Crisis Talk - The World Bank Group

Weekend Reading (and viewing)

The Big Picture declares, "The Great Recession is Over! Long Live the Ordinary Recession..."

Simon Johnson makes the case for capital controls, concluding:

For better or worse, we are likely heading towards a world in which capital no longer flows so freely across borders.  Look for the start of this in Asia.

The IMF is worried about debt levels in wealthy countries, which are approaching 120 percent of GDP.

Sébastien Wälti, writing on VoxEU, claims that decoupling was a myth, as "globalisation brings national business cycles closer together".

Noam Scheiber from the New Republic sticks up for Hank Paulson, sort of...

I think it reflects well on Paulson that he was willing to change course when it became obvious that his initial ideas were off-base

...meanwhile, Tim Geithner can't seem to sell his house, and refuses to change course and lower the price.

This Week in China

In honor of this week's US-China Strategic and Economic Dialog, today's Crisis Talk is dedicated to the latest discussions on Sino-American economic relations.

To start, Brad Setser has three excellent articles on Chinese-American monetary relations:

• The first article points out that the PBoC's balance sheet totals 70% of GDP, compared to the Fed's, which recently hit 15% (and was 6% before the crisis).
• The second asks, "Doesn’t a smaller (external) deficit mean less dependence on (external) creditors, including China?" Setser thinks so, and I agree.
• Third, for all its concerns about a weak dollar, China has been allowing its own currency to depreciate lately. 

Simon Johnson analyzes Tim Geithner's China strategy:

Any country that runs such a current account surplus is implicitly taking a great deal of currency risk – China was in effect deciding to take the biggest ever official long-dollar position.  The idea that the US government should spend time reassuring them is somewhere between quaint and not good strategy.

Today's FT has two commentaries on China and the dollar. The titles speak for themselves:

• Washington risks taking China too seriously
• Chatter about a new global currency is overblown

Finally, China Law Blog gives advice on how to avoid getting kidnapped in China.  The solution: "Plan in advance or go home."

World Bank VP: Recovery Uncertain

In an interview yesterday with Reuters, Marwan Muasher, the World Bank's senior vice president for external affairs, called any type of recovery "uncertain", and warned that the poorest nations are just starting to feel the worst of the crisis.  Muasher called for rich nations to set aside 0.7 percent of their stimulus packages for poorer countries, adding:

There are other measures that need to be taken, including the cleaning of the banking sector, putting in place new financial regulations, concluding the Doha round of trade talks so we don't end up in protectionist measures and makings sure that the poor are not left behind

The road out of the crisis risks leaving the world's poor behind, no matter what shape it takes.

Emerging Market Wrap Up

Today's FT has a comprehensive summary of the current state of emerging markets. Not surprisingly, China and India are the clear winners, while the picture in the rest of the world is more murky. Perceived government mismanagement has steered investors away from Argentina and Venezuela, while Central and Eastern European nations, particularly Russia, continue to suffer the most.

The article, "Developing nations shine amid the crisis gloom", is well worth the read, and has some excellent quotes from leading emerging market investors, like this one from Robert Buckland, global head of equity strategy at Citigroup:

The financial crisis has been the making of the emerging markets in that they are no longer some kind of super-cyclical play.  It is no longer the case that if you downgrade US GDP by 1 per cent, the emerging market GDP will be downgraded by 2 or 3 per cent.  The balance sheet management of the emerging markets has been better in this crisis than the developed world.

Decoupling, anyone?

Currency Swaps: Fed=>Brazilian Central Bank=>Real Sector

Last week, the IMF held a discussion entitled "From Lombard Street to Avenida Pauista: Foreign Exchange Liquidity Easing in Brazil in Response to the Global Shock of 2008-09". The presentation highlighted the Brazilian Central Bank’s FX swap agreements with the Fed in the aftermath of the Lehman Brothers collapse.

These swaps had several unusual features.

This Week in Crisis

Tyler Cowen claims that a new book on the crisis, In Fed We Trust: Ben Bernanke's War on the Great Panic, is "so far the most entertaining and most readable book on the financial crisis". In typical dramatic fashion that makes Cowen's praise seem subdued, Joseph Stiglitz argues, "no one can understand what happened and what did not happen without reading this book". 

East Asia & Pacific on the rise has two excellent articles on China's economic robustness. The first discusses the growing presence of Chinese firms on the Fortune 500. The second post highlights growing internet use in China, with current figures topping 338 million users.

