IMEN Letter August 2026 #2: Global Imbalances and Exchange Rates

Growing global imbalances have almost always given rise to debate and controversy. In principle, current account imbalances are normal and even desirable, as long as they do not become too large. They reflect international trade and capital flows and allow a country to invest more or less than it saves domestically, something that matters, for example, in the context of demographic change.

Having narrowed after the global financial crisis, imbalances have widened again in the 2020s. China stands out. Its current account surplus reached around 4% of GDP in 2025. The headline ratio, however, understates the picture. On customs data, China’s goods surplus is now around USD 1.2 trillion (roughly 6% of Chinese GDP). Since China changed its balance-of-payments methodology in 2022, customs and balance-of-payments figures have diverged noticeably, so that the measurement of the surplus has itself become part of the dispute. Apart from China, South Korea and Taiwan also show large current account surpluses.

The United States, meanwhile, continues to run persistent deficits. The euro area records a surplus, but a shrinking one: 1.7% of GDP in 2025, down from 2.7% in 2024. Germany contributes the bulk of it, with a surplus of 4.5% of GDP in 2025, certainly large, though well below the peak of almost 9% reached in the middle of the last decade. Ireland also runs large current‑account surpluses, but it is a special case, largely driven by U.S. multinationals, particularly pharmaceutical companies.

The current debate about China’s surplus is not purely economic; it is also shaped by geoeconomic considerations. Europe aims to reduce its dependence on China and sees its industries threatened by Chinese imports. That concern is visible in the euro area’s own external accounts. The ECB identifies growing competition from China as one factor behind the narrowing of the euro area surplus, although changes in services trade and income flows were quantitatively more important.

Criticism of China’s surpluses must therefore be read together with what is now often called the second China shock. Unlike the original episode after China’s WTO accession, which was felt mainly in labor-intensive manufacturing, Chinese producers today compete with European firms across a far wider range of sectors, including the automotive industry, and European companies often cannot match Chinese prices. Part of the explanation lies in state subsidies and in cheap credit from state-linked banks and enterprises; part of it lies in weak domestic demand in China, which has depressed producer prices and turned excess capacity outward.

China is a country of stark contrasts. On the one hand, it is a high-tech economy that increasingly competes with Western producers across a wide range of goods. On the other, it is a country with many people on low incomes and limited social protection. It is also a country struggling with a protracted real-estate crisis that is weighing on potential growth and feeding deflationary tendencies. That crisis is not a separate story from the external accounts: with households still saving heavily and investment in property collapsing, domestic demand absorbs less of what China produces, and the difference shows up as a current account surplus.

A purely economic approach, one that abstracts from geopolitical considerations, would suggest that the Chinese government should aim for a higher wage share and an expansion of social benefits in order to reduce the savings rate and, with it, the surplus. This is the kind of recommendation large international organisations make when they focus on overall welfare, and it is broadly the agenda Beijing has itself endorsed rhetorically for more than a decade. Implementation has been another matter: the structure of fiscal federalism and the debt burden of local governments stand in the way of a durable shift towards household consumption.

Adjustment on the deficit side is no less demanding. The US external deficit partly reflects a low domestic savings rate and persistent fiscal deficits. A meaningful correction of global imbalances would require action in both the United States and China.

From a geopolitical perspective, in any case, the rebalancing agenda is unlikely to change the situation fast enough for governments that are under political pressure. A more immediate, though politically and economically difficult, adjustment mechanism would be an appreciation of the Chinese currency: the undervaluation of the renminbi is probably somewhere between 15 and 20%.

This raises the question of whether China would have any interest in a significant appreciation. China is unlikely to welcome a significant appreciation, since it would reinforce deflationary pressures and weaken the competitiveness of Chinese exporters.

Given weakened international institutions and elevated geopolitical tensions, we will probably have to live with these imbalances for some time. But the question remains how they will eventually be resolved: through a disorderly adjustment in China as excess capacity meets closing export markets; through renewed financial stress in deficit countries; or through a further escalation of trade restrictions that reduces the imbalance by fragmenting the trading system rather than by correcting the underlying saving and investment behaviour.