Krzysztof Rybiński: Global imbalances and implications for emerging markets
Address by Mr Krzysztof Rybiński, Deputy President of the National Bank of Poland, at the Panel
Discussion on Scenarios for Emerging Markets at the OKB Roundtable, Vienna,
14-15 December 2006.
Views presented here are my own and they do not represent the official position of the National Bank of Poland. Here I only
sketch the key arguments, extensive discussion of issues related to global imbalances is presented on my blog
www.rybinski.eu.
* * *
'Hard' and 'soft' landing are aeronautical terms. Many decades ago plane crashes were so alarmingly
frequent, that some believed that every flying plane was an accident waiting to happen. Today, the
advance of technology makes the past concerns look ridiculous; plane crashes are rare and require
exceptionally adverse weather conditions, human failure or a terrorist attack. Likewise, large current
account deficit in the United States and large current account surpluses in China and oil-exporting
countries, jointly labeled as global imbalances are considered as unstable just as planes used to be
several decades ago. Similar aeronautical vocabulary - hard landing, soft landing, crash etc. - is also
used to describe the range of possible outcomes for the global economy, which embarked on a global
imbalances journey about ten years ago1.
The goal of my speech, which is constrained in time to ten minutes is to stimulate discussion on what
could be the implications of global imbalances on emerging markets, in particular what are possible
EM scenarios in case of soft and hard landing of the global plane.
As you will see later the range of possible outcomes depends on what is the actual cause of the
emergence of the global imbalances. Let me briefly review the most popular hypotheses.
How did we get into global imbalances?
The need to identify the type of the flying airplane and its technical conditions implies that one has to
understand the nature of global imbalances. And here we run into the first problem, as the top 'aviation
specialists', including 'pilots' themselves cannot agree on that. I have identified at least ten major
views about the nature of global imbalances, namely2:
1. emergence of the new Bretton Woods regime3. This concept was put forward by Michael
Dooley, David Folkerts-Landau and Peter Garber, who argue that a new world equilibrium
has emerged and it is in the best interest of both the United States and China to continue
financing consumption of American households with Chinese savings until Chinese economy
reaches a status of a developed economy, so the new Bretton Woods can last for many
years;
2. global savings glut hypothesis was proposed by Ben Bernanke4, who postulates that the
shock causing global imbalances originated from Asia as a result of excessive saving rates;
1
I borrowed this aeronautical comparison from a recent paper by Calvo G. and Talvi E. (2006) "The Resolution of Global
Imbalances: Soft Landing in the North, Sudden Stop in Emerging Markets?", CERES, Documentos de Trabajo.
2
This list is based on Rybinski K. (2006) "Global imbalances", Ekonomista 4/2006 (in Polish).
3
Dooley M., Folkerts-Landau D., Garber P. (2003) "An Essay on the Revived Bretton Woods System", NBER Working Paper
9971; Dooley M., Folkerts-Landau D., Garber P. (2004) "The Revived Bretton Woods System: The Effects of Periphery
Intervention and Reserve Management on Interest Rates and Exchange Rates in Center Countries", NBER Working
Paper 10332; Dooley M., Folkerts-Landau D., Garber P. (2004) "Direct Investment, Rising Real Wages and the Absorption
of Excess Labor in the Periphery", NBER Working Paper 10626; Dooley M., Folkerts-Landau D., Garber P. (2004) "The US
Current Account Deficit and Economic Development: Collateral for a Total Return Equity Swap", NBER Working Paper
10727; Dooley M., Folkerts-Landau D., Garber P. (2005) "Savings Glut and Interest Rates: the Missing Link to Europe",
NBER Working Paper 11520.
4
Bernanke B. (2005) "The Global Saving Glut and the U.S. Current Account Deficit", Remarks by Governor Ben S. Bernanke
At the Homer Jones Lecture, St. Louis, Missouri Updates speech given on March 10, 2005, at the Sandridge Lecture,
Virginia Association of Economists, Richmond, Virginia.
