The recent need for global co-ordination has not been limited to the banking sector. Despite historical evidence of the destructive effects of beggar-thy-neighbor currency devaluations, G-20 countries are increasingly moving towards another round of this behavior. At its root is China’s unwillingness to accelerate its currency appreciation though this would assist in rebalancing trade, harness its domestic inflation and decrease the risk of outright deflationary trends across the global economy.
Some of the difficulty in this task is encapsulated in the two charts below. Despite more countries discussing this issue, the charts also reveal why this is primarily a US - China issue.
(Click to enlarge)
To understand this issue, data* for the top 10 trade surplus and trade deficit countries was compiled. For size and relevance considerations, the list was expanded to include Brazil, Japan, Indonesia and Malaysia. Generally, the chart above reveals one of the basic tenets of economics, a current account surplus typically means a trade surplus. Furthermore, the size of respective trade deficits and surpluses decline quickly for the rest of the countries.
Specifically, the US had, by a wide margin, the largest economy ($14.2 trillion), current account deficit ($746.0 billion) and trade imbalance ($836.3 billion) amongst global peers. Viewed relative to GDP, it was well positioned compared to many global peers. Benefiting from a large domestic market and attractive population demographics (see discussion here), its economy is driven by both domestic consumption and exports. The size of its trade deficit shows that its importance in global consumption has been unparalleled.
The UK, Spain and France, though lacking similar attractive demographic trends, are the next closest in terms of similar concerns. Cumulatively, these economies are half the size of the US. Of the major fast growing developing markets, India has a trade deficit, consistently building since 1978.
Of the countries with trade surpluses, China, Germany and Saudi Arabia have the largest. Numerically, their cumulative surplus equals the US trade deficit. Excluding the oil-rich countries, China’s trade surplus relative to GDP of 8.3% is the highest amongst top peers. This also holds true for its current account surplus relative to GDP (9.8%).
For this same group of countries, the 10-year average GDP growth in the chart above shows that the largest trade deficit and surplus countries have had the lowest and highest growth rates. The US figure is shaped by the law of large numbers. China’s average double digit growth over the past 10 years has today catapulted its economy into the third largest globally. But, Spain, UK and India, each with significant trade deficits, still generated average mid-single digit over the last 10 years. Unlike the previous chart, no consistent relationship is revealed amongst these three variables.
In the current environment of weak growth, all countries are seeking to protect their economies. The developing world in particular is dependent on exports for a significant portion of growth. A large portion of these exports has been destined for the US. As in the past, exchange rate flexibility can play an important role in facilitating growth. Most recently, many Asian economies consistently relied on weak currencies to sustain demand for their exports. This is understandable as it can be the least painful choice - easy to implement, imposes minimal industrial hardship and has only a token impact on the broad domestic population.
The charts above make clear that the most pressing issues are rebalancing the economic positions of China and the US. Delays in addressing these imbalances are already resulting in repercussions for other countries, further complicating resolution. However, the urgency of resolution for other countries has not yet peaked. Japan’s poor success in shifting from an export led economy to a more balanced domestic consumption led one is a recent lesson for many developing economies following that model. Increased reliance on other countries to sustain growth is a natural outcome and near guarantees closely linked, inter-connected economic trends. China’s poor demographic trends, under developed social net and skewed wealth accumulation to date increases the risk of leaving these issues unresolved.
In the last century, though the players were different, the world has faced similar issues. Resolution, while requiring agreement from multiple participants, was typically driven by the mostly dominant economic position of the US. Today, it is the largest economy seeking to address weaknesses in its own economy. Driven by its large domestic economy, it is conceivable that the US, albeit painfully, could muddle through. But this would hardly bode well for the rest of the world still dependent on it for their economic growth. From a broader investment perspective, interest rate parity is becoming more relevant for exchange rates. Importantly, the markets’ tolerance of political ambivalence and often intransigence on this matter still has room, but is not unlimited. Perhaps that might be the ultimate driver for resolution.
*based on 2008 which is the most recent complete dataset