So the challenge of designing an international monetary system that could prevent the emergence of “too high to last” imbalances remains. The financial crisis has reminded us all of the importance of solving this problem. Sudoku for economists shows that it is essentially a political and not a technical problem: how can we ensure that the economic policy frameworks of countries are consistent with each other? At present there is no political mechanism for achieving that consistency. Finding such a mechanism is urgent. Having narrowed somewhat at the height of the crisis, the imbalances are now widening again. There is a risk that countries will, out of frustration, impose unilateral  BIS Review 4/2010  3  and ultimately self-defeating protectionist responses. Because the number of countries involved in the international trading system is now so large, and the countries so diverse, the idea of another Bretton Woods conference is wholly impractical. The IMF, despite the legitimacy bestowed by its membership of 186 countries, is too unwieldy without reform. The G7 omits some of the key players, such as China. Of more immediate promise is the G20 group of countries, which produces almost 90% of world GDP. Last year, under the UK Presidency, the G20 agreed to a new policy coordination framework which commits member countries to a process, using the expertise of the IMF, of assessing the consistency of their national policies. G20 Heads of Government will meet twice this year, in June and November, to discuss progress.
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. 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. 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. We saw that following the first oil crisis in the 1970s when the attempt to “recycle petrodollars”, as they were called, led to defaults by a number of emerging market economies and a crisis in western banks. And sudden shifts in capital flows have led to periods of remarkable volatility in exchange rates between the world’s major currencies, the dollar, yen and euro (and, before 1999, the deutschmark).