Economists have warned that growing trade imbalances between high-income countries such as the United States and export-driven economies such as China could lead to a global recession. The International Monetary Fund this month echoed those concerns. The issue is expected to be high on the agenda of the annual meeting of the World Bank and the IMF, which begins September 19 in Singapore.
The global economy is set to grow by around five percent this year, but global trade and fiscal imbalances are also on the rise. Many economists say if they do not start soon to gradually shrink, economic growth across the world could fall abruptly.
The U.S. trade deficit, the highest in the world, is growing at $100 billion a year and looks to set surpass $800 billion this year.
"The flip side of that is big surpluses around the world. China is now running the world's largest trade surplus, this year probably coming in about $250 billion," said Fred Bergsten, director of the International Institute for Economics in Washington, D.C. "Japan is second, Europe, the NAFTA countries are running small trade surpluses as well. And the other big trade surplus is now in the oil exporting countries because of high energy prices, Saudi Arabia, Russia, other major oil exporters also running surpluses."
Bergsten says this imbalance cannot last forever.
"The correction of these imbalances, which history would suggest is inevitable and can come in a very disruptive way, could push the world economy as a whole sharply downward, possibly into a global recession," he said.
Bergsten and many Western economists say the U.S. dollar is overvalued while Asian currencies such as the Chinese yuan and the Japanese yen are undervalued. He says this misalignment will have to be corrected one day, and if the correction is too sharp it could make imports into the U.S. far more expensive, push up interest rates and weaken economies across the globe.
The largest trade imbalance, between the United States and China, is of particular concern as the two economies, one the largest and the other the fastest growing in the world, have become more interdependent.
The U.S. government says trade between the two countries topped $285 billion last year - and that the trade deficit with China was $202 billion.
Jeffery Frankel is an economics professor at Harvard University. He says the imbalance is encouraging protectionism among U.S. politicians, business owners and workers, which could further upset healthy trade.
"People in Congress, rightly or wrongly, are very upset about this, and China has become sort of what we call a scapegoat," he said. "A lot of people are sort of blaming China in the way that we used to blame Japan 10 or 20 years ago. And there is a potential for damaging legislation to pass, it would be damaging to us and to our trade partners as well."
Many trade experts warn that restrictive tariffs or quotas on Chinese goods would hurt U.S. consumers, who would have to pay higher prices, and could encourage China to respond with trade barriers of its own.
Beijing argues its cheap exports benefit American consumers and that many of the companies exporting from China are foreign enterprises.
Many experts - in China and outside - say the yuan needs to be revalued gradually to avoid triggering inflation and causing a severe drop in exports, which could lead to higher unemployment and social unrest.
The trade imbalances contribute to another imbalance - many exporting countries essentially are hoarding foreign exchange reserves - most of it in dollars. Essentially, they are saving the money made from trade, instead of spending it to improve public services and infrastructure, or to import goods.
But if the U.S. dollar weakens suddenly, or U.S. investments become unpopular, those foreign reserves will lose value. And the United States, which has financed its trade deficit by borrowing, could find it no longer can borrow overseas.
Many economists say the United States needs to reduce its spending and increase interest rates to encourage citizens to save more money and make the country less reliant on foreign capital flows. At the same time, surplus countries such as China need to rely less on exports and encourage domestic spending to reduce imbalanced trade.
At the annual World Bank and International Monetary Fund meeting in Singapore this month, trade and fiscal imbalances are expected to be high on the agenda.
China has the world's largest foreign exchange reserves at over $875 billion.
Already, IMF officials have said China should allow the yuan to fluctuate more in value, while the World Bank wants Beijing to spend more on health, education, and other social infrastructure so Chinese consumers will be comfortable spending their money.
Economists say a coordinated approach is needed to ensure a smooth unwinding of trade imbalances.
Earlier this year, the IMF created a multilateral consulting mechanism to try to narrow imbalances by encouraging trading partners to coordinate economic policies.
So far, the consultations have been limited to bilateral discussions between the Fund and individual governments - China, the European Union, Japan, Saudi Arabia, and the United States. However, the Fund's chief Rodrigo Rato says they plan to hold roundtables with representatives from all these countries in the coming months.