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T Towards d the th End-Stage E d St off Global Gl b l Capitalism? A Critique of Universal Capital Mobility and th S the Search h for f Alternatives Alt ti Prof. Dr. Jan Priewe Hochschule für Technik und Wirtschaft Berlin – U i University it off A Applied li d S Sciences i October 2013 1 Trend towards complete p g global capital p flow liberalization (CFL) 2 Drivers for capital flows 3 Mainstream I: why global CFL is good 4M Mainstream i t II II: why h global l b l CFL iis nott always l good d 5 Old critics and new critics of mainstreams 6 From CFL to universal Capital Account Management: g Beyond y Mainstream II 7 Learning from Keynes 1944: from too little to too much capital mobility 1 Capital flow liberalisation – 2010 halfway reached towards complete de jure “laisser faire” Chinn-Ito-index for de jure capital account openness for different country groups (min -2.5, max 2.5) 2,5 , 0,5 -0,5 -11,55 high income countries upper middle income countries l lower middle iddl iincome countries ti l iincome countries low ti 10 20 08 20 06 04 20 20 02 20 00 20 98 96 19 19 94 19 92 19 90 88 19 19 86 19 84 19 82 19 80 19 78 19 76 74 19 19 72 19 70 -2,5 19 indexx 1,5 1 Trend towards de facto trade and financial openness Trade and financial openness total exports and imports (high income OECD, OECD middle income countries;, countries; gross capital in- and outflows* in 23 advanced and 59 emerging economies 70 60 % of GDP 50 trade 40 30 Financial flows 20 10 0 1980 1982 *absolute values °2010 1 °2010: 1stt h half lf 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Finance: advanced economies° Finance: emerging economies° Trade: high income OECD Trade: middle income 1 Stocks of assets held abroad abroad, selected countries Assets abroad (Financial Account), % of GDP % of G GDP Source: IMF, BOP, WEO, own calculations 1400 1300 1200 1100 1000 900 800 700 600 500 400 300 200 100 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Germany A Japan A France A United Kingdom A United States A Switzerland H k Hongkong Si Singapore 1 Stocks of assets held abroad and liabilities to abroad, selected countries Assets abroad and liabilities to abroad, abroad 1980-2011 800 600 500 400 300 200 100 0 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08 20 10 % off GDP 700 Germany A United Kingdom A Japan L United States L Japan A United States A France L France A Germany L United Kingdom L 1 Stocks of assets held abroad, selected countries – 6-9 fold increase 1980-2011 – focus on gross g flows/stocks A Assets t abroad b d (Financial (Fi i l Account), A t) % off GDP Source: IMF, BOP, WEO, own calculations 300 % of GDP 250 200 150 100 14-27% of GDP 50 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Germany A Japan A France A United States A Forex markets – extreme g growth and huge g volume c urrent bill ion US-$ Global daily foreign exchange transactions 5000 4500 4000 3500 3000 2500 2000 1500 1000 500 0 24 times global GDP 1989 1992 1995 1998 2001 2004 2007 spot markets outright forward market FX swaps estimated gaps currency swaps FX option and others 2010 1 Huge magnitude of short-term short term financial flows • Global GDP 2011: 70 trillion USD • Biggest financial market: global forex market volume: 1,028 trillion USD (est.), 16 times global GDP • 2nd biggest financial market: derivatives turnover 2011 704 trillion USD (10 times GDP) • Other Oth assets: t 256 ttrillion illi USD USD, 3 3.7 7 titimes GDP • Most of these markets a cross-border transactions 2 Drivers for financial globalisation • Pull and push factors often hard to distinguish • Main push/pull p p factors a) differential growth expectations b) risk and currency diversification c)) fluctuating fl i risk i k appetite/degree i /d off liquidity li idi preference f d) nominal interest rate differentials e) safe haven for reserves f) expected asset price increases • One ppush factor seems to dominate: risk appetite/degree pp g of liquidity preference/degree of uncertainty • Hélène Rey: global financial cycle, centre is US • FDI in stocks of A/L is small: US 2013 (2nd qu.) qu ) 24.5% 24 5% of ext. ext assets, 12.2% of foreign assets in US; Germany: end 2012 16.6% of external assets, 12.8% of external liabilities 3 Mainstream I: why global CFL is good • Emerged not before late 1970s, mainly from EU countries, and OECD headquarter (Abdelal 2007) • Optimal international allocation