By Jonathan Anderson (Caixin Online)

Clamor over emerging market surpluses and China’s exchange rate conveniently shucks off the hugely dominant effect of oil prices.

(Caixin Online) Splashed across the pages of every financial pe
riodical recently, global imbalances have become a focal point of interest for investment research houses and leading lights of the academic community. In past months, the issue has crystallized in the form of raucous political debate over the value of the Chinese renminbi. 

The common refrain to the average investor plays out as a scenario of living on borrowed time – the U.S. and other developed countries have been propping up their spending with cheap foreign funds at low interest rates. The emerging bloc, and in particular, China, has artificially weak consumption demand and has essentially supported growth by selling goods to the advanced world, keeping exchange rates cynically pegged at an undervalued rate in the process. Heavy central bank intervention is the lubricant that holds this pernicious system together, as ever-increasing surpluses are recycled directly back into the developed world to finance rising export purchases.

The U.S. and European economies can stabilize, but can’t begin to grow until the emerging world stops living at their own expense and starts pulling its own weight. This entails a wrenching change in the growth model, where sharp currency appreciation is the singular answer to removing distortions that prevent domestic consumption. Otherwise, the rising weight of never-ending surpluses and intervention risks will lead to bubbles. Then, collapse. Fate stares straight into the eyes of the global economy.

A Plight Fantastic

These imbalances have been exaggerated. First, imbalances were never as large as commonly believed – and they’re even smaller now. There was a clear widening in emerging market surpluses and developed-country deficits from 2000-06, but one that probably only accounted for a small fraction of growth and consumption. Since 2007, those gaps have narrowed visibly, and as of 2010, we are not far off from our best estimate of historical “balance.”

Secondly, it’s mostly about oil prices. China did see a sharp rise in its own surplus balance over the past decade, but mainland surpluses never contributed more than one-quarter to the total emerging market increase. Rather, by far the single most important factor was oil and fuel, which accounted for over half of cumulative imbalance.

Lastly, the main drivers of rising surpluses were supply shocks. Everyone points to low emerging consumption ratios, but on a structural basis these are almost exactly the same as in the advanced world. And the more recent fall was not due to weak consumer spending but rather to a sudden supply-driven expansion in the GDP denominator. Among oil exporters, this reflected the impact of rising commodity prices, and in China this was due to the rapid rise of steel and other heavy industrial capacity.