FIRST, the good news: China, the country at the centre of the debate about global imbalances, has a current-account surplus that has fallen sharply over the past few years. Now the bad: China was never really the prime culprit when it comes to imbalances at the global level. The biggest counterpart to America's current-account deficit is the combined surplus of oil-exporting economies, which have enjoyed a huge windfall from high oil prices (see left-hand chart). This year the IMF expects them to run a record surplus of $740 billion, three-fifths of which will come from the Middle East. That will dwarf China's expected surplus of $180 billion. Since 2000 the cumulative surpluses of oil exporters have come to over $4 trillion, twice as much as that of China. One reason why this enormous stash has received much less attention than China's is that only a fraction of it has gone into official reserves. Most of it is in opaque government investment funds. Middle Eastern purchases of Treasury bonds are often channelled through intermediaries in London, hiding their true ownership. A lot of money has been invested in equities, hedge funds, private equity and property, where ownership is harder to track. Oil exporters' surpluses are also proving much more durable than those accumulated after previous oil-price shocks. This is partly because the tightness of oil supplies has kept prices high, and partly because oil exporters have spent less of their windfalls on imports than in previous booms. The impact of higher oil prices on the world economy depends on whether oil exporters spend or save their petrodollars. If they recycle them by buying more from oil-importing countries, this cushions global demand. But if they save them, income is permanently transferred from oil consumers to oil producers, depressing global demand. After the oil-price shocks in the 1970s, about 70% of the increase in export revenues was spent on imports of goods and services. But IMF figures suggest that less than 50% of the windfall is likely to be spent in the three years to 2012. Recycling initiative

Moreover, whatever recycling of petrodollars occurs is unevenly distributed. Oil exporters buy a lot more of their imports from Europe and Asia than from America, so a shift in the “terms of trade”, which redistributes income from oil consumers to oil producers, tends to reduce the relative demand for American goods. According to research by the International Energy Agency, for each dollar America spent on oil imports from OPEC countries last year, only 34 cents came back in exports, whereas the European Union got back more than 80 cents. For each dollar China handed to OPEC, 64 cents flowed back in increased exports.

Oil producers understandably do not want to repeat the mistakes of previous times, when spending surged as oil prices rose—only to leave behind large deficits when prices later fell. Saudi Arabia, for instance, shifted from a current-account surplus of 26% of GDP in 1980 to a deficit of 13% in 1983. Exporters should certainly run a surplus as a buffer for when oil prices drop or wells run dry. The surpluses of 5-7% of GDP run by Russia, Nigeria and Venezuela seem sensible, but some countries' prudence looks excessive. Saudi Arabia's current-account surplus could hit 28% of GDP this year, and Kuwait's 46% (see right-hand chart). Kuwait's cumulative surpluses over the past decade, even ignoring capital gains, amount to a whopping 200% of last year's GDP.

Normally, a large current-account surplus would be eroded over time by stronger domestic spending and a higher exchange rate. But the Gulf currencies are pegged, or closely linked, to the dollar. Over the past ten years their real trade-weighted exchange rates have stayed flat or fallen, despite the massive gain in their terms of trade. A floating exchange rate could lead to excessive volatility and discourage diversification of these economies (by making other sectors uncompetitive as the currency appreciates), but a bit more flexibility might assist global rebalancing.

Some economists have suggested that oil exporters' currencies should be pegged to a basket which includes the oil price as well as other currencies. A more flexible exchange rate which rose (and fell) with the oil price would boost (or reduce) consumers' purchasing power, and hence imports, and also smooth out the local-currency value of government oil revenues. But that would not be a silver bullet. A 2009 IMF working paper* concluded that exchange-rate appreciation is unlikely to have much impact on oil exporters' external balances. The authors estimated that it would take a 100% appreciation to reduce a surplus by just 2.5% of GDP, both because a revaluation has no effect on oil revenues, which are priced in dollars, and because there is little scope for imports to substitute for domestic production since the manufacturing sectors of these economies are generally tiny. A huge appreciation would also drive down the local-currency value of the large net external assets of some of these countries.

The most effective policy tool to reduce oil exporters' current-account surpluses is public spending, and investment in particular because of its high import content. Increased public spending could also help these economies diversify away from oil. That would support their future economic development and create more private-sector jobs for young, growing populations. To maintain social stability, many of these governments need to spend more on education, health care, housing and welfare benefits. Some oil producers, such as Russia and Nigeria, are running fairly balanced budgets, but the governments of the Gulf states are awash with cash. Since 2005 Saudi Arabia, Kuwait and the UAE have increased public spending by 7-8 percentage points of GDP. Even so, the three countries are expected to run an average budget surplus of over 15% this year. That leaves plenty of room to be a little more spendthrift.

* “Global imbalances and petrodollars”, by Rabah Arezki and Fuad Hasanov, IMF Working Paper, April 2009.

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