Belfer Center Economics Seminar Series, Harvard Harvard Kennedy SchoolKennedy School :

Lessons from the Current Crisis Belfer Center Library, 3-4:30 p.m.,May 4, 20092009

Jeffrey FrankelJeffrey Frankel

How do we know this will not be another Great

Depression?

2

Origins of the crisisOrigins of the crisis Well before 2007, Well before 2007,

there were danger signals there were danger signals in US:in US: Real interest rates <0 , Real interest rates <0 ,

2003-04 ; 2003-04 ; Early corporate scandals Early corporate scandals

(Enron (Enron 20012001…);…);

Risk was priced very low, Risk was priced very low,

housing prices very high, housing prices very high, National Saving very low,National Saving very low, current account deficit big,current account deficit big, leverage high,leverage high, mortgages imprudent…mortgages imprudent…

3

US real interest rate < 0, US real interest rate < 0, 2003-042003-04Source: Benn Steil, CFR, March 2009

Real interest Real interest rates <0 rates <0

4

Six root causes of financial Six root causes of financial crisiscrisis

1. US1. US corporate governance falls corporate governance falls shortshort E.g., rating agencies; E.g., rating agencies; executive compensationexecutive compensation … …

options; options; golden parachutes…golden parachutes…

2. US households save too little,2. US households save too little, borrow too much.borrow too much.

3.3. Politicians slant excessively Politicians slant excessively toward toward homeownershiphomeownership

Tax-deductible mortgage interest, cap.gains; Tax-deductible mortgage interest, cap.gains; FFannieannieMMae & Freddie Macae & Freddie Mac; ; Allowing teasers, Allowing teasers, NINJANINJA loans, liar loans… loans, liar loans…

MSN Money & Forbes

5

Six root causes of financial crisis,Six root causes of financial crisis, cont.cont.

4. Starting 2001, the 4. Starting 2001, the federal budgetfederal budget was set on a reckless path,was set on a reckless path,

reminiscent of 1981-1990reminiscent of 1981-1990

5. Monetary policy was too loose 5. Monetary policy was too loose during 2004-05,during 2004-05,

accommodating fiscal expansion,accommodating fiscal expansion, reminiscent of the Vietnam era.reminiscent of the Vietnam era.

6. Financial market participants during 6. Financial market participants during this period grossly this period grossly underpriced risk.underpriced risk. Possible risks were: Possible risks were:

housing crash, housing crash, $ crash, $ crash, oil prices, oil prices, geopolitics….geopolitics….

6

Monetary policy easy

2004-05

Federal budget deficits

Underestimated

risk in financial mkts

Failures of corporate

governance

Households saving too little, borrowing too

much

Excessive leverage in financial institutions

Stockmarketbubble

Housing

bubble

Stock marketcrash

HousingcrashFinancial

crisis2007-08

China’s growth

Low national saving

Lower long-term

econ.growth

Eventual loss of US hegemony

Recession2008-09

Oil price spike2007-08

Gulfinsta-bility

Foreign debt

Origins of the financial/economic Origins of the financial/economic crisescrises

Excessive complexity

CDSsMBSs

CDOs

Predatory lending

Homeownership bias

7

The return of KeynesThe return of Keynes

Keynesian truths abound todayKeynesian truths abound today:: Origins of the crisisOrigins of the crisis The Liquidity TrapThe Liquidity Trap Fiscal responseFiscal response Motivation for macroeconomic Motivation for macroeconomic

intervention:intervention:to save market microeconomicsto save market microeconomics

International transmissionInternational transmission Need for coordinated expansionNeed for coordinated expansion

8

The origin of the crisis was an asset bubble The origin of the crisis was an asset bubble collapse, loss of confidence, credit crunch….collapse, loss of confidence, credit crunch….

like Keynes’ animal spirits or beauty contestlike Keynes’ animal spirits or beauty contest . . Add in von Hayek’s credit cycle, Add in von Hayek’s credit cycle, KindlebergerKindleberger78 78 ’s “manias & panics”’s “manias & panics” the “Minsky moment,” the “Minsky moment,” & Fisher’s “debt deflation.”& Fisher’s “debt deflation.”

The origin this time was The origin this time was notnot a monetary a monetary contraction contraction in response to inflationin response to inflation as were 1980-82 or 1991.as were 1980-82 or 1991.

