Crisis Talk - The World Bank Group

Crisis Talk is Moving!

Brian Hoyt — Mon, 02 Nov 2009 14:29:32 -0500

Dear Crisis Talk readers,

In an act of consolidation and collaboration, Crisis Talk is merging with the World Bank's Private Sector Development blog, where we will continue our conversation about emerging markets, finance, and the implications of the crisis.

We do not believe that the financial crisis is over and/or no longer worth discussing; rather, we feel that our discussion will compliment and be complimented by the ideas and insights offered by the PSD blog. Content that is strictly related to the financial crisis can be found under the Financial Crisis category.

For other crisis-related content, be sure to check out many of the World Bank's other blogs, including:

In the meantime, we look forward to hearing from you at our new home.

Crisis Talk Team

Crisis Roundup

Brian Hoyt — Fri, 30 Oct 2009 15:07:22 -0400

"It's Alive, It's ALIVE, It's ALLLIIIIVVVE!"

The economics profession may become more mathematical, and friendlier to women.

Unemployment in the US is going to be a problem for a long time.

Commodity prices aren't really based on fundamentals like weather and geopolitics.

Lords of Finance. Best business book of the year.

Brad DeLong ♥ Financial Times.

Surprise! Paul Krugman thinks that the stimulus is working, but wants it to be bigger.

China can't cool down its steel bubble.

There is a large gap between new and existing home sales in the United States.

People are eating out less frequently.

One bit of proof that the recovery is real.

Finally, the recession is taking its toll on California.

The Double-Edged Sword of Emerging Market Growth

Brian Hoyt — Thu, 29 Oct 2009 15:13:49 -0400

The Economist has two interesting articles this week about capital flows in India. The Indian government is currently confronted with the a challenge of nurturing the growth of India's financial markets and multinationals, while mitigating the risks of excessive "hot money" flowing into the economy.

Proponents of capital controls point to India's success in avoiding the worst of the Asian financial crisis in the late 1990s and the current crisis, which was in part achieved by limiting the amount of money flowing in and out of the economy (for example, foreigners are limited in the amount of local bonds they can purchase).

Yet, India remains a sponge for foreign capital. The Economist notes that foreigners have invested $13.8 bn in India’s stockmarkets since April, having withdrawn $8.6 billion over the same period last year. The Sensex, India’s most widely watched stockmarket index, has surged by almost 100% since its March lows.

Advocates of a stricter capital controls are facing a strong resistance from the market...

India is steadily becoming more financially stitched in to the rest of the world. Its foreign assets and liabilities add up to over 60% of GDP. In the 1990s that ratio was only about 40%. It has risen partly because India’s own companies are eager to acquire foreign firms. In March 2009 India’s stock of direct investment abroad was worth over $67 billion, more than twice the figure in March 2007.

A 2007 report commissioned by the government to assess Mumbai’s prospects of becoming an international financial centre argued that India has a comparative advantage in financial services, like the one it has in information technology. India, after all, has a common-law legal tradition and a stockmarket that is 130 years old. Many bankers working in London, Dubai and Singapore have their roots in India.

...and from India's growing corporate champions:

As more big Indian firms become multinational companies, it will be harder for politicians to resist the demands for a freer flow of finance. “It’s one thing for India to impose restrictions upon foreign multinationals like Enron or IBM,” says Ajay Shah of the National Institute of Public Finance and Policy, “but it’s harder for the Indian government to hobble its own multinationals. I think this is a qualitative change.” Indian companies are too ambitious to confine themselves to their borders. Likewise, India itself is too big a prize for foreign capitalists to ignore. Money has a way of finding opportunity.

Furthermore, it is unclear whether additional capital controls would have much of an effect on curbing of inflows. Brazil's recent introduction of a 2 percent tax on certain capital flows is unlikely to tame the Bovespa's animal spirits (it is beginning to claw back much of its initial losses from the announcement) and the rise of the real. Moreover, Brazil's measures have attracted a range of international criticism, including from the IMF.

As growth lags in the US, Europe and Japan, investors will continue to seek higher returns elsewhere. The impressive recovery of India and Brazil will only add to their attractiveness as alternative, high-yield, investment destinations (Brazil's credit rating was recently elevated to investment grade. The World Bank no longer considers India a low-income country).

By attempting to limit capital controls, while simultaneously using their place in a globalized economy as a trojan horse for growth, emerging markets are faced with the challenge of wanting to have their cake and eating it too. As Brazil's experience is proving thus far, this is going to be a very difficult task.

What's New in Decoupling?

