A RECOGNITION OF THE DEEP ROOTS OF THE CRISIS / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( HIGHLY RECOMMENDED READING )

A recognition of the deep roots of the crisis

By Wolfgang Münchau

Published: September 28 2009 00:49

Global imbalances have finally made it on to the agenda of the Group of 20 summit. It looked for a while as though the world’s most powerful leaders, obsessed with the minutiae of banking regulation, would turn themselves into the political wing of the Basel committee. We are still a long way away from dealing with the underlying causes of the crisis in an effective manner, but at least there is now an official recognition that the crisis is not just about financial regulation and supervision, but that it has deeper roots in global macroeconomic policy.

Why do we need such an agenda? The reason is that large and persistent imbalances drive ever larger capital flows, which can destabilise the global economy. Since current account surpluses denote an excess of national savings over investments, this excess has to be either invested abroad directly, or it piles up at home in the form of foreign currency reserves, which are then rerouted into the global capital markets. Without excessive imbalances, the demand for products we now refer to as toxic assets would have been smaller.

Not everyone has signed up to the idea. It is perhaps no surprise that countries with persistent current account surpluses are sceptical. Angela Merkel, the German chancellor, warned that global imbalances were an “ersatz” issue, which served to deflect from the real agenda, by which I presume she meant the regulation of bonus payments. I never cease to be amazed how her coalition managed to frame this complex financial crisis purely in terms of Anglo-Saxon greed. When you are holding on to such a convenient narrative, you do not want to answer awkward questions about imbalances.

To address global imbalances, at least four questions need to be answered. The first is to what extent global imbalances are self-correcting? The idea is that changed household behaviour in the US might take care of the problem by itself. I would agree that the effect of deleveraging in the US private sector should not be underestimated. But I am not so optimistic that this alone will solve the problem. The countries with large current account surpluses and deficits all have problems that need to be addressed by policy. If we relied solely on the US for adjustment – in combination perhaps with a fall in the US dollar – severe shocks could emerge elsewhere. A US-only adjustment could lead to a disastrous overshoot in the euro’s exchange rate, especially if half the world were to follow the US. So the answer is No, the problem is not fully self-correcting, and to the extent that it is not, we need to have a policy agenda.

The second question is how to deal with the eurozone. The eurozone as a whole has been running a small deficit. But there are large cross-country imbalances inside the eurozone. I used to believe that national current account deficits do not matter, but the crisis has demonstrated that political leaders treat the eurozone not as a true economic union but merely as a joint currency area that is comprised of sovereign states. The Germans invoke the eurozone defence when confronted with accusations of excessive current account surpluses, yet when the crisis broke, the policy response was unco-ordinated and nationalistic. By contrast, the French never cease to defend the notion of a eurozone polity, yet they torpedoed a joint eurozone external representation at the International Monetary Fund by insisting that France retain its seat. This is not an honest position. For as long as the Europeans remain confused, it is best to treat imbalances as an issue for countries, not currency areas.

The third question refers to what policy action should be taken. The answer is that policy will have to be tailor-made to suit the specific circumstances of each country. China will probably not be able to reduce its excessive current account surplus without a revaluation of the renminbi. In Germany, the best overall macro-policy instrument would be a big tax cut to boost domestic demand. In the UK, restoration of balance will have to include heavy cuts in public spending, while Spain will also have to raise taxes, even in addition to last week’s announcement of a rise in value-added tax. Without labour market reform, Spain is unlikely to make a full recovery in the long run.

The fourth question is how should this process be policed. I am sceptical of proposals to impose rigid numerical caps on current account imbalances, especially as they are often driven by the private sector. It is hard enough for governments to make commitments on the public sector. To do so for the entire economy may be a touch ambitious.

I have even heard the suggestion of a penalty procedure should the cap be broken. The experience with Europe’s stability and growth pact, which failed to do just that for public sector deficits, should serve as a warning. Inflexible rules, however well intended, are not going to solve the problem. In any case, the G20 has no legitimacy to impose policies on those who do not agree, and especially not on non-members. Detailed and public scrutiny and peer group pressure are the most we can hope for. But since the members of the G20 account for the lion’s share of global imbalances, they are, for now, the right inter-governmental group to address the issue at the highest political level. In Pittsburgh, a start has been made.

Copyright The Financial Times Limited 2009