Mervyn King, the Governor of the Bank of England, gave a speech at the University of Exeter this week. He uses an example of “Sudoku for Economists” (pdf file, 47 kB) to illustrate why the mess the world economy is in is unlikely to get any better. He produces a small 9-celled “sudoku table”, to illustrate that the high-saving countries (e.g. China, Japan) and the low-saving countries (USA, UK, Spain) are dependent on the choices the other group of countries make:

Sudoku for economists shows that countries cannot pursue for long incompatible economic policy frameworks.

The reason why continuing large deficits are not sustainable indefinitely is that for every current account deficit there is an equal net capital flow in the opposite direction. Even if those flows remain constant in size, they imply an ever increasing stock of international asset and liability positions. Today China alone has reserves of over two trillion dollars, and Japan another trillion dollars…

The problem being, as Keynes said at the Bretton Woods Conference in 1944:

The process of adjustment is compulsory for the debtor and voluntary for the creditor. If the creditor does not choose to make, or allow, his share of the adjustment, he suffers no inconvenience. For whilst a country’s reserve cannot fall below zero, there is no ceiling which sets an upper limit.

King proposes that the G20 countries, who between them produce 90% of the global GDP, should work closely together to coordinate the reduction of global trade imbalances.

However, looking at the level of trust and support the member states in the EU are currently prepared to give each other, I think that is a non-starter. You have Portugal, Ireland, Italy Greece and Spain (the PIIGS), who need to reduce government debt on the one hand and the comparatively strong economies, in particular Germany, on the other. The citizens of the PIIGS are likely to erupt in civil unrest as the pain of even partially addressing their need to reduce government spending is felt (there has already been unrest in Greece), and the German finance minister has reacted strongly against suggestions that Germany should help these countries. Germany is in a better position, but that is only a relative position. Germany also needs to balance its books and the government sees looming difficulties maintaining the standard of living that its citizens expect. Politicians’ main goal is to get re-elected every 4-5 years, so they have no motivation to upset their voters with tough government saving or giving financial help to other nations.

If close neighbours can’t pull together, the chance that the USA, China, Britain, India, Germany, Turkey and Japan (to name some of the G20 members) will agree to pull together to correct economic imbalance seems remote.

We have just seen how little common ground could be found to deal with the potentially catastrophic changes looming as a result of climate change.

The speech is quite short, worth reading, and contains some thought-provoking comments. But I don’t feel optimistic that his suggestion will be followed. Unfortunately he rates other alternatives that have already been mooted as even less likely to succeed. Not encouraging.