By Simon Johnson
Most accounts of the ministerial meeting last weekend of the Group of 20 — 19 nations plus the European Union that represent the world’s wealthiest economies —implied that it continued to perform sterling service – heading off currency wars, keeping explicit protectionism under control and deftly managing the process of reforming governance at the International Monetary Fund.
Post-financial crisis, middle-income countries continue to rise in economic importance, and the recent shift in global leadership from the Group of 7 (the United States, Canada, Britain, Italy, France, Germany and Japan) to the G-20 is commonly supposed to accommodate the growing claims of “emerging markets” on the world stage.
This interpretation is correct as far as it goes, but it also misses the main story, which is that emerging markets have two primary goals that are increasingly at odds with each other. These goals – to hold large stocks of American dollars and to stave off a flow of capital from abroad – add up to wanting to retain the emerging markets’ recently achieved status of collective net creditors (i.e., being owed more than they owe). Unfortunately, this contributes to the serious vulnerability of the world economy as we head into the next credit cycle.
Emerging markets want to hold onto – or increase further – the vast stock of foreign exchange reserves that they have recently accumulated through current-account surpluses. In part these assets are a buffer against future shocks, but the countries now hold much more than they would need for purely precautionary purposes – China alone acknowledges holding around $2.5 trillion, much of which is presumably in American dollars.
Increasingly, emerging markets think about using the value of these reserves (or what they could buy with them) in a broader manner. They enjoy the status and power that comes with being a net creditor to the system – rather than a net debtor, as in the past (which involved periodic crises, loans with unpleasant conditions from the International Monetary Fund and having to be deferential to the United States when times were tough and so on).
They even begin to think about forming the basis for a new monetary arrangement that is less dependent on the dollar – since the 2008 financial crisis, both the Russians and Chinese have spoken in public about this objective, and it is shared in private by most policy-makers outside Europe and the United States.
The “reserve currency” status of the dollar means just that – private and public sector investors around the world hold their rainy-day funds in dollars. Traditionally, at least, this arrangement has been seen as a major economic advantage and source of political power for the United States.
Emerging markets want to discuss moving reserves into a basket of currencies, presumably involving some Chinese renminbi, Indian rupees, Russian rubles and Brazilian reals (the four Rs), among other currencies.
But this is where tension with the second goal enters the picture. Most emerging markets – including those with the four Rs – do not want to allow their currencies to appreciate, and they are also unwilling to take other measures (like cutting fiscal spending) that would be likely to hold back appreciation in some instances (Brazil, in particular, takes this stance). Instead they are imposing capital controls to prevent inflows.
The controls are unlikely to prove fully effective, but they do slow the appreciation for now – and they also send a very clear signal: Foreign investors will be treated at a differential disadvantage when the chips are down.
Ask an Indian executive whether she is thinking about investing in Brazil and the answer is an unequivocal yes. But ask whether she or her policy-making colleague would like to hold reserves in reals and the answer is also quite frank: no, thank you.
Emerging markets will continue to save for a very rainy day (or a bright unspecified future) – in dollars. They intervene to keep their exchange rates relatively depreciated and will try to run current-account surpluses for as long as they can. This behavior pushes down long-term interest rates in the United States, relative to what those would be otherwise.
And – here’s the kicker – very low interest rates in the United States contrast sharply in the minds of yield- and risk-seeking investors with the situation in Brazil, where you are now offered 11 percent interest rates.
In other words, the global credit machine in this part of its cycle takes savings from emerging markets, runs them through the United States, and – at the margin — plows them back into emerging markets. Dollars are bought up through central bank intervention and – you guessed it – funneled back into the United States. The Institute for International Finance, which represents global banks, just revised upward its estimate of capital flows into emerging markets this year.
This is exactly the kind of issue – inherently cross-border and very political – for which a structure like the G-20 is needed. But it will do nothing about these flows for three reasons:
1. The emerging markets want to save in this fashion, thinking they can dodge the consequences.
2. The United States needs to borrow, big time. Our politicians refuse even to think about the first-order causes of our recent fiscal disaster; they would rather just continue to borrow (at least as long as interest rates remain low).
3. The big banks like this approach. Their influence is in no way diminishing, and there is nothing about their recent track record that has diminished their appeal in the eyes of policy-makers (just this week, for example, the I.M.F. appointed a senior Goldman Sachs executive to head its high-profile European Department).
Accommodating emerging markets in global governance structures is appealing; their aspirations are legitimate, and the G7 looks outmoded. The profound instability of global financial structures and the broader “doom cycle” today is not the fault of emerging markets – the blame lies squarely with the United States and Western Europe, which have consistently failed to rein in their global megabanks. (For an 8-minute primer on the “doom cycle,” if you are not familiar with the concept, try this video.)
The argument that the global savings glut, largely from emerging markets, was a major driver of the 2008-9 crisis is tenuous at best. But there is no question of a dissonance within the current policy goals of emerging markets – and this is not helpful to financial stability moving forward. Most likely it helps feed – or otherwise becomes central to – the next financial frenzy. And there is nothing the G-20 can or will do about it.