But, rather, a credit cycle: 2003-04 monetary But, rather, a credit cycle: 2003-04 monetary expansion showed up only in asset prices. expansion showed up only in asset prices. (Borio (Borio

of BIS.)of BIS.)

9

Onset of the crisisOnset of the crisis Initial reaction to troubles:Initial reaction to troubles:

Reassurance in mid-2007: “The subprime Reassurance in mid-2007: “The subprime mortgage crisis is contained.” mortgage crisis is contained.” It wasn’t.It wasn’t.

Then, “The crisis is on Wall Street; Then, “The crisis is on Wall Street; it may spare Main Street.” it may spare Main Street.” It didn’t.It didn’t.

Then Then de-couplingde-coupling : : “The US turmoil will have less effect on the “The US turmoil will have less effect on the rest rest of the world than in the past.” of the world than in the past.” It hasn’t.It hasn’t.

By now it is clear that the crisis is By now it is clear that the crisis is the worst in 75 years, the worst in 75 years, and is as bad abroad as in the US.and is as bad abroad as in the US.

10

Bank spreads rose sharplyBank spreads rose sharplywhen sub-prime mortgage crisis hit (Aug. when sub-prime mortgage crisis hit (Aug.

2007) 2007) and up again when Lehman crisis hit (Sept. and up again when Lehman crisis hit (Sept.

2008).2008).

Source: OECD Economic Outlook

(Nov. 2008).

11

Corporate spreadsCorporate spreads between corporate & government between corporate & government

benchmark bondsbenchmark bonds zoomed after zoomed after Sept. 2008Sept. 2008

US

€

12

US RecessionUS Recession

The US recession started in December 2007 The US recession started in December 2007 according to the NBER Business Cycle according to the NBER Business Cycle Dating Committee Dating Committee (announcement of Dec. 2008)(announcement of Dec. 2008) . .

As of April 29, 2009, the recession’s length As of April 29, 2009, the recession’s length tied tied thethe postwar records of 1973-75 & 1981-82 postwar records of 1973-75 & 1981-82 = 4 quarters; 16 months= 4 quarters; 16 months One has to go back to 1929-33 for a longer One has to go back to 1929-33 for a longer

downturn.downturn.

Likely also to be also as severe Likely also to be also as severe as oil-shock as oil-shock recessions of 1973-75 and 1980-82, though not yetrecessions of 1973-75 and 1980-82, though not yet..

13

BUSINESS CYCLE REFERENCE DATESBUSINESS CYCLE REFERENCE DATES   Source: NBERSource: NBER

PeakPeak TroughTrough ContractioContractionn

Quarterly dates are in parenthesesQuarterly dates are in parentheses Peak to TroughPeak to Trough

August 1929 (III)August 1929 (III)May 1937 (II)May 1937 (II)February 1945 (I)February 1945 (I)November 1948 (IV)November 1948 (IV)July 1953 (II)July 1953 (II)August 1957 (III)August 1957 (III)April 1960 (II)April 1960 (II)December 1969 (IV)December 1969 (IV)November 1973 (IV)November 1973 (IV)January 1980 (I)January 1980 (I)July 1981 (III)July 1981 (III)July 1990 (III)July 1990 (III)March 2001March 2001 (I) (I)December 2007December 2007 (IV) (IV)

March 1933 (I)March 1933 (I)June 1938 (II)June 1938 (II)October 1945 (IV)October 1945 (IV)October 1949 (IV)October 1949 (IV)May 1954 (II)May 1954 (II)April 1958 (II)April 1958 (II)February 1961 (I)February 1961 (I)November 1970 (IV)November 1970 (IV)March 1975 (I)March 1975 (I)July 1980 (III)July 1980 (III)November 1982 (IV)November 1982 (IV)March 1991March 1991 (I) (I)November 2001November 2001 (IV) (IV)

434313138811111010881010111116166616168888

Average, all cycles:Average, all cycles: 1854-2001 (32 cycles) 1854-2001 (32 cycles)

1945-2001 (10 cycles)1945-2001 (10 cycles)

  

1717

1010

14

US employment peaked in Dec. 2007,which is the most important reason why

the NBER BCDC dated the peak from that month.

Since then, 5 million jobs have been lost (4/3/09).

