Transcript Perspectives on the Current International Financial and Macroeconomic Situation Celebrity Speakers Ltd., London, May 14, 2007 Jeffrey Frankel Harpel Professor of Capital Formation and Growth Harvard.

Perspectives on the Current
International Financial and
Macroeconomic Situation
Celebrity Speakers Ltd., London, May 14, 2007
Jeffrey Frankel
Harpel Professor of Capital Formation and Growth
Harvard University
Four points to be covered
•
•
•
•
Emerging markets are now in the boom
phase of the 3rd consecutive 15-year
emerging-market cycle.
“Is this time different?”
China: the miracle is real
but the RMB is wrong
Commodities and carry trade
Twin deficits:
Is US losing economic hegemony?
2
We are now in
the 3rd big consecutive cycle of
capital inflows to developing countries
It’s the biblical rule:
7 fat years followed by 7 lean years
1) Recycling petrodollars: 1975-81
– 1982 international debt crisis,
then 7 lean years:
-1989
2) Emerging market boom: 1990-96
– 1997 East Asia crisis,
then 7 lean years:
-2003
3) Current boom, 2003-
3
The cycles show up in capital flow quantities
Capital Inflows to Developing Countries as percent of Total GDP
(Low and Middle Income)
5.00
4.50
4.00
3.50
Net Total Private
Capital Flows
3.00
2.50
3r
d
2.00
1.50
1.00
Net Foreign Direct
Investment Flows
1st boom
0.50
2nd boom
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
-
Source: World Development Indicators
4
They also show up in prices: sovereign spreads.
EMBI was up in 1995 & 98;
Calvo, BIS, 2006
down in 2003-07
The Economist 2/22/07
5
Is “this time different”?
• Ken Rogoff* says “no.”
• Some things are different this time:
– Current accounts are stronger (esp. Asia)
– Reserve holdings are much higher.
– Exchange rates are more flexible.
– More countries issue debt in domestic currency,
vs.$ (in part due to exchange rate volatility)
– More debt carries Collective Action Clauses
– More openness to trade and FDI.
* ”This Time It’s Not Different,” Newsweek International, Feb.16, 2004
6
Most large emerging markets are not using
the capital inflows to finance CA deficits
as much as they did in the 1990s
10
Malaysia
Average CA/GDP(%): 2000-04
8
6
4
Indonesia
2
Argentina
0
SSouth Africa
-10
-9
-8
-7
-6
-5
-4
-3
Ecuador
Mexico
CAD 2000-04 < in 90s
-2
-1
0
-2
Brazil
Turkey
-4
-6
CAD 2000-04 > in 90s
-8
-10
Average CA/GDP (%): 1990-99
7
Instead, countries are using the inflows
to build up forex reserves
Flows to Developing Countries
(Low- & middle-income),
Current Account, Capital Account and Change in Reserves as a % of Total GDP
6.00
1982-2004
Change in Total Reserves
Net Total Private
Capital Flows
5.00
4.00
(Including Gold)
3.00
2.00
1.00
-
(1.00)
Net Trade in Goods & Services
(2.00)
Source: World Development Indicators
8
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
(3.00)
Export/GDP ratios 2000-04 > than in 1990s
40
More
open
Average Export/GDP(%): 2000-04
35
30
Indonesia
South Africa
Turkey
Ecuador
Mexico
25
Argentina
20
15
Brazil
Less
open
10
5
0
0
5
10
15
Average Export/GDP (%): 1990-99
20
25
30
35
9
New emerging market crises will come; but
• they won’t necessarily take currency crisis form
(vs., e.g., crashes in land & securities markets).
• they won’t necessarily be soon:
– Emerging markets not yet ripe for a new crisis round
• Memories are still fresh.
• Traders’ jobs have not yet turned over.
– Global monetary policy has been easy (as in the boom
phases of the late 1970s & early 1990s).
– Commodity prices are still near historic peaks
10
China
• China, in its own interest, should let the RMB appreciate.
• Despite July 2006, the regime has not genuinely changed.
• A global cooperative deal would simultaneously appreciate
the RMB & other currencies among Asian and oil-exporters,
while the US raised national saving.
– IMF could broker the deal. But it won’t happen.
• The Chinese growth miracle will probably encounter a crash
somewhere along the road
– the banking system, real estate, or stock market.
• Every new economic power goes through a rite of passage:
financial bubble and crash.
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Every new economic power goes through
a rite of passage: financial bubble and crash
Holland
Great US
Britain
Japan
China
Take-off
dates
Change
in GDP
16th
17th
century century
19th
century
1950s1980s
Current
X3
X6
X8
X10
(1870-1913)
(1950-1973)
Bubble
Dutch South Roaring Late
tulip
seas
20s
1980s
mania bubble (stocks & (stocks &
Crash
X6
(1500-1600) (1600-1820)
1637
1720
Fla. land)
land)
1929
1990s
2006(stocks, real
estate, &
banks)
?
12
Why did prices of oil & other commodities
rise so much 2001-06?
• E.g., Copper, platinum, nickel & zinc all hit record highs in
2006
• Mankind has to live in the physical world after all !
• Many causes. One neglected cause is monetary policy:
high real commodity prices can reflect low real interest rates.