of capital/finance, capital/finance analogue to national free allocation • Optimal intertemporal allocation of capital, consumption smoothing • Risk diversification, reduce average risk of portfolio and take on higher risk on some investments • Support of catching-up • Universal production function • Pressure on macroeconomic discipline of debtor countries • Monetary sovereignty can be secured with floating XR regime • Overall: growth enhancing in world economy • If this is not visible: „bad governance“ and poor use of capital inflows, lack of human capital, fixed XR regime etc. 4 Mainstream II: why global CFL is not always good • IMF 2010ff.: emerging/developing countries may use, under specified conditions, temporary inflow controls (Ostry et al. 2010 ff ff.)) • Fear of appreciation in emerging economies • “Capital p controls” applicable pp under several restrictive conditions: + first check whether XR are really getting overvalued + if so, give i preference f to t reserve accumulation l ti + if too expensive, try monetary policy (lower interest rates) + or tighten fiscal policy + check use of prudential regulation (micro & macro) + last resort: “capital controls” • In the long run, emerging economies shall open the capital accounts completely • Advanced countries must not use such measures 5 Old critics and new critics Old critics - capital/finance should be mainly national (Keynes) philosophy, p y, IMF Articles of Agreement g - Bretton Woods p - Free capital flows floating XR regimes high volatility of XR, misalignments risk of BOP crises global imbalances in current accounts - CFL might make global financial systems more unstable - Boom-bust-cycles y for emerging g g economies - Sudden reversals of capital flows (Calvo et al. 1996 and many others) - Focus of critique is more on net flows and financial crises in emerging economies - Also: critique of „hot money“ in- and outflows, e.g. in China Chi - No robust evidence for economic benefits from free capital mobility – but some evidence for negative effects 5 Old critics and new critics New critics - More attention for mushrooming gross flows - Include advanced economies and financial hubs - Big asset bubbles are made internationally - Derivatives used for bubbles ((e.g. g commodities)) and carryy trade - „subprime crisis“ strongly fueled by gross inflows from Europe - Euro-crisis: supported by asset price speculation of wealth owners in i surplus l countries ti - Carry trade: emerging countries faced with strong in- and outflows caused byy Q QE is US etc. - Key factors: too high leverage, false risk perception, too low liquidity preference, no controls in source countries - Contagion risks amplified unbridled capital flows - No „circuit breakers“ to avert risks (e.g. China, India 1997-98) - More stable global XR regimes needed – global forex markets are biggest unregulated markets 5 Old critics and new critics • Rey: evidence for global financial cycle with epicentre mainly in prime reserve currency country • Ebbs and floods in risk appetite and monetary policy of Fed – „global factors are a major determinant of international capital flows“,, most international capital flows correlated flows • VIX („Chicago Board Options Exchange Market Volatility Index“) – proxy for risk aversion and uncertainty • Global monetary policy made by Fed • „impossible trinity“ is out, it‘s a dilemma: with free capital fl flows independent i d d t monetary t policy li impossible i ibl in i non-reserve countries • „Independent Independent monetary policies are possible if and only if the capital account is managed.“ (Rey 2013 in Jackson Hole) • Option „Capital mobility + sovereign monetary policy“ is elusive 5 “Impossible Trinity” or dilemma C Independent p monetary policy Exchange rate stability A B Free capital fl flows D • XR cannot be defended with monetary policy • Monetary policy cannot ignore strong XR changes • Hence, Hence most non-reserve currency countries are pushed away from options C, A or B towards D – losing both independent monetary policy and stable XR 6 From CFL to universal „Capital Account Management“: Beyond Mainstream II • Little empirical p evidence for benefits from free capital p mobility y full capital account mobility should be questioned as a goal in itself • Unilateral inflow controls in emerging economies may be too weak • How to include source countries? • More comprehensive management necessary, incl. outflow