An edited version of this post appeared this morning on the NYT’s Economix blog; it is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.
The Baseline Scenario 
“But Parker Brothers has a technology, called Monopoly (or, today, its electronic equivalent), that allows it to produce as many Monopoly dollars as it wishes at essentially no cost. By increasing the num-ber of Monopoly dollars in circulation, or even by credibly threatening to do so, Parker Brothers can also reduce the value of a dollar in terms of fictional Atlantic City, NJ real estate, which is equivalent to raising the prices in dollars of that real estate. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.” paraphrasing Ben Bernanke, 21 Nov 2002.
Would a fictional Indian executive really rather have Monopoly dollars yielding 0% than Brazilian Reals yielding 11%?
When I read a post like this, I come away with a couple of impressions.
One, we are moving into a world where no one is in charge. Nor are any two parties (viz., China and US today, like the US and USSR a generation ago) in charge. Like political and cultural strength, on a global basis economic power has diffused. Is this altogether a bad thing, or just a change so fundamental as to be unnoticed?
I also get the impression that the major actors are internally conflicted, like in any good theatre. Outcomes will result not just from the interplay between the characters but also from how the characters themselves grow or decay (what strengths mature with time, what flaws are revealed in extremis). Perhaps all the quants need to be replaced by lit crits? Where is Derrida when u needa . . . (never mind).
In any event, welcome to the 19th century, I mean, the 3rd millenium.
Simon, I’m not trained as an economist, although I have read lots of books and read your blog religiously. That having been said, my intuition, which has, thusfar, proven fairly accurate in its reading of situations is responding to this article with a big nod of my mental head (odd metaphore, but you may get the picture). My perception is that the G-20 isn’t changing the playing field because the resident oligarchs love the level of arbitrage that is created by this economic context. I might even say that, from my perspective, this level of imbalance allows for absolutely incredible rivers of profitable arbitrage on all of the key fronts. Yes, in the long run, it is both unsustainable and even destructive, but the feeding frenzy is just too much fun, and, with the billions to be made by the various oligarchies, each can essentially “carve out” a future “safe haven” in which to continue their reigns. This is the globalist perspective. No, it is not socially acceptable, but then when did an oligarch think of social acceptability. They’ve got one job, to make money. And global politics and its intersection with the wealthy elitists has created perhaps the greatest destructive global dynamic in memory, if not in all of history. Let’s make it clear, these beings don’t have any true national allegiance at all. Quite frankly, they don’t care whether their nations or populations even survive, let alone thrive. I have heard that the level of greed now existing at the upper levels of wealth are substantially caused by addiction to the dopamine response. That may be true. We may be seeing the result of faulty biology at work. Sure, drugs and alcohol kill, both directly and collaterally, but, I would argue that the addiction to the dopamine response kills more effectively by a more global process. It’s like we have entered a new Dark Ages where the plague is not some microorganism, but a flawed human response. A few, like Bill Gates and others who want to actually give up wealth to find happiness constructively, are, sadly, in the vast minority. The new nouveau riche are Machiavellian to their cores. One indication is that the latest $250,000 Porsche performance car has sold out in the first two months of limited production, and there are those who want more. Most of the rest of us soon won’t be able to afford the model kit of that car at a hobby shop.
The G-20 is not irrelevent, as you have suggested, because the leaders of it are the leaders of the NEW GLOBAL PLUTOCRACY. If we look at developed and emerging markets, each may be fairly labeled as a plutocracy. Look what has happened in Europe and Great Britain, they are now trashing the general populace, just like America, to pay for saving their largest banks. How could we beleive in the G-20. It’s just more global politics as usual. Kind of like Karzai taking his bags of cash from both the US and Iran while those two countries are essentially at war.
Surprised not more comments in this thread, because I think it was a pretty good post by Professor Johnson.
I’d like to see them raise rates a quarter point, or even see them raise it 1% in phases over the next 6 months. I think a lot of investors are chasing after higher yields as we speak and we’re seeing too much risk. There was an article in FT just recently about a $400million CLO soon to be sold or created. That’s just one of many bad signs.
There is a pretty good article in a St. Louis Fed publication addressing low interest rates.
http://www.stlouisfed.org/publications/re/articles/?id=2022
I guess there is nothing “Earth-shattering” in it, but I think it is a reminder that there are societal costs that come with keeping interest rates low over an unnaturally long time. I don’t think it would be the end of the world if rates were about 1% higher.
After the G-20 meet I scrolled through 2,600 articles on the subject on Google news. I read the Headlines on all 2600 of them and lead-ins on most every article although after a while I became adept at spotting the redundant feeds. This all took about 2 hours but I found most of the pieces to the puzzle.
The thing is, reading only the US/UK/MSM take on any story with geopolitical implications is perhaps the most misleading experience a person can have. For instance there were actually 2 Fin Mins who sent subordinates, (Brazil, Indonesia) but of course only one of these cases was widely reported.
