There go the Emerging Markets

We talked in class today about Sweden's need to raise overnight lending rates to ridiculous levels in its attempt to defend the kroner in the fall of 1992. I read tonight that Romania has a current account deficit of 14 percent of GDP and has pushed overnight rates to 900 percent to defend its peg against the euro.

As was the case with Sweden, this is likely insufficient. "Merrill Lynch has advised its clients to take "short" positions against the leu. "The fundamental picture suggests that Romania may face a currency crisis in the near term, similar to what Hungary has gone through over the last week," it said. The bank also warned that Turkey and the Philippines are vulnerable."

Things look pretty grim for emerging markets and western Europe. "Stephen Jen, currency chief at Morgan Stanley, says the emerging market crash .. threatens to become “the second epicentre of the global financial crisis”, this time unfolding in Europe rather than America.:

• "Austria’s bank exposure to emerging markets is equal to 85pc of GDP – with a heavy concentration in Hungary, Ukraine, and Serbia."
• Exposure is 50pc of GDP for Switzerland, 25pc for Sweden, 24pc for the UK, and 23pc for Spain.
  
• Spanish banks have lent $316bn to Latin America, almost twice the lending by all US banks combined ($172bn). Hence the growing doubts about the health of Spain’s financial system as Argentina spirals towards another default, and Brazil’s currency, bonds and stocks all go into freefall.
• The US figure is just 4pc.

IMF Rising

Another phase of the global credit crisis has begun; developing nations are running to the IMF for emergency aid.   And finance ministers across the world don't see many other options for how to survive a crisis created by developed credit markets.  Capital flight, wide-swinging currency fluctuations, tightening private market credit - we've seen this all before.  

Now the IMF has begun talks to increase their lending capabilities to as much as $1 trillon.  Considering the bank has $200 million in collateral, they'll need quite a bit of supplemental cash.  Perhaps most telling of how weak the US economy is, the IMF has failed to even approach the Fed for support.  Instead, the bank is in talks with Japan and oil-producing companies.

So, is the IMF poised for a renaissance?  Gordon Brown certainly hopes so (interesting that Brown chaired the IMF's policymaking committee for several years).  The IMF's leader, Dominique Strauss-Kahn, stresses that the Fund will eliminate many of the loan conditions that made leaders such as Hosni Mubarak of Egypt refer to the IMF as the International Misery Fund.  However, new conditions have not yet been outlined and a recent study in the Harvard Medical Review found that IMF lending in the post-communist European Bloc directly led to decreased health conditions in recipient nations.  

Check out this map of Eastern European Countries and their debt load (source: www.economist.com):

The Politics of Farm Subsidies

In honor of tomorrow's exam in POLI 442, I bring you a segment from last week's 20/20 with John Stossel on Agricultural subsidies. He's a libertarian, and does not pretend to be unbiased.



My favorite quote (by a legislator): "I would say to you, then, you don't want to push us." It comes right at the end.

Live by the crude, die by the crude

The NY Times has a nice article on how collapsing oil prices are starting to affect the ambitions of Hugo Chavez, Mahmoud Ahmadinejiad, and Vladimir Putin. As oil prices sky-rocketed, these leaders found plenty of cash for building international alliances and shoring up domestic support through lavish social spending programs. This domestic support in turn provided these leaders with the flexibility to pursue more aggressive foreign policies with the hopes of expanding their international influence, particularly in opposition to the U.S. But it now appears that they may have over-reached: inflation is over 30% in both Venezuela and Iran, and the Russian stock market has dropped by two-thirds in recent months. Meanwhile oil prices, and thus revenues, continue to decline. If the trend continues, these leaders may have to start making hard choices between populist domestic social programs and expansionary foreign policy.

Even so, there are still some signs that the relative economic power of the U.S. may be in decline. European leaders have been at the forefront of the response to the financial crisis, and some of the U.S. government's actions are partially explained by international concerns (e.g. the Fannie/Freddie conservatorship was necessary because of heavy Chinese investment; the AIG bailout had major international implications). And does anyone remember the strong words the U.S. had for China regarding currency manipulations? There've been crickets coming from that corner for awhile.

Still, as Daniel Drezner notes, it doesn't appear that any other country is quite ready to fill the U.S.'s shoes:

However, this interdependence cuts both ways. Because of its slowing growth, China has no choice but to continue purchasing dollar-denominated debt in order to goose its export earnings. As for Russia, $500 billion in reserves has not prevented the crash of its own equity markets.

The bottom line seems to be this: the U.S. may be incapable of continuing to run the international finance system entirely on its own as it has done since the end of WWII, but the rest of the world is incapable of controlling the system without the U.S. So the story may not be de-coupling, as some had thought; Indeed, we may see more interdependence rather than less in the near future.

Reassurance

I don't see that they've achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job.

