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Global Imbalances, Peak Oil, and the Next Global Economic Crisis

Dr. Minqi Li, Assistant Professor

Department of Economics, University of Utah

Salt Lake City, Utah

Phone: 801-828-5279

E-mail: [email protected]

Webpage: www.econ.utah.edu/~mli

Paper Submission to The State of Nature

February 2011

Under the neoliberal global economy, global effective demand (mass consumption, productive

investment, and government spending) tends to be depressed. Liberalized capital flows have led

to global financial instability and frequent financial crises. Despite these inherent weaknesses,

the neoliberal global economy has been able to function as the US has played an indispensable

stabilizing role. The US current account deficits have allowed China, Japan, other Asian

economies, and Germany to pursue export-led growth. Moreover, the US foreign liabilities have

created assets for the “emerging economies” allowing the emerging economies to pursue

expansionary macroeconomic policies.

With the Great Recession of 2008-2009, the US economy has been seriously weakened.

In the coming years, the US will have growing difficulty to continue functioning as the world’s

“borrower of last resort”. In the near future, as the world oil production approaches the peak and

starts to decline, the global economy is likely to be constrained by the oil supply capacity. In the

post-peak oil world, the pattern of global imbalances is likely to change dramatically. The center

of global trade surpluses is likely to shift away from East Asia and towards the main oil

exporters.

China is currently the world’s largest net creditor and has been crucial in financing the

US current account deficits. As the advanced capitalist economies stagnate, but China’s

demands for technology, energy, and resources continue to surge, it is a matter of time before

China turns from a net exporter into a net importer. In the future, China will face balance of

payment constraints and will be unable to function effectively as either the world’s lender of last

resort or the world’s borrower of last resort. Without an effective lender or borrower of last

resort, the neoliberal global economy will be fundamentally unstable.

The following section discusses one of the basic contradictions of global capitalist

economy – how to sustain the expansion of effective demand in the global context in the absence

of a world government. Section 3 discusses the structural contradictions of neoliberalism and

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how the US has been indispensable for stabilizing the neoliberal global economy. Section 4

reviews the internal and external imbalances of the US economy and argues that the US can no

longer act as an effective borrower of last resort for the neoliberal global economy. Section 5

argues that while China has become a leading contributor to global economic growth, it will not

be able to stabilize the global economy by acting as the world’s lender of last resort. Section 6

argues that if the world oil production peaks in the near future, it will impose limits on global

economic growth and the advanced capitalist economies are likely to bear the main burden of

adjustments. Section 7 concludes the paper by discussing the impact of peak oil on global

imbalances and the future of the global economy.

Global Capitalist Dilemma

The great depression demonstrated that a small government, free market capitalist economy was

fundamentally unstable. A big government sector is indispensable for the stability of a modern

capitalist economy. However, at the global level, there is not a world government that is

responsible for the macroeconomic management of the global capitalist economy.

The national economies that run trade deficits need to be financed by net capital inflows.

Sudden reverse of capital flows could precipitate a national economy into a balance of payment

crisis, often leading to a deep recession. Concerned with the risk of balance payment crisis, the

deficit countries are under pressure to reduce internal demand to restore trade balance.

On the other hand, the surplus countries are not under the pressure to expand their

internal demand. On the contrary, the surplus countries may have incentive to maintain and

expand trade surplus in order to accumulate reserve assets to insure against possible balance of

payment crisis. As the deficits countries are pressured to reduce internal demand but the surplus

countries may be motivated to further increase their surpluses, there would be a tendency for

global effective demand to be depressed unless it is offset by some counter tendencies.

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The national motivation to maintain and expand trade surplus is reinforced by the

favorable impact of trade surplus on capitalist profit. For a capitalist economy to function well,

the capitalist profit rate needs to be high and stable. Other things being equal, lower wages and

taxes would contribute to high profits. However, if wages and taxes are too low, mass

consumption and government spending would be depressed, leading to insufficient overall

demand for capitalist production (the “realization problem”). How could this dilemma be

addressed?

Consider the following macroeconomic identity:

W + Π + T = C + I + G + NX

The equation says that in a capitalist economy, the sum of wages (W), profits (Π), and

taxes (T) must equal the sum of consumption (C), investment (I), government purchases (G), and

net exports (NX, that is, exports less imports, or net purchases by the foreigners). In other

words, total incomes must equal total expenditures.

Rearrange terms, one arrives at the following profit determination formula:

Π = I + (C-W) + (G-T) + NX

The equation says that the capitalist profit is determined by the sum of capitalist

investment, household consumption in excess of wages (which roughly corresponds to

“household deficit”), government deficit, and trade surplus.

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If wages and taxes are kept low, the profit may be increased through an increase in

household or government deficits. However, this “solution” could lead to unsustainable

household or government debt, ending with a financial crisis either in the private sector or the

public sector.