BIS Review 124/2006
3. global investment drought hypothesis advocated by the IMF5, which puts emphasis on low
Asian investment following the Asian crisis in creating savings-investment imbalances in
these countries;
4. negative US savings, in the household sector stimulated by stock exchange bubble and later
by a lot of local housing bubbles6; and in the public sector, however there are very different
estimates about the impact of the budget deficit in the United States on the US current
account deficit ranging from 0.2 to 0.57;
5. effects of Asian crises in 1990s combined with the pursuance of export-led growth model in
Asia8;
6. shocks changing the relative investment prospects of various parts of the global economy9,
such as productivity shock in the United States in the mid-1990s or the inability of Asian
countries to generate good quality financial assets;
7. much higher rates of return enjoyed by United States on its foreign assets than the cost of its
foreign liabilities10, this cushioned the trade deficit impact on net international investment
position and was labelled as US 'exorbitant privilege';
8. global imbalances are optimal choices of rational US consumers11, who expect that the USA
will account for a bigger share of global GDP in the future;
9. there are theories about imbalances originating from the statistical offices' failure to account
properly for the US exports of 'dark matter'12.
10. recently Ricardo Caballero13 presented his theory that (financial) asset shortages are at the
heart of the global imbalances problem, and his idea was also put forward by Raghuram
Rajan14 speaking recently on (real, fixed) asset shortages. Asset shortages hypothesis
5
Rajan R. (2006) "Perspectives on Global Imbalances", Remarks by Economic Counsellor and Director of IMF Research
Department at the Global Financial Imbalances Conference London, United Kingdom, 23 January 2006; and Rato R. (2006)
"Shared Responsibilities: Solving the Problem of Global Imbalances", Speech of the International Monetary Fund Managing
Director at the University of California at Berkeley, 3 February 2006.
6
Greenspan A., Kennedy J. (2005) "Estimates of Home Mortgage Originations, Repayments, and Debt on
One-to-FourFamily Residences." Federal Reserve Board, Finance and Economics Discussion Series Paper 2005-41; Lansing K. (2005)
"Spendthrift Nation", FRBSF Economic Letter, November 2005.
7
Greenspan A. (2005) "Current Account" presentation at Advancing Enterprise 2005 Conference (London, United Kingdom),
4 February 2005; OECD (2004) "Economic outlook", June 2004; Faruqee H., Laxton D., Muir D., Pesenti P. (2005) "Current
Accounts and Global Rebalancing in a Multi-Country Simulation Model", presented at the NBER conference, "G-7 Current
Account Imbalances: Sustainability and Adjustment", 1-2 June 2005; Chinn M. (2005) "Getting Serious about Twin Deficits",
working paper, The Bernard and Irene Schwartz Series on the Future of American Competitiveness, CSR No. 10,
September 2005.
8
Gruber J., Kamin S. (2005) "Explaining the Global Pattern of Current Account Imbalances", Board of Governors of the
Federal Reserve System International Finance Discussion Papers Number 846, November 2005; Mendoza R.(2004)
"International Reserve-Holding in the Developing World: Self Insurance in a Crisis-Prone Era?" Emerging Markets Review
5(1); Aizenman J., Lee J. (2005) "International Reserves: Precautionary vs. Mercantilist Views, Theory and Evidence", IMF
Working Paper WP/05/198, October 2005; Gosselin M-A. Parent N. (2005) "An Empirical Analysis of Foreign Exchange
Reserves in Emerging Asia", Bank of Canada working paper 2005-38, December 2005; EBC (2006) "The Accumulation of
Foreign Reserves", Occasional Paper No. 43, International Relations Committee Task Force, February 2006.
9
Caballero R., Farhi E., Gourinchas P. (2005) "An Equlibrium Model of Global Imbalances and Low Interest Rates", mimeo,
MIT, September 2005; Faruqee H., Laxton D., Muir D., Pesenti P. (2005b) "Smooth Landing or Crash? Model-Based
Scenarios of Global Current Account Rebalancing", NBER working paper 11583, August 2005.
