fixing global finance
TRANSCRIPT
Fixing Global FinanceMartin Wolf, Associate Editor & Chief Economics Commentator, Financial Times
Leverhulme Centre for Research on Globalisationand Economic Policy and School of Economics, Nottingham University
October 13th 2008
2
Fixing Global Finance
“Things that can’t go on forever, don’t”Herbert Stein
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Fixing Global Finance
“The current financial crisis in the US is likely to be judged in retrospect as the most wrenching since the end of the second world war.” Alan Greenspan, Financial Times, March 16th 2008
4
Fixing Global Finance
“Asia has become the source of finance, the source of savings. It now has the human capital to manage that well. Why doesn't it take the advantage of that opportunity to try and create financial markets that work better for the people of Asia?” Joseph Stiglitz.
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Fixing Global Finance
• Outline of the argument:1. The emerging market crises showed the danger of foreign currency
borrowing
2. Many emerging economies decided to self-insure and become creditor nations
3. The US and a few other high-income countries became borrowers of last resort
4. This created twin economic risks: external and internal
5. The internal risks have proved dominant, but this saga is not over
6. More emerging economies will now move into current account deficit
7. This means we need a much stronger system of global finance
6
1. Emerging market crises
• In the 1980s and 1990s, emerging market economies suffered a series of shattering foreign currency and banking crises
• These culminated in the Asian crises of 1997-98, the Russian and Brazilian crises of 1998-99 and the Argentine crisis
• A central feature of many of these crises was current account deficits, financed by short-term foreign currency borrowing
• When the crises hit, the currencies collapsed and the currency mismatches created mass bankruptcies
7
1. Emerging market crises
VALUE AGAINST THE US DOLLAR: EAST ASIA(January 1996 = 100)
0.0
20.0
40.0
60.0
80.0
100.0
120.008
/03/
1996
08/0
7/19
96
08/1
1/19
96
08/0
3/19
97
08/0
7/19
97
08/1
1/19
97
08/0
3/19
98
08/0
7/19
98
08/1
1/19
98
08/0
3/19
99
08/0
7/19
99
08/1
1/19
99
08/0
3/20
00
08/0
7/20
00
08/1
1/20
00
08/0
3/20
01
08/0
7/20
01
08/1
1/20
01
08/0
3/20
02
08/0
7/20
02
08/1
1/20
02
08/0
3/20
03
08/0
7/20
03
08/1
1/20
03
08/0
3/20
04
08/0
7/20
04
08/1
1/20
04
08/0
3/20
05
08/0
7/20
05
08/1
1/20
05
08/0
3/20
06
SOUTH KOREAN WON MALAYSIAN RINGGIT PHILIPPINE PESOINDONESIAN RUPIAH THAI BAHT
CURRENCY COLLAPSES IN THE CRISES
8
1. Emerging market crises
FOREIGN CURRENCY LIABILITIES OF THE BANKING SYSTEM(per cent of GDP)
5.9% 5.6%4.8%
12.7%
6.2%
26.8%
17.2%
9.3% 9.2%
5.6%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
Thailand Philippines South Korea Malaysia Indonesia
1992 1996
Source: Barry Eichengreen (2004)
DANGER OF FOREIGN CURRENCY LIABILITIES
9
1. Emerging market crises
THE MACROECONOMIC CONSEQUENCES OF THE ASIAN CRISIS(GDP in the year before a crisis and four subsequent years)
80.0
85.0
90.0
95.0
100.0
105.0
110.0
115.0
120.0
1 2 3 4 5 6
Indonesia 1996-2001 Korea 1996-2001Malaysia 1996-2001 Thailand 1996-2001
CONSEQUENT ECONOMIC COLLAPSES
10
1. Emerging market crises
FISCAL COST OF SOME OF THE BIG EMERGING MARKET CRISES(per cent of GDP)
55.0% 55.0%
42.0%
34.8%
30.5%28.0%
19.3%16.4%
7.0% 6.0%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
Indonesia1997-
Argentina1980-82
Chile1981-86
Thailand1997-
Turkey2000-
SouthKorea1997-
Mexico1994-97
Malaysia1997-
Philippines1998-
Russia1998-99
Source: Caprio and Klingebiel
AND HUGE FISCAL LOSSES FOR BAIL-OUTS
11
2. Rise of emerging country surpluses
• In the 2000s the emerging world moved into massive current account surplus
• This was part of the explanation for the “savings glut”and low global real interest rates pointed to, correctly, by Alan Greenspan and Ben Bernanke
• Behind the emerging savings glut were three forces:– Cut-backs of investment in countries affected by financial
crises;
– Emergence of vast Chinese surpluses; and
– Emergence of the surpluses of oil exporting countries with high oil prices.