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The profit may be increased through an increase in capitalist investment. But excessively

high investment could lead to excess production capacity and lower profit rate.

From the point of view of a national capitalist economy, it would seem that higher trade

surplus would offer the most ideal solution. If a national capitalist economy can maintain and

expand large trade surplus, then it can achieve high profit without worrying about the realization

problem, household or government debt, or over investment.

However, in the global context, if all national economies attempt to generate large trade

surplus by using policies that tend to keep wages and taxes low, it would create a global “race to

the bottom” that depresses global effective demand. How could the global capitalist economy

get around this dilemma?

Historically successive hegemonic powers have functioned as proxies for world

government to regulate the collective interest of the global capitalist economy. In principle,

there are two possible ways for the hegemonic economy to stabilize the global capitalist

economy and promote the expansion of global effective demand.

First, the prevailing hegemonic economy could run sustained large trade surpluses against

the rest of the world and function as the world’s “lender of last resort”. By providing large and

stable capital outflows to the rest of the world, the hegemonic economy could help to remove the

balance of payment constraints on the rest of the world and encourage other national economies

to promote expansion of internal demand. In this scenario, the hegemonic economy would

accumulate net foreign assets over time.

Alternatively, the prevailing hegemonic economy could run sustained large trade deficits

against the rest of the world, allowing the rest of the world to pursue export-led growth and

accumulate reserve assets. The hegemonic economy would lead the expansion of global

effective demand. Under this scenario, the hegemonic economy would accumulate net foreign

liabilities over time.

Neoliberalism and the Global Imbalances

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In the early postwar years, the advanced capitalist countries undertook a set of major

institutional restructurings. The size of the government sector was greatly expanded. Keynesian

macroeconomic policies became standard practices. Welfare state institutions were established

and expanded. National income was redistributed from capital to labor and social spending. All

of these contributed to the rapid expansion of effective demand in the advanced capitalist

countries during the 1950s and 1960s.

At the global level, under the Bretton Woods System, fixed exchange rates were

maintained and capital flows were regulated. From the mid-1940s to the mid-1960s, the US had

run significant current account surpluses. The US corporate foreign investments and official

foreign assistances supplied capital to the rest of the world and had to a large extent removed the

balance of payment constraints on the rest of the world’s economic growth.iii

The “Golden Age” ended as decades of rapid economic growth depleted the surplus labor

force in the advanced capitalist countries. Growing working class bargaining power led to

declining profit rate. As the governments of the advanced capitalist countries attempted to

prolong economic expansion through Keynesian economic policies, intensified class conflicts led

to a period of “stagflation” (or a combination of high unemployment and high inflation).

By the mid-1960s, the US industrial monopoly was seriously challenged by the rapidly

growing Western European and Japanese economies. The US hegemony was further

undermined by the defeat at Vietnam. As the US trade surplus disappeared, the Bretton Woods

System fell apart.

In response to the crisis, the global capitalist classes pursued a new set of policies and

institutions that had become known as “neoliberalism”. In the 1980s and 1990s, monetarist

macroeconomic policies became the standard practices in the advanced capitalist countries.

Under monetarism, “independent” central banks focused on price stability rather than output and

employment expansion. High interest rates in combination with fiscal austerity were

recommended as the primary weapons to contain inflation. In effect, monetary policies helped to

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keep the unemployment rates high for a sustained period of time, weakening the working class

bargaining power and contributing to the recovery of the profit rate.

In developing countries and formers socialist countries, “structural adjustment” and

“shock therapy” programs were imposed by the International Monetary Fund and the World

Bank. These programs often included immediate and full liberalization of prices, extreme

versions of the monetarist policies, massive privatization of state owned enterprises, and massive

cuts of social spending. In Latin Africa, Africa, Eastern Europe, and the former Soviet Union,

these programs had led to massive declines of living standards for the great majority of the

population.

A key aspect of neoliberalism was “globalization” or trade and financial liberalization.

With liberalized flows of goods, services, and capital, capital could be relocated from the

advanced capitalist countries to the periphery taking advantage of the cheap labor force and the

weak environmental and social regulations. The “threat effect” in turn undermined the

bargaining power of the working classes in the advanced capitalist countries.iv

All of these developments contributed to the global redistribution of income from labor to

capital. Labor income shares had fallen in all the major economies. In the US, working class

real wages had declined from the 1970s to the 1990s. In much of the world (Latin America,

Africa, Eastern Europe, and the former Soviet Union), large sections of the population suffered

from massive absolute declines of living standards. Global mass consumption had been

depressed.v

Liberalized capital flows greatly increased financial instability and led to more frequent,

more violent financial crises (the Mexican crisis in 1994, the Asian crisis in 1997, the Brazilian-

Russian crisis in 1998, the Argentine-Turkish crisis in 2001).vi Financial instability and high

interest rates tended to depress productive investment. Financial crisis had forced many

governments to adopt fiscal austerity programs, further depressing internal demand.

