The Great Rebalancing The Great Rebalancing Trade, Conflict, and the Perilous Road Ahead for the World Economy M i c h ae l P ett i s Princeton University Press Princeton and Oxford Copyright © 2013 by Princeton University Press Published by Princeton University Press, 41 William Street, Princeton, New Jersey 08540 In the United Kingdom: Princeton University Press, Oxford Street, Woodstock, Oxfordshire OX20 1TW press.princeton.edu All Rights Reserved Sixth printing, and first paperback printing, with a new preface by the author, 2014 Paperback ISBN: 978-0-691-16362-8 The Library of Congress has cataloged the cloth edition of this book as follows Pettis, Michael The great rebalancing : trade, conflict, and the perilous road ahead for the world economy / Michael Pettis p. cm Includes bibliographical references and index ISBN 978-0-691-15868-6 (hbk.) 1. Balance of trade. 2. Balance of payments. 3. International trade. 4. International economic relations. 5. Financial crises. I. Title HF1014.P46 2013 3829.17—dc23 2012039175 British Library Cataloging-in-Publication Data is available This book has been composed in Minion Pro, Futura, and ITC Mona Lisa Std Printed on acid-free paper Printed in the United States of America 7 9 10 8 6 To my mom, from whom most of my very few good habits come, and to my friends Zhang Gengwang, Charles Saliba, and the brilliant former and current students of my central bank seminar at Peking University, who have helped make my ten years in China (and counting) a real pleasure “But I don’t want to go among mad people,” said Alice “Oh, you can’t help that,” said the Cat “We’re all mad here.” —Lewis Carroll The exportation of our moneys in trade of merchandize is a means to increase our treasure —Tomas Mun of London, merchant, 1664 The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought —Rudiger Dornbusch CONTENTS Preface to the Paperback Edition xi chapter one Trade Imbalances and the Global Financial Crisis Underconsumption 4 The Different Explanations of Trade Imbalance Destabilizing Imbalances We Have the Tools 11 14 Why the Confusion? 17 Some Accounting Identities The Inanity of Moralizing 19 The New Economic Writing 22 Chapter two How Does Trade Intervention Work? Trade Intervention Affects the Savings Rate Currency Manipulation Exporting Capital Means Importing Demand What Happens If China Revalues the Renminbi? Wealth Is Transferred within China Does China Need a Social Safety Net? 26 29 32 34 37 40 42 Chapter three The Many Forms of Trade Intervention 47 How Changes in Wealth Affect Savings Wage Growth Trade Policy as the Implicit Consequence of Transfers Financial Repression Higher Interest Rates and Household Wealth Do Higher Interest Rates Stimulate or Reduce Consumption? Currency versus Interest Rates 50 52 55 58 61 64 66 Chapter four The Case of Unbalanced Growth in China What Kind of Imbalance? 69 74 viii Growth Miracles Are Not New The Brazilian Miracle Powering Growth Paying for Subsidies Limits to Backwardness The Trade Impact A Lost Decade? Can China Manage the Transition More Efficiently? Some More Misconceptions 78 81 84 87 89 92 94 96 97 Chapter five The Other Side of the Imbalances 100 Can Europe Change American Savings Rates? How Does Trade Rebalance? Globalization Is Not Bilateral The Global Shopping Spree Trade Remains Unbalanced Chapter six The Case of Europe The Mechanics of Crisis Too Late German Thrift Forcing Germany to Adjust Two-Sided Adjustment Chapter seven Foreign Capital, Go Home! 103 106 109 113 115 119 122 125 128 131 133 136 Swapping Assets It’s about Trade, Not Capital Trade Imbalances Lead to Debt Imbalances The Current Account Dilemma 139 142 144 147 Chapter eight The Exorbitant Burden 150 Why Buy Dollars? It Is Better to Give Than to Receive Foreigners Fund Current Account Deficits, Not Fiscal Deficits 153 157 161 C O NT E NT S ix Rebalancing the Scales When Are Net Capital Inflows a Good Thing? Can We Live without the Dollar? Why Not Use SDRs? An American Push Away from Exorbitant Privilege 163 166 168 172 174 Chapter nine When Will the Global Crisis End? 178 Transferring the Center of the Crisis Reversing the Rebalancing Some Predictions The Global Impact appendix Does income inequality lead to unemployment? 180 183 185 191 197 Notes 217 Index 225 .. .The Great Rebalancing The Great Rebalancing Trade, Conflict, and the Perilous Road Ahead for the World Economy M i c h ae l P ett i s Princeton University Press Princeton and Oxford Copyright... destabilizing, both for the world and for the countries that employ these policies For the sake of completion we should mention that the third theory that justifies trade intervention is the “infant... power and it is only if he is successful that Beijing will be able to impose the difficult reforms that will transform the economy at the expense, and with their tremendous resistance, of the very