controls • Bypassing inflow controls through loopholes need to be prevented • Controls should not be a measure of last resort • Independent I d d monetary policy li is i not only l at risk i k in i inflow/outflow surges g needed,, targeting g g ggross inflows • Selective inflow management 6 From CFL to universal „Capital Account Management“: Beyond Mainstream II Main goals of capital account management Avoid excessive XR volatility CAM Avoid current account imbalances Avoid speculative inflows Enable independent monetary policy Avoid currency & maturityy mismatch Avoid contagion risks, circuit breaker 6 From CFL to universal „Capital Account M Management“: t“ B Beyond d Mainstream M i t II Capital Account Management also needed for advanced countries p for “bad” ggross capital p flows amongg • Manyy examples developed countries • Most arguments pro CAM apply also to advanced countries • Special emphasis on management of gross flows avoid bubble-seeking flows • Avoid A id regulatory l t arbitrage bit in i face f off differential diff ti l national regulations – absence of global regulation • Mitigation of XR volatility, avoid misaligned XR 6 From CFL to universal „Capital Account Management“: Beyond Mainstream II CAM is direct or indirect control of capital account balance and d off specific ifi inflows i fl or ouflows fl Policy options - Foreign exchange interventions, interventions managed floating - Reserve accumulation - Monetaryy policy: y adjusting j g policyy rates - Macroprudential regulation of banks/nonbanks: cyclically, structurally (esp. control leverage of financial institutions) - Market-based Market based capital controls: tax on inin or outflows; special required reserve on inflows, Tobin tax - Administrative capital controls (long-standing or temporary): prohibitions, hibi i permits, i caps - Internalization of negative external effects by reserve central bbankss ((acting c g ass gglobal ob ce central banks) b s) co controls o s in thee epicentres 6 From CFL to universal „Capital Account Management“: Beyond Mainstream II Policy options for CAM FX exchange interventions managed floating Reserve accumulation Monetary policy: p y adjusting policy rates Microprudential regulation l ti off banks/nonbanks Market-based „capital controls“: tax on in- or outflows; special required reserve on inflows Administrative capital controls (long-standing y) or temporary) prohibitions, permits, caps Macroprudential regulation of banks/nonbanks Internalization of negative external effects by reserve central banks (acting as global central banks) ??? 6 From CFL to universal „Capital Account Management“: Beyond Mainstream II • Macroprudential regulation (MPR) often considered superior and THE alternative to capital controls • But: Basle 3 cyclical capital buffers apply only to banks, exclude nonbank financial institutions • National N ti l MPR can h hardly dl preventt b bubble-seeking bbl ki iinflows fl • MPR is still in a nascent stage, black box • MPR & „capital capital controls“ controls need to be combined to bite • Combine policies & tools flexibly, experimentation needed • National action needed in absence of g global jjurisdiction and different regulations across the globe • International „coordination“ of regulatory framework leaves many loopholes, loopholes even in EMU • Multilateral guidelines for CAM need to avoid abuses • International institution for surveillance of capital flows needed 7 Learning from Keynes 1944: from too little to too much capital mobility • 1944: few cross-border capital flows, Keynes‘s focus on reuscitation i i off trade; d no international i i l banking b ki yet • 2014: no return to 1944, ever mushrooming international capital p flows since 1980;; China and India ante portas p to join j global finance; forward to complete financial globalisation? • Alternative: Rule-based international coordination plus national CAM, CAM in emerging AND advanced countries • Reign in excessive gross capital flows, not beneficial for output/employment • … but risky for financial stability • Higher financial stability risks in wealthy economies with high stock of financial assets/GDP • National re-regulation of finance requires international complement Appendix Three “Ages of Globalization” in comparison: Post Bretton Woods is worst Three “Ages of Globalization” in comparison: Post Bretton Woods is worst From: Bush/Farrant/Wright 2011 (Bank of England)