THE GLOBAL IMBALANCES MYTH / THE WALL STREET JOURNAL OP EDITORIAL ( VERY HIGHLY RECOMMENDED READING )

OPINION


DECEMBER 22, 2009.

The 'Global Imbalances' Myth

By ZACHARY KARABELL


As the economic crisis has eased in recent months, a questionable international consensus has emerged: The global economy needs to be rebalanced. "We cannot follow the same policies that led to such imbalanced growth," President Barack Obama said during his Asia trip last month. European Central Bank head Jean-Claude Trichet declared in September that "imbalances have been at the roots of the present difficulties. If we don't correct them, we'll have the recipe for the next major crisis."

These global "imbalances" supposedly include excessive American consumption, too much trade flowing from Asia to the West and not enough from the U.S. to Asia, and too much saving combined with insufficient spending by Chinese consumers. But what if the whole notion of global imbalances is a myth, and that policies to reverse them only make things worse?

The blunt fact is that at no point in the past century has there been anything resembling a global economic equilibrium.

Consider the heyday of the "American century" after World War II, when Western European nations were ravaged by war, and the Soviet Union and its new satellites slowly rebuilding. In 1945, the U.S. accounted for more than 40% of global GDP and the preponderance of global manufacturing. The country was so dominant it was able to spend the equivalent of hundreds of billions of dollars to regenerate the economies of Western Europe via the Marshall Plan, and also of Japan during a seven-year military occupation. By the late 1950s, 43 of the world's 50 largest companies were American.

The 1970s were hardly balanced—not with the end of the gold standard, the oil shocks and the 1973 Arab oil embargo, inflation and stagflation, which spread from the U.S. through Latin America and into Europe.

The 1990s were equally unbalanced. The U.S. consumed and absorbed much of the available global capital in its red-hot equity market. And with the collapse of the Soviet Union and the economic doldrums of Germany and Japan, the American consumer assumed an ever-more central position in the world. The innovations of the New Economy also gave rise to a stock-market mania and overshadowed the debt crises of South America and the currency implosion of South Asia—all of which were aggravated by the concentration of capital in the U.S. and the paucity of it in the developing world. When the tech bubble burst in 2000, it had little to do with these global dynamics and everything to do with a glut of telecommunication equipment in the U.S., and stock-market exuberance gone wild.

When officials and economists today speak of correcting global imbalances, it is unclear what benchmark they have in mind.

So-called excessive American consumption, East-West trade flows, Chinese savings and the like were not responsible for the recent crisis. That was instead triggered by massive misplaced bets on the U.S. housing market and trillions of dollars of derivatives built upon that flimsy foundation.

Yes, many have woven a compelling narrative of how the relationship between China and the U.S.—distorted by China's fixed and nonconvertible currency on the one hand and America's debt-fueled appetites on the other—led to massive flows of capital out of the U.S. But that money flowed right back into the U.S. in the form of Chinese purchases of Treasury bonds, mortgage-backed securities and other dollar-denominated assets, which then flowed into the American banking system, which then made its way back to U.S. business and to the Treasury, some of which then circulated back into China.

What some see as imbalances can also be described as a system of capital and goods in constant motion. Chinese reserves and U.S. government debt didn't trigger the meltdown, nor did U.S. consumers cause the meltdown. It wasn't even U.S. consumer debt—after all, more than 90% of Americans have remained current on their credit cards and their mortgages. The real (and much messier) cause of the meltdown was a potent brew of financial innovation, electronic and instantaneous flow of capital, greed on the part of banks and investors world-wide, against a backdrop of an economic fusion between China and the U.S. that kept interest rates low and inflation lower.

Today's consensus sounds very much like the orthodoxy of yesteryear—let each nation be its own system in equilibrium, interacting with other systems to create one mega-balanced system. Yet such balance has only existed in theory and only ever will.

Indeed, if the crisis of the past year teaches us anything it should be that forcing reality to conform to abstract theory is a sure recipe for disaster. Forced to act with expediency in the moment, the central banks and governments of the world did a surprisingly good job of triage during the economic emergency that swept the globe. The eclectic demands of a crisis outweighed models and theories, and that was a good thing.

Now that the crisis has eased, the greatest danger is that our collective belief in how the world should work drowns out the creative nimbleness of policy that adapts to the world as it is actually working. Policies that might stem from the global imbalances consensus include American government incentives to increase domestic savings. This sounds good, but not if it leads to underinvestment in innovation, education and infrastructure.

It could also lead Chinese officials to attempt to shift away from exports and state spending. Over the long term this might be beneficial, but it could wreak havoc on domestic Chinese growth and global supply chains if it is done under the erroneous belief that urgent action is required. For its part, the European Union rightly claims that it has not been a primary cause of the perceived imbalances. But its leaders have been central to pushing that thesis and urging China and the U.S. to redress them.

Thankfully, there is less risk of the Chinese government upsetting their apple cart than there is of the American government acting precipitously.

—Mr. Karabell is president of River Twice Research and the author, most recently, of "Superfusion: How China and America Became One Economy" (Simon & Schuster, 2009).

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