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The standard discussion of the unbalanced world divies the world up into three: the US, Europe and Japan/ Asia. And the standard discussion of global imbalances says all three need to do their part - the US with fiscal adjustment, Europe with structural reform to reinvigorate growth and Asia with more exchange rate adjustment, along with structural reform in Japan (though Japan seems to be getting credit for structural reform now that it has growth).
When I do presentations on global imbalances, I tend to divide the world up differently and talk about:
- The United States
- China - as the leading emerging manufacturing powerhouse (actually no longer so emerging, judging from the size of its exports, its contribution to global industrial production and its contribution to global investment in manufacturing) and the leading economy of emerging Asia
- Saudi Arabia. Saudi Arabia serves as a metaphor for the other big change of the past few years -- the surge in the price of oil, and how that is influencing the global economy.
I do this consciously, to emphasize that the counterpart to the United States' rising deficit has not been a rising surplus in Europe but rather a rising surplus in the world's emerging economies. Euroland's surplus has fallen since 97, and surpluses outside Euroland in places like Sweden and Switzerland are offset by deficits in the UK and Eastern Europe.
The rise in the US deficit has been accompanied by a rise in the surplus in emerging Asia, and a rise in emerging Asia's willing to extend vendor financing to the US. More recently, the rise in the oil surplus has been accompanied, as Stephen Pearlstein notes, by a rise in oil exporters' willingness to extend their own form of vendor financing to the US.
But reduce it to its bare essentials, and the story of 2005 was that oil producers proved just as willing to lend us the money to buy oil that we otherwise could not afford as the Japanese and Chinese have been to lend us the money to buy cars, jeans and flat-screen TVs. The arrival of this newest credit card from the Middle East may have allowed us to live above our means for yet another year. But let's not fall into the trap of confusing that with long-term economic health.
I would add that just as China over-finances the US with reserve accumulation in excess of its current account surplus (China effectively intermediates much of the surplus of the rest of East Asia, taking on the resulting exchange rate risk: Asia invests in China, and China uses those funds to buy US bonds), so too have the oil exporters over-financed the US, though the mechanism is a bit different. The oil exporters seem to use some of the cash that they earn selling oil to East Asia to finance some of the United States' non-oil import bill.
Of course, finding data to support that argument is a constant source of frustration. We all sort of know it has to be happening, but the hard data just isn't there. And that forces some big contortions. Look at Alison Fitzgerald's Bloomberg story on petrodollars. Her editors must have wanted some firm numbers. She wiggles around a bit, artfully framing data showing a broad surge in overall capital inflows to the US ("international investors, flush with petrodollars"). And she notes the 50% increase in OPEC's Treasury holdings since the end of 2003. But that increase is not so impressive. It all occurred in 2004 for one. Yet OPEC has a far bigger surplus in 2005 than in 2004. And in 2005, OPEC's holdings of Treasuries have been more or less constant (they are up $1.7 billion v. the end of 2004). The $21.8 billion cumulative increase over the past two years is TINY relative to OPEC's current account surplus over that period.
No matter. There is good reason to think that the US data is missing most OPEC holdings, and the bigger story is true -- for all the reasons Alison Fitzgerald lays out. Full disclosure: I am quoted in Fitzgerald's article, so my agreement is hardly a surprise.
There is good reason to think the surge in petro-savings reflects government policy in the oil exporting states, not just market forces.
One example: Saudi Arabia. Look at its 2005 budget (and its 2006 budget forecast).
In 2005, the Saudi government took in $148 billion - compared to the $75 initially expected (talk about revenue over-performance). It jacked up spending by 22% over the $75 billion in the forecast, to $91 billion, and still ran a surplus of $57 billion. Some of that was used to pay down debt, some to build up the government (as opposed to the central bank's) external assets. For more on the budget, see either Riyad Bank or Bourland and Sfakianakis of SAMBA.
The big budget surplus is one reason why Saudi Arabia spent only about ½ of its 2005 export revenues ($175 billion or so) on imports (including transfers), and saved the rest, running a current account surplus of $87 billion.
The 2005 budget had assumed an oil price of something like $25 a barrel - it turned out to be just a bit higher. So what does the 2006 budget look like? Well, it seems to be based on an oil price of around $31 a barrel, which will bring in $104 billion. The government will spend $89 billion (expect a bit more in reality ...) and have a surplus of something like $15 billion.
Not bloody likely. Saudi Arabia is in a rather unique position. Right now it is the global swing producer - the central bank of oil, par excellence. It has pretty much the only spare capacity around (alas, for rather heavy sludge). And more importantly, if it takes a bit of oil out of production, it can pretty much assure that prices don't fall too much. Most folks think the Saudis will try to keep oil prices well above $40 a barrel - even if the world economy slumps and oil demand growth slows.
And right now, oil is a bit higher the $40 in any case. With oil at $50 or so, Riyad Bank calculated that Saudi revenues might jump to $156 billion in 06, and the Saudis might run a budget surplus of $67 billion.
Saudi Arabia does need to protect its budget against big swings in the price of oil - but pumping oil directly into euro and dollar denominated bank accounts in various offshore centers (counting London as offshore ... ) doesn't do all that much for the Saudi economy in the short-run. Big budget surplus in Saudi Arabia and other oil producers, and big addition's to Russia's oil fund are well and good, but there can be too much of a good thing. These huge surpluses are a drag on global demand.
There are more creative ways out there, I suspect, of managing oil price volatility that just building up the government's fiscal reserves at the central bank. For example, I have suggested exchange rate adjustment can help buffer the budget from swings in the oil/ dollar, so long as oil state currencies move in line with the price of oil. Jeff Frankel has suggested pegging the currencies of commodity countries to the price of a globally-traded commodity, not the dollar. Iraq, for example, could peg to oil. I am sure that there are other ideas though. The precise solution doesn't matter so much.
What matters is that oil prices either need to fall, or oil states, like China, otherwise need to start to spend a bit more. Otherwise, low levels of consumption (relative to income) in the oil states will reinforce low levels of consumption (relative to income) in China, dragging down global aggregate demand. Saudi Arabia and Russia like China have to play a role in the global adjustment process.
Let me end by returning to Europe. If you follow the money trail that finances the US, it doesn't take you back to Europe. But I do think Europe has a role to play in the eventual unwinding of the US current account deficit. There is no doubt that the global adjustment process would be easier if German domestic demand could (somehow) grow as strongly as French domestic demand, let alone Spanish domestic demand - pushing overall euroland demand growth up. And if that demand growth were strong enough to generate a euroland current account deficit that helps to offset the US deficit, all the better. There is no necessary reason why the US should be absorbing all of the saving surplus of Japan and the emerging world - though, as Edward Hugh would note, Europe's demographics probably will get in the way of too big a deficit.
That's why I think real global adjustment is unlikely without a reduction in the aggregate current account (savings) surplus of the emerging world.
Update: Dan Gross thinks German consumption growth is picking up. Barring a huge surge in consumption growth (financed through a fall in household savings), though, it will take some time to generate a big swing in Germany's current account -- and, over time, a fall in Germany's surplus might in the end be partially offset by a fall in say Spain's deficit. Still, a sustained revival in consumption growth in Germany is unambiguously good news.