Imbalance in Nations' Savings Clouds Forecasts for Recovery

By MARK WHITEHOUSE London When leaders of the world's 20 largest economies meet in London April 2, they'll have a lot on their plates, from preventing a global depression to fixing a broken banking system. But economists are hoping they also will pay some attention to what many see as a root cause of the financial crisis: a vast disparity in the way big nations save. In recent weeks, a growing chorus of prominent economists -- including U.S. Federal Reserve Chairman Ben Bernanke and Bank of England Gov. Mervyn King -- have pointed out that it took more than greedy bankers, profligate American consumers and lax regulation to generate a crisis of global proportions. While all those factors played important roles, they say, the conditions were created in part by China and other Asian nations, which over a decade of export-led growth socked away trillions of dollars in the form of foreign-currency reserves. Their efforts to invest those savings flooded Western financial markets with cash, making it cheaper to borrow at a time when people in places like the U.S. and the U.K. were building up debts at an alarming rate. The huge machine of subprime-mortgage lending that triggered the crisis, the logic goes, was just one of the many ways bankers took advantage of these so-called "global imbalances" by putting savers and borrowers together. "Bankers have always been avaricious, regulation didn't get worse and we've always had crises -- it's just that this crisis has some special features, and the key special feature is the global imbalances," says Richard Portes, professor of economics at London Business School and president of the Centre for Economic Policy Research. As the G-20 meeting approaches, Mr. Portes and others are offering a menu of remedies, from boosting the authority of the International Monetary Fund to making the fund a central repository for foreign-currency reserves -- an idea reminiscent of the global central bank economist John Maynard Keynes had in mind in 1944, when world leaders created the IMF at a meeting in Bretton Woods, N.H. All the options have their drawbacks, but if some way can't be found to get Asians to save less and Americans to save more, economists warn that the world will inevitably find itself in trouble again. "It's a big mistake to ignore the imbalances despite all the other stuff that's going on, and the G-20 would do so at its peril," says C. Fred Bergsten, director of the Peterson Institute for International Economics in Washington. Even as global economies have taken a turn for the worse, one measure of the imbalances -- China's vast current-account surplus -- has hardly subsided. The IMF estimates that the surplus, which reflects both China's net exports and how much capital it sends abroad, grew to about $399 billion last year from $372 billion in 2007. If the surplus persists, it could fan the flames of protectionist sentiment, as Western politicians worry that their countries' huge stimulus packages are boosting exporters on the other side of the planet. Asian nations' penchant for thrift can be traced back to the financial crisis they suffered in the late 1990s. At the time, countries in the region were living beyond their means and building up foreign debts. That ultimately spooked foreign investors, who fled en masse, triggering sharp currency devaluations and painful recessions. After the crisis, the countries changed tack, focusing on spurring exports by keeping their exchange rates low against the dollar -- a strategy that boosted foreign-currency reserves to record levels. As they invested those reserves in places like the U.S. and U.K., they put an unprecedented strain on financial markets. One indicator of that strain -- net cross-border capital flows -- stood in 2008 at about $1.9 trillion, or 3% of global gross domestic product, according to IMF estimates. That's more than twice the level of 1997, before the Asian financial crisis hit. As the latest financial crisis takes a toll on global trade, the imbalances are likely to ease somewhat. But many economists believe more must be done to get both Asia and the U.S. to change their ways. In a recent paper, Steven Dunaway, who directed the IMF's country work in China from late 2001 through 2008, proposes changing the fund's rules to allow its experts to provide franker assessments of countries' economic policies, without the involvement of the fund's highly politicized board. That, he says, would allow the fund to generate "peer pressure" that will be hard for the U.S. and China to ignore. Others, though, believe persuasion alone won't be enough. Mr. Portes sees the main impetus for China's and other nations' accumulation of foreign reserves in their desire to insure themselves against a crisis like that of the late 1990s. One solution, put forth in a list of proposals to the G-20, is to provide a substitute for that insurance -- for example, by pooling foreign-exchange reserves at the IMF and giving the fund greater power to step in and provide crisis-stricken countries with unconditional emergency financing. To make the insurance more credible, China and other emerging markets would be given more say at the IMF -- a direction in which the G-20 is moving. One problem with the insurance plan, though, is that if it worked, it could encourage countries to act irresponsibly, keeping their exchange rates at unsustainable levels on the assumption that the IMF would come to the rescue in an emergency. "It's putting barrels of propane around your house to protect it," says Catherine Mann, professor of international economics and finance at Brandeis International Business School in Massachusetts. In other words, as Asia's response to the late 1990s shows, policy makers will have to be careful that the solution to one crisis doesn't set the stage for the next. Write to Mark Whitehouse at mark.whitehouse@wsj.com