From the International Herald Tribune:

Global imbalances — roughly defined, the different emphasis the world’s leading economies place on savings, spending and debt — is a phrase much used and little acted upon.

Well before the current financial crisis began, world leaders pledged to address this disconnect. At an International Monetary Fund meeting in 2007, for instance, representatives of the United States and the European Union agreed they should change economic incentives to encourage more savings and less spending; officials speaking for China, Japan and Germany, meanwhile, pledged to take steps to encourage spending. At the end of the day, nothing much happened, and these imbalances helped grease the skids for the global descent toward the economic abyss.

This might not be readily apparent from current numbers; in fact, the financial crisis has contributed to a significant narrowing of global economic imbalances. Consumers in so-called “deficit countries” — states like the U.S., Britain, Spain and the countries of Eastern Europe that have huge trade deficits — are saving more as the crisis has exposed the dangerous extent of their indebtedness. Meanwhile, in China and other large export-driven economies, fiscal stimulus spending and some other policy moves have encouraged more domestic consumption.

The reduction in the U.S. current account deficit — the broadest measure of trade in goods and services — is particularly striking and serves as an example. This reduction holds true across other, less robust economies, too. Many of the emerging economies of Eastern Europe had easily financed wide deficits during the boom years. Now they find they are reducing private consumption in light of the lack of credit.

In more desperate cases like Ukraine and Kazakhstan, this has necessitated currency devaluation that boosts the costs of imports. Others, especially Eastern European countries in line for E.U. membership, have clung to their currency pegs. This leaves room for adjustment only via a sharp reduction in domestic demand.

Changing ingrained habits — whether the tendency is to be too thrifty, or too loose with money — is never easy. There is a powerful temptation to point at current trends and argue that rebalancing is taking place naturally. That would be a big mistake.

All evidence suggests that this rebalancing is temporary — the result of reactive policy measures among exporters and retrenchment among the profligate.

China, the world’s sovereign wealth machine over the past decade, is a case in point. My colleague, Rachel Ziemba, projects China’s current account surplus will likely narrow to $350-370 billion depending on the import trajectory, down from a record $420 billion in 2008. China’s trade surplus was just under $100 billion in the first half of 2009. A trade surplus of about $30 billion in the third quarter of this year is expected, which is well below 2008 levels. Increased spending at home rather than savings could further reduce the surplus. Yet with China reluctant to allow currency appreciation, reserve accumulation has resumed at a strong pace.

Although the export-oriented growth model has been shaken by the crisis, many countries seem reluctant to recalibrate. The beginning of inventory restocking has buoyed Asia significantly, as companies that cut back sharply have now increased output. Avoiding currency appreciation will exacerbate this trend, adding to reserve accumulation and distortions.

The most recent I.M.F. estimates — released in the October 2009 World Economic Outlook — suggest that imbalances could widen again but remain lower (as a share of G.D.P.) than their 2006 peak. Yet the dollar values of these imbalances could be very large.

In the I.M.F.’s forecast, China’s surplus will widen again in 2010, even as a retrenched U.S. consumer remains weak.

So who offsets the U.S. deficit? The I.M.F. suggests a diffusion of imbalances, where surpluses of Germany and Japan will remain in shrinking mode even in 2010, while the deficits of Canada and Australia, as well as emerging economies like Brazil, will offset the growth of China’s surplus.

However, the I.M.F. five-year projections also show a widening current account surplus for the entire world. This could suggest that some of the underlying export assumptions are too optimistic given the growth estimates.

Global imbalances are back on the policy agenda with the G-20 agreeing to create a peer review of macroeconomic policies including imbalances to avoid another crisis. The details are limited so far, but focus once again on an agreement that the U.S. will consume less and save more; Japan, Germany and China will spend more and will reallocate investment away from the export sector.

These are the right goals, to be sure. But a joint communiqué from a nascent international organization isn’t much to hang the world’s hat upon. The I.M.F. needs teeth, perhaps along the lines of the W.T.O.’s authority to prod member states toward “out of court” settlements, in order to enforce these difficult political and economic goals.

These imbalances represent serious misallocations of capital in domestic economies that, projected globally, raise the risks considerably of future financial crises and asset bubbles.

While imbalances did not cause the current financial crisis — I believe lax regulation bears a far greater onus — these imbalances certainly helped create the conditions for this crisis. Easy money and low long-term interest rates created an incentive to invest in seemingly-safe high-yield assets. An orderly unwinding of imbalances might put a lid on global growth during the adjustment, but is fundamental to achieve sustainable global growth.

Nouriel Roubini is a professor of economics at the Stern School of Business, New York University. 

