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Title: Jeffrey Frankel Harpel Professor, Harvard University


1

Asia, the US, and the G20 in 2010
  • Jeffrey FrankelHarpel Professor, Harvard
    University
  • Harvard Project for Asian International
    Relations 2010 Conference
  • February 19, 2010

2
Each decade gives rise to a new conventional
wisdom
  • 1990 20 years ago, many had drawn a lesson from
    the 1980s Japan had developed a kind of
    capitalism, which outperformed the US.
  • 2000 10 years ago, many had drawn a new lesson
    from the 1990s The US offered the superior model
    after all. East Asia should emulate the US,
    to solve the structural flaws that had led to
    the 1990s crises.
  • 2010 Today, many have drawn the obvious lesson
    from the 2000s The US suffers from the same
    flaws (crony capitalism). The future belongs
    to China.

3
20 years ago Lessons from the 1980s
  • The US was said to be in decline
  • The hollowing out of manufacturing.
  • Paul Kennedys The Rise and Fall of the Great
    Powers
  • Imperial overstretch would be the downfall of
    the US, just as with its predecessor.
  • Reagans legacy was tarnished,
  • by the Iran-Contra scandal
  • and twin deficits (big fiscal trade deficits).

4
  • Japan was thought a juggernaut, taking over the
    world economy.
  • Journalists and revisionists extrapolated that
    Japan would overtake the US in coming decades.
  • The new national security competition between
    countries was said to be economic, not military.
  • Japan was thought a juggernaut, taking over the
    world economy.
  • Journalists and revisionists extrapolated that
    Japan would overtake the US in coming decades.
  • The new national security competition between
    countries was said to be economic, not military.
  • Best-selling books caught the mood
  • Ezra Vogels Japan as Number One
  • Chalmers Johnsons MITI and the Japanese Miracle
  • Michael Crichtons Rising Sun (1992).

5
Japan (and the Asian NIEs) were said to have a
superior model of capitalism

Vs. Anglo-American model
  • Asian values
  • Long horizons
  • Keiretsu / chaebol
  • Low cost of capital
  • Lifetime employment
  • Relationship banking
  • Government guidance
  • Pro-saving financial system
  • Firms maximize size (capacity or market share)

Corporate governance maximizes profits stock
prices for shareholders.
Financing via securities markets .
Competition in goods and labor markets.
Consumerculture
6
Minority voices International politics
  • Joe Nyes Bound to Lead (1990)
  • US global leadership was not exhausted.
  • East Asian countries were important allies.

Minority voices Financial economics
  • The 1987-89 bubbles in land stock markets
  • were due to
  • Low Japanese interest rates
  • which were in turn due to high saving.

7
Minority voices International economics
  • Most economists
  • Japans trade surplus was not attributable
  • to a superior economic model,
  • nor to strategic trade policy,
  • nor to US naively keeping markets open to
    imports.
  • Rather it was due, again, to National Saving
  • which in 1990 was as high in Japan as it was low
    in the US.
  • High Japanese saving was in turn probably due to
    demographics more than culture or policies.

8
As soon as the 1990s started, the 1980s
conventional wisdom was proven wrong
  • The US triumphed militarily in the Gulf War
    (1991).
  • The US triumphed politically with the fall of
    the Soviet Union (1991).
  • The Japanese model burst,
  • along with its land-stock-market bubble (1990)
  • and economy (1991-) .

9
And as the 1990s progressed,
  • the US experienced the longest economic
    expansion of its history.
  • The budget was restored to surplus, with the help
    of actions by G.H.W.Bush (1990) Clinton (1993,
    98).
  • America was declared to have a New Economy.
  • IT carried the US stock market to stratosphere by
    1999.
  • Korea, Thailand, Indonesia other NIEs
  • carried the mantle of the Asian miracle,
  • until severe currency crises hit them in
    1997-98.