That is Anna Schwartz, one of the foremost economic historians in America, particularly in the areas of the Fed, the Great Depression, and monetary policy in general. More here.

(ht: Mankiw)

To Grandmother's House We Go

If banks are the bridges of the financial industry, and world governments are able to prop them up sufficiently well as to avoid any more major collapses, then where do we find ourselves? According to Gordon Brown, the next step is the development of a new Bretton Woods system. Nevermind the poor historical analogy; if Bretton Woods I was formally constructed as an international security measure while WWII was still raging, and if Bretton Woods II was informally constructed by the U.S. running current account deficits in order to finance cheap current consumption, which in turn boosted export-biased growth in developing countries (with the U.S. dollar as the de facto reserve currency for the world), then I'm interested in what Bretton Woods III would look like. What formal or informal structure will emerge in the coming years as the controlling mechanism for the world economy? Or, more specifically, what institutions might be developed which would prevent future crises from resembling the present one? I see several possibilities, none of which strike me as being especially likely.

1. The development of a new international agency, with the scope and resources of the IMF, dedicated to providing short-term liquidity directly to major banks (or investment firms with large counter-party obligations?) in any country, without the approval of that bank's host country. This agency would have the authority to demand structural changes to lending or investment practices of the banks they aid. In other words, the loans would be tied to some actions. These demanded actions may include things like higher reserve requirements, equity stakes in the banks in exchange for the capital, preclusion from engaging in credit default swap markets or taking on other investments with large exposure to system risk. It's possible that this could be done under the auspices of the IMF if certain changes were made to its charter, tho considering the P.R. problems facing the IMF, it may be better to develop an entirely new agency.

2. The development of a global version of the Securities and Exchange Commission, which closely regulates the balance sheets of major banks, and has strict restrictions on what types of investments certain banks may make. Although, given that these sorts of regulatory agencies had no real positive preventative effect on the current crisis, it seems unlikely that a global agency would've done much better. There are also corruption problems in many countries. And would countries with a nationalized banking system accept foreign control? Of course not.

3. The development of a global FDIC, which guarantees depositors in traditional bank accounts and money market funds. This, however, is a rather mild symptom of the global contagion; it isn't the disease itself. And many countries in the developing world have incredibly corrupt banking systems. It would require a massive reform of a corrupt political culture in order to make such a plan feasible in those countries; that, obviously, would be quite hard to do.

What else? In my opinion, #2 and #3 would have little effect on the international financial system, plus enforcement would be mostly impossible even if enaction weren't. #1 is essentially the same as recapitalization of banks, and this can already be done by private investors or local governments in most cases. When that proves problematic, the IMF (see: Hungary, Ukraine) or neighboring countries (see: Iceland, Pakistan) are capable of pitching in.

Perhaps I'm missing something obvious, but Bretton Woods I picked the low-hanging fruit in a time when the Western economic powers were capable of forcing the agenda. Bretton Woods II was an informal mechanism in which the world voluntarily tied its sails to the fortunes of the dominant economic powers by organizing their economies to sell to the world's biggest markets. I don't really see a realistic place for a third organizational system at present. If folks have ideas, put them in the comments. Or, if folks have things they'd like to see in a BWIII, even if they aren't realistic, put those ideas in the comments also (I'm looking specifically at you, Emmanuel).

Americans are saving?!

What?! Since when do Americans save? Well, according to the latest figures, the personal savings rate in the United States was up to almost 3% for the second quarter of '08, the highest its been in at least five years, and is predicted to at the very least stay at this level for a while. This is an interesting development. 

This news bodes well for the American economy in the long run, as "domestic savings create a pool of money from which companies can borrow to invest in new plants and equipment, creating the jobs that push living standards higher over time. A growing domestic savings pool could also reduce America's need to borrow money overseas - which would make the U.S. less beholden to foreign creditors who now supply us with hundreds of billions of dollars in financing every year."

However, in the short run, "saving more means spending less - which translates into more hard times in retail and other consumer-driven businesses like the auto industry. The latest evidence of the shift came in Wednesday's steeper-than-expected pullback in retail sales. They dropped 1.2% in September, in their first year-on-year decline in six years and only their third drop in the past 16 years. Given that two-thirds of economic activity is consumer spending, today's thrift [may] exacerbate a general downturn and [may] weaken the impact of the massive interventions the government has made in the financial markets."

This development has consequences for the predicted (or actual, depending on your definition of the term) recession and recovery.  If Americans aren't willing to go out and do what they do best (shop and eat) and instead stuff their money under the mattress, it is a signal that the American economy may be in for a longer and deeper recession than originally predicted. Furthermore, the recovery from the Great Financial Crisis of 2008 (catchy huh?!) and its ensuing recession may take longer than we thought it would. (We may be sitting here in the 3rd and 4th quarter of 2010, still awaiting the recovery to begin.) 

So I say unto you America, shop, baby, shop!