12 Twenty-Five Years of Global Imbalances MAURICE OBSTFELD The modern floating exchange rate era that began in 1973 falls into two stages. The first, which ended in the mid-1990s, was a period of adjustment to the new international monetary regime. Financial markets underwent lib- eralization, internationally as well as domestically, and international trade expanded, while central bankers learned how to manage inflation in a world of national fiat currencies. The period’s end is marked by the foundation of the World Trade Organization (WTO) and the 1994–95 Mexican crisis, which Michel Camdessus, the managing director of the International Mon- etary Fund (IMF) at the time, labeled “the first 21st century crisis.” The second 21st century crisis arrived even before the 21st century did, in the form of the 1997–98 Asian crisis. The Asian crisis was notable in that several of its victims succumbed despite the absence of garden-variety macroeconomic imbalances—such as big public deficits—that IMF econo- mists and others viewed as red flags. This facet of the crisis certainly influ- enced academic thinking (witness the celebrated Kaminsky and Reinhart 1999 analysis of twin banking and currency crises), but it also pointed to the dawn of a new, second stage of the post-1973 era. Maurice Obstfeld is director of the Research Department at the International Monetary Fund. This chapter is based on remarks made at the conference on “Prospects and Challenges for Sustained Growth in Asia” orga- nized by the Bank of Korea, the Korean Ministry of Strategy and Finance, the International Monetary Fund, and the Peterson Institute for International Economics in Seoul on September 7–8, 2017. The author is grate- ful for suggestions and assistance from Gustavo Adler, Eugenio Cerutti, Luis Cubeddu, Thomas Helbling, and Haonan Zhou. The views expressed in this chapter are those of the author and do not necessarily represent the views of the IMF, its Executive Board, or its management. All errors and interpretations are the author’s alone. 269 That stage, covering roughly the last 25 years, is characterized by hyper- financialization, greater exchange rate flexibility on the part of many emerg- ing-market economies, and a decisive shift of Asian growth leadership from Japan to China, especially after China’s accession to the WTO. Subrama- nian and Kessler (2013) characterize developments in international trade, including rapidly expanding global value chains, as “hyperglobalization.” The forces unleashed after the mid-1990s led to the global financial crisis of 2008–09, a crisis with long-lived repercussions that are still being felt. One notable feature of the second period of floating was a significant widening of global current account imbalances, which roughly tripled in the decade after 1995 and remained higher, albeit at lower levels than the peak they reached before the global financial crisis (figure 12.1). That global imbalances had the potential to widen is not surprising, given financial market development, including further financial opening, after the mid- 1990s. Controversy remains, however, over both the causes of these imbal- ances and their potential causal role in the global financial crisis. On one side is the view, expressed by US Treasury Secretary Henry Paulson as he was leaving office in 2009, that global imbalances originating in the emerging markets were the root cause of the global crisis.1 Others (such as Obstfeld and Rogoff 2009) have argued that this view deflects too much blame from other critical factors. The debate raises at least four questions, which this chapter tries to answer: n Why did global imbalances expand after the mid-1990s? n What circumstances and concomitant factors provide clues about the origins of the global financial crisis? n If one accepts that a monocausal story about the global financial crisis based on global imbalances is inaccurate, how should one view the potential threats from excessive global imbalances today? n What policy implications follow? Rise of Global Imbalances A prominent feature of the expansion of global imbalances after the mid- 1990s was the growing US deficit (see figure 12.1). In a justly famous speech, Bernanke (2005) argued for “locating the principal causes of the US current account deficit outside the country’s borders.” In his telling, in 1. See Krishna Guha, “Paulson says crisis sown by imbalance,” Financial Times, January 1, 2009, www.ft.com/content/ff671f66-d838-11dd-bcc0-000077b07658. 270 SUSTAINING ECONOMIC GROWTH IN ASIA Figure 12.1 Global current account balances and reserve purchases, 1990–2017 percent of world GDP 2.5 2.0 1.5 TWENTY-FIVE YEARS OFGLOBALIMBALANCES 1.0 0.5 0 –0.5 –1.0 –1.5 –2.0 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 United States Other advanced economies China Other EMDEs Oil exporters EMDEs = emerging-market and developing economies Note: “Oil exporters” follows WEO classification and includes Norway. Bars represent regional current account balances, the dotted line total reserve purchases. Source: IMF, World Economic Outlook. 