10
Asians were told to emulate the US model
10 years ago Lessons from the 1990s
  • especially its financial system
  • corporate governance,
  • accounting standards,
  • consumer finance, innovative products,
  • securities markets, rating agencies, and
  • Anglo-American style banking (market-oriented
    arms-length)

11
But as soon as the 2000s started,the 1990s
assumptions were proven wrong
  • Bursting of the US dot-com bubble (2000).
  • Failure of US electoral institutions (Nov.2000).
  • Failures of Sept.11 (2001) US response (Iraq,
    Guantanamo)
  • Failure of US corporate governance in scandals
    of Enron, etc. (2001).
  • Decade of flat median income and rising debt.

12
Financial crisis (2007-2009)
  • Bursting of US housing bubble (2006)
  • inevitably led to sub-prime mortgage crisis
    (2007).
  • Less predictably, failures of US financial
    system led to disappearance of liquidity (2008)
  • and the 2nd recession of the decade,
  • the worst since the 1930s.
  • The rest of the world followed.

13
The US has lost its claim as an exclusive model
for others to emulate
  • The desirable principles havent changed, only
    the claim that the US uniquely embodies them
  • Open democracy, rule of law, human rights
  • Competition in goods labor markets
  • Corporate governance should focus on long-term
    shareholder value,
  • not executives options prices
  • nor empire-building.
  • Government intervention to address market failure
  • E.g., tax pollution (dont subsidize fossil
    fuels).
  • Supervise banks, under rules (dont take them
    over).

14
The US is in a hole
  • Adroit monetary fiscal management has
    succeeded in limiting the length severity of
    the recession.
  • The turning point was probably early summer,
    2009
  • gt we have avoided the mistakes of
  • the Depression (1929-1937),
  • or Japans lost decades (1991-2010).
  • But the long-term fiscal outlook already bad
    has gotten worse.

15
The same with other major industrialized
economies.
  • A remarkable role-reversal
  • Debt/GDP of the top 20 rich countries
  • ( 80) is already twice that of the top 20
    emerging markets
  • and rising rapidly.
  • By 2014 (at 120), it could reach triple the
    big emerging market debt levels.

16
The US financial positionhas deteriorated
internationally
  • The twin deficits
  • China became our largest creditor
  • The dollar appears in long-term decline.

17
Exorbitant Privilege of
  • Among those who argue that the US current account
    deficit is sustainable are some who believe that
    the US will continue to enjoy the unique
    privilege of being able to borrow virtually
    unlimited amounts in its own currency.

18
When does the privilege become exorbitant?
  • if it accrues solely because of size history,
    without the US having done anything to earn the
    benefit by virtuous policies such as budget
    discipline, price stability a stable exchange
    rate.
  • Since 1973, the US has racked up 10 trillion in
    debt and the has experienced a 30 loss in
    value compared to other major currencies.
  • It seems unlikely that macroeconomic policy
    discipline is what has earned the US its
    privilege !

19
The Bretton Woods II hypothesis
  • Dooley, Folkerts-Landau, Garber (2003)
  • todays system is a new Bretton Woods,
  • with Asia playing the role that Europe played in
    the 1960sbuying up to prevent their own
    currencies from appreciating.
  • More provocatively China ( Asia) is piling up
    dollars not because of myopic mercantilism, but
    as part of an export-led development strategy
    that is rational given Chinas need to import
    workable systems of finance corporate
    governance.

20
My own view on Bretton Woods II
  • The 1960s analogy is indeed apt,
  • but we are closer to 1971 than to 1944 or 1958.
  • Why did the BW system collapse in 1971?
  • The Triffin dilemma could have taken decades to
    work itself out.
  • But the Johnson Nixon administrations
    accelerated the process by fiscal monetary
    expansion (driven by the Vietnam War Arthur
    Burns, respectively).
  • These policies produced declining external
    balances, devaluation, the end of Bretton
    Woods.

21
There is no reason to expect better today
  • Capital mobilityis much higher now than in the
    1960s.
  • The US can no longer necessarily rely on support
    of foreign central banks
  • neither on economic grounds (they are not now,
    as they were then, organized into a cooperative
    framework where each agrees explicitly to hold
    if the others do),
  • nor on political grounds (China OPEC are not
    the staunch allies the US had in the 1960s).
  • 3) A possible rival currency to the exists.