12
2. Rise of emerging country surpluses
SAVINGS, INVESTMENT AND CURRENT ACCOUNTS OF EMERGING MARKET AND OIL-PRODUCING COUNTRIES
(per cent of GDP)
-2-10123456789
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Current Account Saving Investment
Source: IMF, World Economic Outlook, April 2007
EMERGING ECONOMIES SHIFT INTO SURPLUS
13
2. Rise of emerging country surpluses
THE GREAT IMBALANCES
RISE AND FALL OF THE GLOBAL IMBALANCES(per cent of world GDP)
-2
-1.5
-1
-0.5
0
0.5
1
1.5
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
United States Euro Area Japan Emerging Asia Oil exporters
Source: IMF, World Economic Outlook April 2008
14
2. Rise of emerging country surpluses
GLOBAL CURRENT ACCOUNT 2006 ($bn)
-$857
-$68
$131
$170
$239
$102
$511
$396
-$131
$19
-$1,000 -$800 -$600 -$400 -$200 $0 $200 $400 $600
US
UK
Western Europe, excluding UK
Japan
China
Rest of Asia
Total Asia
Fuel exporters
Rest of World
Discrepancy
Source: IMF, World Economic Outlook, April 2004, April 2007 and April 2007
Database.
US AS BORROWER OF LAST RESORT
15
2. Rise of emerging country surpluses
SURPLUS COUNTRIES 2007 ($bn)
$512
$361
$213
$185
$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
$1,600
$1,800
2007
Remaining Surplus Countries
Malaysia
Taiwan Province of China
Sweden
Singapore
Netherlands
Switzerland
Germany
Japan
China
Oil Exporters
GLOBAL SURPLUSES
16
2. Rise of emerging country surpluses
GLOBAL DEFICITS
DEFICIT COUNTRIES 2007 ($bn)
-$739
-$146
-$136
-$1,600
-$1,400
-$1,200
-$1,000
-$800
-$600
-$400
-$200
$0
Remaining Deficit CountriesRomaniaFranceTurkeyGreeceItalyAustraliaUnited KingdomSpainUnited States
17
2. Rise of emerging country surpluses
RISE OF FOREIGN CURRENCY RESERVES
GROWTH OF FOREIGN CURRENCY RESERVES ($m)
$0
$1,000,000
$2,000,000
$3,000,000
$4,000,000
$5,000,000
$6,000,000
$7,000,000
$8,000,000
Jan-9
9May
-99Sep
-99Ja
n-00
May-00
Sep-00
Jan-0
1May
-01Sep
-01Ja
n-02
May-02
Sep-02
Jan-0
3May
-03Sep
-03Ja
n-04
May-04
Sep-04
Jan-0
5May
-05Sep
-05Ja
n-06
May-06
Sep-06
Jan-0
7May
-07Sep
-07Ja
n-08
May-08
Industrial Countries Asian Developing Countries Oil Exporting countries Other Developing Countries
18
3. US becomes borrower of last resort
• US emerged as the principal borrower in the system
• This created external and internal financial deficits
• These were also promoted by the loose monetary policy, made partly in response to the savings glut
• The most important aspect of internal deficits was the huge financial deficits of US households
• These were sustained by the ability to borrow against rising housing wealth
19
3. US becomes borrower of last resort
• But the result was growing vulnerability of the US financial system to housing-related debt
• This was made worse by extremely poor regulation –indeed active encouragement of very bad lending
• It was the internal, not the external deficits, that proved the “killers”
20
3. US becomes borrower of last resort
US NET INTERNATIONAL INVESTMENT POSITION(as per cent of GDP)
-100.0%
-50.0%
0.0%
50.0%
100.0%
150.0%
200.0%
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
U.S.-owned assets abroad (with FDI valued at market prices)Foreign-owned assets in the U.S. (with FDI at market prices)Net International Investment Position Net International Investment Position (cumulative current account)
US “CHEATS” ITS CREDITORS
21
3. US becomes borrower of last resort
US DOMESTIC IMBALANCESFINANCIAL BALANCES IN THE US ECONOMY, SINCE 1990
(per cent of GDP)
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
1990-I
199
0-IV
1991-I
II 199
2-II
1993-I
199
3-IV
1994-I
II 199
5-II
1996-I
199
6-IV
1997-I
II 199
8-II
1999-I
199
9-IV
2000-I
II 200
1-II
2002-I
200
2-IV
2003-I
II 200
4-II
2005-I
200
5-IV
2006-I
II 200
7-II
2008-I
Private Financial Balance Government Financial Balance Foreign Financial Balance
22
3. US becomes borrower of last resort