271 Figure 12.2 Real 10-year bond yield in advanced economies, 1990–2018 percent 8 United States 6 Japan United Kingdom Canada 4 Euro area 2 0 –2 Asian crisis Global financial crisis 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 Sources: Consensus Forecasts; Haver Analytics. For the euro area, the period before 2003 is based on German data. a global capital market equilibrium, higher net saving by emerging-market and developing economies (EMDEs)—precautionary saving by Asian emerg- ing economies after their crisis, bigger surpluses of oil exporters as the price of oil rose—needed to be matched by bigger US deficits. What mechanism induced the United States to save less and invest more? Initially responsible was a run-up in equity prices. After they crashed, the main driver became a fall in real interest rates that, among other effects, fueled a housing price and residential investment boom. Real 10-year Treasury rates rose after the Asian crisis, returning to their long-term decline as recession set in during 2001 (figure 12.2). The pattern was similar for the short-term “natural” policy rates (r*), as calculated by Holston, Laubach, and Williams (2017) (see figure 12.3). Figure 12.4 is another way to visualize the dramatic widening of the US external deficit after the mid-1990s. Where are the counterpart widening surpluses? The top panel shows that deficits of non-oil-exporting EMDEs (including China) did start to rise as the Asian crisis erupted, but the extent of the increase was dwarfed by the rise in the US deficit. More important was the increase in oil exporters’ surpluses. In Asia (bottom panel), surpluses of East Asian economies other than China and Japan rose after the Asian crisis. China’s surplus began to rise later, in the mid-2000s, reaching about 0.6 percent of global GDP in 2008. There were multiple counterpart surpluses to the US deficit; one of the biggest came from oil exporters. Their surpluses were driven by steeply 272 SUSTAINING ECONOMIC GROWTH IN ASIA Figure 12.3 Natural rate of interest (r*) in advanced economies, 1990–2016 percent 4 3 2 1 0 –1 Asian crisis Global financial crisis 1990 1993 1996 1999 2002 2005 2008 2011 2014 United States United Kingdom Canada Euro area Source: Holston, Laubach, and Williams (2017). rising global oil prices, however (figure 12.5).2 As US real activity, financial conditions, and domestic oil production are critical determinants of con- ditions in the world oil market, it seems implausible that changes in oil prices emanated entirely from outside US borders to influence its current account. Instead, the US deficit reflected domestic as well as global forces— global forces coming from other advanced economies, not just EMDEs—all of which helped set the stage for the global financial crisis. Background to the Global Financial Crisis Common factors drove oil prices, oil surpluses, and bigger current account deficits in several advanced economies. They included very loose global fi- nancial conditions, enabled by generally accommodative monetary policies, as well as financial deregulation and innovation, and a global reach for yield and safety that contributed to widespread housing market booms. One component of this constellation, though likely not the most im- portant one, was the accumulation of foreign reserves by EMDEs, which Bernanke (2005) noted (figure 12.1). During 1998–2008, intervention 2. In the early 2000s, measured world surpluses surged above world deficits; a substantial global discrepancy—a “missing deficit”—emerged. Missing deficits tend to be positively corre- lated with oil prices. The discrepancy could be related to some countries understating the cost of oil imports. TWENTY-FIVE YEARS OF GLOBAL IMBALANCES 273 Figure 12.4 Current account balances, 1991–2017 a. World percent of world GDP 1.0 0.5 0 –0.5 –1.0 United States Other advanced –1.5 economies Oil exporters –2.0 Other EMDEs Asian crisis Global financial crisis 1991 1995 1999 2003 2007 2011 2015 b. East Asia percent of world GDP 1.0 0.6 0.2 –0.2 China Japan –0.6 Other East Asian advanced economies Other East Asian –1.0 EMDEs Asian crisis Global financial crisis 1991 1995 1999 2003 2007 2011 2015 EMDEs = emerging-market and developing economies Source: IMF, World Economic Outlook. tended to be associated with wider surpluses for countries purchasing foreign exchange. But the US housing bubble also drew fuel from European banks’ purchases of asset-backed securities, as Bernanke et al. (2011) and Bayoumi (2017) document. Perceiving low sovereign and no currency risk within a permissive regulatory environment, banks in France, Germany, and other European countries recycled global funding into peripheral econ- omies in the euro area, such as Spain, Ireland, Portugal, and Greece, financ- ing housing or sovereign debt bubbles and big external deficits (Hale and Obstfeld 2016).