22
When will the day of reckoning come?
  • Not in 2008 In the short run, the financial
    crisis caused a flight to quality which evidently
    still meant a flight to US .
  • Chinese warnings in 2009 may have marked a
    turning point
  • Premier Wen worried US T bills will lose
    value.On Nov. 10 he urged the US to keep its
    deficit at an appropriate size to ensure the
    basic stability of the .
  • PBoC Gov. Zhou in March proposed replacing as
    international currency, with the SDR.

23
The global monetary systemmay move from
dollar-based to multiple international reserve
currencies
  • The could challenge the .
  • The SDR is again part of the system.
  • Gold in 2009 made a comeback as an international
    reserve too.
  • Someday the RMB will join the roster with
    .
  • a multiple international reserve asset system.

SDR
24
Decoupling?
  • Initial hopes of decoupling succumbed at the
    height of the crisis
  • Financial contagion
  • Asian exports were especially hard-hit.

25
Asian exports plummeted
via RGE Monitor 2009 Global Outlook
26
  • But, in the end, there was a measure of
    decoupling after all.
  • China, India Indonesia kept growing
    throughout.
  • All of Asia has now come roaring back.
  • Asia now constitutes an independent growth
    pole in the world.

27
Developing Asia growth rates gt 8
Year-over-year growth rates. Source IMF WEO
Jan. 2010 Projections 2008 2009
2010 2011 World output 3.0 -0.8 3.9
4.3 Advanced economies 0.5 -3.2 2.1 2.4
Developing Asia 7.9 6.5 8.4 8.4
China 9.6 8.7 10.0 9.7
India 7.3 5.6 7.7 7.8
ASEAN-5 4.7 1.3 4.7 5.3
28
2010 Lessons from the 2000s
  • America is not as exceptional as claimed.
  • Domestically, US democracy fell short.
  • In international relations, our leadership
    faltered.
  • The US economic system suffers from problems of
    crony capitalism too.
  • The future belongs to China.
  • Dynamic entrepreneurship has moved there.
  • China as wealthy creditor will claim its due
    power.

29
What might this new conventional wisdom of 2010
be forgetting?
  • China is not yet ready to be global leader
  • It is not ready politically.
  • It is still quite a poor country.
  • It will run into its own problems, e.g., a
    banking crisis somewhere down the road.
  • Asians dont want to be dominated by either China
    or Japan, and will always welcome the US as a
    counterweight.

30
Developing Asia is now a large share of world
GDP, growth, reserves
  • But even after recent adjustments, its share in
    IMF voting shares, for example, is still
    disproportionately small
  • China 3.81
  • Korea 1.36
  • India 2.34
  • Singapore 0.59

31
Country   GDP 2009 ( billions)  Country   GDP 2009 ( billions)  
  World 57,530
 EU 15,990 11  Russia 1,255
1  US 14,270 12  India 1,243
2  Japan 5,049 13  Australia 920
3  China 4,758 14  Mexico 866
4  Germany 3,235 15  Korea 800
5  France 2,635 17  Turkey 593
6  UK 2,198 18  Indonesia 514
7  Italy 2,090 23  S. Arabia 379
8  Brazil 1,482 31  Argentina 301
9  Spain 1,438 32  S.Africa 277
10  Canada 1,319 33  Thailand 266
32
the G-20 suddenly supplanted the G-7.
History will judge one of themost important
developments of 2009
  • G-20 meetings in 2009
  • London in April
  • Pittsburg in October

33
How successful were the measures supported by US
Korea at the G-20 meetings (2009)?
  • Coordinated fiscal stimulus to fight the
    recession
  • as in the locomotive plan of G7s Bonn Summit of
    1978
  • no formal agreement, but it seemed to happen
    anyway.
  • Unexpected revival of the SDR and tripling IMF
    resources
  • The usual agreement for a standstill/rollback in
    trade barriers. Some backsliding followed,
    little progress in Doha Round
  • on the US side
  • tariffs on Chinese tires,
  • inability to ratify FTAs (US-Korea, etc.).
  • But, so far, not a bad trade record, for a
    severe recession.

