FT.com / Columnists / Martin Wolf - It is in Beijing’s interests to lend Geithner a hand

FT.com / Columnists / Martin Wolf - It is in Beijing’s interests to lend Geithner a hand:

A recent paper from Goldman Sachs ...points to four salient features of the world economy during this decade: a huge increase in global current account imbalances (with, in particular, the emergence of huge surpluses in emerging economies); a global decline in nominal and real yields on all forms of debt; an increase in global returns on physical capital; and an increase in the “equity risk premium” – the gap between the earnings yield on equities and the real yield on bonds. I would add to this list the strong downward pressure on the dollar prices of many manufactured goods.
The paper argues that the standard “global savings glut” hypothesis helps explain the first two facts. Indeed, it notes that a popular alternative – a too loose monetary policy – fails to explain persistently low long-term real rates. But, it adds, this fails to explain the third and fourth (or my fifth) features.
The paper argues that a massive increase in the effective global labour supply and the extreme risk aversion of the emerging world’s new creditors explains the third and fourth feature. As the paper notes, “the accumulation of net overseas assets has been entirely accounted for by public sector acquisitions ... and has been principally channelled into reserves”. Asian emerging economies – China, above all – have dominated such flows.
The huge capital outflows were the consequence of policy decisions, of which the exchange-rate regime was the most important. The decision to keep the exchange rate down also put a lid on the dollar prices of many manufactures. I would add that the bursting of the stock market bubble in 2000 also increased the perceived riskiness of equities and so increased the attractions of the supposedly safe credit instruments whose burgeoning we saw in the 2000s. The pressure on wages may also have encouraged reliance on borrowing and so helped fuel the credit bubbles of the 2000s.
The authors conclude that the low bond yields caused by newly emerging savings gluts drove the crazy lending whose results we now see. With better regulation, the mess would have been smaller, as the International Monetary Fund rightly argues in its recent World Economic Outlook. But someone had to borrow this money. If it had not been households, who would have done so – governments, so running larger fiscal deficits, or corporations already flush with profits? This is as much a macroeconomic story as one of folly, greed and mis-regulation.
The story is not just history. It bears just as heavily on the world’s escape from the crisis. The dominant feature of today’s economy is that erstwhile private borrowers are, to put it bluntly, bust. To sustain spending, central banks are being driven towards the monetary emissions of which Ms Merkel is suspicious and governments are driven towards massive dis-saving, to offset higher desired private saving.

The banks are the intermediaries of the capital inflow due to the current account deficit (trade deficit). If we have a huge current account deficit, then we will have a huge amount of money for the banking system to loan out. And the effects of the imbalance have not ended; at some point we will need to pay all that money back to foreigners with interest.