Rachel Lomax: Global financial imbalances Remarks by Ms Rachel Lomax, Deputy Governor of the Bank of England, at the Chatham House conference on Global Financial Imbalances, London, 24 January 2006. *  *  *  One spin off from the debate about global imbalances has been renewed interest in the international monetary system. It is a benign aspect of a potentially acrimonious debate about whether the scale and persistence of global imbalances – and specifically the US current account deficit – was made in the USA or made in Asia – or conceivably Europe (and maybe even the Middle East). A better approach is to view global imbalances as the outcome of decentralised savings-investment decisions within an interdependent global system. And it’s worth emphasising straight away that substantial imbalances may be the natural product of a healthy global monetary and financial system: they do not necessarily represent a problem. But is the current pattern of large and persistent global imbalances healthy in this sense? Or does it reflect unsustainable behaviour on the part of policy makers, companies or private individuals around the world, rooted in unrealistic expectations, sub optimal economic policies or tensions between national policy objectives? Are global imbalances now on such a scale that their reduction inevitably poses a threat of some kind, whether to global activity, trade or financial stability? And does the current international monetary system embody sufficient incentives to deliver an orderly correction of imbalances?

It is, of course, conceivable that these imbalances will prove to be relatively short lived. They might be driven by underlying influences that prove to be largely temporary – for example an investment overhang in East Asia, which is eventually worked off, or a purely cyclical divergence in growth rates between major regions, or a short lived spike in world oil prices. But at the moment there is little sign of this – rather the reverse. It is therefore worth reflecting whether today’s international monetary system (IMS) is sufficiently robust to ensure that global imbalances can be financed, contained or corrected through the normal mechanism of market forces, without crisis; or failing that, whether institutional arrangements exist to resolve collective action problems and conflicting priorities without damage to the wider world economy. There are three key features of today’s IMS which are particularly relevant in thinking about this question. The first is financial globalisation which has totally transformed the landscape over the past two decades. Total financial wealth has risen sharply relative to GDP; and investors are now able and willing to hold a higher proportion of their portfolios in external assets. The trend to larger external asset and liabilities has been particularly significant in industrial countries, whose external assets and liabilities relative to output roughly tripled between 1990 and 2003, reaching average levels of more than 200 per cent of GDP. This has two effects. First, the expansion in external balance sheets has relaxed the constraints on the financing of countries’ savings and investment imbalances.