Payroll employment series Source: Bureau of Labor StatisticsPayroll employment series Source: Bureau of Labor Statistics

15

My favorite monthly indicator:My favorite monthly indicator:total hours worked in the total hours worked in the

economyeconomy

It confirms: US recession turned severe in September, when the worst of the financial crisis hit (Lehman bankruptcy…)

16

The The US recessionUS recession so far is so far is deep,deep,

Source: IMF, Source: IMF, WEOWEO, April 2009, April 2009

compared to compared to pastpast

and to and to others’others’

17

Recession was soon Recession was soon transmittedtransmitted

to rest of world: to rest of world: Contagion: Falling securities Contagion: Falling securities

markets & contracting credit.markets & contracting credit. Especially in those countries with weak fundamentals: Especially in those countries with weak fundamentals:

Iceland, Hungary & Ukraine…Iceland, Hungary & Ukraine… Or oil-exporters that relied heavily on high oil prices: Russia…Or oil-exporters that relied heavily on high oil prices: Russia… & even where fundamentals were relatively strong: Brazil, & even where fundamentals were relatively strong: Brazil,

Korea…Korea…

Some others are experiencing their own housing Some others are experiencing their own housing crashes:crashes: Ireland, Spain…Ireland, Spain…

Recession in big countries has been transmitted Recession in big countries has been transmitted to all trading partners through loss of exports.to all trading partners through loss of exports.

18

Source: OECD

International Trade has Plummeted

19

The recession has hit more The recession has hit more countries than any in 60 countries than any in 60

yearsyears

20

Unemployment rates are rising Unemployment rates are rising everywhereeverywhere

21

Forecasts

22

Interim forecastInterim forecast OECD OECD 3/13/093/13/09

Forecastfor 2009 = - 3 ½ %

23

IMF, too, forecasts 2009 as IMF, too, forecasts 2009 as sharpest downturnsharpest downturn

Source: Source: WEOWEO,,April 2009April 2009

24

““WorldWorld Recession” Recession”

No generally accepted definition.No generally accepted definition. A sharp fall in China’s growth from 11% is a A sharp fall in China’s growth from 11% is a

recession. recession. Usually global growth < 2 % is considered a Usually global growth < 2 % is considered a

recession.recession.

The World Bank The World Bank (March)(March) now forecasts now forecasts negative global growth in 2009,negative global growth in 2009, for the first time in 60 years.for the first time in 60 years. So does the IMF So does the IMF (April) when GDPs compared at current exchange rates.(April) when GDPs compared at current exchange rates.

25

U.S. output lost in the current U.S. output lost in the current downturndownturn

Source: Federal Reserve Bank of St. Louis

would still have a very long way would still have a very long way to goto go

before reaching the depth of the before reaching the depth of the 1930s...1930s...

26

……but, by at least one measure, the but, by at least one measure, the world is world is

on track to match the Great on track to match the Great Depression !Depression !

Industrial productionSource: George Washington’s blog

27

especially considering that especially considering that successive forecasts of the successive forecasts of the current episode have been current episode have been repeatedly over-optimistic?repeatedly over-optimistic?

How do we know this will

not be another Great Depression?

The usual answer: we The usual answer: we learned important lessons learned important lessons from the 1930s, and we from the 1930s, and we won’t repeat the mistakes won’t repeat the mistakes we made then.we made then.

28

One One hopeshopes we won’t repeat the 1930s we won’t repeat the 1930s mistakes.mistakes.

Monetary response: good this timeMonetary response: good this time

Financial regulation: we already have bank Financial regulation: we already have bank regulation regulation to prevent runs. But it is clearly not to prevent runs. But it is clearly not enough.enough.

Fiscal response: OK, Fiscal response: OK, but but : : constrained constrained by inherited debt. Also Europe wasby inherited debt. Also Europe wasunwilling to match our fiscal stimulus at G-20 unwilling to match our fiscal stimulus at G-20 summit.summit.