In the last few months the world economy has been saved from a near depression. That feat has been achieved by a range of extraordinary government stimulus measures: In the U.S. and in China, and to a lesser extent in Europe, Japan and other countries, governments have pumped liquidity, slashed policy rates, cut taxes, primed demand and ring-fenced and back-stopped the financial system. All of this has worked, but it has worked at a cost. Governments have been spending and borrowing like never before. The question now is: how do they stop?

This is not a simple problem. Restore normality too soon and the risk is that a weak recovery will double dip into a second and deeper recession. Restore it too late and inflation will already be ingrained.

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As I discussed a few weeks ago in a New York Times op-ed the Chinese are flexing their muscles on the question of the global reserve currency system dominated by the dollar.

With the revision of the SDR basket (so far including only dollar, euro, yen and pound) coming to the table next year it is clear that the Chinese will push for including the renminbi in the new SDR basket. And senior Brazilian policy sources suggest in private that, if the RMB is included in the SDR, so should the Brazilian Real as there is already a much deeper bond market for Real debt and as - unlike China - Brazil has a more liberalized capital account. And the Russians are now openly pushing for commodity currencies - the Canadian and Australian dollar but also the Ruble - to be included in the SDR basket. And the BRICs are on record pushing for the IMF to issue SDR denominated debt.

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From The New York Times:

THE 19th century was dominated by the British Empire, the 20th century by the United States. We may now be entering the Asian century, dominated by a rising China and its currency. While the dollar’s status as the major reserve currency will not vanish overnight, we can no longer take it for granted. Sooner than we think, the dollar may be challenged by other currencies, most likely the Chinese renminbi. This would have serious costs for America, as our ability to finance our budget and trade deficits cheaply would disappear.

Traditionally, empires that hold the global reserve currency are also net foreign creditors and net lenders. The British Empire declined — and the pound lost its status as the main global reserve currency — when Britain became a net debtor and a net borrower in World War II. Today, the United States is in a similar position. It is running huge budget and trade deficits, and is relying on the kindness of restless foreign creditors who are starting to feel uneasy about accumulating even more dollar assets. The resulting downfall of the dollar may be only a matter of time.

But what could replace it? The British pound, the Japanese yen and the Swiss franc remain minor reserve currencies, as those countries are not major powers. Gold is still a barbaric relic whose value rises only when inflation is high. The euro is hobbled by concerns about the long-term viability of the European Monetary Union. That leaves the renminbi.

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A few years back, before this crisis erupted, several economists were concerned about the sustainability of the large global imbalances fueled by the so-called Bretton Woods 2 (BW2) system. These economists recognized in the tendency of emerging (export-led) economies to manage their exchange rate systems the origin of large trade and current account surpluses that, via large foreign reserve accumulation, were financing the mirror of those surpluses, namely the large U.S. trade and current account deficits. These surpluses, primarily in several exports-led Asian economies, and also in oil producing countries, ballooned to extensive proportions in 2007 and 2008. The purchases of U.S. government bonds by these investors helped keep long-term interest rates low and led many investors to seek out high-yielding investments especially in some emerging markets.

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William Pesek, the savvy Asia columnist for Bloomberg, reports - in his latest column (see below) - my views about the structural crisis faced by Japan that I outlined in a 1996 paper titled “Japan’s Economic Crisis”. Thirteen years later Japan is entering another severe slump that looks like even worse than that of other advanced economies: while in US, Europe and some other advanced economies and China the second derivative of growth and of other economic indicators is turning closer to becoming eventually positive rather than negative (i.e. growth is still negative but GDP may be falling at a decelerating – rather than accelerating - rate) in Japan is still highly negative (i.e. the fall is accelerating and looking like a free fall, a severe case of stag-deflation).

The sad case of Japan free fall is a cautionary tale of what happens when a high flying economy has a real estate and equity bubble that goes bust and avoids for too long doing the painful structural reforms and clean-up of the financial system that is necessary to avoid a long-term L-shaped near depression. Japan had over a decade of stagnation and deflation, then a mild sub-par growth recovery that lasted only three years and is now spinning into another severe stag-deflation. Keep alive zombie banks and zombie corporations whose balance sheets and debts are not restructured as in Japan (zombie banks and zombie insolvent households in the US today) and you end up in a L-shaped near depression.

Let me explain next in this note why the US and the global economy face the risk of an L-shaped near depression if appropriate policy actions are not undertaken…

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The interview below – published in the Turkish newspaper Hurriyet – presents my views on the Turkish economy expressed during a recent visit to Turkey.

I would characterize the strengths and vulnerabilities/risks of Turkey as follows:

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I have been warning since January 2008 that the biggest risk ahead for the US and the global economy is one of a stag-deflation, the deadly combination of an economic stagnation/recession and deflation.

Let me discuss the details of this toxic mixture of deflation, liquidity trap, debt deflation and rising household and corporate defaults:

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Here is a below brief summary of many of the points that I have made for the last few months on the outlook for the U.S. and global economy and for financial markets:

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