G2's Pre-Crisis Imbalance and Post-Crisis Rebalancing

1. G2's Imbalances' meaning, background and distinctive characters

The literal meaning of the global imbalance is that the current account imbalance, which refers to the imbalanced net of exports and imports of goods and services, net factor incomes and net transfer payments between countries.

Thanks to import and consumption, rich countries aggregate large current account deficits, while with export and high savings emerging countries aggregate large current account surpluses, and flows go from rich to emerging countries, on the other hand the reverses do not happen.

Finally, some countries enjoy current account surpluses but others suffer chronic current account deficits for years, and at the center of the global imbalance lies the US and China, which is called G2.

There are three main causes for the G2 imbalance: different growth strategies of major powers, different patterns of savings and investment in those countries and the international preference of the U.S. financial assets.

First, the different strategies between two countries use for their growth partly resulted in a global imbalance. China has depended on export-oriented growth strategies. To implement such policies, China used a currency devaluation to increase their export volumes. This led to current account surpluses and growth of foreign exchange reserves.

Secondly, contrast to low private and public saving in the US, China's fast-growing savings and investments especially since the 1997-98 Asian financial crisis, have contributed to savings glut which became the source of investments in the United States. This has deepened the imbalance.

Third, the international preference for U.S. assets helped form a global imbalance. The emerging Asian market, including China, grew much faster than other advanced regions, which induced relatively higher investment profits. However, emerging countries put their surplus money into more liquid but less risky U.S. Treasuries. This preference for low-risk assets maintained the U.S. current account deficit and the global imbalance.

As the outcomes of the distinguishment above, China has the largest foreign-exchange reserves and is one of the largest holder of U.S. Treasury bonds. While China is hitting a record trade surplus year by year, the U.S. is being indebted every year. However, what the U.S. government considers bad is not necessarily so for its citizens.

the U.S. derives two benefits from the current global imbalance. It can sustain the domestic debt-financed consumption splurge despite a spiralling current account deficit with financing from abroad. This ensures that U.S. income and employment growth remains reasonable despite its loss of manufacturing competitiveness. It can partly neutralise the effects of the worsening deficit on account of trade in merchandise with a surplus on the services and investment income accounts, by using capital inflows to sustain investments abroad.

Under normal circumstances, those countries that finance this "virtuous deficit" of the U.S. should have put a stop to this trend with adverse consequences for that country. But they too are dependent on the U.S. market and U.S. buoyancy to sustain their growth.

US Government argues that China's inordinately mercantilist currency policies were a significant cause of the U.S. trade deficit. China is maintaining an artificially weak currency(de-facto pegging system) to make Chinese goods relatively cheaper for foreign countries to purchase, thereby keeping its vast workforce occupied and encouraging exports to the U.S. One byproduct was a large accumulation of US dollars by the Chinese government, which were then invested in US government securities and those of Fannie Mae and Freddie Mac, providing additional funds for lending that contributed to the housing bubble.

2. Prospects for G2s Rebalancing possibilities in coming future

In order to solve the imbalance, the most important thing is to come to an agreement over a long-term solution under favorable circumstances. My guess seems that trade tensions are going to continue rising and things are going to get worse. Besides, both governments do not just consider the issue as economic but also political problem. The China-US policy game on the renminbi exchange rate can be characterized like a "prisoners' dilemma".

US Government believes that China has deliberately undervalued its currency to support its export-oriented economy. US criticizes China's mercantilism is hurting the world economy as well as America, and the Chinese want to be treated as a developing country, in spite of a global giant, the leading exporter in the world.

On the other hand, China insists that the revaluation of the renminbi have nothing to do with the imbalance and it will not bring jobs back to the US. Even though such a change in Chinese policy does happen, then China asserts US will have to find a new scapegoat for the double-digit unemployment problem.

Another problem is US wants a very quick resolution, but China is in too

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