SDR
34
Whatever the causes of the great recession, the
policy response avoided 1930s mistakes
  • No Smoot-Hawley tariffs
  • No failed London Economic Summit
  • Aggressive monetary expansion rather than
    contraction.
  • Fiscal expansion too.

35
The true significance of the G-20 in 2009
  • The G-20 accounts for 85 of world GDP.
  • A turning point The more inclusive group has
    suddenly become central to global governance,
    eclipsing the G-7, and thereby at last giving
    major developing/emerging countries some
    representation,
  • after decades of fruitless talk about raising
    emerging-market representation in IMF.

36
G-20 membership
  • China
  • India
  • Indonesia
  • Republic of Korea
  • Australia
  • Canada
  • France
  • Germany
  • Italy
  • Japan
  • Russia
  • UK
  • USA
  • EU
  • Argentina
  • Brazil
  • Mexico
  • Saudi Arabia
  • South Africa
  • Turkey

37
The G-20 in 2010
  • Korea has assumed the presidency this year
  • the first non-G7 host of the G20.
  • Canada Korea will host the meetings in June
    November, respectively.

38
Implications for Korea
  • Korea is the bridge between the G-7 and
    developing countries.
  • Especially China India
  • What can the G-20 accomplish for Korea?
  • What can the G-20 accomplish for the world?

39
Opportunity/burden for Korea
  • Will chairing the G-20 help consolidate Koreas
    status as an advanced economy?
  • Yes, as did
  • hosting the Olympics,
  • joining the OECD,
  • attaining the per capita income of some
    industrialized countries (20,000 Portugal).
  • But Korea should now seize the chance to
    exercise substantive leadership.
  • Otherwise, the risk is Czech presidency of EU

40
Four items on G-20 agenda for 2010
  • Possible financial regulatory reform
  • Some steps underway in Basle, Financial Stability
    Forum
  • The Europeans would like more, but are unlikely
    to get it.
  • Personally, I might favor a small global tax on
    financial transactions.
  • Macroeconomic exit strategies
  • Global imbalances between developing countries
    and industrialized
  • US and China should both admit responsibility
  • US the budget deficit is too big. Needs to be
    fixed.
  • China RMB is too low. Needs to be unfixed.
  • Post-Copenhagen progress toward new agreement on
    climate change to take effect 2012.

41
Two principles of multilateral institutions
  • 1. It is inevitable that more power go to
    large-GDP countries than small.
  • This is why IMF works better than UN .
  • The problem is that China, India, Korea, Brazil,
    etc.,are larger than Canada, Netherlands Hence
    the G-20.
  • The outcome must leave small countries better
    off, of course, or they will not go along.

2. Conversation is not possible with more than
20 in the room.
42
Example many rounds of trade negotiations under
the GATT.
  • Worked well for years,
  • with small steering groups (US-EU, the Quad
    G-7)
  • and few demands placed on developing countries.
  • Failed when developing countries had become big
    enough to matter,
  • but were not given enough role
  • Doha Round

43
Conversation is not possible with more than 20
people in the room.
  • Delegates just read their talking points.
  • The latest evidence The Climate Change CoP in
    Copenhagen
  • The UNFCCC proved an ineffectual vehicle
  • Incompetent management of logistics
  • Small countries repeatedly blocked progress
  • Obama was able to make more progress at the end
    with a small group of big emitters.
  • Korea is in a good position to build on this
    progress
  • as the 1st non-Annex I country to take on binding
    emission targets.
  • To be honest, the G-20 is too big.
  • My recommendation an informal steering group
    within G-20.

44
Emissions targets taken on under Copenhagen
Accord (Jan 31, 2010 deadline)
45
Emissions targets taken on under Copenhagen
Accord (Jan 31, 2010 deadline)
46
(No Transcript)
47
Addenda
  • 1. Global climate change negotiations.
  • A proposed new architecture.
  • Climate change and trade
  • 2. The global financial crisis of 2007-09
  • Origins
  • Lessons
  • 3. The US current account deficits
  • What about the economists who argue that they
    are sustainable?