Without an effective counteracting force, the neoliberal global economy could sink into a

downward spiraling vicious circle under the general tendency of demand depression and growing

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financial instability. In this context, the US has played an indispensable stabilizing role by

acting as the world’s borrower of last resort.

From the 1990s to the early 2000s, the US had run large and rising current account

deficits, allowing China, Japan, other Asian economies, and Germany to pursue export-led

growth, compensating their insufficient internal demand.

Moreover, the US current account deficits had allowed the rest of world (especially the

rapidly growing “emerging economies”) to accumulate reserve assets. As the emerging

economies accumulated more and more reserve assets, financial crisis had become much less

threatening. By the early 2000s, the leading emerging economies (such as China, India, Brazil,

and Russia) had regained or further enhanced their capacity to undertake autonomous

macroeconomic expansion. From 2003 to 2007, the global economy enjoyed several years of

rapid growth.

The US: External and Internal Imbalances

Figure 1 shows the current account balances of the world’s major economies from 1980 to 2009.

The US has been running large current account deficits since the early 1990s. The US annual

deficit peaked at about 800 billion dollars in 2006. The European Union as a whole has had

either a small surplus or a small deficit in recent years.

East Asia as a whole has been the largest contributor to global current account surpluses.

In 2007 and 2008, the East Asian current account surpluses were roughly comparable to the US

deficits. As the oil price surged from 2003 to 2008, the oil exporters (represented by the sum of

Middle East, North Africa, and Russia) became another major source of global current account

surpluses.

[Figure 1 is about here]

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Figure 2 compares the US net foreign liabilities (foreign assets in the US less the US

assets in the rest of the world), the US cumulative current account deficits (the cumulative

current account balances since 1929, with deficits stated in positive terms), and the rest of the

world’s foreign exchange reserves.


If there were no change in the value of US dollar, the net foreign liabilities should

theoretically equal the cumulative current account deficits. In reality, the US dollar value does

change and since 2002, as the US dollar depreciates, a large gap has been opened between the

net foreign liabilities and the cumulative current account deficits (dollar depreciation raises the

nominal dollar value of the US assets abroad and therefore reduces the US net foreign liabilities).

However, the growth of the US cumulative current account deficits has roughly matched

the growth of the world foreign exchanges reserves since the mid-1980s. Thus, the US current

account deficits have allowed the rest of the world to accumulate official reserve assets. The

accumulation of reserve assets has allowed the rest of the world, especially the emerging

economies, to pursue demand expansion as financial crisis becomes less threatening. This

development contributed to the rapid growth of the global economy from 2003 to 2007 as well as

the relative stability of the emerging economies.

A country’s external financial balance has to be matched by its internal financial

balances. This can be illustrated with the following macroeconomic financial identity:

Current Account Balance = Private Sector Balance + Government Sector Balance

Thus, if a country runs current account deficit, then either the private sector, or the

government sector, has to run a deficit in term of sector financial balance.

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Figure 3 compares the US current account balances with the US private and government

sector financial balances from 1980 to 2009. Figure 4 compares the US private sector financial

balances with the household and corporate sector financial imbalances.



From the 1980s to the early 1990s, the US private sector had consistently run surpluses.

The relatively large government deficits had more than offset the private sector surpluses,

leading to current account deficits for most years in this period.

In the late 1990s, the US government sector actually moved into surpluses. It was the

private sector that had run increasingly larger deficits, driven by deficits in both the household

sector and the business sector. After the 2001 recession, the business sector moved back to

surpluses as corporations reduced investment and increased cash holdings. But the household

sector continued to run deficits.

From the late 1990s to 2007, the US economy had essentially been driven by debt-

financed household consumption. The household debt had increased steadily from about 50

percent of GDP in the early 1980s to near 100 percent of GDP by 2008.vii

In the wake of the Great Recession of 2008-2009, both the household sector and the

business sector have increased savings sharply. The US private sector balance moved from a

deficit of near 4 percent of GDP in the third quarter of 2006 to a surplus of near 10 percent of

GDP in the second quarter of 2009. This drastic turnaround was mostly offset by an equally

drastic deterioration in the government sector balance. The US government sector deficit

increased from less than 2 percent of GDP in the fourth quarter of 2006 to the peak of 12 percent

of GDP in the second quarter of 2009.

The analysis above helps to illustrate the current dilemma of the global economy. The

stable expansion of the neoliberal global economy requires the hegemonic economy function as

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the world’s effective borrower of last resort. The US had indeed played this stabilizing role from

the 1990s to the early 2000s. However, the US stabilizing role required the US run large current

account deficits, which in turn required either the US private sector or the US government sector

run large deficits.

From the late 1990s to 2007, it was primarily the private sector that had driven the

expansion of the US current account deficits. The private sector deficits reflected, first, the stock

market bubble in the late 1990s, and then the housing bubble from 2004 to 2007.