Trade policy:Trade policy: Let’s not repeat Smoot-Hawley ! Let’s not repeat Smoot-Hawley ! E.g., the Buy America provisionE.g., the Buy America provision Mexican trucksMexican trucks

29

U.S. Policy U.S. Policy ResponsesResponses

MonetaryMonetary easingeasing is is unprecedented, unprecedented, appropriately avoiding the mistake of appropriately avoiding the mistake of 1930s. 1930s. (graph)(graph) But it has largely run its course: But it has largely run its course:

Policy interest rates ≈ 0.Policy interest rates ≈ 0. (graph)(graph)

The famous liquidity trip is not mythical after all.The famous liquidity trip is not mythical after all. & lending, even inter-bank, builds in big spreads. & lending, even inter-bank, builds in big spreads.

Now we have aggressive quantitative easing: Now we have aggressive quantitative easing: the Fed continues to purchase assets not the Fed continues to purchase assets not previously dreamt of.previously dreamt of.

30

The Fed certainly has The Fed certainly has not not repeated repeated the mistake of 1930s: letting the the mistake of 1930s: letting the

money supply fall.money supply fall.

SourcSource: e:

IMF, IMF, WEOWEO, , April April 20092009Box Box 3.13.1

1930s

2008-09

31

Source: OECDMajor central banks have cut interest Major central banks have cut interest rates sharply.rates sharply.

32

Policy Responses,Policy Responses, continuedcontinued

Obama policy of Obama policy of “financial repair”:“financial repair”:Infusion of funds is more conditional,Infusion of funds is more conditional,

vs. Bush Administration’s no-strings-attached. vs. Bush Administration’s no-strings-attached. Some money goes to reduce foreclosures.Some money goes to reduce foreclosures. Conditions imposed on banks that get help:Conditions imposed on banks that get help:

(1) no-dividends rule,(1) no-dividends rule, (2) curbs on executive pay, (2) curbs on executive pay, (3) no takeovers, unless at request of authorities &(3) no takeovers, unless at request of authorities & (4) more reporting of how funds are used.(4) more reporting of how funds are used.

Enough to make some banks balk at keeping the Enough to make some banks balk at keeping the funds.funds.

But so far we have avoided “nationalization” of But so far we have avoided “nationalization” of banksbanks

33

Secretary Geithner announced PPIP 3/23/09: Secretary Geithner announced PPIP 3/23/09: Public-Private Partnership Investment Public-Private Partnership Investment ProgramProgram When buying “toxic” or “legacy assets” When buying “toxic” or “legacy assets” from

banks, their prices are to be set by private bidding

(from  private equity, hedge funds, and others),

rather than by an overworked Treasury official pulling

a number out of the air and risking that taxpayers grossly overpay for the assets, as under TARP.  

Policy Responses -- Financial Policy Responses -- Financial

Repair,Repair, cont.cont.

34

The PPIP was attacked from The PPIP was attacked from both sidesboth sides

in part due to anger over AIG bonuses, etc.in part due to anger over AIG bonuses, etc.

FT, Mar 25, 2009

35

Desirable longer-term financial reformsDesirable longer-term financial reforms

Executive compensationExecutive compensation Compensation committee not under CEO. Maybe need Chairman Compensation committee not under CEO. Maybe need Chairman

of Board.of Board. Discourage golden parachutes & options, unless truly tied to Discourage golden parachutes & options, unless truly tied to

performance.performance. SecuritiesSecurities

Regulatory agencies:Regulatory agencies: M Merge SEC & CFTC?erge SEC & CFTC? Create a central clearing house for Create a central clearing house for CDSsCDSs . . Credit ratings: Credit ratings:

Reduce reliance on ratings: AAA does not mean no risk.Reduce reliance on ratings: AAA does not mean no risk. Reduce ratings agencies’ conflicts of interest.Reduce ratings agencies’ conflicts of interest.

LendingLending MortgagesMortgages

Consumer protection, including standards for mortgage brokersConsumer protection, including standards for mortgage brokers Fix “originate Fix “originate to to distribute” model, so lenders stay on distribute” model, so lenders stay on the the hook.hook.

Banks: Banks: Regulators shouldn’t let banks use their own risk modelsRegulators shouldn’t let banks use their own risk models;; should make capital requirements less pro-cyclical .should make capital requirements less pro-cyclical .

Extend bank-like regulation to “Extend bank-like regulation to “near banksnear banks.”.”

