Uncoordinated

Macro Maestro believes global imbalances played a critical role in the 2008/09 crisis and continue to highlight the problems faced by the global economy today. In short, they suggest the need for a degree of policy co-ordination that will be impossible to achieve. For that reason, it's hard not to take a pessimistic view about growth prospects in 2012 and beyond.

Over the past few years, global policymakers have been quick to blame each other for the imbalances that developed in the run up to the crisis. For a nice summary, see here. Notably, the Chinese contribution blames the US for its irresponsible monetary and financial-sector policies, whereas the consensus among US policymakers has always been to blame the Asians and their saving glut/currency interventions. The reality is that all these things played a role.

China exported cheap goods to the US and then invested the proceeds in US financial instruments, notably Treasuries. The second part of this process was essential to sustain the first - otherwise the RMB would have appreciated and gradually eroded the Chinese trade surplus. The US, of course, benefited from falling import prices, which lowered inflation and raised real incomes. As a result, both economies enjoyed strong growth - China benefiting from strong export demand and the US from strong consumption.

But these trade patterns also created domestic imbalances in both economies. Strong economic growth and low inflation in the US, together with rapid capital inflows, triggered a series of asset price bubbles, most notably in housing. China became increasingly dependent on exports, manufacturing and investment.

MM believes both deficit and surplus countries must share the responsibility for these problems since both could have pursued policies to address them and chose not to. Instead, both had a short-term vested interest in allowing these imbalances to continue. Western central banks, notably the Fed, could have raised rates earlier and more aggressively to damp house-price growth and discourage risk taking in financial markets. Financial regulation had also become ridiculously lax and should have been tightened. Market surveillance wasn't just poor, it was not-knowing-where-to-look poor. In general, deficit-country policymakers were too focused on relatively short-term and narrow measures of inflation. Meanwhile, the Chinese could have facilitated their own domestic rebalancing by allowing their currency to appreciate.

None of this happened and the imbalances eventually collapsed under their own weight. US sub-prime was epicentre, but also a symptom of a much broader set of problems.

So where does this leave us? The US and other deficit countries now need to delever, implying a period of weak demand in the private sector - especially the household sector. This has left a huge gap in global demand. Ideally, the excess-saving countries (not just China, but notably Germany too) would fill this gap by pursuing policies aimed at boosting domestic demand. Unfortunately, there are no signs this is happening.

Instead, the deficit countries have tried to offset deleveraging in the private sector by increasing public-sector debt. This was necessary, but it was always unlikely to be enough given the scale of the debt problem. Moreover, as deficits have grown, policymakers in these countries have become more anxious about avoiding a negative reaction in financial markets. As a result, many of these countries are now tightening policy, simultaneously. This is undermining global demand and intensifying pressure on the private sector.

The only benign solution to all this seems to involve a degree of global policy co-ordination we are unlikely ever to see. That's why MM is worried.