Crisis Talk - The World Bank Group

Crisis Roundup

"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

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 The Economist notes that foreigners have invested $13.8 bn in India’s stockmarkets since April, having withdrawn $8.6 billion over the same period last year.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...

What's New in Decoupling?

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?

Today in Bubbles

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.

Weekend Reading

"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

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.

Rising Reserves

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.

Crisis Roundup

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.

Local Bond Markets: From Strength to Strength

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:

 

Weekend Reading

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?"

Credit Rating Agencies: No Easy Regulatory Solutions

Editor's Note:  This is the eighth in a series of policy briefs on the crisis—assessing the policy responses, shedding light on financial reforms currently under debate, and providing insights for emerging-market policy makers.

About the authors: Jonathan Katz is a consultant and former secretary of the U.S. Securities and Exchange Commission. Emanuel Salinas is a senior investment officer at the Multilateral Investment Guarantee Agency (MIGA) of the World Bank Group. Constantinos Stephanou is a senior financial economist in the Financial and Private Sector Development Vice Presidency of the World Bank Group.

In the United States and Europe faulty credit ratings and flawed rating processes are widely perceived as being among the key contributors to the global financial crisis. That has brought them under intense scrutiny and led to proposals for radical reforms. The ongoing debate, while centered in major developed markets, will also influence policy choices in emerging economies: whether to focus on strengthening the reliability of ratings or on creating alternative mechanisms and institutions that can perform more effectively the role that in developed markets has traditionally been conferred on credit rating agencies.

Click here to view the policy brief in its entirety.

IFC Distressed Debt Update: China's On Board

Last week I discussed IFC's new plan to launch a vehicle to purchase toxic assets in emerging markets. The initial report indicated that much of the financing was expected to come from private sector banks. Reuters is now reporting that China's Sovereign Wealth Fund, China Investment Corp, is interested in participating in the project:

China has shown interest in investing in a new International Finance Corp program to acquire and restructure distressed debt in developing countries, World Bank President Robert Zoellick said on Monday.

Zoellick, speaking at a ceremony to launch the program that that aims to mobilize more than $6 billion to help banks and companies sell or restructure troubled assets, said he recently discussed the program with China Investment Corp, Beijing's sovereign wealth fund.

"They're interested in investing in distressed debt. They told us 'we can do it in the United States, but we're a little wary of doing it in the developing world because we don't want to be accused of anything'," Zoellick said. "To come in with us in a real restructuring program, they have some significant interest."

History Lessons

As the crisis enters its second year, the economic history books have already begun publishing an early account of first stages of the crisis. In particular, two articles have been released this week that serve as essential reading.

First, this month's Vanity Fair features an excerpt from Andrew Ross Sorkin's upcoming book, Too Big to Fail. Sorkin's piece gives a thrilling, minute by minute account of the chaos within the halls of Wall Street during the aftermath of the Lehman collapse. The article offers a view of the day's events through the perspective of the most important players in finance, including Timothy Geithner.

Crisis Roundup

China has replaced the United States as South Africa's largest trading partner.

In other Africa news, the World Bank has released a report on Doing Business in Kenya.

Problems with America's fiscal exit strategy. With a rebuttal.

Is the Fed too hawkish? Maybe because it's easier to be a hawk than a dove.

A pessimist's case for optimism. Plus, the probability of a US recession is diminishing.

But unemployment is looking ugly.  

UC Berkeley Professor Brad DeLong posts his lecture notes on the Great Depression, Keynes, and World War 1.

Free Exchange is hosting an excellent discussion on incentives and public regulators. Guest authors include Simon Johnson, Mark Thoma, and Tyler Cowen.

Finally, a loyal reader of Crisis Talk makes the case for freedom from imprudent risk aversion.

China Can't Do It Alone

As rich countries, led by the Untied States, prepare themselves for a tepid recovery, can the BRICs, led by China, pick up the slack?

In a new paper for Vox, Deutsche Bank's Markus Jäger discusses China's prospects for becoming the de-facto engine for global growth. His concussion: China already is the decisive engine for global growth. 

