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GLOBAL IMBALANCES Notes for Discussion Guillermo Calvo October 20, 2005 Hard Landing Hypothesis Major Advocates: Krugman; Obstfeld & Rogoff; Roubini & Setser; Eichengreen “Here's what I think will happen if and when China changes its currency policy, and those cheap loans are no longer available. U.S. interest rates will rise; the housing bubble will probably burst; construction employment and consumer spending will both fall; falling home prices may lead to a wave of bankruptcies (...). In other words, we've developed an addiction to Chinese dollar purchases, and will suffer painful withdrawal symptoms when they come to an end.” Paul Krugman USA External Deficit Financing (billions of US dollars) “Neoclassic” Period Reflow of Private Capital to EMs Crisis in EMs 0 -100 -200 -300 -400 -500 -414 -600 -700 Source: WEO 679 2003 2002 2001 2000 1999 1998 1997 1996 1995 167 1994 800 700 600 500 400 300 200 100 0 -100 -14 1993 Official Financing 246 200 100 0 -100 1992 Private Financing -666 2004 Current Account Who is Financing the Current Account Deficit of the US? Prima Facie, Asian Central Banks... International Reserves Accumulation Reserve Accumulation in US Dollars (in % of the US Current Account deficit, 2004) 35% 31% 30% 2000 2001 27% 2002 71% 88% 2003 Reserves in US dollars over total reserves, average 1992-2003: 63% 24% 25% 20% 57% 20% 15% 15% 10% 7% 5% 3% 0% China Japan Rest of Asia* Middle East** Latin America Others *Includes: Korea, Hong Kong, India, Indonesia, Malaysia, Philipines, Singapore, Taiwan y Thailand. **Includes Oil Producers: Bahrain, Iran, Kuwait, Oman, Qatar, Saudi Arabia, Syria, United Arab Emirates and Yemen. How Do They Do It? Non-US central banks buy US Treasury bonds by issuing their own debt to: Private sector, or Other banks who use private sector deposits. Thus, directly or indirectly, private investors lend to US government!! How was International Reserve Accumulation Financed? Senioriage Revenues in % of International Reserve Accumulation 90% Fiscal Deficit 80% In % of GDP 2003 2004 China 2.5% 1.5% Japan 7.9% 6.7% Korea 1.7% 2.0% 70% 60% 50% 40% 30% 20% 10% 0% 2003 2004 China 2003 Japan 2004 2003 2004 Korea What If Asia Floats? (Krugman’s concern) If Asia floats, then Asian central banks stop buying US public bonds, and, therefore, the private sector will buy US public bonds directly, instead of indirectly (as before). Thus, if private sector demand for public sector bonds remains unabated (a reasonable assumption), Krugman need not worry. . . Unless, of course, political and other considerations generate high market volatility. Moreover Interest rates on long-run US public bonds are not unprecedentedly low, and The US public sector is not heavily indebted, compared with other industrialized countries. The private sector savings have already undergone a large increase. US Interest Rates: A Long Run View (real interest rate, 10-year US Treasury Bond, Jan-55 – Jun-05) 12,0 Average: 1.7 Average: 1.8 10,0 8,0 6,0 4,0 2.0 2,0 0,0 -2,0 -4,0 Jan-05 Jan-03 Jan-01 Jan-99 Jan-97 Jan-95 Jan-93 Jan-91 Jan-89 Jan-87 Jan-85 Jan-83 Jan-81 Jan-79 Jan-77 Jan-75 Jan-73 Jan-71 Jan-69 Jan-67 Jan-65 Jan-63 Jan-61 Jan-59 Jan-57 Jan-55 -6,0 US Public Debt is Still Small Public Debt in Industrialized Countries (Central Government, in % of GDP) 180% 162% 160% 144% 126% 101% 108% 90% 72% 53% 54% 40% 39% 37% Germany UK USA 36% 18% 0% Japan Italy France US Twin Deficits: Ricardian Equivalence? (In % of GDP) Post US Recession Post EMs Crises 1.0% 3.0% 2.0% 0.0% 1.0% -1.0% -1.0% -2.0% -3.0% -3.0% Fiscal Result -4.0% -4.0% -5.0% Mar-05 Mar-04 Mar-03 Mar-02 Mar-01 Mar-00 Mar-99 Mar-98 Mar-97 Mar-96 Mar-95 Mar-94 Mar-93 Mar-92 -6.0% Mar-91 -5.0% -6.0% Fiscal Result Current Account -2.0% Mar-90 Current Account 0.0% The Changing Anatomy of the US External Imbalance (% of US GDP) Private and Official Current Account Savings & Investment 21% 0% 6% 5% 20% 4% 19% -2% 18% Investment 17% -3% 16% -4% Current Account 3% 2% Official 1% 0% -1% -2% Total -3% 15% -5% -4% -5% 14% 2004 2002 2000 1998 1996 1994 -7% 1992 -6% 2004 2002 2000 1998 1996 1994 Private -6% Savings 13% 1992 Savings and Investment -1% Assessment The current imbalances are sustainable, even if non-US central banks stop buying US public debt obligations, if private sector propensity to buy public sector bonds remains largely unchanged. Given current low interest rates, Emerging Markets will become magnets for capital flows. This may give rise to higher investment and growth in EMs but given their small size compared to the US, this trend will likely have little impact on interest rates, unless the US fiscal deficit shows no downward trend GLOBAL IMBALANCES Notes for Discussion Guillermo Calvo October 20, 2005