Imbalances, Schmalances

We’ve been at first amused but more recently alarmed at how “global imbalances” are becoming many people’s preferred explanation of the financial crisis. At first you could brush it off this way: “global imbalances (read: ‘blame China’) . . .” But this explanation is going mainstream, not least because it is always more convenient for policymakers and bad actors to blame someone far away. For example, Dealbook (New York Times) kicked off a roundtable on the causes of the financial crisis this way:

“There is a conventional view developing on the financial crisis. The Federal Reserve’s policy of historically low interest rates spurred a worldwide search for higher risk and return. Concurrently, the entrenched United States trade imbalance led to a huge transfer of dollar wealth to Asian and commodity-based countries. The unwillingness of Asian economies, particularly China, to stimulate their own domestic consumption led these countries to reinvest the proceeds into the United States. This further contributed to lower American interest rates and further fueled the search for return.”

(Mortgage securitization gets mentioned, but only in the fourth paragraph!)

Simon and I took this on in our Washington Post online column this week, but I thought it was interesting enough to repost here in full, below.


The time is here for our nation to actually do something about the recent financial crisis — that is, do something to prevent it from happening again. But instead, many people are finding it easier to pass the buck than to, say, regulate the financial sector effectively.

The recent Group of 20 conference in Pittsburgh was replete with talk about “global imbalances,” which means — in the spirit of the “South Park” movie — “blame China!”

According to this story, the global financial crisis was caused by hardworking Chinese factory workers who committed the sin of over-saving, which created a glut of money that needed to be invested, conceptualized in a great episode of public radio’s “This American Life” as the “giant pool of money.” (Japan and the oil exporters also had large surpluses, but for political reasons, the finger generally gets pointed at China.)

This beast from the East, seeking higher yields than it could find in Treasury bonds, flooded into the housing market, pushing down interest rates and pushing up housing prices, and creating a bubble that finally collapsed, with the results we all know. (More nuanced proponents of this theory hold, in a “fair and balanced” sort of way, that over-savers in China and under-savers in the United States — and other countries, like Spain, Britain and Ireland — are equally to blame; in any case, it’s the imbalance that’s the problem.) This is a convenient story because it absolves us of any need to put our own house in order through better regulation.

Like most errors, this story contains an element of truth. In general, it is not a good thing for a country to consume more than it produces indefinitely because to pay for its excess consumption it must borrow money from the rest of the world, and that country can consume more than it produces only if some other country produces more than it consumes. In particular, the U.S.-China imbalance is due in part to the Chinese policy of keeping its the value of its currency artificially low — encouraging Americans (and other foreigners) to buy Chinese exports and discouraging its citizens from buying imported goods.

But the “blame China” story (or the “half-blame China” variant) suffers from serious problems. First, it takes two to tango. No one put a gun to the American consumer’s head and forced him to buy a new flat-screen TV or to do so by taking out more debt. (Nor are the Chinese somehow morally superior to us; one reason why they save so much more than Americans is that, with no social safety net to speak of, they have to.)

Second, the Chinese government did not lend to American home buyers directly. China bought U.S. Treasury and agency (Fannie Mae, Freddie Mac, etc.) bonds, which put more money into housing and also crowded other people’s money into housing. But the vast majority of Chinese money went into the safer bits of the U.S. financial system; the speculative money came largely from European banks. And all the actual lending decisions were made by financial intermediaries (banks, mortgage lenders, etc.), which made plenty of bad decisions along the way while regulators, from Alan Greenspan on down, looked the other way.

Third, there is no particular reason why a “giant pool of money” should produce a bubble. A savings glut should lower interest rates, which should increase the value of housing; a bubble occurs when prices go up more than dictated by fundamentals like as interest rates. If the run-up in housing prices was a direct result of over-saving in China, then housing prices should have fallen only if China stopped over-saving — which has not happened.

While Chinese over-saving was a contributing factor to the recent crisis, it was neither necessary nor sufficient. Cheap money is not bad in and of itself — all other things being equal, it’s better to have people lending to you at low rates than at high rates. The problem is what we did with the cheap money.

For the long-term health of the economy, we want that money to flow into capital investment by the business sector because that is the best thing we know of to boost long-term productivity growth. Instead, though, Tim Duy has a great chart, showing that the rate of growth of investment in equipment and software in the 2000s was far below the rate in the 1990s, even with all the cheap money of this decade.

This may seem like an obscure point, but basically it means that even with the low rates of the Greenspan Fed, and even with all that cheap money from overseas, we couldn’t get it where we needed it to go because it was being sucked up by the housing sector. And it was being sucked up by the housing sector because lenders earned fees for making loans that could not be paid back, and banks earned fees for packaging those loans into securities, and credit rating agencies earned fees for stamping “AAA” on those securities, and all sorts of financial institutions — including those same banks — loaded up on these securities because they offered high yield and low capital requirements. In short, we had a dysfunctional financial system that failed at its most fundamental job — allocating capital to where it benefits the economy the most.

Encouraging productive investment by businesses and preventing the next bubble go hand in hand — both require fixing the financial system. Blaming global imbalances — a consequence bereft of either a subject (an actor) or a verb (an action) — is only a way of avoiding our real problems.

By Simon Johnson and James Kwak

34 responses to “Imbalances, Schmalances

  1. James & Simon:

    I agree with your first point but with a slight variation. Yes, it takes two to tango, but someone has to lead and that someone was the Fed. In my view, the Fed’s low interest policy is more at fault since it helped generate to some degree the excess savings in Asia. I explain this in more detail here, but in short the Fed’s easy monetary policy was getting recycled back into the United States.

    I do question your claim, however, that “there is no particular reasons why a giant pool of money should generate a bubble.” If that giant pool of money is the result of monetary policy that pushed market interest rates below the natural interest rate level then it is likely asset prices would increase faster than fundamentals dictate. In the early-to-mid 2000s productivity growth–one of the key determinants of the natural rate of interest–was accerlerating in the United States. This development implies interest rates should have been increasing, all else equal. Of course that did not happen and the rest is history.

  2. Does productivity growth produce price deflation?

    If so, should the fed attempt to prevent price deflation with debt?

  3. I’m curious. “Oversaving” by Chinese workers seems unlikely, in view of low wage rates and the fact that the Chinese government has embarked on a stimulus program. My guess is that the accumulation took place higher up in the savings food chain.

  4. You might like this article:

    The voyage of a dollar

    Part of it:

    “At no point did an ordinary Chinese person decide to send so much money to America. In fact, at no point was most of this money at his or her disposal at all. These are in effect enforced savings, which are the result of the two huge and fundamental choices made by the central government.”

  5. Further to my last post. I have a pet saying: every dollar spent is somewhere saved, even if the “somewhere” is highly fractionated. The issue with money is in whose hands does it ultimately come to rest? If fools, the outcome will be obvious.

  6. Look people, it’s not that hard. Banksters stole your national wealth, and now they want you to blame the Chinese.

  7. Bingo!
    I would add that the banksters had powerful enablers, namely, the politicians in DC.

    Otherwise, how can one explain that NOTHING has been done yet in terms of financial reform coming from Washington?

    Because, like Senator Durbin so aptly put it: “Quite frankly, they own the place.”

  8. Let me first admit my personal attitude to China is maybe biased for reasons I won’t go into here. Many things about China I “strongly dislike” shall we say. But for the record let me make it very clear I don’t blame China for any of the problems America faces as a nation domestically. I do not blame China for ANY of the economic problems or systemic problems we now face.

    And I haven’t heard anyone (please correct me if you can site some reference) who has blamed the average Chinese citizen for saving too much in their bank accounts. And I do not blame the average Chinese citizen saving every dollar he/she can. They would be fools if they didn’t, especially based on economic upheavals of their country’s past. 1958-1960 and 1966-1976 come to mind.

    What most people are making reference to is the Chinese GOVERNMENT’S mistakes. Please read again, not the citizens savings habits, but the Chinese GOVERNMENT’S hoarding of currency reserves. And the fact of the matter is there are large sections of China were you can’t get clean drinking water. And I’m not just talking about having to boil it. I’m talking availability of drinking water and water that could never be drank even after you boiled it. Still large sections of the country don’t have adequate toilet facilities. The only time they felt good toilet facilities were important was for foreigners for the Olympics in Beijing. Young people with degrees migrate long distances from their families for factory jobs (many in Guangdong province). Married couples are sometimes forced to live and work in different cities.

    THE CHINESE GOVERNMENT’S OWN PEOPLE SUFFER for their hoarding of those reserves. Generally, and there are always exceptions, but GENERALLY only Chinese in the coastal cities of China have gotten to taste the big slice of the economic pie. Inland Chinese get the crumbs that drop off the table. And that is a sad shame.

  9. If you were around in the late 80’s you’d have heard the same sort of stuff about Japan, slighly modified to suit their particular circumstances. For some reason, Americans hate to think they’re not Number 1. News flash: you are rapidly approaching Number 37.

  10. Seriously? Not everyone gets rich the same instant? Wow!

    And I always thought we didn’t go through Great Depressions and giant economic shitstorms before we all got a car and a steak in Europe and the USA/Canada/Japan.

  11. Let me put it another way.

    You guys are stupid. You bought Chinese stuff. No one forced you to buy it, but you did it anyways. Because it was cheap. Don’t buy cheap. What losers! What were we supposed to do? Lend it out fraudulently, that’s what. That and invade some middle eastern countries. We couldn’t help ourselves. You know how we are, right? So, just to summarize it’s your fault, and then it’s the Chinese people’s fault.