Brian Hoyt — Wed, 28 Oct 2009 15:52:48 -0400

I recently wondered what the relationship between developed and emerging economies would look like during the recovery phase of the crisis:

Will a robust emerging market rebound boost OECD growth? Or, are we due to see a multi-speed global recovery?

John Authers points out that, thus far, the recovery has been quite heterogeneous:

The grand theory was that decoupling by emerging markets would be good for everyone- they would grow even if consumers in the developed world caught a cold, and help everyone through. The latest data suggest a decoupled world, but that does not seem so positive.

Authers highlights the Reserve Bank of India's recent decision to raise rates and the "stunning" recovery in South Korea. Meanwhile, consumer confidence in the US is awful. He concludes:

Asian economies are already at the point where overheating is the main danger, while US consumers, for all the money thrown at them, are still not feeling any better. This is not encouraging.

Meanwhile, equity indices are down and the dollar is up. Perhaps investors were a bit too sanguine, and are now sobering up?

More on bubbles

Brian Hoyt — Wed, 28 Oct 2009 11:28:52 -0400

A few days ago I offered a series of bubble warnings from a German financial pundit, two academics, the man who broke the Bank of England, and the man who built Singapore. Today, we have a warning from the world's largest bond fund.

Free Exchange links to a discussion (via Buttonwood) about asset inflation, led by Pimco's Bill Gross.

Bottom line:

Cumulatively, asset values have risen twice as fast as GDP over the 50 year period. As Gross writes "you would have been far better off investing in paper than factories or machinery or the requisite components of an educated workforce."

Nuff said.

A Long Way To Go

Brian Hoyt — Tue, 27 Oct 2009 16:07:01 -0400

There is a short but sweet article from All Roads Lead to China on Shanghai's 100 hardest jobs, which looks at the lives of China's poorer workers (who make up the bulk of the country's 1.3bn citizens). The editors conducted over 100 interviews with workers ranging from a cigarette salesman to a watermelon vendor.

I was particluarly struck by an interview with a hat salesman, who reminds the reader of the challenges facing China's underclass

Q: If there was one thing you could change about your job, what would it be?
A: Change? It is such a luxury to me. How can I dream about changing my current status? I want to do my own business, like opening my own restaurant, but who will give me the money? I want to recruit and train my employees, but who will teach me how to manage or run my place? I dare not think of change. I guess my only hope is my son. He is the one (sic) can bring real changes.

The authors note a recurring theme of "hope and opportunity for the next generation".

China's immense population is frequently criticized for saving too much and consuming too little, which makes the country dependent on exports in order to grow. These interviews serve as a reminder that, because many of China's citizens are placing their hopes with the next generation, saving is likely to remain a fact of life in China for a very long time.

(h/t China Law Blog)

Today in Bubbles

Brian Hoyt — Mon, 26 Oct 2009 14:37:50 -0400

The editors of the Financial Times appear to be concerned about bubbles. Three out of today's four op-eds are dedicated to the theme.

First, George Soros argues that the implosion of 2008 was an aggregation of a series of bubbles over the past decades, creating, in his words, a "super-bubble":

The crash of 2008 was caused by the collapse of a super-bubble that has been growing since 1980. This was composed of smaller bubbles. Each time a financial crisis occurred the authorities intervened, took care of the failing institutions, and applied monetary and fiscal stimulus, inflating the super-bubble even further.

Soros then turns to the financial system, regulation, and the money supply:

The financial system is far from equilibrium. The short-term needs are the opposite of what is needed in the long term. First you must replace the credit that has evaporated by using the only source that remains credible- the state. That means increasing national debt and extending the monetary base. As the economy stabilises you must shrink this base as fast as credit revives- otherwise, deflation will be replaced by inflation.

Next, over on the right-hand column, two senior fellows from the Peterson Institute make the case for the IMF to help Brazil tackle capital inflows, before markets start to overheat:

The Brazilian action in imposing a tax on certain kinds of foreign inflows... is important in increasing the arsenal of weapons that countries can deploy to moderate overheating of their economies. It is a good illustration of the type of measure policymakers can use to arrest incipient asset price overheating.

The authors then go on to criticize the IMF for criticizing Brazil:

The world needs a less doctrinaire approach to foreign capital flows. Helping Brazil in its decision last week rather than issuing a negative response would signal that the IMF is playing a constructive role in facilitating this shift.

Meanwhile, down below, Wolfagang Münchau offers "A polite discourse on bankers and bubbles"

I suspect strongly that we are already in another bubble in the global equity and bonds markets, and also in sections of the commodity markets. These may burst well before the world economy recovers the most recent bubble. Central banks should eventually prick them before they cause calamity.

