Global imbalances could lead to a recession warns David Dodge, governor of the Bank of Canada.

In a speech to the Barbados International Business Association in Bridgetown, Barbados, today, Dodge explained that the Bank of Canada sees these imbalances, “as reflecting the financial flows associated with mismatches in savings and investment within major regions of the global economy.”

So far, global financial markets have accommodated these imbalances, “However, the sheer size of these financial flows into the United States is not sustainable indefinitely,” he said. “We know that U.S. external indebtedness — even with that country’s reserve-currency status — cannot keep growing forever. This is especially so given that this borrowing is being used mainly to finance current consumption.”

“Eventually, domestic savings in the United States will have to increase. Should that occur suddenly, we could see global economic growth slow sharply, unless there was corresponding growth in domestic demand outside the United States,” he warned. “Such a slowdown in growth, in turn, raises the risk that policy-makers might resort to protectionism. In that event, a period of very slow growth could, perhaps, be punctuated by periods of outright recession.”

Dodge insisted that he’s not predicting recession, “I am only saying that such an outcome could be the consequence of inappropriate policies in many economies. And this outcome would hurt all countries, including those that are following appropriate policies.”

To solve these imbalances in an orderly way, he suggested that countries focus on having a sustainable ratio of public debt to GDP; that domestic policies are promoting well-functioning markets for goods, services, capital, and labour; there’s a well-functioning social safety net; and, authorities everywhere also need to follow policies that help a country’s financial system to work well.

Dodge added that, “the global economy needs a commitment by all countries to a renewed international monetary order, and a willingness to play by accepted rules within this order.”

“In this context, it is also very important that all countries work to protect and enhance the free flow of goods and services by finding a way to break the stalemate at the Doha round of trade talks and by strengthening the World Trade Organization. We all need to support these efforts and to be vocal in resisting calls for protectionism,” he added.

“This does not represent a new prescription for global economic health. But the need for urgent action has increased,” Dodge stressed. “Imbalances are persisting, and if they aren’t resolved in an orderly way, we face the threat of great disruption.”