  12. The problem is valuation of housing. The current method for valuation is comparables – and if comparables are going up, everything is going up. There are no fundamental economic factors involved.

    The average American simply bought more than they could afford. They should not be allowed to stay in these houses as a reward for their bad decisions, and allow the market to correct itself.

  13. I personally feel that Americans should live on the streets while most houses are empty. Especially the real estate appraisers. It’s all their fault.

  14. ThisAmericanLife

    Sir, we should absolutely blame the chinese for producing too much, saving too much, and buying too little. You see, we in America should only deserve to be like our puritan fore-fathers, eat little, pray a lot, and enjoy none. The chinese worker is making all these indulgences too available at too low a price that makes us Americans all being seduced into such corrupt practices. We should ban all production, be it in China or America, that way, and only through that way we can return to our roots and become God’s children again.

  15. Larry Kudlow is giddy

    What products and technology did the Chinese invent and create? Verses what did they in fact steal and manufacture without the burden of fixed research and development costs. I love being a Chinese manufacturer that just received a new IPod III or Dell Superbook. Tear it down, tool it up and tee it off. … …

    Cars, computers, medical devices, CDs and DVD’s, televisions, phones, nuclear reactors, missle guidance systems. When you get R&D for free, and the competative advantage that entails the profit potential is unlimited. The only better deal is the one the North Korea’s have with their super counterfeit currency plant. Fixed costs: paper and ink.

  16. Modern inventions include the first synthesis of bovine insulin, an important anti-malarial drug, certain vaccines, and high-yielding hybrid rice.
    A better question would be: what didn’t the Chinese invent?

  17. Also, if you broaden it to Chinese nationals working abroad, most everything recent has been invented by the Chinese.

  18. “Third, there is no particular reason why a “giant pool of money” should produce a bubble. A savings glut should lower interest rates, which should increase the value of housing”

    Stupid question: Why housing in particular, why not everything?


  19. First, it’s not the value of housing that increased it’s the cost. Value if anything declined.
    Second, everything did end up costing more. There was inflation (note that the official statistics keeped redefining it so as to hide it). Housing was particularly wild because of the one two three punch of fraudulent originations, followed by government guarantees, followed by securitization and misrating of securities.

  20. The Chinese workers save because they have to. No safety net. Yes you are right.

    But why do the Chinese buy T-bills?

    To peg their currency. That was their choice, and it has had a huge effect on our manufacturing job base. You ignore that, but the truth is, the job market collapse is just as much a catastrophe to this economy as the financial crisis.

    Actually, I think your perspective here is elitist. I suggest you take a tour of the devastated Rustbelt so that you can understand what has happened to the people of this country, and not just the financial system.

  21. The job market collapse is irrelevant because all the people who lost their jobs voted for politicians who deem them just so much cannon fodder for the international economy. Maybe next time they will think twice about electing their republicrat representative. Or not.

  22. I subscribe to the global imbalances view. The average current account deficit/surplus per country from a historical 2%gdp leaped to 6% since 2003. The global economy became characterised by a strict divide between creditor and debtor economies. The main creditors were Japan (carry trade), Germany (export support at expense of domestic consumption), China (undervalued currency & export of surpluses), oil and commodity producers (Russia, S. Arabia etc) and the main debtors (US, UK, Spain, Eastern Europe). The surpluses accumulated in the financial systems of a few advanced economies and were partly recycled arounf the world by a few major banks (e.g. this how Eastern European ecoonmies sustained deficits at 10-15% of their GDP). Once overborrowing became manifest in unstainable bubbles it became obvious that this model of global economic development had to give way as debtors deleveraged dragging with them creditots that could not sell their exports anymore. The accumulated liquidity led to the collapse of key banks, as intermediaries of the whole process, compounded by the weaknesses of the financial sector in terms of regulation-supervision (unless all bankers went crazy at the same time). Obviously it took quite a few to tango and rebalancing will require higher consumption by creditors as debtors deleverage and will need to rely on net exports for growth. By the way, in China it was the corporate sector that accumulated most of the savings as Chinese workers subsidised both them and western consumers. In fact, on a global scale and especially in creditor economies (including Germany) the share of wages in GDP has declined significantly. So, More democracy and hedonism for the puritans

  23. Guys – I love a lot of your commentary But to me, you seem to be missing the point of the focus on imbalances.

    Addressing the causes of the financial crisis is one worthy objective of the reform agenda. But it isn’t the only objective — restoring GDP growth in the developed world is another agenda item. In the past, growth has come from consumption driven by increasing consumer leverage. That’s not going to work going forward for reasons that you well know.