It may not be the time yet to deploy an anti-bubble strategy. But we sure need to put one together.

If this cocktail of pundits, financiers, and academics fails to persuade the reader of the risks of upcoming bubbles, perhaps a revered head of state will?

Lee Kuan Yew, "Mentor Minister" of Singapore and former prime minister, had a marvelous discussion with Charlie Rose last week which included, among other topics, a bubble warning.

Lee argued that Ben Bernanke needs to "clean up the liquidity" in the American financial system before the United States faces a liquidity bubble, leading to inflation and a run on the dollar. From the transcript:

CHARLIE ROSE: What would you want to ask him (Obama)? What would you want to know about him?

LEE KUAN YEW: Two things. First, that the 21st century will be a contest for supremacy in the Pacific because that’s where the growth will be. That’s where the bulk of the economic strength of the globe will come from.

If you do not hold your ground in the Pacific you cannot be a world leader. A world leader must hold his ground in the Pacific. That’s number one.

Number two, to hold ground in the Pacific, you must not let your fiscal deficits and dollar come to grief. If it comes to grief in the short term and there’s a run on the dollar for whatever reason, because of deficits are too big and the world -- the financial community and the bankers and all the hedge funds and everybody come to a conclusion that you’re not going tackle these deficits and they begin to move their assets out, that’s real trouble.

CHARLIE ROSE: And there is a risk of that perception today?

LEE KUAN YEW: Absolutely, yes.

And Ben Bernanke knows that. And he has to somehow or the other clean up and soak up the liquidity. But if he does it too soon you get into another recession. But you cannot dig up enormous deficits that allows all the -- and do nothing about it, where people say this is hopeless.

I second the concerns of Messrs Soros and Lee. Just as the paper profits of the mid-2000s were largely fueled by easy money and hubris, the current market successes are based on unprecedented government liquidity provisions. The true test for policymakers is to pull back this support without bringing the recovery to a halt (which will jeopardize future growth), while at the same time not allowing the stimulus to support another bubble that will have even more severe consequences then the previous "super-bubble."

The last thing the world economy needs in an "über-bubble" which destroys America's fiscal credibility.

Weekend Reading

Brian Hoyt — Fri, 23 Oct 2009 16:12:01 -0400

"Good news for investors who like to lose all their money". LTCM 3.0 is here.

The dangers of ultra cheap money.

Is US Government debt actually "risk-free"?

Historically, a weak dollar has been deflationary.

Great charts from Calculated Risk and Barry Ritholtz.

The average unemployment period in the US is at an all-time high.

Another take on why bankers make so much money.

Is Paul Krugman Panda-bashing?

"If you are going to be doing business in a foreign country, particularly China, it pays to do so legally and it pays to have the right visa."

South-South Trade Tensions

Brian Hoyt — Fri, 23 Oct 2009 12:20:39 -0400

John Authers argues that the newsworthy economic story of late isn't dollar weakness; rather, it is the weak renminbi:

Many, if not most, hopes for global recovery are pinned on China buying goods from countries such as Brazil. Commodity prices, a key driver of equities and forex rates, also move in response to the new orders received by China's manufacturers.

This currency regime makes it far harder for such countries to sell to China. So it is no wonder that currencies are back at the top of the agenda.

China's currency is 15 percent cheaper against the dollar than it was in 1993. Meanwhile, many emerging market currencies are returning to their pre-crisis exchange rates.

China has been building stronger trade relations with the Global South for quite some time. It is now South Africa's top export destination. But many of these partnerships are built around China purchasing commodities, and selling manufactured goods. With a weakening currency, China is likely to purchase fewer non-commidty goods from its trading partners. This may lead to growing trade tensions, particluarly with countries who are not endowed with commodities.

Much attention has been paid to the importance of the economic relationship between China and the United States, or "Chimerica" (See this week's Economist cover story. Or Paul Krugman). Rising trade tensions between the two economic powers could spell doom for the global economy.

Yet, one should not discount the importance of emerging market trade relations, and the possible tensions that may arise. Today's Wall St Journal reports of Indian grievances toward China's trade practices:

Trade friction is growing between India and China. India leads all members of the World Trade Organization in antidumping cases against China. India has banned imports of Chinese toys, milk and chocolate, citing safety concerns, and has launched investigations into export surges of Chinese truck tires and chemicals, among other products.

Heavy industries minister Vilasrao Deshmukh recently told reporters, "We don't want India to be turned into a dumping ground". Yet, India's actions have had little effect on the growing trade imbalance between the two countries:

Alas, trade tensions are not only worrisome between the West and the East. They may prove problematic between the emerging markets of the Global South.