36

Policy Responses,Policy Responses, continuedcontinued

Unprecedented $800 b Unprecedented $800 b fiscal fiscal stimulusstimulus.. Good old-fashioned Keynesian stimulusGood old-fashioned Keynesian stimulus

Even the principle that spending provides more Even the principle that spending provides more stimulus than tax cuts has returned;stimulus than tax cuts has returned;

not just from Larry Summers, e.g., not just from Larry Summers, e.g., but also from Martin Feldstein.but also from Martin Feldstein.

Is $800 billion too small? Too big?Is $800 billion too small? Too big? Yes: Too small to knock out recession ;Yes: Too small to knock out recession ; too big to keep global investors confident inUS too big to keep global investors confident inUS

debt.debt. I.e., just about right.I.e., just about right.

37

Fiscal responseFiscal response“Timely, targeted and “Timely, targeted and

temporary.”temporary.”

American Recovery & Reinvestment Plan American Recovery & Reinvestment Plan includes:includes:

Aid to states: Aid to states: education, education, Medicaid…; Medicaid…;

Other spending.Other spending. Unemployment benefits, food stamps,Unemployment benefits, food stamps, especially infrastructureespecially infrastructure, and, and

Computerizing medical records, Computerizing medical records, smarter electricity distribution grids, andsmarter electricity distribution grids, and high-speed Internet access.high-speed Internet access.

38

Fiscal stimulus also included tax cuts: Fiscal stimulus also included tax cuts: for lower-income workers (“Making Work Pay”)for lower-income workers (“Making Work Pay”)

EITC, EITC, refundable child tax credit.refundable child tax credit.

Fix for the AMT Fix for the AMT (for the middle class).(for the middle class).

Soon we must return toward fiscal discipline.Soon we must return toward fiscal discipline. Let Bush’s pro-capital tax cuts expire in 2011.Let Bush’s pro-capital tax cuts expire in 2011.

The budget passed by Congress omitted The budget passed by Congress omitted some of the best features proposed by some of the best features proposed by Obama:Obama: Cuts in farm subsidies for agribusiness & farmers > $250 Cuts in farm subsidies for agribusiness & farmers > $250

millionmillion Auctioning of GHG emission permits in future,Auctioning of GHG emission permits in future,

with revenue used, e.g., to cut taxes on low-income workers.with revenue used, e.g., to cut taxes on low-income workers.

39

International International coordination coordination of fiscal expansion?of fiscal expansion?

As in the classic Locomotive TheoryAs in the classic Locomotive Theory

Theory:Theory: in the non-cooperative equilibrium, each in the non-cooperative equilibrium, each country holds back fiscal expansion for country holds back fiscal expansion for fear of trade deficits.fear of trade deficits. Classic prisoner’s dilemma of NashClassic prisoner’s dilemma of Nash Solution: Solution:

A bargain where all expand together.A bargain where all expand together.

40

The Locomotive Theory in The Locomotive Theory in PracticePractice

The example of G-7 Bonn Summit, 1978The example of G-7 Bonn Summit, 1978 didn’t turn out so well: didn’t turn out so well:

inflation turned out to be a bigger problem than inflation turned out to be a bigger problem than realized realized

& the German world was non-Keynesian.& the German world was non-Keynesian. Inflation is less a problem this time; Inflation is less a problem this time;

the Germans are the same.the Germans are the same.

Coordinated expansion failed Coordinated expansion failed at G-20 Summit in London, this April.at G-20 Summit in London, this April.

As had cooperation in 1933As had cooperation in 1933 (London Monetary & Economic (London Monetary & Economic Conference)Conference)

41

USfiscal

stimulus

looks the

largest of

the G-10.

than the USBut others point out that they have larger automatic stabilizers

42

Expansion of the IMFExpansion of the IMF Tripling of size of IMF quotas. Tripling of size of IMF quotas. New issue of SDRs New issue of SDRs (a la Keynes)(a la Keynes)

More inclusion of developing countriesMore inclusion of developing countries Eventually: Eventually:

Reallocation of voting shares in IMF and World Bank?Reallocation of voting shares in IMF and World Bank? Break US-EU duopoly on MD & President?Break US-EU duopoly on MD & President?

Locus shifted from G7 to G20 at London meetingLocus shifted from G7 to G20 at London meeting..

Regulatory reform? Still to come. Regulatory reform? Still to come. Reduce procyclical Basel capital requirements; FSB; Reduce procyclical Basel capital requirements; FSB;

….….

