Middle East: Innocent as charged (page 1 of 3)

The major cloud hanging over the world economic outlook is the size of global imbalances. Latest data notwithstanding, the US current account deficit continues to widen and absent a slowdown in the US economy, the possibility of a USD 1 trillion deficit in 2007 cannot be ruled out. In terms of net external liabilities, the international investment community owns around 30% more of the US assets (as a percentage of US GDP) than US investors hold of overseas assets. Only one developed country that we have found is in a worse net external position - the more open and commodity-related Australian economy. This has led the IMF to conclude:

"As a matter of simple arithmetic, the global imbalances remain on an unsustainable trend over the long run, as - unless returns on U.S.-issued financial instruments continue to substantially underperform those issued in other countries, thus generating large further capital gains for the United States - they would lead to an ever-accumulating stock of emerging Asian and oil exporters' assets and U.S. external liabilities. Therefore, the issue is not whether but how and when they adjust."
Source: IMF World Economic Outlook, April 2006

It is clear that it is everybody's interest to correct these external imbalances in a gradual manner. And the longer their expansion continues, the more likely it is that the ultimate correction will be damaging to the global economy in a way that everybody fears, but nobody appears to expect - although risk appetite has wavered a little in recent weeks. In this region, we cannot ignore developments in this area as a failure to proactively address global imbalances increases the risks to the global economy. For a market predicting oil prices to stay above USD 60pb through the rest of the decade, any such destructive correction could be catastrophic for these projections and could seriously undermine economic activity in the region were low oil prices to be sustained for a long period of time. This is especially the case were oil prices to settle significantly below USD 30 per barrel where the GCC is estimated to break-even on their fiscal accounts.

Unfortunately, thus far, the discussion of global imbalances in international policy circles has been a blame, name and shame game rather than focusing on a multilateral solution to the problem. The US has been blamed for cutting taxes and interest rates so aggressively even as the economy recovered in 2002, thus giving a further push to domestic demand, increasing the demand for US imports and putting upward pressure on its current account deficit.

Meanwhile, the US has been keen to blame virtually everybody else. Japan was blamed for failing to push through with structural reforms and for intervening to keep the yen artificially weak. However, the rebound in the economy to above-trend growth rates, and the fact that the Bank of Japan has physically left FX markets to find their own level - although the US is still upset at the verbal intervention that we see on a weekly, if not daily, basis - has reduced the focus of attention on Japan.

Europe is similarly criticised for failing to push through with economic reforms to boost trend economic growth. In the US's opinion, Europe's failure to recognise that it has a role to play in correcting global imbalances means that the US has to pursue expansionary policies because, absent an alternative growth driver of sufficient size, the alternative is a global recession.
Then, of course, there is the G7's attack on China and its failure to change its exchange rate policy rapidly enough for the West, despite the huge competitive advantage possessed by the economy.