Globalization and its Disconnects : The Trading System Under Financial Volatility

The early years of the global recovery from the bout of emerging market crises of the late 1990s and the bursting of the internet/technology bubble in 2000-2001 were marked by abnormal macroeconomic conditions. Ken Rogoff, then Chief Economist of the IMF, introduced the IMF's Fall 2003 World Economic Outlook with the following words: "For the first time in a very long time we are reasonably optimistic about seeing a return to normal growth in the global economy, or perhaps even better." This paper argues that, from the perspective of October 2003, the global economy is only midway through a major sequence of adjustments triggered by the Asian Crisis in 1997. It argues that volatility witnessed during the crises is endogenous to the global system of trade, finance and exchange rates and identifies five apparent anomalies or "disconnects" that create uncertainty and the scope for further volatility in the future: (a) the perception that US external deficits cannot continue forever (in Herbert Stein's famous words, "What can't go on forever will stop") juxtaposed with the current conventional forecast that the deficits will not only continue into the medium term but will widen; (b) the conundrum that the "market" exchange rate that might emerge for China's RMB if that currency were floated might be higher (based on foreign exchange accumulation), might be little changed (based on absence of inflation and a declining current account surplus), or might be lower (based on potential capital flight from China as holders of RMB-deposits seek to avoid holding the bag for the bad loans in China's banking system); (c) there is no clear direction of movement for the euro and yen versus the US dollar that at once helps resolve global imbalances and serves to align the real side of these two economies with global prices so that they too can contribute to the global recovery; (d) the adjustments which the global economic system requires to return to "normal" now depend on generalized development; yet during the life of the current global “non-system”, it has not proved itself conducive to the kind of income convergence required; (e) for a trading nation like Canada, the uncertainty translates in widely divergent perspectives on future trends - for example, where forecasters are expecting currency appreciation, forward spot rates predict depreciation, over every time horizon