BREAKINGVIEWS – Crisis hasn’t made the world more balanced

January 20, 2010

— The author is a Reuters Breakingviews columnist. The opinions expressed are his own —

By Edward Hadas

LONDON, Jan 20 (Reuters Breakingviews) – Some crises lead to the solution of an underlying problem. Mervyn King, the governor of the Bank of England, pointed out in a speech on Tuesday that the recent financial mess has as yet done nothing of the sort.

The problem in question is the accumulation of foreign currency assets. Those pile up — like a brick tower built without mortar — whenever cross-border trade is unbalanced. As of 2008, the world’s high-saving countries were adding bricks at an annual rate of $1 trillion, about 2 percent of global GDP.

The world just does not have enough safe investments to absorb all that cash. So the tower has a tendency to sway — rapid shifts of exchange rates and asset prices — and could some day collapse. The higher it gets, the more likely a great big fall.

Even after the credit crunch, the tower is still standing. The dollar has been battered, but remains the world’s reserve currency. The U.S. trade deficit has shrunk but is still unhealthily large, and once again increasing. The reforms of the financial sector currently under discussion are necessary, but will do almost nothing to make the tower more secure.

King blames this unsafe construction on countries making different “economic policy choices”. That was his polite way of saying China and other big exporters are unwilling to change their ways merely for the sake of reducing trade surpluses, while Americans and British are happy enough to borrow and spend.

The tower has been growing since the late 1960s, when the Bretton Woods agreements, which tied the world’s currencies to the dollar and the dollar to gold, started to fail. After two post-war decades of peace and increasing prosperity, governments became less willing to put aside the national interest for the greater global good.

Four decades and any number of cross-border financial crises later, the necessary sacrificial decisions on imbalances are still, in King’s words, “notable by their absence”. He is right that the problem is political rather than technical. It can only be hoped that King is right in presuming that the G20 does not need another — even worse — crisis to learn that “cooperation is better than conflict”.


— Mervyn King, the governor of the Bank of England spoke on global imbalances to the Exeter Business Leaders’ Forum on Jan. 19. Along with calling for the G20 to take a more active role in reducing trade imbalances, he predicted that the current rise in inflation would prove temporary and that difficult economic conditions meant “the patience of UK households is likely to be sorely tried over the next couple of years”.

(Editing by Peter Thal Larsen and David Evans)


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