Supervision, Regulation and the Crisis

In addition to our policy brief on Blanket Guarantees, the World Bank Group has released two more papers as part of the Crisis Response series:

• In Trust Less, Verify More, Clive Briault, director of Risk and Regulation Consulting Limited, argues that financial supervision will need to change in response to the causes of the financial crisis and the regulatory proposals arising from it. Supervisors will need to take a tougher and more challenging approach to the firms they regulate, exercise more supervisory judgment, involve themselves in macro-prudential oversight, and participate more actively in the supervision of firms with crossborder activities. Supervisors in all countries need to take up these challenges—notwithstanding differences in the style of supervision, in culture and legal tradition, in institutional and organizational structure, and in the powers and resources available to the supervisory agency.
  
• In Macro-Prudential Regulation: Fixing Fundamental Market (and Regulatory) Failures, Avinash Persaud, chairman of Intelligence Capital Limited, describes how this is not the first international banking crisis the world has seen. The previous ones occurred without credit default swaps, special investment vehicles, or even credit ratings. If crises keep repeating themselves, it seems reasonable to argue that policy makers need to carefully consider what they are doing and not just “double up” by superficially reacting to the specific features of today’s crisis. While we cannot hope to prevent crises, we can perhaps make them fewer and milder by adopting and implementing better regulation—in particular, more macro-prudential regulation.

Blanket Guarantees: What next?

Editor’s note: The World Bank Group has just released the fourth paper in its Crisis Response series, which aims to chart a path out of the crisis. This current release discusses deposit insurance and government guarantees of other bank liabilities, and possible strategies for winding down the blanket guarantees issued during the crisis.

The expansion of deposit insurance and introduction of debt guarantees have played a crucial role in containing the financial crisis while giving governments time to develop suitable policy responses. But these measures do not address the root causes of the crisis, and they lead to competitive distortions, moral hazard, and large fiscal contingent liabilities. Rolling them back is likely to require an internationally coordinated effort—and an answer to the important question, “exit to what?”

To download a PDF of the paper, please click here.

Commercial Real Estate: Looking Toxic

There is mounting evidence that the latest roadblock to an economic recovery may stem from, alas, the US property market. This time, commercial property is the bête noir. From Bloomberg:

U.S. commercial property prices fell 7.6 percent in May from a month earlier, bringing the total decline to 35 percent since the market’s peak, Moody’s Investors Service said in a report this week. Commercial properties in the U.S. valued at more than $108 billion are now in default.

Dollar Devaluation: The Fed's Secret Weapon?

Continuing our discussion on the contradictory nature of the US dollar, Seeking Alpha has an article by Prieur du Plessis asking, "Is the U.S. Dollar the Fed's Next Weapon?" Du Plessis argues that the Fed's responses to the crisis, from eliminating interest rates to expanding its balance sheet by over 100 percent, have failed to bring about positive growth and curb unemployment, which leaves it with few remaining options beyond devaluation. He quotes a recent report from David Rosenberg, chief economist at Gluskin Sheff:

(Dollar devaluation) is the only policy tool that has not budged one iota since the crisis erupted two years ago. But we are sure that as the unemployment rate makes new highs and increasingly poses a political hurdle in a mid-term election year, it would make perfect sense for a country that always operates in its best interest - even if it may not be in everyone’s best interest - to sanction a U.S. dollar devaluation as a means to stimulate the domestic economy.

An Optimist's View of Declining Trade

Last week I discussed the relationship between falling GDP growth and the decline in international trade. Today, I will go beyond why trade is falling, and take a look at how it is doing so.   

A recent article by Brad Setser from the Council on Foreign Relations analyzes the effects of diminishing international trade on global imbalances. The pattern of these declines is not symmetrical. In the US, falls in income have had a stronger impact on imports than exports. The opposite is true in China. This is good news:

Weekly Crisis Roundup

Frederico Sander from our East Asia blog examines the state of Thailand's economy and its prospects for recovery. His prognosis: very cautious optimism.

It now appears that the fire has been put out (with much liquidity…), but the green shoots emerging in the burned forest remain very fragile as hot spots remain and the risks of the fire re-igniting are not negligible

Over at Follow the Money, there is less caution about Chinese green shoots; rather, some are wondering if China's stimulus is working too well. 