By 2014, assuming things are back to normal, China and the US will account for around 30% and a little over 10% of global growth, respectively – and this assumes relatively optimistically US growth of more than 3% per annum. In this sense, China will be the global growth “engine”. But this is nothing new. China’s contribution to global growth amounted to 20% during the better part of this decade, almost twice size of the US contribution.

Better Credit for Brazil

Yesterday, I analyzed the prospects for decoupling during the recovery. Will a robust emerging market rebound boost OECD growth? Or, are we due to see a multi-speed global recovery? The rise of emerging market IPOs, and its positive influence on IPO markets in developed economies, provides one data point in favor of the first theory. Today's news from Brazil may support the second. 

Moody's announced that it has elevated Brazil's credit rating to investment grade. The ratings agency described Brazil as a "winner", primarily because of its quick rebound from the recession, and strong growth potential for the future. This in an important step for Brazil, as it allows many institutional investors, who are forbidden from investing in "junk" debt, the opportunity to invest in Brazilian bonds.

Which country is next?

Emerging Market IPOs: Leading the way

Two years ago, as financial markets in the United States and Europe began to break down, there was much speculation over whether emerging markets would continue to grow in spite of the woes in the West. A year ago, this idea of decoupling was quickly dispelled.

As emerging markets rebound from the crisis, will there be a new decoupling, where they grow, and OECD economies struggle? It is probably too early to tell, but in one area, IPOs, developed economies are profiting from emerging market successes.

Pity the Pound

A few weeks ago I wondered if Britain was back. According to the Bank of England, it's not.

The Times reports:

In its Quarterly Bulletin, the Bank tried to explain the reasons for the collapse in value of sterling since the final quarter of last year. It said: "It is possible that sterling's depreciation may be part of a more prolonged process of rebalancing of the UK economy, generating a fall in the long-run sustainable real exchange rate."

Weekend Reading

The European Central Bank's crisis efforts are laudable. The current account surplus is back in the black, and the euro is hitting one-year highs against the dollar.

Meanwhile, sterling continues to suffer.

An explanation of the new dollar carry trade.

The American manufacturing sector is rebounding.

The jobless recovery has been kind to those with jobs. Wages are up.

California is investigating the ratings agencies.

Speaking of California and the ratings agencies, Moody's forecasts that California's real estate sector won't return to normal until 2030.

Finally, where is Paul Volcker?

Plus: In case you get lost in the thicket of financial jargon, the Devil's Dictionary is here to help. A taste:

STRESS TEST, n. 1. A measure of arterial blood flow to the head. 2. Alchemic process by which struggling, undercapitalized banks are transformed into paragons of modern finance. (See BANKS, GOOD.) Also known as the "Timothy F. Geithner Seal of Approval," which some bankers insist is good until it isn't anymore. (See BANKS, BAD.)

The Sino-American Economy: Mutually Assured Destruction

This week's New Republic has two interesting articles about China's economic rise, and its implications for the global economy.

In the first piece, This Giant Isn't Sleeping, Zachary Karabell argues that Chinese growth is both sustainable and here to stay, and that doubts about the Chinese economic model are overblown: 

China has produced more growth over the past 25 years than any country, ever (averaging more than 9 percent a year). And after stalling in the fall of 2008 and in the early months of 2009 along with the rest of the world, China has been growing at an astonishing rate in the past six months--manufacturing has been expanding, exports have been surging (more than $20 billion a month to the United States alone), property prices and activity have soared, and stocks are on fire. Interior cities have replaced the coastal provinces as the engine of growth, and that process has barely begun.

Karabell goes on to say that rising commodity prices (the price of copper has doubled over the past six months) mean that the Chinese economic engine is alive and well. 

The Fed's Next Move: Hibernation

Yesterday I commented on the role of inflation in the crisis, which was explored at length during a symposium on Dealing with America's Debt Overhang. Any good conversation about inflation has to be followed with a discussion about the Federal Reserve.

Liaquat Ahamed, author of Lords of Finance: the Bankers Who Broke the World, gave a summary of the Fed's exceptional role during the crisis, which can be broken down into three key areas:

1. Acting as a lender of last resort
2. Aggressively cutting interest rates
3. Lending against assets that would normally be considered unacceptable collateral

The Bernanke Fed has been lauded for having prevented another Great Depression, and many, including Barack Obama, consider Bernanke to have been the right man for the right job at the right time.