    The focus on global rebalancing is an effort to ensure growth going forward – the US exporting goods and capital to emerging markets so that we can actually provide for our people jobs, income, food, and stuff.

    A functioning financial sector that is resistant to bubbles is good and all. But where is it written that you must have reformed the entire banking sector and gotten all that in place before you can adopt policies to actually, um, encourage growth?

  24. China in 2007 had a savings rate of 60% of GDP and an investment rate of 50% of GDP. It’s gotta go somewhere.

    Martin Wolf’s book, Fixing Global Finance, is an excellent read on how global imbalances played a very significant role leading up to the crisis, but how the deleveredging of American firms following the dot-com burst further contributed to the ‘money-glut’.

    Another key factor is that with an overvalued exchange rate in the US (due largely to East-Asian policymakers), the Fed needed to keep aggregate demand in the US above supply (ie run a deficit) in order to maintain high levels of employment, further contributing to excess liquidity and leveraging of US households.

    Financial sectors mess things up all the time (1987, savings and loans, dot-com, LTCM, emerging market crises…) but surely the money glut created by the global and domestic imbalances are a big factor which heavily amplified the effects of the current crisis.

    There’s probably a reason why all the big deficit countries such as the US, UK, Australia and New Zealand have all had the biggest real estate bubbles…

  25. Alfred NZ: “Financial sectors mess things up all the time (1987, savings and loans, dot-com, LTCM, emerging market crises…)”

    Interesting that “all the time” starts in 1987. ;)

  26. I was born in ’87! haha good point though, before Reagan the US hadn’t ran big current account imbalances since WWII!

    You could add 1929, which was, funnily enough, preceded by major global imbalances! (At least according to Hugh Hendry, see link below)

  27. Richard Hoogesteger

    While you are correct that blaming China as some sort of substitute for adequate financial regulation is a serious mistake, one might even say delusion. There is a part of this crisis involving China which has not been adequately discussed. That is the use of forced labor in Chinese factories located within their prison camps or “Lao Gai”to make inexpensive goods. This activity has been well documented by Harry Wu in his book “Troublemaker” and by both Human Rights Watch and Anti-slavery International.

    When China was admitted to the WTO it made it possible for goods made by slave labor to be sold in the U.S.. This made life more difficult for the other east asian economies who had to compete with a forced labor economy, but the biggest victim of this change in policy, apart from the Chinese people trapped in the Lao Gai, was the United States itself. The US. began to suffer from an economic malaise very similar to the “Dutch disease” except that instead of exporting a natural resource we sent little pieces of green paper with the word dollar printed on them to China in exchange for manufactured goods. The Chinese government, not needing to pay the inhabitants of the Lao Gai, horded some of these pieces of paper for political leverage. Much of the rest was invested in the U.S. in mortgages helping to create the bubble. The U.S. lost much of its manufacturing base and now is caught in a financial crisis partly as a consequence of this.

    Sadly our failure to respect basic labor rights which is to say human rights in China has been part of our undoing.

  28. Actually, Americans use slave prison labor too. Lots of it.

  29. Come on! Americans do not use slave prison labor. They teach inmates manufacturing skills.

  30. True, and they do pay them something like 10 cents an hour, sometimes.

  31. In addition to slave prison labor, there is conventional slavery. Slavery employed by American multinationals abroad.
    And human rights violations of migrant workers, workers in American companies abroad and their contractors and sub-contractors, and an overall push to hammer the working class as much as possible.

    It’s a close race between the U.S. and China to see who can crack the whip hardest on their labor force.

  32. Is there is an optimistic message out of this crisis? The least costly way for the world economy to return to sustainable growth is for creditor countries to become spenders so that debtors can export their way out as they continue to deleverage. In this case, democracy and higher living standards for workers in creditor emerging ecoonmies will be part and parcel of the process. In debtor economies a shift towards exports will help them built more efficient economies for the future. I am sure there will be plenty of accidents on the way to get there but i dont know of any better alternatives. Ethics and stereotypical reactions will not do much good e.g. Germany asking the Eastern Europeans to save more and repay their debt to hardworking Germany will simply destroy Germnany’s main export market, bankrupt more Germnan banks over exposed to E.Europe and eventually lead to defaults should Germany want to persue the issue even further.

  33. “we couldn’t get it where we needed it to go because it was being sucked up by the housing sector.”

    The money was going to Iraqistan, housing was a side show.

    Alternative energy like ethanol and solar, plus all the other crazy schemes was another money waster.

  34. Ethanol from corn is wacko, because it takes almost as much energy to produce as you get out of it. It is really just another gov’t subsidy.

    Solar is another matter. The main costs of solar are up front capital, not production. That is the kind of new industry that our gov’t has a history of supporting to get off the ground. This recession provides an opportunity to put people to work building an infrastructure for solar powered electricity.