The Case for Prudency: Latin America Edition

Brian Hoyt — Thu, 22 Oct 2009 11:01:11 -0400

Bloggers at the IMF are looking at why Latin America fared better in this crisis than during previous episodes of financial duress. Their explanation: financial soundness mixed with enhanced credibility.

This improvement can be attributed to the fact that the region faced the crisis equipped with economic policy frameworks that were more solid and credible than in the past, and with smaller financial, external, and fiscal vulnerabilities. This allowed a number of countries of the region to implement countercyclical monetary and fiscal policies.

The estimates here suggest that these countries were able to “save” about 4 percentage points of GDP during the crisis, thanks to their better preparations for confronting external shocks.

A key element of this preparedness was credibility. Those countries which had responsibly managed their monetary and fiscal policies before the crisis were able to quickly lower interest rates, while increasing public expenditure and fiscal deficits. Countries such as Brazil, Chile and Peru managed to store away enough revenues from the commodity booms of the previous years in order to enact the necessary mix of countercyclical policies. Mexico, which is suffering from dwindling oil reserves, had less of a cushion, and has in turn struggled more than most of its neighbors.

Update: Vox has an interesting paper on the policy responses of Latin America Central Banks during the crisis, written by the former governor of the Central Bank of Ecuador.

Crisis Viewing

Brian Hoyt — Wed, 21 Oct 2009 17:02:26 -0400

Our friends at PBS have released a couple of interesting crisis-related television programs this week.

First, Charlie Rose has an excellent interview with Andrew Ross Sorkin (type Sorkin's name into the Charlie Rose search window to access the video). Mr Sorkin discusses his just-released book, Too Big to Fail, telling the story of last year's Wall Street meltdown through the window of Paulon, Blankfein, Geithner, and other members of Wall Street's ruling coterie.

Next, Frontline has a new program entitled The Warning, which traces the roots to the crisis back through the 1990s. Naked Capitalism has several posts that provide useful background information to the characters and themes of the show.

Both are well worth viewing, particularly if you don't have time to read through Sorkin's 600+ page monster.

East Asian Production Networks: Beggar Thy Neighbor?

Brian Hoyt — Tue, 20 Oct 2009 16:04:36 -0400

There is an interesting article in Econbrowser by Willem Thorbecke of the Asian Development Bank, which looks at East Asian Production Networks, Global Imbalances, and Exchange Rate Coordination.

Thorbecke highlights the important relationship between exchange rates and production chains in East Asia, arguing for increased policy coordination between the two. The paper presents both good news and bad news regarding East Asia's crisis recovery. First, the good news:

Signs are emerging that East Asian production networks are reviving. Imports for processing and processed exports both collapsed earlier this year. Since then, however, imports for processing have recovered 85 percent of their losses and processed exports 75 percent. Thus trade within East Asian production networks is recovering.

However, currency markets may put an end to this growth. More specifically, China's crisis-inspired dollar peg may hamper this recovery by introducing excessive volatility to East Asia's production networks:

Exchange rate arrangements within the region may not allow this revival to be sustained. While many Asian countries have adopted greater exchange rate flexibility, China has returned to a de facto dollar peg. This implies that exchange rates between Asian countries have become very volatile...In a recent survey found that exchange rate stability between Asian currencies is essential for the uninterrupted flow of parts and components within regional production networks.

In addition, since Asian economies do not only cooperate within production networks but also compete in third markets, China's exchange rate peg puts pressure on other countries in the region to prevent their exchange rates from appreciating. If the renminbi is kept fixed, it becomes much harder for the huge surpluses generated within East Asian production networks to lead to a generalized appreciation of Asian currencies.

Asian production networks are highly dependent on exports to the US, Europe and Japan. The crisis has hampered the demand coming from these countries, which has led to a breakdown in East Asian industrial production, creating massive unemployment.

China has held down the value of the renminbi in order to increase its own industrial competitiveness and mitigate unemployment. This has adverse consequences not only for China's neighbors, but for China itself. Quite simply, by pegging the renminbi to the weakening dollar, China has introduced a short-term solution (boost exports via a cheaper currency) to a long term problem (global imbalances, weak domestic demand, and exchange rate-induced competitiveness).

Thorbecke calls for greater monetary coordination within the region in order to address the problems associated with Asia's export-led growth models:

A good policy mix for Asia would thus involve relatively stable intra-regional exchange rates that could appreciate together in response to regional trade surpluses combined with more spending on human capital. Stable exchange rates would help to strengthen regional production networks. Joint appreciations would prevent unpleasant outcomes such as beggar-thy-neighbor policies and excessive reserve accumulation while also reducing global imbalances and encouraging production for domestic markets.

