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Experts Warn of Mounting Global Financial Imbalances

Financial experts say policy makers in the major economic powers need to take action to reduce the trade imbalances under which East Asian nations and oil exporters are accumulating growing reserves of assets.

Charles Dallara, the head of the Institute of International Finance, a grouping of 360 banks, says the global outlook is clouded by widening trade imbalances. Dallara is calling on the International Monetary Fund, which meets September 19 and 20 in Singapore, to devise a cooperative strategy that over time could correct the problem.

The core of the imbalance are steadily rising trade surpluses in China and Japan that are mirrored by a steadily rising deficit in the United States. As imports surge well ahead of exports, the US external deficit has doubled in four years, reaching $805 billion in 2005. Meanwhile, China's overall trade surplus rose last year to over $100 billion, not far behind Japan's $164 billion surplus. In addition, the tripling of oil prices since 2001 led to oil exporting countries last year accumulating a surplus of over $300 billion. Rodrigo de Rato, the head of the IMF, is organizing a high level panel to examine the problem.

"Global imbalances have been built over a number of years and will not be reduced to sustainable levels quickly unless we have a crisis. However, I hope the consultation will produce, A) a shared analysis of the nature and consequences of global imbalances; and B) a common understanding of policies designed to make things happen in several countries together; and C) an understanding of the role the Fund can play as a forum for implementing a common approach," he said.

The classic method for correcting a trade imbalance is for the currency of a surplus country to rise in value and the currency of the deficit nation to fall. But in the case of China and the United States that hasn't happened. China, with the world's fastest growing economy, has carefully controlled the value of its currency and has permitted only a modest three percent rise over the past year. Meanwhile, defying expectations of a dollar decline, the US currency actually rose on foreign exchange markets during most of 2005.

It is the China / U.S. imbalance that gets the most attention. Lawmakers in the United States are increasingly worried that surging imports of low-cost Chinese goods have cost millions of US jobs. In addition, there is concern about the implications of China's accumulation of US government debt . Tim Adams, the US Under Secretary of the Treasury, recently told a Senate committee that China is on course to hold nearly $1 trillion of US currency and government securities.

"We stay very engaged with them (the Chinese authorities), all elements of the Treasury Department, in trying to understand how they manage those reserves and their intentions in managing those reserves. And so far we're comfortable with the way they have been managing them and the way they plan to manage them in the future," he said.

Overall, East Asian countries have reserves totaling over $two trillion.

Dallara of the Institute of International Finance minimizes the chances of investors dumping their dollar reserves, thus triggering a precipitous fall in the US currency. Rather, he says, investors have confidence in the growing US economy and they regard US financial assets as safe and stable.

Adams of Treasury says the Bush administration is determined to keep pressure on China to revalue its currency. "We need to hold them accountable to what they said they were going to do. They have done some things to build the financial infrastructure so that we can see greater exchange rate flexibility over time. So, I don't want to deny that they have done some things that are important to bring about greater flexibility. But we've not seen the kind of progress we should see and we want to see. And we're not going to rest until we do see," he said.

There are expectations that China could soon make another incremental revaluation of its currency. But to correct the overall global imbalance, experts say a very significant devaluation of the dollar is required. Fred Bergsten and his colleagues at Washington's Institute for International Economics, say the dollar needs to come down by 15 to 25 percent against the currencies of not just China but other exporting economies of East Asia.