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 The Economist notes that foreigners have invested $13.8 bn in India’s stockmarkets since April, having withdrawn $8.6 billion over the same period last year.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

More on bubbles

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.

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."

East Asian Production Networks: Beggar Thy Neighbor?

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.

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.

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:

 

Global Monetary Architecture Matters

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.

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?"

Emerging Market Merry-go-Rounds

Paul Kedrosky writes about one of my favorite topics, emerging market decoupling. He cites a new report by HSBC which discusses a "global monetary merry-go-round":

Our optimistic views on the emerging world are also based on what we call the monetary merry-go-round. Low US interest rates typically encourage capital to flow into the emerging world. Attempts by emerging nations to limit the resulting exchange rate appreciation lead to offsetting capital outflows in the form of rising foreign exchange reserves which are often invested in US Treasuries. Higher demand for Treasuries keeps yields low and, hence, leaves US interest rates low, thereby allowing the merry-go-round to repeat, seemingly ad infinitum.

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.

Tweets of the Day: Istanbul Edition

Here are the latest updates from the World Bank/IMF meetings from our Tweeter-in-Chief, Neil Gregory:

nfgregory: In Istanbul for World Bank annual meetings - focus this year on post-crisis economic recovery. First impressions - mood mostly bullish.

nfgregory: importance of developing local capital markets, local funding. Can still benefit from skills of international banks, but with local funding

nfgregory: Protectionism, restrictions on capital flows mean that economies like Egypt need to rely more on domestic demand, domestic capital markets

nfgregory: Entrepreneurship key to new job creation. Governments supporting through deregulation, venture capital, local equity market development.

You can follow all of Neil's Tweets here, or from our World Bank PSD Twitter page.

More Tweets after the jump...

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.

Washington Update

Although much of the Washington-based development community is headed to Istanbul, there is quite a bit of news coming from headquarters.

First, IFC is teaming up with several private sector banks to launch a vehicle to purchase distressed assets in emerging markets. IFC will commit $1.5bn to the fund and is hoping to raise an additional $4bn from the private sector. A particular emphasis will be on Eastern Europe, which was home to 40 percent of pre-crisis foreign capital flows. Further details of the project will be announced in Istanbul. In the meantime, the FT reports:

The idea is to mimic the functions of a "bad bank" at an international level through a number of platforms rather than a single global investment vehicle.

As part of the initiative...the IFC is teaming up with HSBC to purchase and restructure distressed assets, in what it hopes will eventually be  $900m scheme.

IFC's chief executive, Lars Thunnel, is known for having managed Sweden's "bad bank" during its banking crisis in the early 1990s.

Deposit Insurance, Blanket Guarantees and Exit Strategies

The World Bank held a discussion yesterday on the role of extraordinary deposit insurance schemes in the crisis. Fred Carns from the FDIC and David Walker from the CDIC (Canada) outlined the lessons learned, measures taken, and future policy recommendations for the world's deposit insurance schemes.

The main crisis driven deposit insurance arrangements include:

• More than one-third of deposit insurance programs around the world have adopted some form of enhanced deposit insurance protection during the crisis.
• Less than 20 percent of deposit insurance jurisdictions have provided blanket guarantees. Yet this minority is significant, and includes the United States. Some schemes apply only to selected categories of deposits, while a handful take the form of political promises as opposed to changes in law or regulations.
• Among jurisdictions that did not provide blanket guarantees but raised their coverage limits, the extent of the increases varies widely.

Crisis Talk Readers: Participate in Next Week's Annual Meetings

The World Bank Group and IMF are descending upon Istanbul for their annual meetings. One of this year's highlights will be a panel on the post-crisis world, led by World Bank Group President Robert Zoellick.

In addition to Mr Zoellick, the panel will feature Sri Mulyani Indrawati, Minister of Finance, Indonesia; Mahmoud Mohieldin, Minister of Investment, Egypt; Eleni Gabre-Madhin, CEO, Ethiopian Commodity Exchange; and Professor Paul Collier, Department of Economics, University of Oxford.

As part of the program, the panelists will be answering questions from the audience, including those sent by the online audience. The debate will be recorded on Friday, October 2, and will be broadcast over the next two days on France 24.

Crisis Talk readers can submit their questions here.

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.

The IMF's Medium-term Outook: Anything is Possible

The IMF released the latest chapters of its World Economic Outlook, which focuses on building a sustainable recovery. The first chapter addresses lessons for monetary policy from asset price fluctuations, while the second deals with the impact of the crisis on medium-term output.

The IMF believes that the crisis has not yet struck a dagger into the heart of medium-term growth prospects, but it does pose serious risks. Historically, the seven-year impact of banking crises reduces output levels by 10 percent of their pre-crisis trend. Things tend to improve afterwards, and a permanent decrease in medium-term output growth is rare.

Yet this has been an a-typical banking crisis, and as such, governments face a complex juggling act in shielding the global economy from acquiring a few scars:

China's Crisis Response Goes Global

China has been an essential player in fostering a global economic recovery. As one of the first countries to announce a massive stimulus package last November, China brought increased stability to markets when it was dearly needed. Today's conventional wisdom holds that in order to ensure a stable global recovery, Chinese consumers must increase their consumption patterns to fill the economic void left by their battered American counterparts (see previous post).

Can the Chinese government succeed in boosting domestic consumption? Are there other initiatives that China can take to put the global economy in motion?

The answer to both of these questions is a tentative 'yes'.

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."

Zoellick's Pittsburgh Prescription

World Bank President Robert Zoellick has given his policy suggestions for this week's G20 summit in Pittsburgh. In an interview with the Financial Times, Zoellick urged world leaders to focus on adopting a responsible approach to global economic growth:

I would like the G20 to talk about responsible globalisation. That would capture balanced global growth, financial stability, climate change, help for the poorest including our proposal for a new facility to help countries cope with economic shocks not of their own making.

Zoellick also called for prudence, warning that a sustained economic recovery is far from certain, even in the brightest patch of the global economy, Asia:

China has expanded credit rapidly. As credit growth is moderated there is a risk that China could turn down again. Conversely, the strong rebound so far in east Asia could lead to increased interest rates that draw in a lot of capital – then what will the governments do in terms of currency policies, inflation policies, interest rate policies?

Sage, rather than sanguine, needs to be the running theme this week.

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.

Declining Consumer Credit + Weaker Dollar = Time to Export

There are two noteworthy stories in the economic blogosphere, aside from the exciting news coming out of the World Bank.

The first has to do with the sharp decline in consumer credit in the United States. Buttonwood reports:

While governments round the world clock up more debts, American consumers are finally cutting back. The volume of consumer credit fell by $21.6 billion in July, the sixth monthly decline in a row. According to Lombard Street Research, this was the second largest percentage decline since World War Two. The 3-month annualised rate of decline is now running at 7%.

It appears that the recession has actually succeeded in frightening the American consumer into saving. This is not an insignificant feat.

Wall Street's Premature Exuberance

I've been wondering lately if investment banks are experiencing a bout of irrational exuberance with respect to a recovery. Bullish advice on China comes to mind in particular.

There is growing momentum behind the idea that many banks are getting the recovery wrong. From Bloomberg: 

Paul Tudor Jones, the billionaire hedge-fund manager who outperformed peers last year, is wagering that Goldman Sachs Group Inc. and Morgan Stanley got it wrong in declaring the start of an economic recovery.

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: