Finacial poster

To an important extent the financial crisis has been a response to tensions built up because of the large structural current-account imbalances in the global economy. These current-account imbalances reflect some extraordinary financial relationships. The savings of thrifty households and companies in China, Japan, Germany, Taiwan or Singapore has found its way, eventually, to the pockets of bank borrowers in the United States, Spain, Australia, the United Kingdom and other countries. The vast surpluses enjoyed by the major resource- exporting economies such as Russia, Saudi Arabia and the United Arab Emirates follow similar routes as they are channelled to the governments and citizens of the major consuming economies of the West. Banks are the intermediaries that recycle these massive global flows of capital, either directly on their balance sheets or indirectly through financial markets.
How big are the flows of credit between nations? The International Monetary Fund (IMF) collects statistics on current-account surpluses and deficits that generate global capital flows. In 2007 the government and citizens of the United States – the biggest net importer – borrowed nearly $750 billion from other countries to finance their expenditures – about $2,500 a year for every man, woman and child. Spain and the United Kingdom each also borrowed around $140 billion from other countries in 2007. Australia, Italy, Greece, Turkey and France were also major borrowers, together borrowing a further $220 billion. At the other end of the scale are the major lending countries. The largest surpluses are those of the big exporters of manufactured goods. China, the biggest of them all, generated a surplus of income over expenditure of $360 billion, Japan of $212 billion and Germany of $185 billion. Not so far behind them are the major resource-exporting countries of Algeria, Iran, Kuwait, Norway, Kuwait, Russia, Saudi Arabia, and the United Arab Emirates which together generated surpluses totalling nearly $400 billion.
What do these large numbers mean? They reflect the balance of income and expenditure for the country as a whole. A current-account surplus of say $5 billion means that a country is generating $5 billion more income from all its economic activities than it is spending on goods and services. Any activity for export, including taking oil out of the ground or manufacturing products for shipment around the world, contributes to an external current-account surplus; and any goods or services purchased from foreign suppliers contribute to an external current-account deficit.
A current-account surplus of $5 billion is similar to the situation of an individual with an excess of income over expenditure of, say, $5 per day. Each day this individual saves $5 and over a year he or she would save around $1,800, investing this money in (for example) bank accounts, government bonds or corporate stocks. What is true for an individual is also true for a country. A current-account-surplus country is a net saver, investing in overseas bank deposits and securities and thus exporting its savings to other countries around the globe. These savings are mirrored by household and other borrowing in deficit countries, such as the United Kingdom, the United States and Spain.
It is helpful to express these current-account deficits as percentages of income. Spain’s deficit of 10 per cent of national product stands out; the economic adjustment necessary to cope with a deficit of this magnitude is very large indeed and its economic situation is extremely challenging, even when compared with the United States, with its 2007 deficit of 5.3 per cent of national product, or the United Kingdom (4.9 per cent) or Australia (6.2 per cent).

Most bank wholesale funding comes, directly or indirectly, from the current-account surpluses of the savings-exporting countries. China, Japan, Germany, Saudi Arabia, Kuwait and the others are the major source of the ‘hot money’ that has now been scared away, and will no longer finance bank holdings of structured securities. Their surpluses provided a large share of the cash deposited with banks through shortterm money markets (this can happen in many ways, through sale and repurchase or ‘repo’ lending, through purchase of asset-backed commercial paper, by investing in money market mutual funds or, most directly, by holding bank deposits).
There are other linkages as well. Government, companies or banks from the surplus countries also hold some bank-issued securities directly (shares, bonds or mortgage-backed and other structured securities). In addition to this direct funding surplus, country savings are invested in many non-bank securities, for example equities, government bonds, corporate bonds or short-term bills and commercial paper. This pushes down their returns and makes them less attractive.
As a result there is displacement of other domestic funds, from companies, insurance companies and pension funds into both short-term funding of bank portfolios through the money markets and bank- issued securities.
This pattern of world savings and investment, with high-saving countries, including Germany and Japan and the emerging market manufacturing exporters and resource exporters such as China, Russia and Saudi Arabia, lending large sums to the high-consuming countries has been a feature of the global economy for several years. Instead of shrinking, these imbalances have risen over the years.
Increasing global trade has opened up tremendous opportunities for growth. The rapidly growing economies of south-east Asia, including South Korea, Malaysia, Taiwan and Thailand, have all benefited, and, more recently, so have India and China. These rapidly growing economies should be the ones with the most attractive business investment opportunities. Yet the world’s savings are being channelled mostly from these fast-growing economies to mature developed economies, ones where the prospects for productive investment are relatively poor.
Why have savings been channelled to governments and consumers in the West rather than to productive investment in the emerging markets? One reason is that returns to investment in emerging markets are surprisingly low, due among other reasons to weak enforcement of property rights in the courts and bankruptcy laws that provide little protection to lenders.
A further part of the answer is the different operation of their banking systems. Banks in the United States, the United Kingdom and other developed countries have been extremely skilful in persuading households to borrow freely in order to finance both house purchase and general consumption. Meanwhile banks in emerging markets have been much less successful at finding opportunities to lend in their own countries, either to companies or to individuals. This reflects both much stronger social security systems in Western countries (households worry less about saving for old age) and more effective systems of credit referencing and credit scoring to identify creditworthy borrowers – systems that have been developed over many years.
The export of savings has also been encouraged by the fiscal and monetary and exchange-rate policies in the exporting countries, for example in China, where the exchange rate has been maintained at a very competitive level to encourage export growth.
This borrowing, or ‘capital importing’, has not just been used for household consumption. It has also financed government expenditures, including, for example, the large increase in military expenditure, especially in the United States, because of the campaigns in Iraq and Afghanistan. Companies and governments have borrowed directly from overseas investors. But the most important destination for this flow of savings has been households, borrowing money from banks through mortgages, credit cards and other forms of personal credit, in turn financed on wholesale funding markets.