10
Gourinchas P-O., Rey H. (2005) "From World Banker to World Venture Capitalist: US External Adjustment and The
Exorbitant Privilege", working paper UC Berkeley, August 2005; Lane P., Milesi-Ferretti HG-M. (2005) "Financial
Globalization and Exchange Rates", IMF Working Paper WP/05/3, January 2005; Lane P., Milesi-Ferretti G-M. (2005b) "A
Global Perspective on External Positions", IMF mimeo, July 2005.
11
Engel C. Rogers J. (2006) "The U.S. Current Account Deficit and the Expected Share of World Output", NBER working
paper 11921, January 2006;
12
Hausmann R., Sturzeneger (2005) "Global imbalances or bad accounting? The missing dark matter in the wealth of
nations", Harvard University working paper, December 2005.
13
Caballero R. (2006) "On the Macroeconomics of Asset Shortages", NBER Working Paper No. 12753, December 2006.
14
Rajan R. (2006) "Is There a Global Shortage of Fixed Assets?", Remarks by Raghuram G. Rajan, Economic Counselor and
Director of Research, IMF At the G-30 meetings in New York, December 1, 2006.
states that there is a shortage of supply of assets - particularly in emerging markets -
relative to demand for these assets. Problem lies in underdevelopment of financial markets
in emerging economies amid various macro- and microeconomic deficiencies.
No single hypothesis is able to explain global imbalances well. I do have a consistent story explaining
the sequence of events that led to development of the global imbalances. I will not present it here,
those interested may take a look at my blog www.rybinski.eu15. Today I will present two opposing
views of what could be the implications of global imbalances for emerging markets: I call them the
Calvo view16 and the Caballero view17.
Calvo view: soft landing in the US and sudden stops in some emerging markets
• if EM central banks stop buying dollars and UST, they will at the same time stop issuing
bonds in domestic currencies which are used to sterilize money markets. It will not imply a
change in total world debt level, but a change in the total world debt composition. If bonds
are highly substitutable (as might be in the case of UST and JGB) then if Japan were to stop
buying US debt instruments the effect on US rates would be minimal. PBoC cannot stop
buying foreign debt instruments as it would imply very big appreciation of renminbi, it can
change the currency structure of its reserve holdings. This would force a change in
composition of debt in hands of private investors and the impact on US rate would be small
again.
• in the scenario of rapid adjustment of US current account deficit, for example following
sizeable Asian currencies appreciation, current account surpluses in EM would have to
correct massively, some countries may find that their current account surpluses are smaller
than debt amortizations, and history shows that in 18 percent of cases sudden stops in
emerging markets took place under current account surpluses.
•
Calvo view implies very low risk of US long term rates going up (high likelihood of soft
landing, low likelihood of hard landing), and relatively high risk of some emerging markets
experiencing sharp current account reversals and possibly sudden stops.
•
Calvo view is reinforced in the recent paper by Faruqee, Laxton, Muir, Presenti (2006)18,
which shows that even when a new wave of protectionism hits the global economy, the US
growth will slow only marginally by 0.2 percent, while impact on Asia could be sizeable,
reducing growth by more than 1 percent.
Caballero view: bubbles are inevitable and possibly long-lasting in economy facing asset
shortages
• there has been significant increase in global savings relative to investments (you can merge
Bernanke global savings glut with IMF global investment drought hypotheses here)
•
this excess saving is chasing too few available financial assets, which leads to very high
valuations (rising equity indices, low long-term rates, low corporate and EM spreads etc.)
•
problem lies in the underdevelopment of financial markets in emerging economies, which
due to poor governance and property rights do not have enough good quality collateral to
back debt obligations. These economies have also many other macroeconomic and
microeconomic deficiencies leading to asset shortages and reduction of value of existing
assets such as: weak bankruptcy procedures, chronic macroeconomic volatility and sheer
appropriation risk.