Hold the line against protectionism? Not Hold the line against protectionism? Not yet clear.yet clear.

But G-20 Summit did accomplish But G-20 Summit did accomplish some thingssome things

43

Motivation for macroeconomic Motivation for macroeconomic interventionintervention

The view that Keynes stood for The view that Keynes stood for big government is not really right.big government is not really right. He wanted to save market microeconomics from He wanted to save market microeconomics from

central planning, which had allure in the 30s & 40s.central planning, which had allure in the 30s & 40s.

Some on the Left today reacted to the crisis & Some on the Left today reacted to the crisis & election by hoping a new New Deal would election by hoping a new New Deal would overhaul the economy.overhaul the economy. My view: faith in the unfettered capitalist system My view: faith in the unfettered capitalist system

has been shaken has been shaken with respect to financial markets, true; with respect to financial markets, true; but not with respect to the rest of the economy; but not with respect to the rest of the economy;

Obama’s economics are centrist, not far left.Obama’s economics are centrist, not far left.

44

Bottom line of Bottom line of macroeconomic policy macroeconomic policy

response:response: A good guess is that the monetary and A good guess is that the monetary and

fiscal response we have seen so far have fiscal response we have seen so far have been sufficient to halt the economic been sufficient to halt the economic free-fall, so that the steep rate of free-fall, so that the steep rate of decline will level off in the 2decline will level off in the 2ndnd half of half of this year.this year.

It won’t be enough to return us rapidly It won’t be enough to return us rapidly to full employment and potential output.to full employment and potential output.

Given the path of debt that was Given the path of debt that was inherited in 2009, it is unlikely that inherited in 2009, it is unlikely that more could be done.more could be done.

45

The The nextnext crisis crisis

The twin deficits:The twin deficits: US budget deficit => current account deficitUS budget deficit => current account deficit

Until now, global investors have happily financed US Until now, global investors have happily financed US deficits.deficits.

The recent flight to quality paradoxically benefited The recent flight to quality paradoxically benefited the $,the $, even though the international financial crisis originated in the even though the international financial crisis originated in the

US.US. For now, US TBills are still viewed as the most liquid & riskless.For now, US TBills are still viewed as the most liquid & riskless.

Sustainable?Sustainable? Can the US rely on support of foreign central banks indefinitely ?Can the US rely on support of foreign central banks indefinitely ?

46

The 2007-08 financial crisisThe 2007-08 financial crisisprobably further probably further

underminedunderminedUS long run hegemony.US long run hegemony.

US financial institutions have lost US financial institutions have lost credibility.credibility.

Expansionary fiscal and monetary policy Expansionary fiscal and monetary policy may show up as $ depreciation in the may show up as $ depreciation in the long run.long run.

The long slow descent of the $ as an The long slow descent of the $ as an international currency may accelerate.international currency may accelerate.

47

““Be careful what you wish for!”Be careful what you wish for!”US politicians have not yet learned US politicians have not yet learned

how dependent on Chinese financing how dependent on Chinese financing we have become.we have become.

48

In the short run, the financial In the short run, the financial crisis crisis

has caused a flight to quality has caused a flight to quality which apparently still means a which apparently still means a

flight to US $.flight to US $. US Treasury bills have been more in demand than ever, US Treasury bills have been more in demand than ever,

as reflected in very low interest rates.as reflected in very low interest rates.

The $ The $ appreciatedappreciated in 2008, rather than depreciating in 2008, rather than depreciating as the “hard landing” scenario had predicted.as the “hard landing” scenario had predicted.

=> The day of reckoning had not yet arrived.=> The day of reckoning had not yet arrived.

Chinese officials’ warnings may be a turning point Chinese officials’ warnings may be a turning point (April (April

2009)2009):: Premier Wen worries US Treasury bills will lose value.Premier Wen worries US Treasury bills will lose value. PBoC Gov. Zhou proposes replacing $ as international currency.PBoC Gov. Zhou proposes replacing $ as international currency.

4949

Simulation of central banks’ of reserve currency holdings Scenario: accession countries join EMU in 2010. (UK stays out), but 20% of London turnover counts toward Euro financial depth, and currencies depreciate at the average 20-year rates up to 2007.