With the burst of the housing bubble, the US private sector has increased savings sharply

and the US current account deficits have shrunk. In this context, is the US still capable of acting

as the world’s borrower of last resort?

As the US households and corporations increase savings to repair their balance sheets, if

the US were to keep running large current account deficits, the US government sector would

have to run very large deficits. If the US current account deficit returns to about 5 percent of

GDP and the US private sector runs a surplus of 5 percent of GDP, then the US government

sector would have to maintain a deficit of 10 percent of GDP. This would obviously be

unsustainable beyond the medium-term.

More optimistically, assume that the US current account deficit would stay at about 3

percent of GDP and the US private sector surplus would gradually fall back to 3 percent of GDP.

This would still imply a long-term government deficit of 6 percent of GDP. If the US long-term

nominal GDP growth rate is assumed to be 5 percent (3 percent real economic growth rate + 2

percent long-term inflation rate), then a long-term deficit of 6 percent of GDP implies that in the

long run the government debt would approach 120 percent of GDP, taking the US government

debt to a potentially dangerous level.viii

On the other hand, if the US current account deficit is limited to no more than 3 percent

of GDP and the US economic growth remains sluggish in the future, the US role as the world’s

borrower of last resort would be greatly reduced.

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If the US can no longer (or will gradually lose its ability to) function as the world’s

borrower of last resort, would another large economy emerge as the world’s next hegemonic

economy, stabilizing the global economy either as a lender of last resort or as a borrower of last

resort?

China: the World’s Lender of Last Resort?

Figure 5 compares the contributions by the world’s major economies (the US, the

European Union, China, and India) to global economic growth. An individual economy’s

contribution to global economic growth is measured by the ratio of the change in the economy’s

GDP over a five-year period over the change in the world GDP over the same period.


From the 1990s to the early 2000s, the US was the largest contributor to global economic

growth, accounting for about one-quarter of the growth of the world economy over this period.

Since 2005, China has over taken the US to become the largest contributor to global economic

growth (even though the Chinese economy remains smaller than the US economy). China now

contributes to about one-third of the world economic growth while the US contribution has

declined to less than 10 percent.

This raises the interesting question whether China can replace the US as the next

hegemonic economy and help to stabilize the global economy by acting either as a lender of last

resort or a borrower of last resort.

Since the early 2000s, China has been running large current account surpluses. China’s

current account surplus surged from 17 billion dollars in 2001 to near 440 billion dollars in 2008

before falling back to about 300 billion dollars in 2009. China’s foreign exchange reserves

increased ten folds from 2001 to 2009 and stood at 2.4 trillion dollars at the end of 2009. China

has become the world’s largest net creditor.

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It is a matter of time before China overtakes the US to become the world’s largest

economy. If China continues to run large current account deficits in the foreseeable future, will

China emerge as the world’s lender of last resort in one or two decades and lead the global

economic expansion in a manner similar to how the US led the global economic expansion after

the Second World War?

Despite China’s rapid economic growth, the Chinese economy continues to lag the

advanced capitalist countries in key technologies and continues to depend on foreign investment

and technology as key engines for economic growth. According to a Chinese government report

in 2006, foreign capital dominated 21 out of 28 China’s industrial sectors. Foreign owned firms

accounted for about 60 percent of China’s total exports and about 90 percent of the so-called

“high tech” exports.

China has become the world’s leading computer exporter, assembling 80 percent of the

world’s notebook and desktop computers. But this is mainly because the Taiwanese companies

that dominated the world computer manufacturing have shifted their entire production to

mainland China. Eight of China’s top ten computer exporters are Taiwanese “original design

manufactures” which supplied unbranded computers and components to branded sellers based in

the US.

Most of China’s current industrial activities involve using foreign technology and

imported foreign capital goods to assemble final manufacture goods and some intermediate

goods to be exported to the advanced capitalist markets. China’s own contribution is largely

limited to cheap labor and cheap land.ix

China’s current pattern of economic development is highly energy and resources

intensive. From 1999 to 2009, China’s total primary energy consumption grew at an average

annual rate of 8.8 percent, coal consumption grew at 8.9 percent a year, oil consumption grew at

6.8 percent a year, and carbon dioxide emissions grew at 8.6 percent a year. During the same

period, China’s oil imports increased from 1.2 million barrels a day to 4.8 million barrels a day.

China has overtaken the US to become the world’s largest energy consumer and largest

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greenhouse gas emitter. China has become the world’s second largest oil consumer and

importer.x

Table 1 compares China’s main export and import commodities. The 20 largest export

items together accounted for 39 percent of China’s total merchandise exports in 2008. The 20

largest import items together accounted for 35 percent of China’s total merchandise imports in

2008. China mainly exports final manufacture goods and some intermediate goods such as

computers, garments, telephone sets, furniture, ships, plastic articles, electrical apparatus, leather

shoes, and steel. China mainly imports energy products, minerals, agricultural and forest

products, and high value-added capital goods such as crude oil and oil products, iron ore, copper,

soybean, paper pulp, aircraft, and machine tools.

