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Asia, the US, and the G20 in 2010. Jeffrey Frankel Harpel Professor, Harvard University Harvard Project for Asian & International Relations 2010 Conference February 19, 2010. Each decade gives rise to a new conventional wisdom.

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slide1

Asia, the US, and the G20 in 2010

Jeffrey FrankelHarpel Professor, Harvard University

Harvard Project for Asian &International Relations 2010 Conference

February 19, 2010

each decade gives rise to a new conventional wisdom
Each decade gives rise to a new conventional wisdom
  • 1990:20 years ago, many had drawn a lessonfrom the1980s: Japan had developed a kind of capitalism, which outperformed the US.
  • 2000:10 years ago,many had drawn a new lessonfromthe1990s: The US offered the superior model after all. East Asia should emulate the US, to solve the structural flaws that had led to the 1990s crises.
  • 2010:Today, many have drawn the obvious lesson from the2000s: The US suffers from the same flaws (“crony capitalism”). The future belongs to China.
20 years ago lessons from the 1980s
20 years ago: Lessons from the 1980s
  • The US was said to be in decline:
    • The “hollowing out” of manufacturing.
    • Paul Kennedy’s The Rise and Fall of the Great Powers:

Imperial overstretch would be the downfall of the US, just as with its predecessor.

    • Reagan’s legacy was tarnished,
      • by the Iran-Contra scandal
      • and twin deficits (big fiscal & trade deficits).
slide4

Japan was thought a juggernaut, taking over the world economy.

    • Journalists and “revisionists” extrapolated that Japan would overtake the US in coming decades.
    • The new national security competition between countries was said to be economic, not military.
  • Japan was thought a juggernaut, taking over the world economy.
    • Journalists and “revisionists” extrapolated that Japan would overtake the US in coming decades.
    • The new national security competition between countries was said to be economic, not military.
  • Best-selling books caught the mood:
    • Ezra Vogel’s Japan as Number One;
    • Chalmers Johnson’s MITI and the Japanese Miracle;
    • Michael Crichton’s Rising Sun (1992).
japan and the asian nies were said to have a superior model of capitalism
Japan (and the Asian NIEs) were said to have a superior model of capitalism

Vs. Anglo-American model

  • “Asian values”
  • Long horizons
  • Keiretsu / chaebol
  • Low cost of capital
  • Lifetime employment
  • Relationship banking
  • Government guidance
  • Pro-saving financial system
  • Firms maximize size (capacity or market share)

Corporate governance maximizes profits

& stock prices for shareholders.

Financing via securities markets .

Competition in goods

and labor markets.

Consumerculture

minority voices international politics
Minority voices: International politics
  • Joe Nye’s Bound to Lead (1990):
    • US global leadership was not exhausted.
    • East Asian countries were important allies.

Minority voices: Financial economics

  • The 1987-89 bubbles in land & stock markets
    • were due to
      • Low Japanese interest rates
      • which were in turn due to high saving.
minority voices international economics
Minority voices: International economics

Most economists:

  • Japan’s trade surplus was not attributable
    • to a superior economic model,
    • nor to strategic trade policy,
    • nor to US naively keeping markets open to imports.
  • Rather it was due, again, to National Saving
    • which in 1990 was as high in Japan as it was low in the US.
    • High Japanese saving was in turn probably due to demographics more than culture or policies.
as soon as the 1990s started the 1980s conventional wisdom was proven wrong
As soon as the 1990s started, the 1980s conventional wisdom was proven wrong
  • The US triumphed militarily in the Gulf War (1991).
  • The US triumphed politically with the fall of the Soviet Union (1991).
  • The Japanese model burst,
    • along with its land-stock-market bubble (1990)
    • and economy (1991-…) .
and as the 1990s progressed
And as the 1990s progressed,
  • the US experienced the longest economic expansion of its history.
    • The budget was restored to surplus, with the help of actions by G.H.W.Bush (1990) & Clinton (1993, 98).
    • America was declared to have a New Economy.
    • IT carried the US stock market to stratosphere by 1999.
  • Korea, Thailand, Indonesia & other NIEs

carried the mantle of the Asian miracle,

until severe currency crises hit them in 1997-98.