From Chinn & Frankel (Int.Fin., 2008)

.0

.1

.2

.3

.4

.5

.6

.7

.8

1980 1990 2000 2010 2020 2030 2040

USD

DEM/EUR

USD forecast

EURforecast

Tipping point in updated simulation: 2015

Simulation predicts € may overtake $ as early as 2015

50

Historical precedent: £ Historical precedent: £ ((1914-1956)1914-1956)

With a lag after US-UK reversal of ec. size & With a lag after US-UK reversal of ec. size & net debt, $ passed £ as #1 international net debt, $ passed £ as #1 international currency.currency.

““Imperial over-reach:” the British Empire’s Imperial over-reach:” the British Empire’s widening budget deficits and overly ambitious widening budget deficits and overly ambitious military adventures in the Muslim world.military adventures in the Muslim world.

The 2001-2020 decline in The 2001-2020 decline in international currency status for the international currency status for the

$ would be only one small part of $ would be only one small part of a loss of power on the part of the US. a loss of power on the part of the US.

But: But:A loss of $’s role as #1 reserve A loss of $’s role as #1 reserve currency could in itself have currency could in itself have

geopolitical implicationsgeopolitical implications..

5151

The 2001-2020 decline in The 2001-2020 decline in international currency status for the international currency status for the

$ would be only one small part of $ would be only one small part of a loss of power on the part of the US. a loss of power on the part of the US.

But: But: A loss of $’s role as #1 reserve currency A loss of $’s role as #1 reserve currency could in itself have could in itself have geopolitical geopolitical implicationsimplications. . [i][i]

Precedent: The Precedent: The Suez crisis of 1956Suez crisis of 1956 is often recalled as the occasion on whichis often recalled as the occasion on which

Britain was forced under US pressure to Britain was forced under US pressure to abandon its imperial designs. abandon its imperial designs.

But recall also the important role But recall also the important role played by a simultaneous run on the played by a simultaneous run on the ££ and the American decision not to help and the American decision not to help the beleaguered currency. the beleaguered currency.

[i][i] Frankel, “Could the Twin Deficits Jeopardize US Hegemony,” Frankel, “Could the Twin Deficits Jeopardize US Hegemony,” Journal of Policy ModelingJournal of Policy Modeling, 28, no. 6, Sept. 2006.  , 28, no. 6, Sept. 2006.  At At http://ksghome.harvard.edu/~jfrankel/SalvatoreDeficitsHegemonJan26Jul+.pdfhttp://ksghome.harvard.edu/~jfrankel/SalvatoreDeficitsHegemonJan26Jul+.pdf . .

Also “The Flubbed Opportunity for the US to Exercise Global Economic Leadership”;  Also “The Flubbed Opportunity for the US to Exercise Global Economic Leadership”;  in in The International Economy, The International Economy, XVIII, no. 2, Spring 2004XVIII, no. 2, Spring 2004 at http://ksghome.harvard.edu/~jfrankel/FlubJ23M2004-.pdfat http://ksghome.harvard.edu/~jfrankel/FlubJ23M2004-.pdf

Jeffrey FrankelJeffrey FrankelJames W. Harpel Professor of Capital James W. Harpel Professor of Capital

Formation & GrowthFormation & GrowthHarvard Kennedy SchoolHarvard Kennedy School

http://ksghome.harvard.edu/~jfrankel/indhttp://ksghome.harvard.edu/~jfrankel/index.htmex.htm

Blog: Blog: http://content.ksg.harvard.edu/blog/jeff_frankels_weblohttp://content.ksg.harvard.edu/blog/jeff_frankels_weblog/g/

53

Emerging markets have been Emerging markets have been hit too;hit too;

now have to spend some hard-now have to spend some hard-earned reservesearned reserves

54

3 cycles of net private capital 3 cycles of net private capital flowsflows

to emerging markets, by regionto emerging markets, by regionpeaking in 1982, 1997 and 2008 peaking in 1982, 1997 and 2008

Source: Capital Flows to Emerging Market Economies, IIF, 1/27/09.

55

Capital flows to emerging Capital flows to emerging marketsmarkets

peaked in 2007peaked in 2007

from: EM Fund Flows, Citi, December 2008

56

BRIC growth has disappeared

57

IMF forecasts, April IMF forecasts, April 20092009