The MAP Account Balance Strategies of the FSB, IMF, and BIS
By JC Collins
In 2010 U.S. Treasury Secretary Timothy Geithner proposed the establishment of symmetric limitations on current account balances of +/- four percent of GDP. The recommendation was put forward at the G20 Summit in Seoul, South Korea as a part of the Macroeconomic Policy Coordination (commonly referred to as MAP), a peer reviewed based mechanism meant to promote and support macroeconomic policies amongst the G20 nations.
The proposal was rejected by both Germany and China to ensure that no numerical benchmark or limitations were set on account balances. This rejection extended to the Cannes summit in 2011 as a response to concerns over the independence of the MAP process from the monetary policies of the Federal Reserve and the EU.
To fully understand the implications of current account balance surpluses and deficits, and how each has impacted the fiscal policies and domestic economies of nations, it is important to further define and clarify the macroeconomic mechanism and dynamic between both positions.
The Gross Domestic Product (GDP) of each country is a measure of its total economic activity. Weighing current account balances against GDP is a method of determining a nation’s international competitiveness. Countries with strong account surpluses, such as China, have a domestic economy which is dependent on exports. These nations have a high rate of savings but domestic demand and consumption levels are weak.
In contrast, countries with a high account deficit, such as the United States, depend on imports. These nations have a low rate of savings with high personal consumption rates as a percentage of disposal income.
One of the overarching mandates of the G20 is to promote reforms to the international monetary and financial system. Some of the recent achievements towards that objective is the enactment of the International Monetary Fund’s 2010 Quota and Governance Reforms, as well as the inclusion of the Chinese currency in the Special Drawing Right basket of currencies.
After a five year delay by the American Congress, the 2010 Reforms have finally been implemented and the renminbi will be included in the new SDR weighting which will become effective this October. Both of these events bode extremely well for further enhancements and reforms to the international monetary framework.
Another aspect of this transition is the Financial Stability Board (FSB) which acts as the financial regulatory and policy development arm of the G20. This positions the FSB as the central governing body over the international financial sector. It is here where the standards which G20 nations must adhere too are developed.
One other component of this transition and methodology which needs to be understood is the Basel III framework of the Basel Committee on Banking Supervision. As a part of the Bank for International Settlements mandate on reforming the international banking regulations, the Basel III framework is meant to increase the quality of capital which banks hold. This is meant to work alongside the mandates of the FSB and the IMF reforms and SDR to achieve the overall macro strengthening of the international monetary framework. An evolution which is meant to minimize and absorb financial crisis and systemic shocks.
All of these factors and regulations are important in order to rebalance the current account surpluses and deficits. It is these imbalances which have created the bulk of systemic financial and monetary challenges which the international committee must now address.
These imbalances have developed as the active component of the Triffin Paradox which was defined as the response to the Bretton Woods Agreement of 1944 and its use of the domestic US dollar as the international reserve asset. The imbalances grew at a steady pace for decades and saw America transition from having the world’s largest trade surplus after World War Two to now having the world’s largest trade deficit. It is this factor alone which has contributed to the loss of American jobs and factories to the emerging economies such as China.
It is understood that one of the key factors in rebalancing the international monetary system is the changes to the existing exchange rate regimes which have been based on USD hegemonic dominance. This would entail adjusting the fixed exchange rate regimes to floating and more market oriented. China and the renminbi would potentially see the largest and most dramatic adjustments under this transition.
The large trade surplus which China holds can be reduced by appreciating the renminbi. This would make Chinese produced goods more expensive and reduce exports, which is something the Chinese are working towards as they transition the domestic economy from an export based model to a consumption based model.
Remember, countries with large trade surpluses have low domestic consumption.
On the other side of this equation is the US dollar. The USD will need to depreciate in order to make American made goods affordable again. This will increase US exports and create domestic jobs. The GDP contribution from this growth will be substantial.
Countries with large trade deficits have a high level of domestic consumption and low savings.
The reversal of the above defined metrics will see China’s domestic economy become more consumption based. This will create an expansion of the Chinese middle class with ready-made cities to meet the migration of 100 million of the rural population into urban centers between now and 2020.
It will also mean that real job growth will return to America along with increasing interest rates. A depreciated USD will impact exports in a positive fashion and the broadening job market, along with increasing interest rates, will contribute to increasing the level of savings. Something which is desperately needed in the US after decades of job losses and decreasing personal wealth.
Both sides of the surplus and deficit dynamic will continue to balance until the +/- four percent account balance of GDP is maintained. The Chinese are practicing patience as they implement their strategy of renminbi internationalization and liberalization. Acting too fast will undermine the evolution of their domestic financial markets and economy. Acting too slow will continue the trend of American macroeconomic and geopolitical dominance account imbalances.
With the start-ups of the AIIB and BRICS Development Bank, along with the New Silk Road Fund and the effective date of October for the new renminbi-included SDR, 2016 will be a monumental year for China. Anyone considering shorting the Chinese currency should consider the larger macroeconomic trends and requirements which have been mandated by the international institutions. Balancing the monetary system is the number one goal of developed nations and emerging nations. Based on this both China and America are working towards the common goal of appreciating and depreciating their currencies. – JC