asians were told to emulate the us model
Asians were told to emulate the US model

10 years ago: Lessons from the 1990s

  • especially its financial system:
    • corporate governance,
    • accounting standards,
    • consumer finance, innovative products,
    • securities markets, rating agencies, and
    • Anglo-American style banking (market-oriented & arms-length)
but as soon as the 2000s started the 1990s assumptions were proven wrong
But as soon as the 2000s started,the 1990s assumptions were proven wrong
  • Bursting of the US dot-com bubble (2000).
  • Failure of US electoral institutions (Nov.2000).
  • Failures of Sept.11 (2001) & US response (Iraq, Guantanamo)
  • Failure of US corporate governance in scandals of Enron, etc. (2001).
  • Decade of flat median income and rising debt.
financial crisis 2007 2009
Financial crisis (2007-2009)
  • Bursting of US housing bubble (2006)
  • inevitably led to sub-prime mortgage crisis (2007).
  • Less predictably, failures of US financial system led to disappearance of liquidity (2008)
  • and the 2nd recession of the decade,
    • the worst since the 1930s.
    • The rest of the world followed.
the us has lost its claim as an exclusive model for others to emulate
The US has lost its claim as an exclusive model for others to emulate

The desirable principles haven’t changed, only the claim that the US uniquely embodies them

  • Open democracy, rule of law, human rights
  • Competition in goods & labor markets
  • Corporate governance should focus on long-term shareholder value,
    • not executives’ options prices
    • nor empire-building.
  • Government intervention to address market failure
    • E.g., tax pollution (don’t subsidize fossil fuels).
    • Supervise banks, under rules (don’t take them over).
the us is in a hole
The US is in a hole
  • Adroit monetary & fiscal management has succeeded in limiting the length & severity of the recession.
    • The turning point was probably early summer, 2009
    • => we have avoided the mistakes of
      • the Depression (1929-1937),
      • or Japan’s lost decades (1991-2010).
  • But the long-term fiscal outlook – already bad – has gotten worse.
the same with other major industrialized economies
The same with other major industrialized economies.
  • A remarkable role-reversal:
    • Debt/GDP of the top 20 rich countries
    • (≈ 80%) is already twice that of the top 20 emerging markets;
    • and rising rapidly.
    • By 2014 (at ≈ 120%), it could reach triple the big emerging market debt levels.
the us financial position has deteriorated internationally
The US financial positionhas deteriorated internationally
  • The twin deficits
  • China became our largest creditor
  • The dollar appears in long-term decline.
exorbitant privilege of
Exorbitant Privilege of $
  • Among those who argue that the US current account deficit is sustainable are some who believe that the US will continue to enjoy the unique privilege of being able to borrow virtually unlimited amounts in its own currency.
when does the privilege become exorbitant
When does the “privilege” become “exorbitant?”
  • if it accrues solely because of size & history, without the US having done anything to earn the benefit by virtuous policies such as budget discipline, price stability & a stable exchange rate.
  • Since 1973, the US has racked up $10 trillion in debt and the $ has experienced a 30% loss in value compared to other major currencies.
  • It seems unlikely that macroeconomic policy discipline is what has earned the US its privilege !
the bretton woods ii hypothesis
The “Bretton Woods II” hypothesis
  • Dooley, Folkerts-Landau, & Garber (2003) :
    • today’s system is a new Bretton Woods,
      • with Asia playing the role that Europe played in the 1960s—buying up $ to prevent their own currencies from appreciating.
    • More provocatively: China (& Asia) is piling up dollars not because of myopic mercantilism, but as part of an export-led development strategy that is rational given China’s need to import workable systems of finance & corporate governance.
my own view on bretton woods ii
My own view on “Bretton Woods II”:
  • The 1960s analogy is indeed apt,
  • but we are closer to 1971 than to 1944 or 1958.
  • Why did the BW system collapse in 1971?
    • The Triffin dilemma could have taken decades to work itself out.
    • But the Johnson & Nixon administrations accelerated the processby fiscal & monetary expansion (driven by the Vietnam War & Arthur Burns, respectively).
    • These policies produced: declining external balances, $ devaluation, & the end of Bretton Woods.
there is no reason to expect better today
There is no reason to expect better today:
  • Capital mobilityis much higher now than in the 1960s.
  • The US can no longer necessarily rely on support of foreign central banks:
      • neither on economic grounds(they are not now, as they were then, organized into a cooperative framework where each agrees explicitly to hold $ if the others do),
      • nor on political grounds(China & OPEC are not the staunch allies the US had in the 1960s).

3) A possible rival currency to the $ exists.

when will the day of reckoning come
When will the day of reckoning come?
  • Not in 2008: In the short run, the financial crisis caused a flight to quality which evidently still meant a flight to US $.
  • Chinese warnings in 2009 may have marked a turning point:
    • Premier Wen worried US T bills will lose value.On Nov. 10 he urged the US to keep its deficit at an “appropriate size” to ensure the “basic stability” of the $.
    • PBoC Gov. Zhou in March proposed replacing $ as international currency, with the SDR.
the global monetary system may move from dollar based to multiple international reserve currencies
The global monetary systemmay move from dollar-based to multiple international reserve currencies
  • The € could challenge the $.
  • The SDR is again part of the system.
  • Gold in 2009 made a comeback as an international reserve too.
  • Someday the RMB will join the roster with ¥ & ₤.
  • = a multiple international reserve asset system.

SDR

decoupling
Decoupling?
  • Initial hopes of decoupling succumbed at the height of the crisis:
    • Financial contagion
    • Asian exports were especially hard-hit.
asian exports plummeted
Asian exports plummeted

via RGE Monitor 2009 Global Outlook

slide26
But, in the end, there was a measure of decoupling after all.
    • China, India & Indonesia kept growing throughout.
    • All of Asia has now come roaring back.
    • Asia now constitutes an independent “growth pole” in the world.
developing asia growth rates 8
Developing Asia growth rates > 8%

Year-over-year growth rates. Source: IMF WEO Jan. 2010

Projections

2008 2009 2010 2011

World output 3.0 -0.8 3.9 4.3

Advanced economies 0.5 -3.2 2.1 2.4

Developing Asia 7.9 6.5 8.4 8.4

China 9.6 8.7 10.0 9.7

India 7.3 5.6 7.7 7.8

ASEAN-5 4.7 1.3 4.7 5.3

2010 lessons from the 2000s
2010: Lessons from the 2000s
  • America is not as “exceptional” as claimed.
    • Domestically, US democracy fell short.
    • In international relations, our leadership faltered.
  • The US economic system suffers from problems of “crony capitalism” too.
  • “The future belongs to China.”
    • Dynamic entrepreneurship has moved there.
    • China as wealthy creditor will claim its due power.
slide29

What might this new conventional wisdom of 2010 be forgetting?

  • China is not yet ready to be global leader
    • It is not ready politically.
    • It is still quite a poor country.
    • It will run into its own problems, e.g., a banking crisis somewhere down the road.
  • Asians don’t want to be dominated by either China or Japan, and will always welcome the US as a counterweight.
developing asia is now a large share of world gdp growth reserves
Developing Asia is now a large share of world GDP, growth, reserves…
  • But even after recent adjustments, its share in IMF voting shares, for example, is still disproportionately small:
  • China 3.81 %
  • Korea 1.36%
  • India 2.34%
  • Singapore 0.59%
the g 20 suddenly supplanted the g 7

History will judge one of themost important developments of 2009:

the G-20 suddenly supplanted the G-7.
  • G-20 meetings in 2009:
    • London in April
    • Pittsburg in October
how successful were the measures supported by us korea at the g 20 meetings 2009
How successful were the measures supported by US & Korea at the G-20 meetings (2009)?
  • Coordinated fiscal stimulus to fight the recession
    • as in the locomotive plan of G7’s Bonn Summit of 1978:
    • no formal agreement, but it seemed to happen anyway.
  • Unexpected revival of the SDR and tripling IMF resources
  • The usual agreement for a standstill/rollback in trade barriers. Some backsliding followed, & little progress in Doha Round;
    • on the US side:
      • tariffs on Chinese tires,
      • inability to ratify FTAs (US-Korea, etc.).
    • But, so far, not a bad trade record, for a severe recession.

SDR

whatever the causes of the great recession the policy response avoided 1930s mistakes
Whatever the causes of the great recession, the policy response avoided 1930s mistakes:
  • No Smoot-Hawley tariffs
  • No failed London Economic Summit
  • Aggressive monetary expansion rather than contraction.
  • Fiscal expansion too.
the true significance of the g 20 in 2009
The true significance of the G-20 in 2009
  • The G-20 accounts for 85% of world GDP.
  • A turning point: The more inclusive group has suddenly become central to global governance, eclipsing the G-7, and thereby at last giving major developing/emerging countries some representation,
  • after decades of fruitless talk about raising emerging-market representation in IMF.
g 20 membership
Australia

Canada

France

Germany

Italy

Japan

Russia

UK

USA

EU

G-20 membership
  • China
  • India
  • Indonesia
  • Republic of Korea
  • Saudi Arabia
  • South Africa
  • Turkey
  • Argentina
  • Brazil
  • Mexico
the g 20 in 2010
The G-20 in 2010
  • Korea has assumed the presidency this year
    • the first non-G7 host of the G20.
  • Canada & Korea will host the meetings in June & November, respectively.
implications for korea
Implications for Korea
  • Korea is the bridge between the G-7 and developing countries.
    • Especially China & India
  • What can the G-20 accomplish for Korea?
  • What can the G-20 accomplish for the world?
opportunity burden for korea
Opportunity/burden for Korea
  • Will chairing the G-20 help consolidate Korea’s status as an advanced economy?
  • Yes, as did:
    • hosting the Olympics,
    • joining the OECD,
    • attaining the per capita income of some industrialized countries ($20,000 ≈ Portugal).
  • But Korea should now seize the chance to exercise substantive leadership.
    • Otherwise, the risk is Czech presidency of EU…
four items on g 20 agenda for 2010
Four items on G-20 agenda for 2010
  • Possible financial regulatory reform
    • Some steps underway in Basle, Financial Stability Forum
    • The Europeans would like more, but are unlikely to get it.
    • Personally, I might favor a small global tax on financial transactions.
  • Macroeconomic exit strategies
  • Global imbalances between developing countries and industrialized
    • US and China should both admit responsibility
      • US: the budget deficit is too big. Needs to be fixed.
      • China: RMB is too low. Needs to be unfixed.
  • Post-Copenhagen progress toward new agreement on climate change to take effect 2012.
two principles of multilateral institutions
Two principles of multilateral institutions

1. It is inevitable that more power go to large-GDP countries than small.

  • This is why IMF works better than UN .
  • The problem is that China, India, Korea, Brazil, etc.,are larger than Canada, Netherlands… Hence the G-20.
  • The outcome must leave small countries better off, of course, or they will not go along.

2. Conversation is not possible with more than 20 in the room.

slide42

Example: many rounds of trade

negotiations under the GATT.

  • Worked well for years,
    • with small steering groups (US-EU, the Quad & G-7)
    • and few demands placed on developing countries.
  • Failed when developing countries had become big enough to matter,
    • but were not given enough role:
    • Doha Round
conversation is not possible with more than 20 people in the room
Conversation is not possible with more than 20 people in the room.
  • Delegates just read their talking points.
  • The latest evidence: The Climate Change CoP in Copenhagen
    • The UNFCCC proved an ineffectual vehicle
      • Incompetent management of logistics
      • Small countries repeatedly blocked progress
    • Obama was able to make more progress at the end with a small group of big emitters.
      • Korea is in a good position to build on this progress
        • as the 1st non-Annex I country to take on binding emission targets.
  • To be honest, the G-20 is too big.
    • My recommendation: an informal steering group within G-20.
addenda
Addenda
  • 1. Global climate change negotiations.
    • A proposed new architecture.
    • Climate change and trade
  • 2. The global financial crisis of 2007-09
    • Origins
    • Lessons
  • 3. The US current account deficits
    • What about the economists who argue that they are sustainable?
3 points
3 Points
  • Proposal for a Global Climate Agreement: Setting Emission Targets by Formulas
  • Global Trade and Global Climate Change What form should border measures take?
  • Modalities: Lessons from 2009. How Should We Proceed in 2010?
  • Charts with details: The Proposed Target Formulas
slide49

1. Proposal: target formulas designed pragmatically,based on what emissions paths are possible politically:

  • unlike other approaches based purely on:
    • Science (concentration goals),
    • Ethics (equal emission rights per capita),
    • or Economics (cost-benefit optimization).
  • Why the political approach?
    • Countries will not accept burdens that they view as unfair.
    • Above certain thresholds for economic costs, they will drop out.
slide50

Proposal

Stage 2:When the time comes for developing country cuts, targets are determined by a formula incorporating 3 elements, designed so each is asked only to take actions analogous to those already taken by others:

  • Stage 1:
    • Annex I countries commit to the post-2012 targets that their leaders have already announced.
    • Others commit immediately not to exceed BAU.
  • a Progressive Reduction Factor,
  • a Latecomer Catch-up Factor, and
  • a Gradual Equalization Factor.
slide51

◙ In one version, concentrations level off at 500 ppm in the latter part of the century.

◙ Constraints are satisfied: -- No country in any one period suffers a loss as large as 5% of GDP by participating. -- Present Discounted Value of loss < 1% GDP.

Co-author: V.Bosetti

Global peak date ≈ 2035

2 what form should border measures take
2. What form should border measures take?
  • Best choice: multilateral sanctions under a new Copenhagen Protocol
  • Next-best choice: national import penalties adopted under multilateral guidelines
      • Measures can only be applied by participants-in-good standing
      • Judgments to be made by technical experts, not politicians
      • Interventions in only a ½ dozen of the most relevant sectors.
  • Third-best choice: no border measures.
  • Each country chooses trade barriers as it sees fit.
  • Worst choice: national measures are subsidies (bribes) to adversely affected firms.
3 modalities
3. Modalities
  • Lessons from Copenhagen
    • Progress is not possible in the UN Framework
      • Small member countries will obstruct
      • The UNFCCC Secretariat is not competent.
  • Big emerging market countries finally have representation, now that the G-20 has supplanted the G-8.
      • Korea chairs the G-20 in 2010, and can take leadership on climate, as a bridge between Annex I & developing countries.
charts with details on proposed emission targets
Charts with details on proposed emission targets

The reductions from BAU agreed to at Kyoto in 1997 were progressive with respect to income.

Cuts ↑

Incomes →

emissions path for rich countries fig 2b
Emissions path for rich countriesFig. 2b

Predicted actual emissions exceed caps, by permit purchases.

emissions path for poor countries fig 4b
Emissions path for poor countriesFig. 4b

Predicted actual emissions fall below caps, by permit sales.

price of carbon dioxide fig 6b
Price of Carbon Dioxide Fig. 6b

rises slowly over 50 years, then rapidly.

addendum 3 the financial crisis
Addendum 3: The financial crisis

Well before 2007, there were danger signals:

Real interest rates <0, 2003-04;

Early corporate scandals (Enron 2001…);

Risk was priced very low,

  • housing prices very high,
  • National Saving very low,
  • current account deficit big,
  • leverage high,
  • mortgages imprudent…
us real interest rate 0 2003 04
US real interest rate < 0, 2003-04

Source: Benn Steil, CFR, March 2009

Real interest rates <0

slide62

Source: “The EMBI in the Global Village,” Javier GomezMay 18, 2008 juanpablofernandez.wordpress.com/2008/05/

In 2003-07, market-perceived volatility, as measured by options (VIX), plummeted.

So did spreads on US junk & emerging market bonds.

In 2008, it all reversed.

six root causes of financial crisis
Six root causes of financial crisis

1. UScorporate governance falls short

E.g., rating agencies;

executive compensation …

options;

golden parachutes…

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

3. Politicians slant excessively toward homeownership

Tax-deductible mortgage interest, cap.gains;

Fannie Mae & Freddie Mac;

Allowing teasers, NINJA loans, liar loans…

MSN Money & Forbes

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

4. Starting 2001, the federal budgetwas set on a reckless path,

reminiscent of 1981-1990

5. Monetary policy was too loose, during 2003-05,

accommodating fiscal expansion,reminiscent of the Vietnam era.

6. Financial market participants during this period grossly underpriced risk.

origins of the financial economic crisis
Origins of the financial/economic crisis

Underestimated riskin financial mkts

Failures of corporate governance

Households saving too little, borrowing too much

Federal budget deficits

Monetary policy easy 2004-05

Excessive leverage in financial institutions

Housing

bubble

Low national saving

Stock

market

bubble

Stock market

crash

Housing

crash

China’s growth

Financial crisis

2007-08

Lower long-term econ.growth

Eventual loss of US hegemony

Homeownershipbias

Predatory lending

Excessive complexity

MBSs

Foreigndebt

CDSs

CDOs

Gulf

insta-bility

Oil price spike

2007-08

Recession

2008-09

which bystanders got hit the worst by the global liquidity crisis of 2008
Which bystanders got hit the worst by the global liquidity crisis of 2008?
  • Most emerging markets had followed the lessons of the 1990s crises:
    • small or no current account deficits
    • more flexible exchange rates
    • more reserves
    • less short-term & $-denominated loans
  • Those that didn’t are those that got into worse trouble: Central & Eastern Europe.
the early warning indicators literature updated
The Early Warning Indicators literature, updated
  • Reserves
    • Economists wondered if emerging market reserves had gotten too high by 2007 –
        • Jeanne (2007), Summers (2006), Rodrik (2006)
    • But high reserves appear to have paid off in 2008.
        • Aizenman (2009) and Obstfeld, Shambaugh & Taylor (2009, 2010)
  • Low short-term foreign debt
        • Sachs, Tornell & Velasco (1996),
        • Guidotti Rule: reserves / short-term debt,
        • Bussiere (2010).
  • Other leading signals
      • Equity prices: Kaminsky, Lizondo & Reinhart (1998); Rose & Spiegel (2009)
      • Composition of inflow, FDI: Frankel & Rose (1996) and Tong & Wei (2010).
who got pieces of it right beforehand
Who got pieces of it right, beforehand?
  • Krugman: If a Depression can happen in Japan, it can happen in any modern economy.
  • Rajan: Crony capitalism in the US.
  • BIS (Borio & White): Too-easy credit, via asset prices, leads to crises -- with no inflation in between.
  • Shiller: US housing price bubble.
  • Gramlich: Homeowners are taking mortgages that they can’t repay.
  • Rogoff: “This Time Is Not Different.”
  • Roubini: The recession will be severe.
where should mainstream macro go in light of the 2007 09 global financial crisis
“Where should mainstream macro go,inlightofthe2007-09 globalfinancialcrisis?”
  • Some models that had been thriving in an emerging markets context may now help answer this question.
  • Some were applications of models originally designed for advanced-country financial markets, but never fully incorporated into the mainstream macro core.
  • A possible explanation why they had been transplanted to emerging markets: assumptions of imperfections in financial markets were considered more acceptable there, than in the context of advanced economies.
financial crises not just for emerging markets anymore an analogy
Financial crises: Not just for emerging markets anymore.An analogy
  • In the latter part of the 19th century most of the vineyards of France were destroyed by Phylloxera.
  • Eventually a desperate last resort was tried: grafting susceptible European vines onto resistant American root stock.
  • Purist French vintners initially disdained what the considered compromising the refined tastes of their grape varieties.
  • But it saved the European vineyards, and did not impair the quality of the wine.
  • The New World had come to the rescue of the Old.
implications of the 2008 financial crisis for macroeconomics
Implications of the 2008 financial crisis for macroeconomics?
  • In 2007-08, the global financial system was grievously infected by “toxic assets” originating in the United States.
  • Many ask what fundamental rethinking is necessary to save orthodox macroeconomic theory.
  • Some answers may lie with models that have been applied to the realities of emerging markets.
  • Purists may be reluctant to seek help from this direction.
  • But they should not fear that the hardy root stock of emerging market models is incompatible with fine taste.
what are some of these models
What are some of these models?
  • Asymmetric information
    • Credit rationing (Stiglitz…)
