China in Transition

Redressing the Global Imbalance
- Increasing Chinese consumption and U.S. savings is the key -

Chi Hung KWAN
Consulting Fellow, RIETI

The potential for a ballooning global imbalance to destabilize the world economy has long been a concern. This fear became a reality when the current global financial crisis was triggered by the subprime mortgage loan crisis. At the core of this global imbalance are the trade deficit of the United States and the trade surplus of China. The former mainly reflects a savings shortfall (excessive consumption) in the United States, while the latter is a result of excessive savings (consumption shortfall) in China. Redressing the imbalance requires suppressing consumption in the United States and increasing consumption in China. Signs that this is happening finally began to emerge following the Lehman shock in September 2008.

Global imbalance centers on the U.S. and China

Together, the large U.S. trade deficit and China's rising trade surplus have become a symbol of the global imbalance. On a customs-clearance basis, the U.S. trade deficit reached $816.2 billion in 2008 and China's trade surplus hit $295.5 billion. On a bilateral basis, China replaced Japan in 2000 as the trade partner with whom the U.S. had the largest deficit, and by 2008 the U.S. deficit with China reached $268 billion, accounting for 32.8% of its total deficit ( figure 1 ).

Figure 1: Increasing U.S. trade deficit with China, Japan, and the rest of the world

Figure 1: Increasing U.S. trade deficit with China, Japan, and the rest of the world

(Source) Prepared based on Foreign Trade Statistics, U.S. Census Bureau

China and the United States also stood in marked contrast in recent years in terms of their current account balances (which include, in addition to the balance of trade, the balance on the services account, the balance on factor income from overseas, and the balance on the transfer account). The U.S. deficit has been expanding sharply (to $673.3 billion in 2008) while China's surplus has been rising (to $426.1 billion in 2008). Indeed, China has been the country with the largest current account surplus since 2006 when it surpassed Japan ( figure 2 ).

Figure 2: Changes in the current account balances of Japan, the United States, and China

Figure 2: Changes in the current account balances of Japan, the United States, and China div class="tagger" style="width:355px">

(Source) China's statistics based on China Statistics Summary 2009; Statistics for the U.S. and Japan based on the International Monetary Fund's World Economic Outlook Database, April 2009

The sharply rising current account imbalances of China and the United States reflect the respective widening savings-investment gaps in the two countries ( figure 3 ). While both the ratio of domestic savings and the ratio of domestic investment to GDP have been rising in China since 2000, the savings ratio has been climbing faster than the investment ratio. As a result, the current account surplus as a percentage of GDP has been rising rapidly, reaching 9.8% in 2008. Meanwhile in the United States, although the ratio of domestic investment has remained at around 20%, the current account deficit as a percentage of GDP has climbed to 4.7% by 2008, reflecting a fall in the domestic savings ratio.

Figure 3: Changes in current account balances in China and the United States reflecting the savings-investment balance

Figure 3: Changes in current account balances in China and the United States reflecting the savings-investment balance

(Note) Current account balance = savings - investment

(Source) China's statistics based on China Statistics Summary 2009; Statistics for the U.S. and Japan based on the International Monetary Fund's World Economic Outlook Database, April 2009

Thus the rising savings ratio (equating to a falling consumption ratio) in China and the falling savings ratio (equating to a rising consumption ratio) in the United States are the most critical factors in the expansion of the global imbalance. In fact, a comparison of major countries in 2008 shows that the United States had the lowest savings ratio while China had the highest. At the same time, the United States had the highest consumption ratio and China the lowest ( figure 4 ).

Figure 4: Comparison of the ratios of savings and consumption to GDP in major countries (2008)

Figure 4: Comparison of the ratios of savings and consumption to GDP in major countries (2008)

(Note) Current account balance = savings - investment

(Source) China's statistics based on China Statistics Summary 2009; Statistics for the U.S. and Japan based on the International Monetary Fund's World Economic Outlook Database, April 2009

Global imbalance centering on the United States and China cited for sparking the financial crisis in the United States

The expanding global imbalance centered on the United States and China is considered one of the causes of the international financial crisis that was triggered by the subprime crisis.

In 2005, when he was a Federal Reserve governor, Ben Bernanke, now chairman of the Federal Reserve Board, asserted that the deteriorating current account balance of the United States was not attributable to a savings shortfall (excessive consumption) on the part of Americans, but was a result of excessive savings in other countries such as China. As grounds for this claim, he noted that the increase in the U.S. trade deficit was in fact proceeding simultaneously with falling interest rates around the world; generally speaking, a savings shortfall in the United States would be expected to cause worldwide interest rates to rise, while excessive savings in other countries would be expected to contribute to lower interest rates globally. In addition, Bernanke warned that capital inflows into the United States accompanying the trade deficit exacerbated the ballooning of the real estate bubble. ("The Global Saving Glut and the U.S. Current Account Deficit," Remarks by Governor Ben. S. Bernanke at the Sandridge Lecture, Virginia Association of Economics, Richmond, Virginia, March 10, 2005).

U.S. Treasury Secretary Henry Paulson echoed this line of thinking in an interview in the British newspaper the Financial Times on January 1, 2009. Paulson, then in his last days in the government, said that one cause of the global financial crisis was that high savings ratios in emerging countries, including China, created imbalances in the global economy and that excess capital in the United States encouraged American investors to purchase high risk assets.

Wen Jiabao, Premier of China's State Council, refuted this view in his own interview with the Financial Times on February 1, 2009, saying, "I think the reason for this financial crisis is the imbalances of some economies themselves." (He was clearly referring to the United States, although he did not name any country.) "They have for a long time had double deficits and they keep up a high level of consumption on the basis of mass borrowing. In those economies the financial institutions have not been put under effective regulation and the financial institutions have reaped massive profits with a very high leverage ratio. Once such a bubble bursts, the whole world is exposed to a big disaster." He added "I think that it is confusing right and wrong when people who have been overspending blame those who lent them the money."

As these comments show, views on who is responsible for the crisis - China as a lender or the United States as borrower - depends on where one stands. Economists are reaching a consensus, however, that the trade imbalance between the United States and China is one of the most important factors in the current crisis and that reducing the imbalance is essential to preventing a recurrence.

Redressing the imbalance

Based on the idea of a savings-investment balance, redressing the global imbalance means China, which has a surplus, must raise its investment ratio while lowering its savings ratio and, the United States, a deficit country, must reduce its investment ratio while raising its savings ratio. Given that China's investment ratio has already reached a very high level in comparison with other countries, raising the rate further will unavoidably bring a decline in investment efficiency At the same time, it will be difficult for the United States to maintain growth if it lowers the investment ratio. Ultimately, then, the most effective way to reduce the global imbalance centering on the United States and China is through a combination of lowering the savings ratio (which equates to raising the consumption ratio) in China and raising the savings ratio (equal to reducing the consumption ratio) in the United States.

This adjustment has already begun, prompted by the global financial crisis. In the United States, private consumption and hence imports are declining sharply as significant falls in the value of assets such as real estate and stocks force households to repay their debt. The U.S. trade deficit has remained below the previous year's level since October 2008, and was down 46.6% year on year, to $216.9 billion, in the first half of 2009. Of that, the trade deficit with China contracted to $103.1 billion, down from $118.6 billion in the same period in the previous year. In contrast, China's trade surplus declined from $123.7 billion in the January-July period of 2008 to $107.5 billion in the same period of 2009, reflecting relatively firm Chinese domestic consumption supported by rising asset values. Given that oil prices have been falling substantially over the last 12 months, the downward trend in China's trade surplus would be more apparent if oil was excluded.

In addition to changes in asset values, exchange rate adjustments of major currencies, including the Chinese yuan against the dollar, should also eventually contribute to reducing the global imbalance by improving the savings-investment balance. As the greenback has been regarded as a safe haven currency since the Lehman shock in September 2008, the effective exchange rate of the dollar against other major currencies has remained firm, backed by the flow of capital into the United States. China has also emphasized the stability of the exchange rate of the yuan against the dollar in its foreign exchange policy, as part of its anti-crisis measures. Sooner or later, however, the dollar will again come under downward pressure because the U.S. current account deficit is still large. A weakening dollar will dampen consumption in the United States as import prices rise and real national income falls. In contrast, consumption in China and other U.S. trading partners will rise as imports from the United States will be cheaper and purchasing power will increase.

Adjustments leading to a reduction in the global imbalance have only just begun. Given that consumption is likely to remain weak over the medium and long term in the United States during this process, hopes that China will emerge as a new engine for the world economy are rising.

September 3, 2009
Related article

"Income Distribution Policy, the Key to Expand Consumption," China in Transition, June 29, 2009.

September 3, 2009