Spending on human capital would facilitate technology transfer by allowing firms in developing Asia to become more involved in the engineering and design aspects of production. If Asian countries could climb the value chain in this way and focus on knowledge-intensive activities rather than assembly operations, not only would living standards in developing Asia rise but the region could become an engine of growth for the rest of the world

There is a certain irony that China has been the most vocal Asian critic of dollar depreciation, yet it is one of the few Asian countries whose currency has not absorbed any of the recent dollar weakness. It is hard not to see a contradiction: a weaker dollar is exactly what the US needs in order to produce a sustainable recovery, which will in turn help restore faith in the fiscal health of the American government, which will thus bring credibility to the health of the dollar. Ben Bernanke hinted at this yesterday in San Francisco.

The issue of reserve accumulation is becoming a serious concern (see yesterday's post). The IMF is now looking for strategies to weaken the case for hording reserves. Deputy Managing Director John Lipsky said yesterday, "We are exploring the possibility of improving our existing facilities or adding other insurance-like facilities that will give our members greater confidence that they don't need to self-insure by building up [foreign] reserves."

The easiest way to stop the trend of stockpiling reserves would be to simply allow the market to determine exchange rates. As Thorbecke's paper concludes, attempting to halt this process can be bad for your neighbors, bad for the global economy, and may even be bad for your own country.

Rising Reserves

Brian Hoyt — Mon, 19 Oct 2009 12:59:33 -0400

One sign of crisis abatement is the downward slide of the US dollar. As the market rediscovers its appetite for risk, the dollar's appeal as a safe haven currency diminishes. Indeed, the dollar has become the de facto carry trade currency.

The market has renewed its faith in emerging markets, and the US has more tools to repair its trade balance and begin a phase of export-led growth? Is this a win-win situation? Not quite.

Although the dollar may be weakening, this weakening hasn't stopped central banks from accumulating more dollar reserves. In fact, dollar weakness may be accelerating accumulation.

Last week, several emerging market countries intervened in currency markets in order to prop up the dollar (or, rather, to push down their own currencies). This involves buying dollars: Russia recently picked up $1.4bn in a single day, and $4bn in the same week.

What are central banks doing with these dollars? Most of them are tucking them away for a rainy day, having seen the benefits of such accumulation during the crisis.

A few months ago, Deutsche Bank released a report which prescribed forex accumulation as a necessary strategy for future emerging market growth and stability:

The amount of FX reserves in relation to external financing requirements is still crucial to the assessment of countries’ resilience to external shocks. From a policy perspective, accumulating FX reserves still seems to be pretty good insurance.

Rebecca Wilder, writing in yesterday's Angry Bear, agrees:

Key markets in Asia (China, or South Korea) and Latin America (Brazil) remained rather resilient to the credit crunch late in 2008 due to sufficient (even excessive) reserves holdings. Brazil, for example, was able to supply private-sector financing needs by draining FX ($USD) reserve holdings. South Korea and other Asian economies, too.

Record inflows of late into EM financial markets (bonds and equities) are providing plenty of liquidity and contributing to reserve accumulation of late. However, having sufficient FX reserves has proven to be the best insurance out there against a stoppage in external financing. And as long as inflation pressures remain muted, acquiring reserves is not too costly economically (there are administrative costs, though, from sterilization when US Treasury rates are near zero.)

Targeted reserve accumulation, in whatever currency but still heavily weighted in $US, buffered EM countries from catastrophe and is not going away.

Wilder notes that reserves in Brazil are now 230% higher than they were in 2007, 197% in China, 190% in Thailand, and 163% in Hong Kong. Reserves in South Korea grew by 26 percent in the first three quarters of 2009, Taiwan's by 14 percent. Indeed, the total supply of global reserves has tripled since 2000.

If pressure on the dollar continues, and countries such as China maintain dollar pegs (while other simply try to limit the appreciation of their own currencies), reserve accumulation is likely to accelerate.

Four months ago, in reaction to the Deutsche Bank report, I concluded:

The question remains as to how central banks' desire to purchase this kind of (fx) insurance can be squared with the need to resolve global macroeconomic imbalances.

This question still remains.

Crisis Roundup

Brian Hoyt — Fri, 16 Oct 2009 14:37:48 -0400

European exports declined by 5.8 percent last month, the biggest drop since last January.

Understanding the European Central Bank means looking at its individual members.

The economic blogosphere really is a remarkable resource.

Bloggers at the IMF's ask, Did Islamic Banks in the Gulf Do Better Than Conventional Ones in the Crisis?