48
3 Points
  1. Proposal for a Global Climate Agreement
    Setting Emission Targets by Formulas
  2. Global Trade and Global Climate Change What form
    should border measures take?
  3. Modalities Lessons from 2009. How Should We
    Proceed in 2010?
  4. Charts with details The Proposed Target
    Formulas

49
1. Proposal target formulas designed
pragmatically,based on what emissions paths are
possible politically
  • unlike other approaches based purely on
  • Science (concentration goals),
  • Ethics (equal emission rights per capita),
  • or Economics (cost-benefit optimization).
  • Why the political approach?
  • Countries will not accept burdens that they view
    as unfair.
  • Above certain thresholds for economic costs, they
    will drop out.

50
Stage 2 When the time comes for developing
country cuts, targets are determined by a
formula incorporating 3 elements, designed so
each is asked only to take actions analogous to
those already taken by others
Proposal
  • Stage 1
  • Annex I countries commit to the post-2012
    targets that their leaders have already
    announced.
  • Others commit immediately not to exceed BAU.
  • a Progressive Reduction Factor,
  • a Latecomer Catch-up Factor, and
  • a Gradual Equalization Factor.

51
? Constraints are satisfied -- No country in
any one period suffers a loss as large as 5 of
GDP by participating. -- Present Discounted
Value of loss lt 1 GDP.
? In one version, concentrations level off at
500 ppm in the latter part of the century.
Co-author V.Bosetti
Global peak date 2035
52
2. What form should border measures take?
  1. Best choice multilateral sanctions under a new
    Copenhagen Protocol
  2. Next-best choice national import penalties
    adopted under multilateral guidelines
  3. Measures can only be applied by
    participants-in-good standing
  4. Judgments to be made by technical experts, not
    politicians
  5. Interventions in only a ½ dozen of the most
    relevant sectors.
  6. Third-best choice no border measures.
  7. Each country chooses trade barriers as it sees
    fit.
  8. Worst choice national measures are subsidies
    (bribes) to adversely affected firms.

53
3. Modalities
  • Lessons from Copenhagen
  • Progress is not possible in the UN Framework
  • Small member countries will obstruct
  • The UNFCCC Secretariat is not competent.
  • Big emerging market countries finally have
    representation, now that the G-20 has supplanted
    the G-8.
  • Korea chairs the G-20 in 2010, and can take
    leadership on climate, as a bridge between Annex
    I developing countries.

54
Charts with details on proposed emission targets
The reductions from BAU agreed to at Kyoto in
1997 were progressive with respect to income.
Cuts ?
Incomes ?
55
Emissions path for rich countries Fig. 2b
Predicted actual emissions exceed caps, by permit
purchases.
56
Emissions path for poor countriesFig. 4b
Predicted actual emissions fall below caps, by
permit sales.
57
Price of Carbon Dioxide Fig. 6b
rises slowly over 50 years, then rapidly.
58
Concentrations stay below 500 ppm goalFig. 7b
59
Addendum 1Proposal for a Global Climate
Agreement

60
Addendum 3 The financial crisis
  • Well before 2007, there were danger signals
  • Real interest rates lt0, 2003-04
  • Early corporate scandals (Enron 2001)
  • Risk was priced very low,
  • housing prices very high,
  • National Saving very low,
  • current account deficit big,
  • leverage high,
  • mortgages imprudent

61
US real interest rate lt 0, 2003-04
Source Benn Steil, CFR, March 2009
Real interest rates lt0
62
Source The EMBI in the Global Village, Javier
Gomez May 18, 2008 juanpablofernandez.wordpress.
com/2008/05/
In 2003-07, market-perceived volatility, as
measured by options (VIX), plummeted. So did
spreads on US junk emerging market bonds. In
2008, it all reversed.
63
Six root causes of financial crisis
  • 1. US corporate governance falls short
  • E.g., rating agencies
  • executive compensation
  • options
  • golden parachutes
  • 2. US households save too little, borrow too
    much.
  • 3. Politicians slant excessively toward
    homeownership
  • Tax-deductible mortgage interest, cap.gains
  • Fannie Mae Freddie Mac
  • Allowing teasers, NINJA loans, liar loans