HOUSEHOLDS SPENT; COMPANIES DID NOTUS HOUSEHOLD AND BUSINESS FINANCIAL BALANCES
(as per cent of GDP)
-5.0%
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
1990
-I 19
90-IV
19
91-III
19
92-II
1993
-I 19
93-IV
19
94-III
19
95-II
1996
-I 19
96-IV
19
97-III
19
98-II
1999
-I 19
99-IV
20
00-III
20
01-II
2002
-I 20
02-IV
20
03-III
20
04-II
2005
-I 20
05-IV
20
06-III
20
07-II
2008
-I
Business Financial Balance Household Financial Balance
23
3. US becomes borrower of last resort
GREAT HOUSEHOLD SPENDING BOOMPERSONAL SAVINGS AND INVESTMENT
(as per cent of GDP)
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
199
0-I
199
0-III
199
1-I
199
1-III
199
2-I
199
2-III
199
3-I
199
3-III
199
4-I
199
4-III
199
5-I
199
5-III
199
6-I
199
6-III
199
7-I
199
7-III
199
8-I
199
8-III
199
9-I
199
9-III
200
0-I
200
0-III
200
1-I
200
1-III
200
2-I
200
2-III
200
3-I
200
3-III
200
4-I
200
4-III
200
5-I
200
5-III
200
6-I
200
6-III
200
7-I
200
7-III
200
8-I
Gross Personal saving Gross Residential Investment Household Financial Balance
24
3. US becomes borrower of last resort
AND MASSIVELY INCREASED OVERALL DEBT
SECTORAL RATIOS OF US DEBT TO GDP
0.0%
20.0%
40.0%
60.0%
80.0%
100.0%
120.0%
140.0%
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Q2
Households Non-financial Business All Government Financial Sectors
25
3. US becomes borrower of last resort
AND MASSIVELY INCREASED HOUSEHOLD DEBTHOUSEHOLD DEBT AND DEBT SERVICE
(as per cent of disposable incomes)
40.0
60.0
80.0
100.0
120.0
140.0
160.0
Q180
Q181
Q182
Q183
Q184
Q185
Q186
Q187
Q188
Q189
Q190
Q191
Q192
Q193
Q194
Q195
Q196
Q197
Q198
Q199
Q100
Q101
Q102
Q103
Q104
Q105
Q106
Q107
Q108
10.0
10.5
11.0
11.5
12.0
12.5
13.0
13.5
14.0
14.5
15.0
US Household Debt US Household Debt Payments
26
3. US becomes borrower of last resort
AND MASSIVELY INCREASED HOUSEHOLD DEBT
HOUSEHOLD LIABILITIES(as per cent of disposable income)
0.0
20.0
40.0
60.0
80.0
100.0
120.0
140.0
160.0
180.0
200.0
United Kingdom United States Japan Canada Germany France Italy
1996 2006 2007
OECD Economic Outlook
27
4. Implications of the “subprime crisis”
• This episode is now at an end, as:– US house prices fall;
– housing-related debt deteriorates in quality; and
– the financial system becomes de-capitalised
• So the US is moving into export-led growth
28
4. Implications of the “subprime crisis”
BURST HOUSING BUBBLEHOUSE PRICES IN THE US (Case-Shiller 10-City Index)
0
50
100
150
200
250
Jan-8
8Ja
n-89
Jan-9
0Ja
n-91
Jan-9
2Ja
n-93
Jan-9
4Ja
n-95
Jan-9
6Ja
n-97
Jan-9
8Ja
n-99
Jan-0
0Ja
n-01
Jan-0
2Ja
n-03
Jan-0
4Ja
n-05
Jan-0
6Ja
n-07
Jan-0
8
-25
-20
-15
-10
-5
0
5
10
15
20
Real House Prices Change in Real House Prices
29
4. Implications of the “subprime crisis”
CREDIT SHOCK IN THE USDISAPPEARANCE OF THE COMMERCIAL PAPER MARKET
0
500,000
1,000,000
1,500,000
2,000,000
2,500,000
30/0
8/20
06
30/0
9/20
06
30/1
0/20
06
30/1
1/20
06
30/1
2/20
06
30/0
1/20
07
28/0
2/20
07
30/0
3/20
07
30/0
4/20
07
30/0
5/20
07
30/0
6/20
07
30/0
7/20
07
30/0
8/20
07
30/0
9/20
07
30/1
0/20
07
30/1
1/20
07
30/1
2/20
07
30/0
1/20
08
29/0
2/20
08
30/0
3/20
08
30/0
4/20
08
30/0
5/20
08
30/0
6/20
08
30/0
7/20
08
Asset-backed Commercial Paper Financial Commercial Paper OutstandingNonfinancial Commercial Paper Outstanding
30
4. Implications of the “subprime crisis”
CREDIT SHOCK IN THE US
SPREADS BETWEEN TREASURY BILL AND COMMERCIAL PAPER RATES IN THE US
(percentage points)
0
1
2
3
4
5
6
7
01/0
9/20
06
01/1
0/20
06
01/1
1/20
06
01/1
2/20
06
01/0
1/20
07
01/0
2/20
07
01/0
3/20
07
01/0
4/20
07
01/0
5/20
07
01/0
6/20
07
01/0
7/20
07
01/0
8/20
07
01/0
9/20
07
01/1
0/20
07
01/1
1/20
07
01/1
2/20
07
01/0
1/20
08
01/0
2/20
08
01/0
3/20
08
01/0
4/20
08
01/0
5/20
08
01/0
6/20
08
01/0
7/20
08
01/0
8/20
08
01/0
9/20
08
US 3 mth Treasury bill yield (%) US A2/P2 non-financial 90 day yield (%) Spread
31
4. Implications of the “subprime crisis”