But times are changing, and now that we are no longer looking into the abyss, what's next for the Fed? What role should it play in the recovery?

The Case for Inflation; or, The End of Orthodoxy

I attended a symposium this morning on America's Debt Overhang, hosted by the non-partisan New America Foundation (NAF). There were several interesting discussions about the present and future implications of America's ballooning public, private and household debts. I will return to these debates in greater detail tomorrow.

One presentation in particular stood out: Christopher Hayes, a fellow at NAF, presented a controversial paper entitled Overcoming America's Debt Overhang: The Case for Inflation.

Hayes argues that America's debt burden has become crippling. Indeed, household debt has risen from 48 percent of GDP in 1981 to 97 percent today. Meanwhile, corporate debt has grown from 22 percent in 1981 to 120 percent in 2009. The federal government is borrowing and spending at unprecedented peacetime rates. This toxic cocktail may spiral out of control:

One Year On

On the one-year anniversary of the Lehman Crisis, the biggest names in financial punditry have been voicing their thoughts and concerns on the most important issues facing the world economy.  Let's take a look:

Martin Wolf, who spent most of the crisis bringing attention to global imbalances, has become a China bull:

China has emerged as the most significant winner from the global financial and economic crisis. At the end of 2008, many questioned whether China would achieve its growth target of 8 per cent in 2009. Who now dares to do so?

Crisis Roundup: Anniversary Edition

Is another boom around the corner?

Or has the real pain only begun?

Fedex can't find any green shoots in the US...

...and American consumers can't find any more credit.

Is the end near for the dollar? Probably not.

Hank Paulson doesn't use email. Can he be trusted?

The upside to rising foreclosures.

Doing Business 2010: Reforming through Difficult Times

The World Bank Group has released its annual Doing Business Report, which provides quantitative measures of regulations of the life cycle of a small or medium-size enterprise. Regulations related to registering property, employing workers, dealing with construction permits, and paying taxes are measured. Getting electricity and worker protection were added to this year's metrics.

In spite (or because) of the crisis, governments worked hard at improving the business climates within their borders:

In 2008/09 more governments implemented regulatory reforms aimed at making it easier to do business than in any year since 2004, when Doing Business started to track reforms through its indicators. Doing Business recorded 287 such reforms in 131 economies between June 2008 and May 2009, 20% more than in the year before.

Reformers focused on making it easier to start and operate a business, strengthening property rights and improving the efficiency of commercial dispute resolution and bankruptcy procedures.

Sovereign Wealth Funds: A Stabilizing Force?

I attended a discussion at the IMF today on the effects of sovereign wealth funds (SWFs) on financial market stability, particularly during the crisis*. It was hosted by two resident economists, Tao Sun and Heiko Hesse, who presented the results from their paper on Sovereign Wealth Funds and Financial Stability. The study analyzes whether or not the introduction of the massive financial resources behind sovereign wealth funds destabilizes capital and equity markets. 

The answer, for now, appears to be no. 

Systemic Risk and the Financial Sector

I'm being called Mr. Bailout. I can't do it again.

-Hank Paulson, September 2008.

The IMF held an unofficial conference yesterday on systemic risks in financial systems. Kay Giesecke from Stanford University presented a paper which argues that the the spillover effects from the failure of a financial firm play a prominent role in systemic risk, far greater than the failure or default of an industrial giant:

We find strong evidence for the presence of spillover effects in the US financial system during 1987-2008, after controlling for the exposure of firms to common or correlated risk factors.  The fraction of systemic risk explained by spillover effects can be substantial, and tends to be higher during periods of economic stress.

Bank failure clusters do not arise solely from exogenous shocks; rather, they are pushed over the edge by the failure of their peers. 

While it may seem obvious that bank failures pose a greater systemic risk threat then other sectors, it wasn't obvious enough to Mr Paulson.

Or, he just let it happen anyway.   

The US Dollar: The worst choice (except for every other option)

Barry Eichengreen has written a piece in this month's Foreign Affairs outlining the difficulties of replacing the dollar with an alternative reserve currency (subscription required).

