September 07, 2005

Global Imbalances and International Cooperation - Shijuro Ogata September 7, 2005

Dean Bosworth, The Honorable Dale, Fletcher Friends, Distinguished Guests, Ladies and Gentlemen, it is indeed a great pleasure for us, the members of the Class of 1955, to be invited to our good old school for our 50th reunion.

50 years ago, mostly living at Wilson and Blakeslee Houses and dining at Wilson House, both at Curtis Street, we studied together and enjoyed together very closely. After we left Medford, however, we have worked in widely different locations and professions, and it has not been easy for us to get together.

On behalf of the Class of 1955, I would like to thank Dean Bosworth and the Fletcher School for arranging this special occasion, which has enabled us to renew our personal friendship, in most cases for the first time in 5O years.

For me in particular, it s a great honor to be chosen as this year's recipient of the Fletcher Class of 1947 Distinguished Leadership Award, although I am fully aware that it is not easy for me to follow outstanding earlier awardees such as Walter Wriston and Thomas Pickering.

The class of 1947 which founded this award includes not only Mr. Dale who has kindly presented this award to me but also Haydn Williams, Associate Dean of our school during our years.. Attending today's Convocation, I am very nostalgic to our days at Fletcher, which was then ably led by Dean Bob Stewart and Haydn Williams, two earlier graduates of our school, and wisely guided by such prominent professors as Leo Gross, Ruhl Bartlett, Albert Imlah, Allan Cole, George Halm amd Harry Iiawkins, among others.

It was in the midst of the so-called " golden 5Os" when the United States was under the leadership of such internationally minded statesmen as Dwight Eisenhower and Adlai Stevenson despite the dark clouds of McCarthyism. Over the 50 years, the school has changed, and the world has also changed for the better as well as for the worse.

On the one hand, the cold war has ended, and the world economy has expanded. On the other hand, however, conflicts, terrorist attacks and insurgencies have increased, within countries and over the borders. Disparities between the rich and the poor have enlarged. not only between countries but also inside countries. In the area where I have been professionally involved as a central banker, one big problem has troubled us for decades. That is very large global imbalances, namely, almost endless increase in already too large current account deficit of the United States. 50 years ago, the United States was in large surplus in current account. Despite huge investment and government disbursement overseas, the US overall balance of payments was positive, and the US holding of monetary gold,American reserves of last resort, was enormous.

Reflecting such a situation, the US dollar was stable. The major problem of the world at that time was the possible " dollar shortage" which could be caused by American recession, as discussed in Professor Kindleberer's book with the same title. 50 years later, the world still depends upon the United States, which continues to be the importer of last resort for the rest of the world. Unlike 50 years ago, however, the United States at present is in large deficit in current account, over 6% of its GDP. This deficit is covered by two kinds of capital inflow, one, private capital from private investors and lenders, attracted by the strength of American economy and financial markets, and the other, official capital from the monetary authorities of surplus countries, which want to build up their foreign exchange reserves and to prevent the rise of their own currencies against the dollar.

Such a situation has benefits both for the United States and for other countries. Helped by the capital inflow, American interest rates are kept low, and American economy can continue its growth and imports. Other countries can continue export-led growth. Such a situation looks fine, but there is no assurance about its sustainability, and potential problems involved are very serious.

One is the danger of protectionism. Though American consumers are able to purchase cheaper and often better foreign products, American producers are increasingly non-competitive. Already there are serious attempts in the United States to restrict the importation of foreign products such as textile and steel.

European producers are also losing their competitiveness against the producers in East Asian countries whose currencies are undervalued. There are some moves toward protectionism in Europe as well. Protectionism in the United States and Europe can spread to other parts of the world and may lead to a trade war between countries.

There seems to be another kind of protectionism against the acquisition of real assets such as energy resources by surplus countries as seen in the oppostion to Chinese government backed companies' attempts to purchase American and Canadian energy companies.

Second is the danger of capital diversification and exchange rate instability. If the already very large net external liabilities of the United States continue to increase, foreign investors, including even monetary authorities of other countries, may shift their investment from the dollar to other currencies. Then, the dollar will fall drastically, and US interest rates will have to rise with adverse impact on the world economy. If oil producing countries refuse to accept the US dollar for settlement of oil transactions, it will also accelerate capital diversification. Having said, it is still not impossible for US current account deficit not to increase endlessly but to fluctuate, due to such factors as cyclical swings, and for the world to muddle through for some more years to come.

A " wolf" may not come too soon despite repeated However, it is more possible and even probable for the problems I have metioned to become real and for markets to react strongly. It is definitely desirable to take appropriate steps to prevent the endless rise of US current account deficit.

