The world it seems is like a game of sudoku.  You known how in the numbers puzzle there has to be a different number in each row. Well, Mervyn King has invented his own version.

It looks like this:seduku  Okay, it is not exactly Sudoku. Maybe Mervyn had hours of fun putting the table together, but when you see it like this there isn’t really a puzzle at all.

Low savings countries, which happen to be the world’s rich countries, are running trade deficits, the big savers are running a surpluses.

And whichever way you look at it, the problem is the same. For as long as the savers run surpluses, the spenders must have deficits. You just can’t have one without the other.

China says that the villain is the West, how dare we complain about China, the solution is in our own hands, we just need to be more prudent.  But the truth, as Doctor King suggested in his speech, is that Chinese growth just wouldn’t have been possible without Western borrowing.

Doctor King said “Just as in a sudoku puzzle, the nine numbers in the table cannot be chosen independently. Sudoku for economists is simpler than ordinary sudoku because the economic adding-up constraints mean that of the nine numbers in the table, only three can be chosen independently. So, for example, if both groups of countries want to achieve full employment levels of GDP, and the high-saving group targets a trade surplus, the low-saving group cannot target a reduction in its trade deficit. Either trade deficits must remain high, which is not likely to prove sustainable, or something else must give. That might involve a recession in the deficit countries, or an acceptance by the surplus countries that, one way or another, trade imbalances must be reduced. Sudoku for economists shows that countries cannot pursue for long incompatible economic policy frameworks.”

And then he gave the warning: “Today China alone has reserves of over two trillion dollars, and Japan another trillion dollars. Adding inexorably to the stock of international assets and liabilities is like adding one brick on top of another to form a tower. With skill, it can be done for a surprisingly long time. But eventually the moment comes when adding one more causes the tower to fall down. If countries do not work together to reduce the ‘too high to last’ imbalances, a crisis of one sort or another in financial markets is only too likely.”

So what is to be done?

China is attempting to deal with the problem by channeling more of is savings into domestic capital projects. But this is leading to growing fears of a Chinese bubble.

The good Doctor looked at whether the world needs an international currency.  This is something China has been making noises about. But the problem, warned the Bank of England governor, is that the surplus country must have an incentive to reduce its surplus.

You may know, back in 1944 Keynes suggested just such a plan at Bretton Woods. He wanted to see an international currency, something he called the Bancor. In his systems the money that makes up a trade surplus would go into a kind of international bank account. Deficit countries would then borrow form this account. But, and this was the key to the Keynes plan, the country with the surplus would be penalized. In other words, the Keynes plan worked back to front from conventional banking. Surplus countries had to pay interest on their the money they held in the world’s central bank.

The US was the world’s big creditor at the time, and rejected the Keynes plan. You can understand why, the Keynes plan was deliberately structured to penalize the creditor nations.

It was a shame. Because if the US had accepted the plan today’s imbalances may never have occurred.  But for the same reason the US rejected the plan 66 years ago, China would be likely to reject a similar plan, today.

© Investment & Business News 2013