When the International Monetary Fund and the World Bank gather for their spring meetings in Washington this week, there will be no pressing euro crisis to address, and that is more than one could say a year ago. But we could be witnessing a future crisis in the making. At least that’s what
Christine Lagarde, the IMF’s managing director, said in New York a few days ago.
She may be right. There is increasing evidence that five years of prolonged financial and economic turmoil, coupled with high growth in emerging-market economies, are leading to a fundamental shift in financial assets away from advanced nations and into the developing and middle-income categories. The question is not whether this is occurring but whether it will ignite the crisis Lagarde worries about.
Lagarde’s evidence is what she terms a “three-speed” global economy. She sees the emerging-market economies regaining momentum after modest dips in growth rates last year. The US and a few smaller economies—Sweden, Switzerland—are meanwhile in recovery mode, even if the pace is painful. They are the second tier.
And Europe and Japan are bringing up the rear, still troubled by debt and banking and economic crises. The danger in this scheme of things is that exaggerated imbalances emerge—not only in economic growth, but also in financial markets, in investment flows, and in currency markets—and these will push us into another global crisis.
FOCUS ON THE BRICS
There are signs we have started down this trail. And it is not simply a matter of capital flows toward those we know as the middle-income economies, with the BRICS (Brazil, Russia, India, China, and South Africa) in the lead. What we are also seeing among the BRICS and others are new policies and strategies that will secure them a more prominent place in the 21st century global economy.
Consider the sovereign bond markets. The wreckage of the past half-dozen years, including the loss of AAA ratings by the US, Britain, and France, has shrunk the field of AAA bond issuers by 60 percent. The Financial Times just released a fascinating study of these markets. North America, Europe, and Russia and its neighbors all showed average downgrades in the 2007–13 period. The big winners on the upgrade side were Latin America and most of Asia.
“This is a dramatic redrawing of the credit-ratings map,” the FT commented. “It is encouraging investment flows into emerging markets and forcing investors and financial regulators to rethink definitions of ‘safe’ assets.”
Now let us look at currencies. We have Japan, the US, and Europe engaged in one degree or another of monetary easing to prime economic activity. The Japanese had a chance to develop a reserve currency in the 1980s, and they punted. So we need not worry about the yen. But what about the dollar and the euro?
As it turns out, the BRICS and other emerging market nations have been dumping euros assiduously because the European Central Bank’s benchmark interest rate, at 0.75 percent (and possibly falling), is simply not compelling. The IMF recently reckoned that central banks in developing countries sold $59 billion, last year, bringing euro-denominated reserves to 24 percent of their total, the lowest level in more than 10 years.
The dollar is holding steady, by comparison, but it looks a little like a default position for many investors. The yield on the 10–year Treasury bond is now 1.7 percent; a lot of Treasury issues offer negative yields, with inflation factored in. The latest revival in the junk bond market, where there is a new flood of liquidity in search of a decent return, tells the story: Investors of all classes are rethinking their risk-assessment models.
THE BIG MONEY SHIFT
More striking is what is happening on a global scale and among the world’s most conservative investors, the central banks. A poll published recently by a British banking journal indicated that a majority of central bankers are reconsidering their risk strategies and moving into higher-yielding currencies and instruments; more than 80 percent of the central bankers polled said this reflected frustration with the low returns available in the US and European Union markets.
Among the emerging market nations, new monetary policies appear to reflect these new investment patterns. China has been stepping ever more aggressively where Japan feared to tread, eager to make the yuan a reserve currency that competes with the dollar. A few weeks ago Beijing announced that it would further open the yuan-denominated markets for stocks, bonds, and other instruments. That is only the latest of many moves toward liberalization.
Since then, China and Brazil have signed a $30 billion currency-swap agreement. These deals enable signatories to borrow in each other’s currencies in the event of trouble in global markets. Bottom line: For the stipulated amount, there is no longer a need to act via US dollars. It is one more step toward the emergence of a global multi-currency system.
Foreign-exchange swap arrangements, as some readers may recall, were much the thing among Asians during their crisis in the late–1990s, when dollar-bearing speculators could ravage an economy in a matter of weeks. So was talk of new institutions, such as an Asian Monetary Fund that would counter what was then called (quaintly, it now seems) the “Washington Consensus.”
At a summit of the BRICS in Durban, South Africa last month, national leaders announced plans to launch a development bank intended—we are talking long term—to counter the Bretton Woods institutions.
I am not in the least surprised. There is much in economic policy that can, and is, learned from others. But policy must also reflect local values, traditions, cultures, and other things we do not ordinarily associate with budgets, debt, and so forth. This was the problem when the Washington Consensus was put on a plane and sent across the Pacific in the late–1990s. It did not quite take.
The BRICS summit provided little detail as to plans for the bank. But it is well worth watching. These countries account for 20 percent of global gross domestic product; they expect to spend $4.5 trillion on infrastructure in the next five years. News reports suggest they consider $50 billion a minimum capitalization for the new bank. They are also putting $100 billion into a currency pool that will act like a commonly shared swap mechanism—“an additional line of defense,” as the summit communiqué put it.
So we are watching not only a fundamental shift in financial assets; we are looking at new institutions and policies, too. In my view, this is what is supposed to happen--it is history’s wheel turning. Let us hope Christine Lagarde is wrong about the crisis history’s wheel could deliver.