Did economic theory actually do a good job of predicting the crisis?

Greg Mankiw ♥ VAT.

Thoughts on exit strategies from one of China's prominent market economists.

Does China have a dollar problem?

Still confused about the dollar? Why do many of Asia's currency remain weak? Why are the euro and yen so strong, when their respective economies look weak? Bilal Hafeez, global head of foreign exchange research at Deutsche Bank is fielding questions from readers, which he will answer on Monday October 19.

World Economic Forum Financial Development Report

Brian Hoyt — Wed, 14 Oct 2009 15:49:22 -0400

The World Economic Forum has released its Financial Development Report 2009, which scores and ranks 55 of the world’s leading financial systems and capital markets according to their level of financial development. It analyzes the drivers of financial system development and economic growth in developed and developing countries to serve as a tool for countries to benchmark themselves and establish priorities for reform.

The United Kingdom replaced the US as this year's top performer. America's fall is largely due to lower financial stability scores and a weakened banking sector:

The report also highlights the impact of the financial crisis on the Millennium Development Goals. Erik Feyen, Financial Economist in the World Bank’s Financial and Private Sector Development Vice Presidency, has written a chapter in the report that highlights this impact.

Below is an excerpt:

Financial Development, Financial Crises, and the Millennium Development Goals

There is no doubt that financial sector development contributes to economic growth and poverty alleviation. And even though financial systems can be prone to instability, studies show that countries that have experienced occasional financial crises have, on average, grown faster than countries with stable financial conditions because they stimulated healthy risk taking, by, for example, financing a small company, a farmer or R&D activities. However, financial crises can have devastating effects on the world’s most vulnerable people. The weakest members of society are often at the highest risk of falling into a poverty trap, which can lead to long-term developmental and economic losses. The current crisis has once again demonstrated that developing countries must strengthen their safety nets and plan their crisis intervention scenarios to protect the weakest in a timely, targeted, and cost-effective manner.

During normal times, both developed and developing countries with sound banking and capital markets enjoy stronger per capita income growth than countries without such markets. Research suggests that financial development results in fewer people living in poverty, since the poor indirectly benefit from economic growth through increases in employment opportunities, real wages, as well as from investment in core infrastructure.

However, although the poor benefit disproportionately from financial development, they also tend to suffer disproportionately from financial crises. This occurs because they are less able than wealthier people to insulate themselves against shocks. Even a small shock can force households to sell off productive assets such as land and livestock, economize on food and healthcare, and pull their children out of school to make ends meet. Thus, financial crises can endanger progress toward attaining the Millennium Development Goals.

Countries should continue to pursue policies that encourage financial development and avoid those that lead to excessive long-term intervention in systems or those that increase protectionism in the wake of a financial crisis. Well-thought-out safety nets and crisis policies would do much to mitigate the worst effects of a crisis on the poor.

Click here to view the report in full

Exchange Rate Movements in the Crisis and Beyond

Brian Hoyt — Wed, 14 Oct 2009 11:24:25 -0400

Editor's note: Sebastian Weber and Charles Wyplosz are from the Graduate Institute in Geneva. They are the authors of a World Bank working paper on Exchange Rates during the Crisis.

A key leitmotiv as the financial crisis unfolded was to avoid a repeat of the policy mistakes of the Great Depression, including the beggar-thy-neighbour competitive devaluations which have had devastating effects causing rising protectionism and a collapse of international trade (Kindleberger, 1973).

Unlike in the 30s, only some 42% of countries are officially pegging their exchange rate today, implying that movements in the exchange rate do not necessarily reflect official decisions, but are rather market-driven. Furthermore, governments today have many more policy tools at hand, ranging from fiscal policy over labour markets to monetary policy measures, making them less reliant on measures that are perceived as beggar-thy-neighbour.

While exchange rates have moved a lot since the onset of the crisis, these movements have mostly been interpreted as a byproduct of expansionary policies and the move to ‘quality’. Sharp depreciations in countries like the UK or South Korea have not been welcomed by the authorities, at least not officially. Intentions, of course, are hard to detect and no one will argue that expansionary policies were not needed.

The sharp appreciation of the dollar against most currencies by the end of 2008 (see graph) and the following decline in the dollar’s value starting again in the beginning of 2009 had two immediate consequences:

First, countries which pegged to the greenback, be it a dejure or defacto peg, lost heavily in competitiveness with respect to most of their floating counterparts in late 2008. This heightened the incentive for many countries, already constrained in their policy options, to devalue against the dollar to “reestablish” their export competitiveness in a time that global demand was already collapsing. Countries like Singapore and Vietnam gave in and lowered their currency’s respective value to the US dollar. Similarly, Kazakhstan and Armenia devalued against the dollar in response to the decline in the value of the Russian ruble and the devaluations in Ukraine and Belarus.