[Table 1 is about here]

If the Chinese economy continues to grow rapidly, China’s demand for energy, natural

resources, and high value-added capital goods is set to grow rapidly. Moreover, China’s

growing demand for energy, mineral, and agricultural products is likely to drive up their world

market prices. On the other hand, the advanced capitalist economies are likely to struggle with

economic stagnation for many years to come. As China’s import bill continues to surge but its

main export markets stagnate, in the coming years China’s trade surplus is more likely to narrow

rather than widen. China’s seemingly enormous trade surplus could be completely eliminated in

the medium term.

Table 2 presents alternative scenarios for China’s trade balance by 2020. Under all

scenarios, world imports are assumed to grow by 10 percent a year from 2009 to 2020 (compared

to the average annual growth rate of 11 percent from 1998 to 2008) and China’s imports are

assumed to grow by 20 percent a year (compared to the average annual growth rate of 22 percent

from 1998 to 2008).

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Under scenario 1, China’s share of the world exports market is assumed to increase

slightly from 8.6 percent in 2009 to 10 percent in 2020. Under this scenario, China will run a

huge trade deficit of 3.9 trillion dollars by 2020. Under scenario 2, China’s world market share

is assumed to increase to 15 percent by 2020 and is projected to run a trade deficit of 1.7 trillion

dollars.

Under scenario 3, China’s world market share is assumed to rise to 20 percent by 2020.

China’s exports will rise to 8.8 trillion dollars and trade surplus will rise to 540 billion dollars.

But these are highly unlikely.

Thus, if the Chinese economy continues to grow rapidly, China’s currently enormous

trade surplus could be eliminated in about a decade. As China starts to run trade deficit rather

than surplus, China will not be in a position to function as the world’s lender of last resort.

The elimination of China’s trade surplus could very well be accelerated by the coming

peak of the world oil production.

Peak Oil and the Next Global Economic Crisis?

In the near term (the next 5-10 years), the global economic growth is likely to be subject to the

limits of the world oil supply capacity. Current evidence suggests that world oil production is

likely to peak in the near future. World oil discoveries already peaked in the 1960s. About 28

significant oil producing countries (together accounting for about 50 percent of world oil

production) have passed the peak and their oil production is in decline. Of the world’s 20 largest

oil fields, 16 have passed the peak and are now in decline.xi

Figure 6 shows the “world oil supply curve”, the relationship between world oil supply

and real oil prices. In recent years, world oil supply has become highly inelastic. From 2004 to

2008, despite surging oil prices, world oil production failed to increase to match the growth of

demand.

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Chris Skrebowski developed an analysis based on the oil megaprojects data. According

to Skrebowski, world oil supply capacity could peak in 2014 and lead to the next round of world

oil price surge. This could trigger the next global economic crisis.xii

How is peak oil likely to impact world economic growth? Table 3 reports results from

bi-variant regressions that study the relationship between GDP and real oil price using data from

1980 to 2009. GDP is in logarithmic values and first differenced. Real oil price is the average of

real oil prices over the previous three years and first differenced.xiii


Oil price has a significant impact on both the world economy and the OECD economies.

An increase in real oil price by ten dollars reduces world economic growth rate by 0.7 percent

and OECD economic growth rate by 1.4 percent. However, oil price seems to have no impact on

the growth of Asian and Pacific developing economies.

The insensitivity of the Asian and Pacific developing economies may have resulted from

the following factors. The two largest economies in the area, China and India, depend on coal

rather than oil as the major source of energy. In the 1980s and early 1990s, China was a net oil

exporter. Over the past decade, the Asian economies have accumulated huge foreign exchange

reserves allowing them to maintain economic growth despite rising oil import expenses.

Table 4 reports regression results that study how oil consumption is determined by GDP

and real oil price. Both oil consumption and GDP are in logarithmic values and first differenced.

xiv


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The world economy has an “autonomous” oil reduction rate of 1.3 percent a year and the

OECD economies have an autonomous oil reduction rate of 1.1 percent a year. The autonomous

oil consumption reduction may have reflected structural improvement in energy efficiency. On

the other hand, the Asian oil demand does not seem to experience autonomous reduction.

In the long run, real oil price should neither rise indefinitely nor fall indefinitely. Table 5

considers the possible impact of peak oil by calculating the GDP growth rate that is consistent

with stable real oil price based on different scenarios of oil consumption growth. The

calculations are based on the regression results reported in Table 4.xv

From 1998 to 2008, world oil consumption grew at an average annual rate of 1.4 percent.

