A recent spate of reports has warned of the dangers posed by the persistent economic imbalances between China, the US, Europe, and Japan. They only mention other countries in passing.
Some commentators have also addressed the question of exchange-rate misalignment. Some have warned of the risks of the continued decline in the value of the Chinese yuan, while others have addressed the US intervention to rescue the Japanese yen, the yen’s exchange-rate misalignment, and the motives and significance of the intervention.
But beyond these two issues lurks an even greater danger.
In its last edition, the UK magazine the Economist featured an article by Gita Gopinath and Pierre-Olivier Gourinchas, both former International Monetary Fund (IMF) chief economists, and Hélène Rey, a professor at the London Business School, titled “Don’t Blame Global Imbalances on the Undervalued Yuan.”
The exchange rate is not the problem, they argue, but is best seen as a symptom of an underlying issue. The underlying cause lies in China’s large production surplus, huge savings, restrained consumption, property investment crisis, and weak social safety net.
These factors combined have contributed to the decline in the yuan, the authors say, and they have also strengthened the competitiveness of Chinese exports, increased China’s trade surplus, and perpetuated an expanding cycle.
By contrast, the huge US fiscal deficit and its high consumption have resulted in insufficient savings. This, combined with the dollar’s international role, has driven up the value of the dollar. Remedying the savings problem in both countries would resolve the exchange-rate issue between them.
China’s recent intervention in its currency market was aimed at preventing the yuan from depreciating. It was not an attempt to artificially lower the value of the currency in order to increase the competitiveness of Chinese exports.
Trying to force China to increase the value of its currency to rectify the current imbalances would inevitably backfire. Most Chinese exports are priced in dollars, which would slow the adjustment, and it would also not reduce the country’s exports.
Washington has called for a revival of the 1985 Plaza Accord with Japan and its application to China in order to solve the problem. However, this would not succeed either, because the two situations are different.
The Plaza Accord emerged within the framework of US-Japanese cooperation, and it was shaped by political considerations that enabled the US to reduce its deficit vis-à-vis Japan to some extent. China would never accept a comparable arrangement.
However, the accord does hold an important lesson for China. As the Japanese economists Koichi Hamada and Yasushi Okada argued in a 2009 study on the monetary and international factors behind Japan’s “lost decade” of the 1990s, the agreement was beneficial to the US but disastrous for Japan.
Gopinath et al argue that the G7 group of industrialised nations and the IMF are right to adopt proposals calling for a shift from the over-emphasis on exchange-rate mechanisms and currency deals to deeper reforms. Such efforts may be less dramatic, but they would address the deeper causes of the problem, the article says.
They would enable the US to remedy its chronic fiscal deficit and low savings level, while China would be able to increase domestic demand and expand its social safety net. The Chinese people would feel more secure about the future, and this would lead to higher consumption and the automatic appreciation of the yuan.
EU member states and other countries should also take measures to strengthen their competitiveness in order to buffer their economies against shocks arising from global surpluses and imbalances, the article says.
Meanwhile, economists are continuing to examine the recent US intervention to support the Japanese yen, after it fell to its lowest level against the dollar in 40 years, despite attempts by the Japanese authorities to support it with approximately ¥12 trillion in extra funds.
US President Donald Trump described his administration’s action as a token of friendship. The financial markets understand that the real purpose was to maintain US Treasury bond yields. Had Washington not intervened, a panicking Japan, which holds more than $1.1 trillion in US securities, would likely have sold them to buy yen. This would have pushed up US bond yields, already at their highest levels since before the 2008 world financial crisis.
In order to prevent this from happening, the Federal Reserve Bank of New York sold some of its euro holdings in order to purchase yen. The markets are continuing to monitor the outcome of the two interventions to bolster the yen.
The situation is alarming, and, as Financial Times columnist Gillian Tett has observed, there is no easy way out. Japan’s debt is more than twice its GDP, while the cost of servicing it accounts for more than a quarter of public expenditure.
Conventional solutions like tightening the budget to reduce the deficit, raising interest rates to contain inflation, and selling assets, are slow and painful. Moreover, if this is the situation in Japan, it will not take investors long to find similar cases elsewhere.
Other advanced economies have similarly high levels of debt, with debt-servicing crowding out other public-spending priorities. Should this situation continue, investors and creditors will become even more cautious than they already are. One consequence of this will be higher interest rates on the grounds of rising credit risks.
This brings me to what I call the “great folly”, for “folly” seems an apt way to describe the state of the global economy, with its fragmentation and imbalances. The term conveys all the muddle-headedness, impetuousness, and carelessness that have led to this situation.
It is a condition marked by a massive and worsening debt crisis. Solutions exist to this, but the will to implement them does not. I will return to this subject in a forthcoming article.
This article also appears in Arabic in Wednesday’s edition of Asharq Al-Awsat.
* A version of this article appears in print in the 13 August, 2026 edition of Al-Ahram Weekly
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