MSN Money Forbes
64
Six root causes of financial crisis, cont.
  • 4. Starting 2001, the federal budget was set on
    a reckless path,
  • reminiscent of 1981-1990
  • 5. Monetary policy was too loose, during
    2003-05,
  • accommodating fiscal expansion, reminiscent of
    the Vietnam era.
  • 6. Financial market participants during this
    period grossly underpriced risk.

65
Origins of the financial/economic crisis
Homeownership bias
Predatory lending
Excessive complexity
MBSs
Foreign debt
CDSs
CDOs
Gulf insta-bility
Oil price spike 2007-08
Recession 2008-09
66
Which bystanders got hit the worst by the global
liquidity crisis of 2008?
  • Most emerging markets had followed the lessons
    of the 1990s crises
  • small or no current account deficits
  • more flexible exchange rates
  • more reserves
  • less short-term -denominated loans
  • Those that didnt are those that got into worse
    trouble Central Eastern Europe.

67
The Early Warning Indicators literature, updated
  • Reserves
  • Economists wondered if emerging market reserves
    had gotten too high by 2007
  • Jeanne (2007), Summers (2006), Rodrik (2006)
  • But high reserves appear to have paid off in
    2008.
  • Aizenman (2009) and Obstfeld, Shambaugh Taylor
    (2009, 2010)
  • Low short-term foreign debt
  • Sachs, Tornell Velasco (1996),
  • Guidotti Rule reserves / short-term debt,
  • Bussiere (2010).
  • Other leading signals
  • Equity prices Kaminsky, Lizondo Reinhart
    (1998) Rose Spiegel (2009)
  • Composition of inflow, FDI Frankel Rose (1996)
    and Tong Wei (2010).

68
Who got pieces of it right, beforehand?
  • Krugman If a Depression can happen in Japan,
    it can happen in any modern economy.
  • Rajan Crony capitalism in the US.
  • BIS (Borio White) Too-easy credit, via asset
    prices, leads to crises -- with no inflation in
    between.
  • Shiller US housing price bubble.
  • Gramlich Homeowners are taking mortgages that
    they cant repay.
  • Rogoff This Time Is Not Different.
  • Roubini The recession will be severe.

69
Where should mainstream macro go, in light of
the 2007-09 global financial crisis?
  • Some models that had been thriving in an emerging
    markets context may now help answer this
    question.
  • Some were applications of models originally
    designed for advanced-country financial markets,
    but never fully incorporated into the mainstream
    macro core.
  • A possible explanation why they had been
    transplanted to emerging markets assumptions
    of imperfections in financial markets were
    considered more acceptable there, than in the
    context of advanced economies.

70
Financial crises Not just for emerging markets
anymore. An analogy
  • In the latter part of the 19th century most of
    the vineyards of France were destroyed by
    Phylloxera.
  • Eventually a desperate last resort was tried
    grafting susceptible European vines onto
    resistant American root stock.
  • Purist French vintners initially disdained what
    the considered compromising the refined tastes
    of their grape varieties.
  • But it saved the European vineyards, and did not
    impair the quality of the wine.
  • The New World had come to the rescue of the Old.

71
Implications of the 2008 financial crisis for
macroeconomics?
  • In 2007-08, the global financial system was
    grievously infected by toxic assets originating
    in the United States.
  • Many ask what fundamental rethinking is necessary
    to save orthodox macroeconomic theory.
  • Some answers may lie with models that have been
    applied to the realities of emerging markets.
  • Purists may be reluctant to seek help from this
    direction.
  • But they should not fear that the hardy root
    stock of emerging market models is incompatible
    with fine taste.