Table 5 considers four possible scenarios for world economic growth in the coming years. If the

world oil consumption continues to grow at an annual rate between 1 and 2 percent, global

economy would be able to grow at a solid pace. If world oil consumption ceases to grow or

starts to decline, global economy will stagnate (global economic growth rate less than 2 percent

is usually considered as global recession).

From 1998 to 2008, OECD oil consumption grew at an average annual rate of 0.1

percent. In the coming years, if OECD oil consumption stays unchanged or grows at an annual

rate of 1 percent, then the OECD economies will be able to grow at 2-3 percent a year.

However, if world oil production peaks and declines, and the Asian oil demand keeps rising, then

the OECD countries will bear the main burden of adjustment resulting from peak oil. In that

case, the OECD economies will stagnate or decline.

From 1998 to 2008, the oil consumption of the Asian and Pacific developing economies

grew at an average annual rate of 4.6 percent. In the future, the Asian economies will be able to

keep growing rapidly if their oil consumption grows at 4-5 percent a year. However, if the oil

consumption growth rate falls below 3 percent, the Asian economies may suffer a significant

slowdown.

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Peak Oil and the Global Imbalances

Peak oil will have significant impact on the future evolution of the global imbalances. Currently,

both the world’s trade surpluses and reserve assets are concentrated in the East Asian economies.

The Asian economies have more or less tied their currencies to the US dollar to maintain export

competitiveness. As a result, they have accumulated their reserve assts primarily in the form of

US dollar assets. The Asian economies’ currency interventions have sent capital flows back to

the US, helping to finance the US current account deficits. This was a crucial mechanism that

had allowed the US to function as the world’s borrower of last resort up to the Great Recession.

As oil price surges in the future and the Asian oil demand continues to increase, global

trade surpluses are likely to shift away from the Asian manufacturing exporting economies and

towards the oil exporters. Unlike the Asian economies, the oil exporters are likely to have little

or no incentive to keep their currencies tied to the US dollar to stimulate exports. Instead, they

may have greater incentive to diversify their reserve assets. This will make the management of

global imbalances much more complicated and potentially highly unstable.

Peak oil is likely to accelerate China’s transition from a net exporter into a net importer.

As the advanced capitalist economies are likely to bear the main burden of adjustment, the

coming peak oil crisis will further depress China’s main export markets. China currently

consumes about 9 million barrels of oil a day. This could rise to 20 million barrels of oil a day

by 2020, implying an import demand of 15 million barrels of oil a day. If oil price stays around

100 dollars a barrel, then China’s oil import bill will rise to 550 billion dollars. If oil price rises

to 200 dollars a barrel, then China’s oil import bill will become 1.1 trillion dollars. This will

certainly more than offset any plausible manufacturing trade surplus China is likely to run by the

end of the decade.

It has been argued that for the global capitalist economy to function well, it needs to have

either a lender of last resort or a borrower of last resort. If the Chinese economy keeps growing

rapidly and China starts to run large trade deficits after about 2020, is it conceivable that China

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could become the leading stabilizer of the global economy by acting as the world’s borrower of

last resort?

In the 1990s and the early 2000s, the US was able to function as the world’s borrower of

last resort because the US dollar had been established for many decades as the world’s leading

reserve currency. The US had developed financial markets and institutions that were far larger,

deeper, and more sophisticated than those in the rest of the world. Because of these advantages,

as the Asian economies pursued export-led growth, they tended to keep their reserve assets in the

form of US dollar assets. The accumulation of dollar assets in turn discouraged the Asian

economies from diversifying away from the dollar due to concern over capital losses. The US,

being the world’s unchallenged military super power, had a geopolitical clout that probably had a

significant influence on many economies’ currency and reserve accumulation decisions.

In the coming one or two decades, it is highly unlikely for China to develop its financial

markets and institutions to a level that could match the US markets and institutions. It is not

even clear whether the Chinese currency could become a significant reserve currency, let alone

the leading reserve currency. It is also highly unlikely for China to match the US geopolitical

clout.

As the global trade surpluses shift away from China and the rest of Asia and towards the

oil exporters, there will be little incentive for the oil exporters to tie their currencies to any

particular currency. Thus, China cannot count on the accumulation of official foreign exchange

reserves in the form of the Chinese currency by the rest of the world to finance its future trade

deficits.

China’s trade deficits will have to be primarily financed by drawing down China’s own

foreign exchange reserves or private capital inflows. China’s own foreign exchange reserves are

limited and eventually will be depleted. Private capital inflows are inherently unstable and carry

the significant risk of financial crisis. Therefore, China will have to face balance of payment

constraints.