•
High interest rates reduce the demand for storable
commodities, or increase the supply through a variety of
channels:
1. By increasing incentives for extraction today rather than tomorrow
2. By decreasing firms’ desire to carry inventories
3. By encouraging speculators to shift from commodities to T bills
13
Statistical relationship 1950-2005.
CRB Commodity Price Index vs. Real
Interest Rate
Annual, 1950-2005
Log Real Commodity Price Index
2.0
1.5
1.0
0.5
0.0
-7.5
-5.0
-2.5
0.0
2.5
Real Interest Rate
Source: Global Financial Data Inc.
5.0
7.5
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Results of regressing $ real commodity
prices against US real interest rates
• Statistically significant at 5% level
for all 3 major price indices available since 1950-- from Dow
Jones, Commodity Resources Board, & Moody’s -- and
significant for 1 of 2 with a shorter history (Goldman Sachs).
• All are of hypothesized negative sign.
• The estimated coefficient for the CRB index,
-.06, is typical.
=> when the real interest rate goes up 100 basis
pts., real commodity price falls by .06, i.e., 6 %.
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UK regression: real commodity prices
in £ on real interest rates
Short Rates
US r
Coeff.
s.e.
-0.053*
0.010
r differential
-0.086*
0.007
Long Rates
US r
r differential
-0.106*
-0.023*
0.007
0.006
* indicates coefficient significant at 5%.
(Robust s.e.s)
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• Theory: Dornbusch overshooting model, with
spot price of commodities replacing exchange
rate, and convenience yield replacing foreign
interest rate.
• Implication: beginning in 2001, easy monetary
policy & low real interest rates among the FRB,
BoJ, ECB & PBoC sent liquidity into commodity
markets, pushing up real prices.
• Similar “carry-trade” arguments apply to other
markets as well: has sent money not only into
commodities, but also into housing, securities,
and emerging markets.
• This phenomenon may start to reverse.
17
It is still puzzling that long-term interest
rates remained so low, even as shortterm rates rose 2004-2006
• spreads on high-income corporate debt in particular
have been inexplicably low.
• Implied options price volatilities have been too low.
• Private equity may also be overdone.
• Part of a general pattern: private markets are
underestimating risk
– a result of 5 years of low real interest rates & of
formulas that estimate volatility from lagged prices –
which look calm – rather than from an intelligent
assessment of the macro outlook & the odds of
unexpected shocks.
• Private markets may in particular be under-estimating
future budget deficits.
• In short, both risk curve & yield curve are too flat.
18
Medium-term global risks
• Bursting bubbles
– Housing market downturns, underway
– Bond market crash, not yet
• Possible new oil shocks,
– e.g., from Russia, Venezuela, Nigeria, Iran…
• Possible new security setbacks
– Big new terrorist attack, perhaps with WMD
– Korea or Iran go nuclear/and or to war
– Islamic radicals take over Pakistan, S.A. or Egypt
• Hard landing of the $: foreigners pull out =>
$↓ & i↑
=> possible return of stagflation .
19
The US Current Account Deficit:
Origins and Implications
Revsied version of Our Fiscal Future, 2006
Trade balance is deteriorating
U.S. Trade Balance and Current Account
Balance, 1960-2004
% of
GDP
2.00
1.00
0.00
-1.00
.
-2.00
-3.00
Balance on goods and services expressed
as a share of GDP
-4.00
Current account balance expressed as a
share of GDP
-5.00
-6.00
-7.00
1960
1964
1968
1972
1976
1980
1984
Sources: Department of Commerce (Bureau of Economic Analysis) U.S. Economic Accounts
1988
1992
1996
2000
2004
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Trade deficit
• Current account deficit for 2006 ≈ 6% GDP, a record.
– Would set off alarm bells in Argentina or Brazil
• Short-term danger:
Protectionist legislation,
such as Schumer-Graham bill scapegoating China
• Medium-term danger:
– CA Deficit => We are borrowing from the rest of the world.
– Dependence on foreign investors may => hard landing
• Long-term danger:
– US net debt to RoW now ≈ $3 trillion.
– Some day our children will have to pay it back
=> lower living standards.
– Dependence on foreign central banks
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may => loss of US global hegemony
The Bush Budget Bungle
23
Official forecast of US budget
deficit vanishing by 2012 is fantasy
24
White House forecast of eliminating
budget deficit by 2012 will not be met
under their policies
• WH and CBO projections still do not allow for
–
–
–
–
The full cost of Iraq and other “national security” spending
Fixing the Alternative Minimum Tax
Making permanent the tax cuts as it has asked for
More realistic forecasts of spending growth, e.g., in line
with population. (Actually spending growth since 2001 has
far exceeded that.)
• More likely, deficits will not fall at all.
• Just as the budget forecasts were predictably
overoptimistic throughout the first Bush term.
– The surplus of $5 trillion+ forecasted in Jan. 2001 over 10 years
became a 10-year deficit of $5 trillion.
25
Further, the much more serious
deterioration will start after 2009.
• The 10-year window is no longer reported
in White House projections
• Cost of tax cuts truly explodes in 2010 (if
made permanent), as does the cost of
fixing the AMT
• Baby boom generation starts to retire 2008
• => soaring costs of social security and,
• Especially, Medicare
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