Second, the ongoing fall in the value of the US dollar since the beginning of 2009 shifts the adjustment burden to a greater extent on those countries which did not depreciate (too much) against the dollar in the midst of the crisis. This includes the euro zone but also Eastern European nations which peg to the euro. Many of these countries already had large pre-crisis trade deficits which tended to widen even further. On the other end of the specter remain the nations with the big surpluses which often peg more or less loosely to the dollar, including several Asian countries, some of which strengthened their nominal competitiveness even more throughout the crisis. Hence, the fall in the dollar’s value may be conducive to the reduction of the US deficit position, and it is likely to contribute to an increasing imbalance between various European states and Asian economies that anchor to the dollar.

Hence, even as the worst of the current crisis may be over, there remains a big uncertainty regarding the future developments of exchange rates and to which extent they will be supportive in facilitating adjustments to external imbalances of countries.

While direct foreign exchange interventions remained contained during the crisis, the incentives to use the exchange rate channel as a mean to overcome the consequences of the crisis (high debt and low demand) remain very vivid.

Local Bond Markets: From Strength to Strength

Brian Hoyt — Tue, 13 Oct 2009 16:47:20 -0400

Most emerging markets are having a better crisis than their G7 counterparts. One sign of robustness in emerging markets is the growing importance of their local bond markets. A new paper from Vox by Ismali Dalla and Heiko Hesse (of the IMF) takes a look at how local-currency bond markets are becoming a viable funding alternative for many emerging market issuers.

Not surprisingly, many of the countries that have succeeded in weathering the worst of the crisis (China, India, Brazil, Poland) also have substantial local bond markets:

Some of the key findings of the paper include:

Local-currency bond markets are becoming an alternative funding source in several emerging economies. These markets have grown rapidly, doubling in size from $2.2 trillion in 2003 to $5.5 trillion at the end 2008
Between 2005 and 2008, domestic bond issuance by corporations in emerging market countries sharply increased from $221 billion to $430 billion and remains strong thus far. The main issuers of corporate bonds in domestic markets are from China, South Korea, India, Russia, Thailand, Malaysia, Mexico and Brazil.
In 2008, eight out of the world’s sixteen largest local-currency bond markets (measured as percentage of GDP) were in emerging markets. The top emerging markets were China, Brazil, India, Mexico, Malaysia, Poland, Turkey, Thailand, and South Africa. Together, these countries accounted for 85% of the value of local bonds outstanding
Domestic investors have been the primary purchasers of local-currency bonds, especially government bonds. In fact, bonds have become the preferred asset class in the portfolios of emerging-market institutional investors

The growth of these bond markets has come at a crucial time, as many borrowers cannot withstand further foreign currency borrowing, having maxed out over the past few years:

Emerging market corporations and banks face large refinancing needs for their foreign-currency-denominated bonds and syndicated loans, especially in emerging Europe. According to estimates by the IMF (2009), these total $400 billion over the next two years. This makes further development of domestic corporate bond markets important to reducing future possible rollover risks in foreign currency bonds.

Local currency bond markets deepened significantly during the crisis as a result of the shortage of available dollars and other hard currencies. By building upon these developments, emerging market economies can increasingly buffer themselves from outside economic externalities.

Furthermore, the highs and lows of the dollar over the past year have illustrated the unattractiveness of having your debt obligations linked to the whims of the forex market. It is simply a lot easier to borrow in your own currency. Fortunately, it is becoming much easier and less expensive to do so.

Update: The World Bank/IFC Capital Markets Advisory Group is an active participant in building local currency bond markets. Through its Global Emerging Markets Local Currency Bond Program (Gemloc), the Bank offers three services:

A private investment manager to promote institutional investment in local currency bonds
A private sector-led global index that tracks emerging market local currency bonds that meet market size and investability criteria
Advisory services that aim to strengthen local bond markets

Global Monetary Architecture Matters

Brian Hoyt — Tue, 13 Oct 2009 10:22:40 -0400

Editor's Note: Nadia Piffaretti is an assistant to the Chief Economist at the World Bank Group and a Special Assistant to the Senior Vice President. She is the author of an upcoming paper on Reshaping the International Monetary Architecture.

The crisis has taught us that economists ought to believe their own warnings about systemic vulnerability. If analysis points out that a system can fail, it probably will at some point. Knowing what we know today, having experienced – in a sort of “real-life economic laboratory” – how systemic vulnerabilities can transmit and amplify shocks, we cannot avoid turning a worried eye to the largely imbalanced growth of the global economy.