Since the G-7 Communique in Dubai two years ago, the following three groups of steps have been recommended in many official communiques and academic and journalistic articles.

First, Americans are urged to save more and spend less; particularly the overspending of their public sector should be reduced.

Second, Europe, Japan, and other East Asia should promote domestic demand-led growth, to share the responsiblity with the United States as major importers of the world.

Third, greater exchange flexibility should be introduced to the currencies more or less pegged to the dollar to promote better balance of payments adjustment.

It is easy to list up these ideal solutions, but all the major players are not so willing to take actions for a variety of domestic and internal reasons. If I try to single out the most important reasons for each of them, in case of the United States, a sense of complacency because of the fairly comfortable domestic economic situation supported by the skillful management of monetary policy; in case of Europe, the reluctance to weaken fiscal and monetary discipline, which is required to " deepen" the regional integration; in case of Japan, very limited room for maneuvre for macro economic policies with already too large fiscal deficit & too easy monetary conditions; and in case of China, the underdevelopment of economic and financial infrastructure.

Ideally, measures recommendedshould be activated jointly and simultaneously. Among them, however, the most cruicial steps should be the reduction of US fiscal deficit and greater exchange rate flexibility. If these two steps are taken, other steps will be bound to follow suit. since the possible deflationary impact of US action and exchange rate changes will have to be coped with by the affected countries individuality and/or jointly.

At present international arguments are focused on China, whose exchange rate adjustment has been urged, and recently a minor step has been taken. But Chinese action alone, even if further revaluation takes place, will not be enough. American imbalance between saving and spending is the most fundamental cause of global imbalances. In view of the fairly comfortable economic conditions there is much more room for maneuvre by the United States than by other countries if American leaders realize the seriousness of the present imbalances and the importance of their global responsibilties.

Knowing of the current political climate in Washington, however, I am afraid that internatinal financial cooperation may not be a popular subject, particularly when the leaders there are preoccupied with the almost endless insurgency in Iraq and the disasters caused by Hurricane Katrina.

But we cannot overlook economic fundamentals of the current imbalances.

American monetary policy seems to be conducted already with careful attention to its global impact, although without any particular announcement.

It is the time for American fiscal policy also to be conducted with more international consideration.

In this connection, I regret Japan's inability to take an effective initiative in international efforts to deal with global imbalances under the present circumstances. However, it is necessary and also possible for Japan to strengthen their domestic economy, by reducing systemic rigidities, while keeping their markets increasingly open and accommodating exchange rate adjustments. The same can be said about other major countries. In view of growing interdependence of the world, economic policies of all major countries should be exercised with serious consideration of their impact on other countries.

I often recall the words of Otmar Emminger, the former President of German Bundesbank near the end of 1985, three years after the Plaza Accord.

He said then, " In 1978 (the year of the Bonn Summit) Germany made not the best decision for Germany but a good decision for the world. The coming year (that is 1986) may be another year when many countries will have to make not the best decision for their respective countries but a good decision for the world."

We should not forget Emminger's determined internationalism based on his clear recognition of the reality of global interdependence and the need for joint efforts. In this connection, I would like to call your special attention to the importance of the multilateral institutions such as the IMF and the WTO.

Since major countries no longer need to borrow from the IMF or other international organizations, the influence of the multilateral institutions on major countries seems to have declined.

But we should make use of these institutions more positively not only as impartial outside advisors but also as guardians of fundamental rules of the multilateral payment and trading system.

Having said, whether international cooperation can be strengthened, or whether multilateral institutions can be respected, all depends upon the political will of their member countries, particularly major ones. Here, I would like to stress the crucial role of public opinion. Even if government leaders are inward looking, narrowly nationalistic and excessively unilateralistic, the enlightened public opinion can eventually influence government policies as long as the freedom of speech is secured.

But such enlightened public opinion can be formed and developed by those who give and receive good advanced education. Our Fletcher School must be one of such important academic institutions, which can train future opinion leaders as well as policy makersnot only for the United States but also for other countries.

I have to confess, however, that despite the excellent education I received at the Fletcher, I have not always been successful in mobilizing Japanese public opinion and in persuading other policy makers for the cause of better international cooperation.

It is my sincere hope that both the faculty and the students of The Fletcher School will be the central driving force of international efforts for the lasting peace and prosperity of the world, without repeating the mistakes and failures of earlier graduates, such as myself.

Thank you again for this special occasion for our class, and for this special honor for me.

Posted by jessica at September 7, 2005 10:11 AM