The countries with big current account surpluses have problems too
We have discussed the problems of those countries running large current account deficits, particularly those of the United States, on many occasions, including the troubling implications for trade policy. But those countries that are running large surpluses have some important structural issues as well.
Martin Wolf writes in the FT, “China’s forecast surplus — an amazing 12 per cent of GDP — is twice as big, relative to GDP, as Japan’s has ever been.” Furthermore, China’s supply-side continues to grow much faster than its demand-side: “China, in particular, is now exporting a big net contraction, not expansion, in demand to the rest of its world, because its supply is growing far faster than its domestic demand. The difference this year alone is 2.5 per cent of GDP.”
Thus, while countries like China with big current account surpluses have the wherewithal to better weather an economic downturn, their huge build-up in their exporting capacity (a) could be a contributing factor to a downturn, and (b) could make a downturn far worse when it eventually arises. Whether increases in domestic demand in these fast-growing economies is enough to take up the slack when demand from the West flags is one of the major economic questions of our time. Martin Wolf explains:
today’s financial strength in emerging economies is a mirror image of US weakness. Charles Dumas of London-based Lombard Street Research brings this point out in an analysis with which I have great sympathy. The global balance of payments sums to zero. If emerging economies have chosen to run huge current account surpluses, partly because they bear deep scars from the financial crises of the 1990s and partly because they wish to conserve revenue from the soaring prices of the commodities many of them export, then someone else must run deficits.
In the 2000s, that someone has largely been the US. This has entailed fast growth of domestic debt and debt service, chiefly among households. Falling house prices and the “subprime” debacle have now derailed this debt-accumulation machine.
The good news, then, is that what has made the US vulnerable is also precisely what has made it easier for emerging market economies to cope with a US-generated shock…The bad news, however, is that the emerging market economies will indeed have to adjust, probably aggressively. It seems unlikely that growth of demand will now accelerate in western Europe and Japan. The opposite is, alas, more likely. More important is the fact that China’s surging current account surplus, forecast by the World Bank to reach $380bn (£187bn) this year, up from $250bn in 2006, is extracting demand from the rest of the world to the tune of ¾ per cent of the latter’s aggregate GDP. China’s forecast surplus — an amazing 12 per cent of GDP — is twice as big, relative to GDP, as Japan’s has ever been.
The analytical point is that offsetting any slowdown in US demand requires faster growth of demand in the rest of the world. This is still more true if, as seems quite likely (and also desirable), US demand growth slows, relative to growth of GDP, and so the US current account deficit shrinks further. In that case, the rest of the world’s demand must rise relative to its output and, ideally, must grow faster than potential output, to ensure full employment of resources. But that is exactly the opposite of what China – vastly the most important of emerging market economies – is now doing.
The conclusion, then, is simple and disturbing. Yes, emerging economies are, with a few exceptions, in a better position to offset a US slowdown and tightening of global credit conditions than ever before. But they are almost certainly going to have to do just that. The difficulty they face, however, is that neither western Europe as a whole, nor Japan, nor, not least, the giant among them, is likely to help the rest very much. China, in particular, is now exporting a big net contraction, not expansion, in demand to the rest of its world, because its supply is growing far faster than its domestic demand. The difference this year alone is 2.5 per cent of GDP.
It is a fascinating time. Whether increases in domestic demand in these fast-growing economies like China’s is enough to take up the slack when demand from the West flags is one of the major economic questions of this period, and a test of China’s development policies.
We observe that when a similar scenario played out 80 years ago in the developing United States in real estate (1926-1927) and then the stock market (1929), things did not end so well. Meanwhile, today the beat goes on for the moment. You will recall that Shanghai 4000 occurred only in May of this year. Now the Shanghai index has touched 5860.86 before closing a little lower. Who knows if and when it will all end?