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If the Chinese economy grows more rapidly than the rest of the world, it is likely to lead

to increasingly larger trade deficits which cannot be sustained and could trigger a balance of

payment crisis. Alternatively, if China attempts to keep its trade balance stable, it may have to

accept much lower growth rates and in that case China will be unable to function effectively as

the world’s borrower or last resort.

i This asymmetry between surplus and deficit countries was first John Maynard Keynes. For a

recent paper discussing the relationship between the surplus-deficit asymmetry and global

imbalances, see Jan Kregel, “An Alternative Perspective on Global Imbalances and International

Reserve Currencies,” The Levy Economics Institute of Bard College, Public Policy Brief,

No.116, 2010, http://www.levyinstitute.org/pubs/ppb_116.pdf.

ii This approach of analyzing capitalist profit was first proposed by Michael Kalecki, and was

used by Hyman Minsky in analyzing the capitalist macroeconomic relations. See Hyman

Minsky, Stabilizing an Unstable Economy, pp.160-171, New York: McGraw Hill (2008).

iii Barry Eichengreen, Global Imbalances and the Lessons of Bretton Woods, pp.12-13,

Cambridge, Mass.: The MIT Press (2007).

iv On how neoliberal globalization led to a global race to the bottom in term of wages and taxes,

see James Crotty, Gerald Epstein, and Patrica Kelly, “Multinational Corporations in the Neo-

liberal Regime,” in Dean Baker, Gerald Epstein, and Robert Pollin (eds.), Globalization and

Progressive Economic Policy, pp.117-143, Cambridge: Cambridge University Press (1998).

v On the devastating impact of the neoliberal policies on people’s living standards in the former

socialist countries and developing countries, see Michel Chossudovsky, The Globalization of

Poverty: Impacts of IMF and World Bank Reforms, London and New Jersey: Zed Books Ltd

(1998).

vi David Felix, “Why International Capital Mobility Should Be Curbed, and How It Could Be

Done,” Conference paper prepared for Financialization of the Global Economy, December 7-8,

2001.http://www.peri.umass.edu/fileadmin/pdf/financial/fin_Felix.pdf.

19

As the US economic and geopolitical decline continues, the US is also likely to face

balance of payment constraints in the coming years. Thus, after about 2020, both of the world’s

two largest economies will lose the capacity to function either as the world’s lender of last resort

or the world’s borrower of last resort. This will leave the neoliberal global economy in a

fundamentally unstable condition. The unrestrained competition between national capitalist

vii Dimitri B. Papadimtriou, Greg Hannsgen, and Gennaro Zezza, “Sustaining Recovery:

Medium-Term Prospects and Policies for the U.S. Economy,” The Levy Economics Institute of

Bard College, Strategic Analysis, December 2009,

http://www.levyinstitute.org/pubs/sa_dec_09.pdf.

viii The long-equilibrium debt-GDP ratio is determined by the ratio of the deficit-to-GDP ratio

over the growth rate of GDP, assuming the deficit-to-GDP ratio and the economic growth rate

are held indefinitely.

ix On the Chinese economy’s dependence on foreign technology, see Martin Hart-Landsberg,

“The Chinese Reform Experience: A Critical Assessment,” Review of Radical Political

Economics, published online before print, September 28, 2010,

http://rrp.sagepub.com/content/early/2010/09/24/0486613410383954.abstract.

x The energy data are from BP, Statistical Review of World Energy 2010,

http://www.bp.com/productlanding.do?categoryId=6929&contentId=7044622.

xi On the evidence that the world oil production is likely to peak in the near future, see Robert L.

Hirsch, Roger H. Bezdek, and Robert M. Wendling, The Impending World Energy Mess: What It

Is and What It Means to You, pp.29-74, Burlington, Ontario: Apogee Prime (2010).

xii Chris Skrebowski, “Peak Oil Update,” presentation at the 2010 Peak Oil Conference by ASPO-

USA, October 8, 2010, http://www.aspousa.org/2010presentationfiles/10-8-

2010_aspousa_PeakOilPicture_Skrebowski_C.pdf.

xiii For readers not familiar with econometrics, the regressions results presented in Table 3 mean

the following: for the period 1980-2009, for the world economy, the OECD economies, and the

20

economies could generate powerful pressures towards global race to the bottom in term of

effective demand. Without powerful counter tendencies, it is difficult to see how the neoliberal

global economy can be sustained.

Asian and Pacific developing economies, the trend economic growth rate was 3.1, 2.5, and 7.1

percent respectively; and for each ten dollar increase in oil price, world economic growth rate

would fall by 0.7 percent, OECD economic growth rate would fall by 1.4 percent, but the Asian

and pacific economic growth rate would increase by 0.1 percent.

xiv For readers not familiar with econometrics, the regressions results presented in Table 3 mean

the following: for the period 1980-2009, for the world economy, the OECD economies, and the

Asian and Pacific developing economies, the “autonomous” oil consumption growth rate (the

part of oil consumption that is independent of economic growth and oil price) was -1.3, -1.1, and

0.4 percent respectively; for each ten dollar increase in oil price, oil consumption would fall by

0.9, 1.6, and 1.6 percent respectively; and for each one percentage point increase in economic

growth rate, oil consumption would increase by 0.7, 0.6, and 0.6 percent respectively.

xv For example, for world oil consumption, the regression results presented in Table 4 lead to the

following formula: Oil consumption growth rate = -0.013 – 0.009 * change in oil price + 0.722 *

economic growth rate. If change in oil price is set to be zero, then an oil consumption growth

rate of -1 percent implies a world economic growth rate of 0.4 percent or an oil consumption

growth rate of 1 percent implies a world economic growth rate of 3.2 percent.

