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The economics of disequilbria:
exchange rates and public
debts
Presentation by Prof. Paolo Savona
University of Zhejiang, Hangzhou, Oct. 28, 2010
2017/5/23
1
What is wrong with men is that they
always want to teach others what to do
Meng Tzu, 3rd century B.C.
The great advance of modern logical
thought consists in having ascertained
that the Truth does not exist and that we
can only argue about it
Karl Popper, 20th century A.D.
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The reference model
 Economists have always studied equilibrium models of
supply and demand (Marshall), up to the “general”
equilibrium (Walras/Pareto)
 Keynes himself started out from the “underemployment
equilibrium” for his theory
 Since the Second World War a large body of literature
has dealt with disequilibrium but little headway has
been made
 Globalization requires us to study disequilibria more
closely if we want to make rational, coordinated
decisions
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Geopolitical Economy
 Geopolitical Economy studies the effects of
these imbalances
 It investigates national economic policy choices from the
point of view of their direct global impact and their
feedback effects on the country that adopted them
 The world is a closed economy in which institutional, legal
and market obstacles give rise to a series of disequilibria
 Among these, two are especially important for the proper
working of the mechanism of development: balance-ofpayments and national and local government budget
imbalances
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External imbalances
Country
•
•
•
•
•
•
•
•
•
Balance of trade
Current account
US$ bn
US$ bn % GDP
United States
-605
-431
-3.3
Japan
87
181
3.3
China
183
289
4.9
United Kingdom
-141
- 34
-1.7
Euro area
13
- 68
-0.5
(Germany)
208
178
5.2
(Spain)
- 74
- 75
-4.6
(Italy)
- 22
- 73
-3.0
Brazil
17
- 46
-2.8
Saudi Arabia
105
23
12.4
South Africa
- 1
-11
-5.0
Australia
- 2
-49
-2.6
Source: The Economist, October 16th, 2010
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Intra-European imbalances
 A situation similar to that between the United States
on the one hand and China-Japan on the other has been
created in the euro area, with Germany strongly in
surplus and Spain-Ireland-Italy and France in deficit
 Exchange rate adjustment is impossible since the
currency is the same, and the preferred course is to
play the card of deflation of the economies in external
deficit
 The problem is being ignored in the official venues in
Brussels, although the European Central Bank is
monitoring it
 The tendency is to blame government budgets, not
foreign trade
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Public finance imbalances
Country
•
•
•
•
•
•
•
•
•
%deficit/GDP
%Public debt/GDP
latest
2009
2014
United States
9.0
88.8
112.0
Japan
7.6
217.4
239.2
China
2.2
20.9
21.3
United Kingdom
10.1
68.6
99.7
Euro area
6.4
84.1
n.d.
(Germany)
3.7
79.8
91.4
(Spain)
9.6
54.7
81.2
(Italy)
5.0
117.3
132.2
Brazil
2.1
70.1
62.2
Saudi Arabia
2.6
14.6
9.4
South Africa
7.3
29.0
29.5
Australia
2.4
13.7
25.9
Sources: The Economist, October 16th, 2010, for deficit/GDP;
McKinsey ,2010, for debt/GDP
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What is being done about the
public finance imbalances
 The United States and the United Kingdom are following
aggressive Keynesian policies;
 the euro area and the rest of the world, moderate policies;
 Japan and South Africa are faced with special problems
 All the countries have an excessive public debt both
according to the European criterion of 60% and by the
standard of 70% that economists indicate as the “point of
no return”, the debt level beyond which there is no turning
back with ordinary policies of fiscal tightening
 Nevertheless, the G20, under the impulse of the European
Union prompted by Germany, has agreed to recommend a
deflationary fiscal policy as a necessity
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The twin deficits
 The gap between saving (S) and investment (I) is
equal to the gap between government spending (G) and
tax revenues (T) plus exports (Ex) minus imports (Im).
 As a formula S – I = (G – T) + (Ex – Im)
 This means that for a country to invest more than it
saves, it must run a budget and/or an external deficit
 The USA, UK, Spain, Italy, Brasil, and Australia have
external deficits, China, Germany and Saudi Arabia
external surpluses
 Except China, Saudi Arabia, South Africa, and Australia,
the other countries have a public deficit pushing their
indebtness beyond the “point of no return”
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The source of the problem
 The United States contends that the source of the
external deficit is the overvalued yuan exchange
rate, while domestic demand is out of balance because
of the budget deficit
 The opposite position is taken inside the European Union:
it is not an exchange rate problem
 China rejects the US thesis and pushes (correctly)
domestic demand in order to reabsorb the external surplus
 When exchange rates or domestic demand are out
of balance, a “balanced” adjustment path must be traced
 The principle of equally shared responsibility for adjusting
imbalances must be restored, whereas today only the
countries in deficit stand accused (except USA!)
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Geopolitical Economy choices
to be made
 Globalization makes national economic systems
interdependent
 By now, virtually no problem can be solved at national level
 Coordination and cooperation are the bases of civil and
peaceful coexistence
 If we want the global market to work, we must accept the
“one market, one money” principle on which the European
Union has founded its Treaty
 China has already come out in favor of SDRs, but almost
no heed has been paid to its position
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Chinese monetary policy:
my own assessment
 The stability of the $/yuan exchange rate is an anchor
of stability for the global market. It should be pursued,
 not to perpetuate the imbalances, but rather in order to
convince the United States to take SDRs as the
international monetary standard, thereby introducing
the principle of the same exchange rate regime for all
 The European Union must work alongside China to reach
this goal, but it is not doing so
 There is a problem of public debt that has to be faced
simultaneously with the alignment of exchange rates and
control of domestic demand
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The problem of public debts
 The debt overhang in all the main countries, except few
countries (included China), can’t be solved through
budget surpluses
 Extraordinary measures are needed to guarantee the
holders of government bonds,
 and to permit the return to orthodox monetary and fiscal
policies
 I propose placing portions of the debt with the IMF,
denominating them in SDRs, indexing them to inflation
(i.e. zero real returns) and lengthening their maturity
 This solution is not unlike that adopted by private firms
in financial difficulty
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Conclusion
 All countries have an interest in eliminating the
imbalances to protect growth, unless governments
have “mental reservations” in favor of adjustment
through inflation or default on their public debt
 This can be done only by strengthening international
policy coordination and cooperation, starting out from
the decisions of the G20,
 giving the international monetary system a standard
that is no longer a national currency, and
 introducing the principles of symmetrical
responsibilities for surpluses and deficits and
balancing interventions on exchange rates with those
on countries’ domestic demand
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The economics of
disequilibria: exchange rates
and public debts
© Paolo Savona
2017/5/23
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