    • Need for collateral (Kiyotaki & Moore, Caballero…)
    • Leverage cycle (Geanakoplos)
  • The credit channel (Bernanke & Gertler… )
  • Balance sheet effects (Calvo…)
  • Bank runs & multiple equilibria (Diamond & Dybvyg; Velasco…)
  • Speculative attacks (Krugman; Obstfeld; Morris & Shin…)
  • Moral hazard & incentive incompatibility (Dooley; McKinnon & Pill…)
slide73
Also newly relevant are some almost-forgotten and less-formalized notions of cycles:
  • the credit cycle of von Hayek,
  • the bubbles & panics of Kindleberger,
  • the Minsky moment, and
  • Irving Fisher’s debt deflation.
addendum 3 the us current account deficits
Addendum 3:The US current account deficits
  • Some economists argue they are sustainable
some argue that the privilege to incur liabilities has been earned in a different way
Some argue that the privilege to incur $ liabilities has been earned in a different way:
  • Global savings glut(Bernanke)
  • The US appropriately exploits its comparative advantage in supplying high-quality assets to the rest of the world.
    • “Intermediation rents…pay for the trade deficits.” -- Caballero, Farhi & Gourinchas(2008)
    • In one version, the United States has been operating as the World’s Venture Capitalist, accepting short-term liquid deposits and making long-term or risky investments -- Gourinchas & Rey(2008).
    • US supplies high-quality assets:Cooper (2005); Forbes (2008); Ju & Wei (2008); Hausmann & Sturzenegger (2006a, b);Mendoza, Quadrini & Rios-Rull (2007a, b)…
global savings glut
Global Savings Glut
  • Global Current Account Imbalances debate, 2001-07
  • On one side:those who argued that US current account deficits
    • had domestic origins (low National Saving),
    • were unsustainable, and
    • would eventually cause abrupt $ depreciation.
    • Obstfeld-Rogoff (2001, 05) ; Roubini (2004); Summers ( 2004); Chinn (2005) ; Blanchard, Giavazzi & Sa (2006) ; Frankel (2007b) …
  • On the other side (sustainability):
    • Global savings glut: Bernanke, Clarida…;
    • Other arguments, e.g.,exorbitant privilege, dark matter…
slide77
The 2007-09 crisis did not resolve the CA imbalances debate.
      • Reaction of the unsustainability side:this is the crisis they were warning of.
      • One response from the other side: the savings glut caused the crisis.
slide78
Regardless,
    • Saving will now fall globally.
      • In the short run, governments are responding to the recession by increasing their budget deficits.
      • In the long run, spending needs created by retiring population & rising medical costs will continue to reduce saving, both public & private.
    • In response, long-term real interest rates should rise, from the recent low levels.
  • Thus, I declare the savings glut dead. †
slide79
The argument that the US supplies assets of superior quality, and so has earned the right to finance its deficits, has been undermined by dysfunctionality that the financial crisis suddenly revealed in 2007-08.
  • American financial institutions suffered a severe loss of credibility (corporate governance, accounting standards, rating agencies, derivatives, etc.).
  • Some banks & non-banks have ceased to operate.
  • How could sub-prime mortgages, CDOs, & CDSs be the superior type of assets that uniquely merit the respect of the world’s investors?
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The events of 2008 also undermined the opposing interpretation, the unsustainability position:
  • Why did the $ not suffer the long-feared hard landing?
  • The $ appreciated after Lehman Brothers’ bankruptcy, & US T bill interest rates fell.
  • Clearly in 2008 the world still viewed
    • the US Treasury market as a safe haven and
    • the US $ as the premier international currency.
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Though arguments about the unique high quality of US private assets have been tarnished, the idea of America as World Banker is still alive: the $ is the world’s reserve currency, by virtue of US size & history.

  • Is the $’s unique role an eternal god-given constant? or
  • will a sufficiently long record of deficits & depreciation induce investors to turn elsewhere?
slide82

Central banks’ reserve holdingsFrankel & Chinn (2007)estimated effects of country size, market depth, ability to hold value, and network effects

Simulation suggests € could overtake $ by 2022.