72
What are some of these models?
  • Asymmetric information
  • Credit rationing (Stiglitz)
  • Need for collateral (Kiyotaki Moore,
    Caballero)
  • Leverage cycle (Geanakoplos)
  • The credit channel (Bernanke Gertler )
  • Balance sheet effects (Calvo)
  • Bank runs multiple equilibria (Diamond
    Dybvyg Velasco)
  • Speculative attacks (Krugman Obstfeld Morris
    Shin)
  • Moral hazard incentive incompatibility
    (Dooley McKinnon Pill)

73
  • Also newly relevant are some almost-forgotten
    and less-formalized notions of cycles
  • the credit cycle of von Hayek,
  • the bubbles panics of Kindleberger,
  • the Minsky moment, and
  • Irving Fishers debt deflation.

74
Addendum 3The US current account deficits
  • Some economists argue they are sustainable

75
Some argue that the privilege to incur
liabilities has been earned in a different way
  • Global savings glut (Bernanke)
  • The US appropriately exploits its comparative
    advantage in supplying high-quality assets to the
    rest of the world.
  • Intermediation rentspay for the trade
    deficits. -- Caballero, Farhi Gourinchas
    (2008)
  • In one version, the United States has been
    operating as the Worlds Venture Capitalist,
    accepting short-term liquid deposits and making
    long-term or risky investments -- Gourinchas
    Rey (2008).
  • US supplies high-quality assetsCooper (2005)
    Forbes (2008) Ju Wei (2008) Hausmann
    Sturzenegger (2006a, b) Mendoza, Quadrini
    Rios-Rull (2007a, b)

76
Global Savings Glut
  • Global Current Account Imbalances debate,
    2001-07
  • On one sidethose who argued that US current
    account deficits
  • had domestic origins (low National Saving),
  • were unsustainable, and
  • would eventually cause abrupt depreciation.
  • Obstfeld-Rogoff (2001, 05) Roubini (2004)
    Summers ( 2004) Chinn (2005) Blanchard,
    Giavazzi Sa (2006) Frankel (2007b)
  • On the other side (sustainability)
  • Global savings glut Bernanke, Clarida
  • Other arguments, e.g.,exorbitant privilege, dark
    matter

77
  • The 2007-09 crisis did not resolve the CA
    imbalances debate.
  • Reaction of the unsustainability sidethis is
    the crisis they were warning of.
  • One response from the other side the savings
    glut caused the crisis.

78
  • Regardless,
  • Saving will now fall globally.
  • In the short run, governments are responding to
    the recession by increasing their budget
    deficits.
  • In the long run, spending needs created by
    retiring population rising medical costs will
    continue to reduce saving, both public private.
  • In response, long-term real interest rates should
    rise, from the recent low levels.
  • Thus, I declare the savings glut dead.

79
  • The argument that the US supplies assets of
    superior quality, and so has earned the right to
    finance its deficits, has been undermined by
    dysfunctionality that the financial crisis
    suddenly revealed in 2007-08.
  • American financial institutions suffered a severe
    loss of credibility (corporate governance,
    accounting standards, rating agencies,
    derivatives, etc.).
  • Some banks non-banks have ceased to operate.
  • How could sub-prime mortgages, CDOs, CDSs be
    the superior type of assets that uniquely merit
    the respect of the worlds investors?

80
  • The events of 2008 also undermined the opposing
    interpretation, the unsustainability position
  • Why did the not suffer the long-feared hard
    landing?
  • The appreciated after Lehman Brothers
    bankruptcy, US T bill interest rates fell.
  • Clearly in 2008 the world still viewed
  • the US Treasury market as a safe haven and
  • the US as the premier international currency.

81
Though arguments about the unique high quality
of US private assets have been tarnished, the
idea of America as World Banker is still alive
the is the worlds reserve currency, by virtue
of US size history.
  • Is the s unique role an eternal god-given
    constant? or
  • will a sufficiently long record of deficits
    depreciation induce investors to turn elsewhere?

82
Central banks reserve holdings Frankel Chinn
(2007) estimated effects of country size, market
depth, ability to hold value, and network effects
  • Simulation suggests could overtake by 2022.
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