Professor Eichengreen sets the stage with the usual talking points over the dollar's weaknesses:

• Confidence in the US-championed global financial system is waning
• The US government will continue to issue staggering amounts of debt
• In order for central banks to acquire dollars, the US must run a current-account deficit, which aggravates global imbalances and puts further downward pressure on the dollar
• The political logic for supporting the dollar has weakened, as the US is no longer seen as the military protector of Europe and Asia

In spite of this cocktail of structural weaknesses, there is an "inconvenient truth" to the dollar: its global importance hasn't changed as a result of the crisis. Based on the Federal Reserve's holdings of US Treasuries on behalf of its foreign counterparts, "foreign authorities have continued to accumulate dollars, and even accelerated their purchases in the first half of the 2009."

What gives? Why stick to a currency that is so clearly flawed? Why buy into a system that many respected economists warn is destined to fail?

Spain's Real Estate Blues

Last week, I questioned whether the good news coming out of the eurozone's core economies, France and Germany, would be enough to drive the continent towards a recovery. One of the biggest obstacles to such a recovery is the Spanish real estate sector, which some are dubbing, "a hole in Europe's balance sheet." A new report by Variant Perception, an economic consultancy, paints a grim picture of the Spanish housing market (emphasis mine):

Spain had the mother of all housing bubbles. To put things in perspective, Spain now has as many unsold homes as the US, even though the US is about six times bigger. Spain is roughly 10% of the EU GDP, yet it accounted for 30% of all new homes built since 2000 in the EU. Most of the new homes were financed with capital from abroad.

The value of outstanding loans to Spanish developers has gone from just €33.5 billion in 2000 to €318 billion in 2008, a rise of 850% in 8 years. If you add in construction sector debts, the overall value of outstanding loans to developers and construction companies rises to €470 billion. That's almost 50% of Spanish GDP. Most of these loans will go bad.

Bernanke's Challenges: Look North

Now that we are due for at least four more years of a Bernanke Fed, what will Act Two look like? The New York Times invited several economists to forecast the challenges lying ahead for Mr Bernanke.

Chief among these challenges is unwinding the massive stimuli and support mechanisms that the Fed introduced in order to "prevent another Great Depression" (in the words of Barack Obama). This will involve a deceleration of monetary easing as the Fed balances growth and recovery with inflation and the credibility of the dollar.

Iceland may be an interesting case study of what's ahead. Just as Iceland was a precursor to the severity of the credit crunch, it may be the first to feel the withdrawal symptoms of diminishing government stimulus policies. Robert Wade argues:

Crisis Roundup

The end of an era for the rich?

The view from Jackson Hole; or, the case against Bernanke. 

Is the United States following in the footsteps of Japan? Michael Mandel believes we are in the midst of a lost decade:

I think we need to wrap our minds around the fact that we’re not having a boom followed by a bust…we’re having a bad decade followed by a slow digging-out process.

IMF Weighs in on Recovery; World Bank Discusses Finance in Africa

The IMF and World Bank have both released reports discussing their latest thoughts on the global and regional effects of the financial crisis. 

Olivier Blanchard, the IMF's chief economist, has published his views on Sustaining a Global Recovery, arguing that the path out of the crisis for emerging markets is much simpler than in developed economies:

If past is prologue, the world economy likely will return to its past growth rate. But, especially in advanced countries, the period of above-average growth, characteristic of normal recoveries, may be short-lived or nonexistent.

Blanchard exposes two caveats to recent good news about growth:

Europe's Recovery: Half full or half empty?

A few weeks ago I pondered if Europe was the biggest loser in the crisis. In light of today's upbeat economic news coming out of France and Germany, was I being too harsh? 

Alas, Europe is not a homogeneous body, and this certainly holds true for its economies. The eurozone's northern members are doing better than those on the Med. Growth within the Europe is uneven and often unrelated. For example, Germany seems to be growing in spite of Europe, tying its export-led fortunes to the winds of Asia.

Furthermore, while good news tends to stay within national borders, bad news can spill over. Stronger exports in Germany cannot fix Spain's unemployment woes, and effective consumer stimulus efforts in France will not cure Ireland's Celtic Tiger hangover. Yet, a currency peg collapse in the Baltics, or a Hungarian debt crisis, can spread damage to Scandinavian and Austrian banks, and beyond.