RISK SPREADS ON US CORPORATE BONDS(percentage points over Treasuries)
0
500
1000
1500
2000
2500
3000
30/0
9/20
02
30/1
2/20
02
30/0
3/20
03
30/0
6/20
03
30/0
9/20
03
30/1
2/20
03
30/0
3/20
04
30/0
6/20
04
30/0
9/20
04
30/1
2/20
04
30/0
3/20
05
30/0
6/20
05
30/0
9/20
05
30/1
2/20
05
30/0
3/20
06
30/0
6/20
06
30/0
9/20
06
30/1
2/20
06
30/0
3/20
07
30/0
6/20
07
30/0
9/20
07
30/1
2/20
07
30/0
3/20
08
30/0
6/20
08
30/0
9/20
08
BBB rated B rated C rated
RISE OF RISK PERCEPTIONS
32
4. Implications of the “subprime crisis”
DEMAND DRIVERS OF US GROWTH
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
Q1 01
Q3 01
Q1 02
Q3 02
Q1 03
Q3 03
Q1 04
Q3 04
Q1 05
Q3 05
Q1 06
Q3 06
Q1 07
Q3 07
Q1 08
Domestic demand Net exports GDP (yoy%)
US EXPORT-LED GROWTH
33
4. Implications of the “subprime crisis”
• At present the risk is almost entirely on the internal side, which the US can manage, because it borrows in its own currency
• But there is also a risk on the external side:– What if creditors decide they are losing too much?
– What if there is a panic sale of dollars
• Then the US may only be able rescue the financial system by an inflationary default and possible collapse of the dollar standard
• So external vulnerability is also an issue
34
4. Implications of the “subprime crisis”
FALLING REAL EXCHANGE RATE FOR THE US
60
70
80
90
100
110
120
130
Jan-
70
Jan-
72
Jan-
74
Jan-
76
Jan-
78
Jan-
80
Jan-
82
Jan-
84
Jan-
86
Jan-
88
Jan-
90
Jan-
92
Jan-
94
Jan-
96
Jan-
98
Jan-
00
Jan-
02
Jan-
04
Jan-
06
Jan-
08
IT’S MANAGEABLE – SO FAR
35
5. Need for adjustment in emerging economies
• This big US adjustment is compatible with global growth only if other countries have smaller surpluses or bigger deficits
• Oil exporters have a good reason to run big surpluses, because they are shifting one asset into another, though the IMF does expect them to spend more
• But non-oil exporters also need to reduce current account surpluses or increase deficits
• This means they must spend more relative to incomes
• China is the most important single case
36
6. Role of reforms in global finance
• So how are emerging countries to run current account deficits safely?
• The answer is that the external finance must itself be relatively stable
• There are three solutions:`– Equity investment (FDI and portfolio);
– Local currency bonds; or
– More collective insurance – e.g. via the IMF
• The development of local-currency bond markets shifts a potentially lethal risk onto foreign investors
37
6. Role of reforms in global finance
• Of course, the development of local currency finance also depends on:– A sustainable fiscal position
– A sound currency
– A well-regulated financial system
– Openness to foreign investors
• Without these qualities local currency finance will fail, for both domestic residents and foreigners
• Countries that cannot generate such conditions need exchange controls
38
6. Role of reforms in global finance
EMERGING MARKET BONDS OUTSTANDING ($bn)
$287$498 $618
$534
$1,312
$43
$369
$875
$2,640
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
$4,000
$4,500
1995 2000 2005
International Domestic Public Domestic Private
Source: "Financial stability and local currency bond markets", BIS, June 2007
RISE OF DOMESTIC CURRENCY FINANCING
39
7. Conclusion
• The financial crisis is far worse than I had expected
• Moreover, interestingly, it is far more related to internal, rather than external, imbalances
• This may not remain the case indefinitely, however
• The reduction in the internal imbalances depends on reducing the external imbalances, while maintaining global economic growth
• This depends on big changes in the rest of the world and reforms in the global financial system
40
7. Conclusion
• These changes include:– Much more local currency finance
– Bigger collective insurance systems
– More co-operative management of the system