia-Pacific Economics for UBS.
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