21

Table 1. China’s Main Export and Import Commodities, 2008 (billion dollars)

Main Export Commodities Value Main Import Commodities ValueComputers and Components 135.0 Crude Oil 129.3Rolled Steel 63.4 Iron Ore 60.5Garments, Knitted or Crocheted 54.6 Petroleum Products Refined 30.0Garments (other) 46.8 Computers and Components 25.4Telephone Sets 41.5 Rolled Steel 23.4Computer Parts 31.4 Soybean 21.8Furniture 26.9 Motor Vehicles 15.1Ships 19.1 Copper and Copper Alloys 11.7Plastic Articles 15.8 Parts of Motor Vehicles 11.1Diode and Semi Conductors 15.7 Copper Ores 10.4Parts of Motor Vehicles 14.8 Edible Vegetable Oil 9.0Petroleum Products Refined 13.7 Aircraft 8.8Insulated Wire or Cable 11.9 Machine Tools 7.6Electrical Apparatus 11.9 Rolled Copper 7.6TV sets 10.6 Paper Pulp 6.7Static Converters 10.4 Polystyrene in Primary Forms 5.9Cotton Cloth 10.2 Pharmaceutical Products 5.5Leather Shoes 9.8 Telephthalic Acid 5.3Containers 9.1 Ethylene Glycol 5.3Motor Vehicles and Chassis 9.0 Logs 5.2Sum 561.7 Sum 400.5Total Merchandise Exports 1,430.7 Total Merchandise Imports 1,132.6

Source: National Bureau of Statistics of the People’s Republic of China, http://www.stats.gov.cn.

22

Table 2. Alternative Scenarios of China’s Trade Balance, 2009 and 2020 (projected)

2009 2020

Scenario 1

2020

Scenario 2

2020

Scenario 3

World Imports (billion dollars) 15,448 44,076 44,076 44,076

China’s World Market Share 8.6% 10% 15% 20%

China’s Exports (billion dollars) 1,333 4,408 6,611 8,815

China’s Imports (billion dollars) 1,113 8,271 8,271 8,271

China’s Trade Balance (billion dollars) 220 -3,863 -1,660 544

Source: World Bank, http://databank.worldbank.org; author’s calculations.

23

Table 3. Oil Price and Economic Growth, 1980-2009

(Dependent variable: logarithmic value of GDP)

World OECD Asia & Pacific

INTERCEPT 0.031

(0.002)***

0.025

(0.002)***

0.071

(0.003)***

OIL PRICE

(unit: $10)

-0.007

(0.003)**

-0.014

(0.003)***

0.001

(0.004)

R-square 0.143 0.417 0.002

Standard errors are in parentheses.

**Statistically significant at 5 percent level.

***Statistically significant at 1 percent level.

Data sources: World Bank, http://databank.worldbank.org; BP, Statistical Review of World

Energy 2010.

24

Table 4. Oil Consumption, Oil Price, and GDP, 1980-2009

(Dependent variable: logarithmic value of Oil Consumption)


INTERCEPT -0.013

(0.006)**

-0.011

(0.007)

0.004

(0.019)

OIL PRICE

(unit: $10)

-0.009

(0.003)***

-0.016

(0.006)***

-0.016

(0.006)***

GDP

(in logarithmic value)

0.722

(0.174)***

0.562

(0.263)***

0.612

(0.263)**

R-square 0.603 0.584 0.324

Standard errors are in parentheses.

**Statistically significant at 5 percent level.

***Statistically significant at 1 percent level.

Data sources: World Bank, http://databank.worldbank.org; BP, Statistical Review of World

Energy 2010.

25

Table 5. Alternative Scenarios of Oil Consumption and Economic Growth

(Economic growth rates consistent with stable real oil price are reported)

Oil Consumption

Growth Rate


-2% -1.6%

-1% 0.4% 0.2%

0% 1.8% 2.0%

1% 3.2% 3.7%

2% 4.6% 2.6%

3% 4.2%

4% 5.9%

5% 7.5%

26

Source: World Bank, http://databank.worldbank.org/ddp/home.do.

27


28

Source: US Bureau of economic analysis, http://www.bea.gov.

29

Source: US Bureau of economic analysis, http://www.bea.gov.

30


31

Sources: BP, Statistical Review of World Energy 2010; US Energy Information Administration, http://eia.doe.gov.

32

Endnotes

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