Before this crisis, many economists had warned about another crisis – a disorderly unwinding of global imbalances. It didn’t happen. It still may.

While most recently global imbalances have been narrowing, due to short term factors (like oil prices), the IMF is forecasting a widening again starting in 2010. At the same time, conditions do not seem to be reunited for a clear shift of growth engines at both sides of the global imbalances, especially at a juncture when governments attempt to calibrate exit-strategies from fiscal stimuli, walking the fine line between possible fiscal unsustainability, and the risk of too early withdrawal of stimulus.

It is against this backdrop, and the realization that the international monetary architecture looks vulnerable indeed, that I reminded myself of the almost forgotten “1941 Keynes’ Plan” which the “Master” had elaborated in view of the Bretton Woods negotiations.

The plan stemmed from the idea that monetary architecture matters.

Keynes’ Plan originated from the ambition to ground growing trade flows and the renewed spirit of trust and cooperation of the post-war period, on a sound international monetary architecture. Suggesting the introduction of an International Clearing Union (first between US and UK) and applying “symmetric rebalancing” that mimicked the action of national central banks seemed, at that time, like a natural analytical extension to international payments of the same institutional arrangement governing settlements within nations.

The central idea is to secure creditor adjustment while maintaining debtor discipline, with provisions crafted in such a way as to discourage creditor countries to accumulate vast reserves. In order to avoid deflationary pressures, imbalances would not be corrected through a unilateral contraction of imports in the deficit country, but kept in check via strong incentives for the surplus country to make use (in international trade) of the purchasing power accumulated, stimulating an expansion of its imports.

Suggestively, Keynes described the structure “as a measure of financial disarmament”.

While we are witnessing the re-evaluation of the centrality of central banks and central clearing in response to the structural vulnerability and failures in the monetary architecture of interbank-markets (exemplified by the deep freeze that interbank-markets experienced for weeks after the Lehman Brothers episode), we have yet to address the remaining shortcomings of the monetary architecture at the international level.

The recent G20 summit featured a strong consensus on the need to foster a “balanced globalization” and address global imbalances, but expressed no consensus view on the institutional arrangements most apt to promote balanced global growth. International monetary architecture was not put forward for discussion.

More than 65 years after a failed attempt to reform, the inherent instability of the international monetary architecture and global imbalances are back to the fore again. Keynes began planning the post-war monetary order in the early days of 1940, a lesson on the need to think ahead. The core ideas of Keynes’ Plan remain the chief blueprint for any further attempt to ground international trade on a less vulnerable monetary architecture.

To read more about this issue, download a full copy of Piffaretti's paper here.

Weekend Reading

Brian Hoyt — Fri, 09 Oct 2009 12:37:51 -0400

Real Time Economics interviews: Hernando de Soto talks about the effects of the crisis on the world's poorest, while our Chief Economist Justin Lin discusses China, the IMF, and stimulus packages.

Paul Kedrosky praises venture capitalists.

One quarter of US jobs are offshorable. It might not matter.

Unemployment is high on Europe's frontiers.

In other unemployment news, Ryan Avent thinks that the stimulus is needed to fight joblessness. Tyler Cowen doesn't.

The US trade gap narrowed last month. It is down almost 50 percent from a year ago. Could it have anything to do with the dollar?

Larry Summers dismisses the idea of a low-growth America.

Our East Asia blog looks at 60 years of China's development, and asks, "Are China's banks having a good crisis?"

The Cost of Remittances

Brian Hoyt — Wed, 07 Oct 2009 15:30:30 -0400

A few months ago I attended a World Bank conference on Diaspora for Development, which featured several discussions about the relationship between economic crisis and migration. An important component of this relationship is, of course, remittances.

The World Bank estimates that remittance flows will drop by 7-10 percent in 2009. Yet, because of the fall in foreign direct investment caused by the crisis, remittances have become a more important source of external financing than ever.

If remittances have become an essential source of external finance for developing countries, then lowering the cost of sending remittances would serve as a de facto foreign currency stimulus.

Which brings me to today's announcement that the World Bank has launched its latest remittance prices data series. The new website has a handy menu where you can insert different corridors and calculate the costs of sending money. It even lets you compare the prices of various banks.

The database has been expanded to include 33 new corridors, and the following new sending countries: Australia, New Zealand, Brazil, Chile, Costa Rica, Dominican Republic, Ghana and Tanzania corridors.

The least expensive corridors are Singapore-Bangladesh and Singapore-Philippines. On the other side of the table are Netherlands-Indonesia and UK-Sierra Leone.