In a two part Vox column, Guido Tabellini discusses the nature of the crisis, and then ponders exit strategies.

Real Time Economics has a guide to the best of the econ blogosphere.

Abnormal Returns provides a nuanced overview of the ongoing Goldman Sachs saga...

...with some added comic relief.

Diaspora Bonds: An Innovative Source of Finance

The final discussion of this week's conference on diaspora for development was dedicated to the growing importance of diaspora bonds, particularly for the world's most vulnerable economies.

Diaspora bonds are financial instruments sold to members of the diaspora, often in small denominations, e.g. US$100. They are a simple means for governments to obtain hard currency, which can help boost central bank reserves, meet government financing gaps or fund infrastructure projects.

Because diaspora investors have different risk perspectives on their home country than the average investor, they may be willing to purchase bonds at interest rates lower than those offered by international capital markets.

Demystifying the Collapse in World Trade

Last week I pondered whether Europe was the biggest loser in the crisis. It appears that collapsing world trade volumes are giving the Old Continent a run for its money. 

In the first quarter of 2009, year-on-year nominal trade volumes dropped by 30 percent. World trade has fallen by 15 percent during the same period. 

What has happened?

A new paper by Caroline Freund (who is also a contributor to Crisis Talk) aims to explain why trade has suffered so much over the past year. Freund reexamines the relationship between trade and income, uncovering an important explanation. 

Bank Dividends and Failures in Governance in the Crisis

An excellent new paper, Dividends and Bank Capital in the Financial Crisis of 2007-2009, provides an important contribution to the debate on the role of bank governance in the crisis. It shows how large banks have been steadily eroding the quality of their capital over time and continued to pay dividends even during the rapidly-worsening situation of 2007-08 in an attempt to keep shareholders happy:

This Week in Bears

Although some corners of Wall St seem to be recovering quite nicely, bearish sentiment remains.  Several interesting articles have been released that confirm the need for caution. 

Tim Lee of pi Economics writes in today's FT that, due to remaining macroeconomic imbalances, the crisis is far from over:

If we do not yet have inflation and we cannot have a new bubble, then there must be more deleveraging and unwinding of the global credit bubble to come.

This means a very weak global economy with falling stock markets and commodity prices, falling government bond yields and widening credit spreads - in short, a troubling return to the markets that we suffered for most of last year.

Economic Crises and Migration: Location, location, location

This morning's International Conference on Diaspora for Development featured an excellent discussion led by Hans Timmer, director of the World Bank's Development Prospects Group, and Dilip Ratha, lead economist and author of the Bank's migration blog. Messrs Timmer and Ratha discussed the impact of the crisis on migration patterns and remittance flows, providing several key insights.

First, to quote Ratha, "The more we learn about remittances, the more we realize how little we actually know." Overall remittance values are difficult to predict due to the size and informality of the sector.

That said, here is the 2008-9 outlook on remittance flows:

• Total estimated remittances for 2008 were $328bn
• Remittance flows in 2009 are expected to drop by 7-10 percent. This negative growth trend began in September 2008
• Paradoxically, remittances have become a more important source of external financing in many countries, as foreign direct investment has dropped by up to 50 percent

Friday Crisis Roundup

Here are some of this week's highlights, from inside and outside the World Bank:

Does easy money and capricious legislation fuel commodity speculation? (Baseline Scenario)

Or is it a curse in general? (The Big Picture)

The World Bank's East Asia blog gives a roundup of the region, arguing that Asia will lead the world out of the crisis.

Meanwhile, our Africa blog ponders success in South Africa.

The European Central Bank has released a report on the international role of the euro...

...with Alea giving us the highlights. Bottom line:

The international role of currencies tends to be relatively stable over time.

Diaspora, Remittances, and the Crisis

The World Bank will be hosting a conference next Monday and Tuesday on diaspora and development. Myriad experts will be attending, addressing a diverse set of topics ranging from "Moroccan Scientific Diaspora between Transfers of Knowledge and Development" to "Diaspora Bonds". There is a session Monday morning from 9:15-10:45 that will discuss the impact of the crisis on migration and remittance flows. For those who would like to watch remotely, the Bank is providing a live webcast.

Note to Central Banks: Get More Dollars

That is what Terrence Keeley, head of sovereign client services at UBS, prescribes in today's FT: 

In an extreme crisis, there is no alternative to the US dollar. Indeed, far from needing a new “super-sovereign currency” most central banks need more US dollars. Moreover, those dollars need to be invested in the safest instruments possible, namely US Treasury bills, notes and bonds. All other assets in a crisis are ineffective.

Over the past eight years, central banks have over-invested in illiquid assets, such as credit and equity instruments, which created the need emergency currency swap lines with the Federal Reserve once the crisis hit:

Europe: The Biggest Loser?

The IMF just released a revised survey of its global economic outlook, which is generally less pessimistic than the one it originally released in April, particularly for GDP growth in 2010. There is one obvious exception amidst this "optimism": Europe.

Of all advanced economies, only Japan is expected to perform worse in 2009 (though the German economy, Europe's largest, should contract more). The Eurozone is the only entity forecasted to experience negative growth in 2010. The recovery in Central and Eastern Europe, when it arrives in 2010, is forecasted to be slower than in any other emerging market.

Deficits and the Dollar, Mutually Exclusive?

There has been a lot of chatter among policymakers about the future of the dollar. In particular, the BRIC countries have opined on the need for a new, global reserve currency to replace the greenback's predominance. (Last week, India chimed in).

At the same time, many emerging market countries, including the BRICs, continue to increase their dollar holdings. I recently posted on how foreign exchange reserves have been very useful in cushioning the adverse effects of the crisis. (Imagine how confidence in the Russian economy would differ if the central bank didn't hold over $400bn in reserves).

What do we make of all of this? How is it that the dollar's reserve status is being questioned, but simultaneously reinforced by the same countries who are doing the questioning? This paradoxical sentiment can probably be viewed as an expression of concern about the United States' deteriorating fiscal health.

A Return to Risk

There is a false sense among some regulators that more capital is the 'solution' to banking problems. Takafumi Sato, commissioner of Japan’s Financial Services Agency, takes issue with this supposed axiom. Writing last week in the Financial Times, Sato argues that bank management needs to change its (excessive) risk-taking behavior, with capital acting as the ultimate backstop:

Just asking for more capital will not cure the disease of capitalism. To avoid a recurrence of crises, we need a paradigm change. A global community adopting a uniform platform is vulnerable to a virus, as we have witnessed during the current financial pandemic. Capital adequacy regulations should be designed to foster diversity in business models, demanding the right level of capital for the business type of the bank in question.

More capital and no change in behavior leads to nothing - hence the importance of governance, where the reforms announced to-date, focusing primarily on executive compensation, are (at least in my mind) very timid in nature.

Zoellick Cautions Against Optimism

World Bank President Robert Zoellick has written to the leaders of the upcoming G-8 conference, warning them against complacency in fighting the crisis. The letter acknowledges the work done by central banks in preventing the global economy from descending into free-fall, but urges leaders to remain vigilant:

2009 remains a dangerous year. Recent gains could be reversed easily, and the pace of recovery in 2010 is far from certain.

The poor continue to be the most vulnerable to further economic volatility: a 1 percentage point drop in developing-country GDP is capable of pushing 20 million people into extreme poverty.

Crisis Roundup

Here's a look at what's being discussed during this short week in finance:

Should China's policy response to the crisis be geared toward short or long-term objectives? (East Asia and Pacific on the Rise)

Is total US unemployment higher than 9.5 percent? Some are arguing it is closer to 16.5 percent. (WSJ Real Time Economics)

Demand for US reserves dramatically increased during the buildup to the Crisis. Now it is falling.  (Excellent graph from Brad Setser at the Council on Foreign Relations) 

Some at the Fed are worried about not enough inflation... (Via Naked Capitalism)

...but that doesn't seem to stop interest rates from going up (Via Credit Writedowns)

Skidelsky, Wolf on Global Imbalances

The most recent issue of the New York Review of Books features an essay by Robert Skidelsky, biographer of Keynes, which discusses Martin Wolf's 2008 book, Fixing Global Finance (itself an excellent summary of global imbalances and the seeds of the crisis). Skidelsky elaborates on the role of the dollar as the world's premier reserve currency, arguing that the dollar's preeminence created a capital glut via the creation of the unofficial "Bretton Woods II" system of fixed exchange rates.

Under Bretton Woods II, many East Asian economies pegged their exchange rates to the dollar in order to build an arsenal of central bank reserves and retain export competitiveness. This buildup allowed the United States government to borrow cheaply and led American consumers to invest in asset-bubbles such as real estate and equities.