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The Problem of Financial Imbalances

Author: Epizentrum, Creative Commons license

In addition to the weakness of self-equilibrating mechanisms within the global monetary system, there is an arguably even more serious problem with underlying financial, trade and debt imbalances. In the words of the BIS, “Historically high debt levels and signs of financial imbalances point to increasing tension between price stability and financial stability.”[1] This view is echoed by another eminent banker, William R White, Chairman of the Economic and Development Review Committee of the OECD, who says that any of the imbalances in the IFMS, “could cause a future crisis.”[2] Temin and Vines go further and claim that, “Continued neglect of international imbalances will lead to conditions reminiscent of the 1930s and possibly even to military conflicts like the 1940s.”[3]

The question that needs to be considered is why do institutions like the BIS and authorities like Michael Pettis, William R White, Peter Temin, and David Vines regard imbalances in the International Monetary and Financial System (“IMFS”) as the central problem in the global economic system; after all, there are a great many books which claim that the Great Financial Crisis was due only to the criminal behaviour of American banks and mortgage lenders. To use a metaphor, you can see the International Monetary and Financial System as a bicycle, if you place a large load (imbalances) on the handlebars, this disturbs the balance of the machine, making it unstable, far more difficult to control, and likely to crash.

The Oxford English dictionary defines “imbalance”, as “An unbalanced condition; a lack of proportion or relation between corresponding things.” The International Monetary and Financial System, is highly complex and consists of many sub-systems, the most important of which are national, or domestic, policy regimes, such as the national policies of China, the United States, Norway et al. However, these national regimes must all operate within an international regime when countries trade, invest, borrow, or otherwise deal with each other. What has been the case, certainly since the Great Financial Crisis, is that that key elements within national regimes and the international regime have become unbalanced. In other words, national policies have not been coordinated and accordingly have lacked harmony. The relationship between Germany and the southern European EuroZone states is a case in point, Germany has continued to run a very high export surplus, whereas countries like Greece are unable to finance their debts and grow their economies and have therefore seen their indebtedness grow. Germany has not proposed any effective mechanism to bring the situation back into balance, for example by buying more goods and services from Greece and writing off a proportion of Greece’s debt.

Certainly the IMF saw debt relief as a key issue in the Greek financial crisis. In April 2016 at an internal meeting, Poul Thomsen, Director of the IMF’s European Department said, “and basically we at that time say ‘Look, you Mrs. Merkel you face a question, you have to think about what is more costly: to go ahead without the IMF, would the Bundestag say ‘The IMF is not on board’? or to pick the debt relief that we think that Greece needs in order to keep us on board?’ Right? That is really the issue.”[4] German reluctance to face up to this obvious solution may have been connected to the problems at the country’s leading banks, which would have needed to acknowledge that some of their assets were non-performing.

As well as Germany, China has been running very large credits on its international trading accounts (balance of payments), while the United States has been running a large deficit. Other elements which have become unbalanced include very high levels of government borrowing/debt in some countries, corporate borrowing, excess savings, the avoidance of tax by international corporations, rising levels of inequality, over and under investment, low levels of domestic consumption (a Chinese problem), extraordinarily low levels of central bank rates (which affects lenders and pension funds), and large fluctuations in community prices. In most cases these imbalances are ultimately due to national policies, particularly the belief in some creditor countries of the virtues of their policies. There is in practice insufficient coordination between nations, as a result there are not agreed international policies for dealing with monetary issues. White says that, “It is a simple fact that we no longer have internationally agreed rules of behaviour to constrain the shorter term actions of individual sovereign states with a view to longer-term benefits for all.”[5] Pettis notes that the classic explanation of the origins of crises in capitalist systems, “points to imbalances between production and consumption in the major economies as the primary source of monetary instability.”[6]

The domestic economy of China, in the period 2008 to 2015, became extremely unbalanced. In 2013, as a percentage of GDP, investment was 48%, private consumption was 36%, government expenditure was 13.6%, and gross savings were 50%. In comparison, the equivalent figures for Brazil were: investment 21%, private consumption 62.1%, government expenditure 19.6% and gross savings 17%.[7] Brazil has its problems, but its figures are more representative than China’s. The imbalances in China show up most strongly in two figures, the extremely low figures for private consumption, and the extraordinary levels of investment. I know of no other economy in history that has invested around 50% of its GDP. The only comparable figures are those for UK defence spending in the Second World War, which exceeded 46% of GDP in 1943.[8] The low figures for private consumption and relatively low levels of government expenditure mean that demand in the Chinese economy has been supressed and that Chinese industry lacks the relative size of domestic market that other emerging economies enjoy. It is this fact that has resulted in China building up such an enormous balance of payments surplus ($182 billion in 2013) and foreign reserves of nearly $4 trillion.

© Andrew Palmer, 2016, not to be reproduced

[1] Bank for International Settlements, 85th Annual Report, Basel, 28 June 2015, p.65

[2] William R White – “System Malfunction” – Finance & Development, March 2015, Vol. 52, No. 1, IMF, Washington DC http://www.imf.org/external/pubs/ft/fandd/2015/03/pdf/white.pdf

[3] Temin, Peter and Vines, David – “The Leaderless Economy”, Princeton University Press, Princeton, 2013, p.247

[4] 19 March 2016 IMF Teleconference on Greece, WikiLeaks release: April, 2nd 2016

[5] William R White – “System Malfunction” – Finance & Development, March 2015, Vol. 52, No. 1, IMF, Washington DC http://www.imf.org/external/pubs/ft/fandd/2015/03/pdf/white.pdf

[6] Pettis, Michael – “The Great Rebalancing”, Princeton University Press, Princeton, 2013, p.3

[7] Unless otherwise stated all figures quoted for expenditure and GDP are from the World Bank’s Data, http://data.worldbank.org/ accessed 19 September 2015

[8] http://www.ukpublicspending.co.uk/spending_brief.php, accessed 19 September 2015

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