In this paper for the Bruegel think-tank, Alan Ahearne (Bruegel), Bill Cline (PIIE), Kyung Tae Lee (KIEP), Yung Chul Park (KIEP), Jean Pisani-Ferry (Bruegel) and John Williamson (PIIE) assess how to avert a potential financial crisis via an orderly reduction in the large and unsustainable global current-account imbalances.
The authors argue that the current large imbalances in countries’ current accounts could potentially lead to a crisis on financial markets that would produce world recession and disruptions to the global- trading system.
To avert this risk, they argue for a policy-led adjustment through a substantial effective depreciation of the dollar and, therefore, an appreciation of Asian currencies.
While European-effective (ie trade-weighted) exchange rates do not need to change, the authors say that global adjustment would require that bilateral exchange rates with the US$ rise to at least $1.45/€1 and well above $2/£1.
The brief outlines some important policy implications:
- As US net exports rise, slower domestic demand – and most probably fiscal contraction – will be necessary to prevent inflation;
- Japan and China must accept appreciation of their currencies in order to lead the region on exchange-rate adjustment against the US dollar;
- China should prioritise the promotion of domestic demand rather than relying on the export sector. This process should be initiated by a 10% step revaluation of the renminbi in the short-term, and;
- Europe should not resist appreciation of the euro and sterling against the US dollar so long as it is matched by depreciation against the yen (Japan) and the renminbi (China) and occurs in the context of a global currency adjustment.
The authors say that an international effort is required to persuade each country or entity to contribute its fair share to adjustment as individual countries are unlikely to come up with a coherent package independently.
They call on leaders to use the opportunity provided by the IMF’s upcoming spring meetings to agree on an adjustment package.