The US has been acting as a ‘consumer of last resort’ by running large current account deficits and thereby stimulating global aggregate demand growth. Stiglitz has argued that this has been made possible by the dollar’s status as a reserve currency. The growth in US consumption and demand from the rest of the world has helped to underpin a rapid growth of exports in East Asia. The latter was underpinned by the devaluations of currencies in the region after the Asian crisis of 1997-98 and the subsequent fixing of these currencies to the dollar. Some oil-exporting countries have tied their currencies to the dollar in recent years and they have also been running current account surpluses. Ultimately this combination of policies has been inflationary for the world economy. A commodity price boom was triggered in the 2000s which peaked in 2007, and consumer credit and house prices boomed in many rich countries during this period. These processes have proved to be unsustainable and their unwinding has been part of the current crisis.
A rebalancing of global growth is necessary in order to make it more sustainable in the future. Is this China’s problem? It may help if China were to reduce its domestic savings rate and increase the proportion of domestic consumption in years to come. As its huge domestic market increasingly makes the transition to a consumer society, and its average wages levels rise, different countries will become the new emerging markets and perhaps engage in some form of export-led growth as they sell cheap goods to the rest of the world. So while China could change its structure of demand and production, the US may remain as global consumer of last resort, continuing to import increasingly sophisticated goods from China, but also importing goods from a new wave of emerging markets or Newly Industrialising Countries (NICs) which have lower productivity and wage levels than China is likely to have as it continues to develop and grow in years to come. Thus the US and other rich countries could still be running substantial current account deficits despite adjustment from China and other East Asian economies.
However, even the scenario outlined above may not come to fruition quickly. There are strong forces working against the adjustment of East and South East Asian economies, namely their governments’ wish to insure themselves against future financial crises by building up large foreign reserves, ironic in the sense that they have helped to precipitate the current crisis in doing so. It seems that the way that one crisis (that of 1997-98) developed and was handled by the IMF set in train processes which allowed new crises to develop. Stiglitz has argued in ‘Making Globalization Work’ that the global reserve system needs to be reformed in order to counter these processes and mitigate the possibility of future major financial crises.
So perhaps it is the world financial system as a whole that needs reform. China’s adjustment is perhaps inevitable as it moves up the value chain and its society transforms to one more geared to consumption. As such a large economy this adjustment will affect the development and trajectory of the global economy dramatically. But the current crisis is not wholly the fault of the East Asian build-up of foreign reserves, let alone China doing likewise. China has a part to play in global adjustment, but it is still the US which has the larger strategic role, in offering leadership and coordinating this adjustment, if global prosperity is to be sustained.