•
Anglo-saxon countries which are very good at producing financial assets have already
shown enormous imbalances, with US current account deficit and housing market bubbles
as the headline examples;
•
emergence of (long lasting) asset bubbles and drop in inflation (and possibly even
emergence of deflation) are market mechanisms to bridge the asset gap;
•
bursting an asset bubble makes asset shortages problem worse;
•
while financial markets development moves ahead (think about large listings in China,
improving corporate governance or rapid development of credit derivatives) it is unlikely that
excess demand for assets will be eliminated soon, as it seems to have a structural origin,
related to demographics (aging), or to higher uncertainty for corporations operating in more
competitive global economy in XXI century, which probably explains why profits to GDP ratio
is at 40-years high and investments fail to recover to pre-Asia-crisis and pre-dot-com-boom
levels
It does matter to what view of the world you subscribe, as it dramatically alters the subjective likelihood
of competing scenarios for 2007. As PIMCO Michael Gomez puts it in September emerging markets
note titled "Is it safe?"19:
"EM has historically been vulnerable to deteriorating economic and financial conditions in the United
States and other developed countries. Slower growth, tighter liquidity, and heightened risk aversion in
mature markets generally mean lower commodity prices, less capital flows, and higher interest rates
for EM borrowers - conditions that helped produce some spectacular financial crises in the past dozen
years. Not a pretty picture, and one that begs the question of what lies around the corner".
However, if asset shortages story is correct, then upcoming US slowdown (or brief recession
according to some non-consensual forecasts) would likely further increase excess saving (as fading
growth prospects will discourage investment projects and encourage more private saving amid rising
uncertainty, only partly offset by higher public dissaving due to automatic stabilizers), and lower
valuation of US equities will make the world supply of assets even more scarce. In such situation US
economy having hard times may not necessarily lead to higher risk premia for emerging markets (as it
was the case in the past) rather any increase in risk premia would be used by investors to enhance
returns, spread compression will continue, and yield curve inversion may even deepen on major
markets, and knock the door in some emerging markets20.
PIMCO seems to subscribe to this possibility, although they do not use asset shortage argument, but
they do say:
"Local markets investments may provide the greatest divergence of returns within the EM universe,
with those "developing" economies furthest along the road to "developed" market status able to enact
traditional policy prescriptions in a slowing global economy and therefore providing enhanced return
potential to local fixed-income instruments".
As a central banker in emerging market economy well advanced on the road to developed status I ask
myself a question which view of the world is correct, because it may have different implications for
growth and inflation prospects. Should we expect slowing external demand combined with local
currency strength or combined with a local currency weakness. These are important questions (even
in the context of falling exchange rate pass-through) which will be empirically answered next year.
Today we can think only in balance of risks terms. Evidence in the last few months, including
December BIS report21 shows, that official institutions may have accelerated their attempts to diversify
reserve assets, which may mean more demand for high-yielding assets and for non-core currencies,
and in particular for emerging market currencies (recall Government of Singapore Investment
Corporation statement that emerging market weight in their assets under management will be
increased, recall a number of hints given by oil exporting nations, or recall the statements given by
Chinese authorities that the central bank should be more open-minded about cooperating with the
government institutions in managing huge reserve assets). So, ceteris paribus, this factor will imply
balance of risks skewed towards further risk premia compression in emerging markets in situation
when US growth slows and expected returns in developed markets drop amid poor growth outlook.
The important question is how it will end? Temporary US growth slowdown is unlikely to solve global
imbalances issue, it is unlikely that oil-exporting countries will accelerate further their investment in
real estate, as the pace is already frantic, lack of reforms in the eurozone indicates that potential
output in this part of the world is unlikely to speed up significantly. So standard, consensus
prescriptions will not work. The only feasible channel that might work is accelerating the pace of
financial sector development, particularly in emerging markets, to produce more financial assets and
more collateral. These reforms are easier to implement, because they do not require taking away
social benefits and they do not hit any specific groups of interests. So it appears that the discussion
should shift away from overvaluation of renminbi, and from implications of pegging gulf currencies to
the weakening dollar, towards ways of speeding up necessary financial markets reforms in
saving-abundant countries. If these reforms gain speed, we may be able to solve global imbalances
problem without much global pain. As a concerned central banker from emerging (converging) market
I would welcome your comments, do you share the Calvo view or the Caballero view of the world. To
borrow a phrase from Calvo-Talvi paper again, planes are much safer nowadays, but not everywhere.
Thank you for your attention.