More importantly, the US delegation came back with their tales tucked between their legs but that was almost impossible to notice from most of the reporting worldwide. But of course the puzzle pieces were available, just not easy to find. The main clue was in the closing communique but the key points were excluded from nearly all of the 2600 articles:
…”move towards more market determined exchange rate systems that reflect underlying economic fundamentals and refrain from competitive devaluation of currencies. Advanced economies, including those with reserve currencies, will be vigilant against excess volatility and disorderly movements in exchange rates. These actions will help mitigate the risk of excessive volatility in capital flows facing some emerging countries. Together, we will reinvigorate our efforts to promote a stable and well-functioning international monetary system and call on the IMF to deepen its work in these areas. We welcome the IMF’s work to conduct spillover assessments of the wider impact of systemic economies’ policies;…”
The key clue is exemplified by this: “Advanced economies, including those with reserve currencies,…” And in the word:”spillover”, the importance of those words though must be contrasted against what Sec. Geithner said, repeatedly, leading into the summit, that being his insistence that the US had not intentionally devalued the dollar with QE. But of course, since the summit, it has become increasingly clear that the FED now intends to take an incremental approach to QE. But if the MSM version of the summit was all that a reader had considered, that reader would most likely interpret the meeting as yet another instance of a US delegation saving the world, or, a more measured view might be that it was presented by the press as ‘business as usual’. But in truth something very unusual happened… the US was in fact taken down a notch. The emerging nations maneuvered the developed nations into a position where there was no choice but to formally agree to limit quantitative easing, and, the existing spillover effect has given the emerging nations a hassle-free opportunity to customize their capital markets with controls. There are in fact some efforts underway to use capital controls in some new and innovative ways, and the unfettered freedom to experiment with these without criticism or fear of retaliation is enabling these efforts. (Capital controls do not specifically violate WTO regulations although there are provisions which can be applied in the event of a complaint. The IMF has no jurisdiction over Capital controls, but like the WTO, the IMF position on capital controls has been negative and so there is simply negative political pressure mostly, although both institutions have stated recently that these types of protections are useful in limited applications. Most US trade agreements on the other hand require the liberalization of all cross-border financial services without exceptions). So, I suppose it is safe to say that the US has become more lenient in regards to capital controls. And this leniency was what the emerging nations wanted maybe as much as they wanted the QE curtailed. So all things considered, I’d say the meet was a major success for the emerging nations. What the Fed does on the QE will be another important piece of the puzzle.
Simon
Overall a great post, paragraph 5 is excellent; but who really trusts the counterparties? And if so, why? To attempt to parlay that kind of creditor status (to deadbeats) into IMF shareholding is hardly a good faith exercise (not that in any event it results in much beyond face anyway).
On your para 15 enumeration, it looks fine, but:
1. not an island (islands), and got there by 2 and 3
2. depends on 1 and is heavily influenced by 3
3. goes back to 1 and heavies 2
The knot still looks a bit gordian to me.
Ultimately, the question of “who’s in charge, really”, if applied to the IMF or G20, might be better framed: at what point in your/that/a country was an IMF or G20 communique the deciding factor in a systemic monetary, fiscal, macro, or geopolitical decision by the highest levels of governance?
Dig into that, and some more material information emerges.
C
SJ : 2. The United States needs to borrow, big time. Our politicians….. would rather just continue to borrow …..
The US government doesn’t need to borrow anything. It is the sovereign monopoly issuer of its own currency. As Thomas Edison famously said: If a nation can issue a bond, it can also issue its own dollar.
It is essential that sovereign governments provide the national circulating media necessary to keep their economies from falling further into economic “instability’, requiring consideration of structural, systemic changes to our macro-economic monetary framework.
BoE’s Governor Mervyn King this week called for the end to fractional-reserve banking. We would all do well to consider his words.
The mechanics of fractional-reserve banking are a process of money creation and destruction. That’s the BIS and IMF’s own definition of financial instability. Today, the stability of our national economies depends upon more stable money systems, more permanent and less cyclical in nature than the one we use today.
Dr. Kaoru Yamaguchi recently released his study of a switch to the debt-free money system advocated in the American Monetary Act.(monetary.org)
Dr. Yamaguchi’s paper: “On the Elimination of Government Debt Under the Debt-Free Money system – modeling the American Monetary Act, is available here –
Click to access DBS-10-01.pdf
Economist Steve Keen described Dr. Yamaguchi’s model as the most sophisticated he has seen.
Time to take the blinders off, Simon Johnson.
Excellent question:
“at what point in your/that/a country was an IMF or G20 communique the deciding factor in a systemic monetary, fiscal, macro, or geopolitical decision by the highest levels of governance?
The comparison to the 19th century is apt. The oligarchs at that time were transitioning from a monarchial to an increasingly democratic polity. We seem to be moving into a post-democratic mode. Authority is shifting from dominant nation-states to a series of national economies that must figure out how to cooperate in a multipolar world. Thus, no one is in charge but everyone is responsible.
Dear Simon,
Maybe under the influence of the recent reading of just published book by the late Tony Judt, I am surprises
that you use the term of ’emerging markets’, instead of
economies, nations
Secondly, as you may know from you insider’s experience,
as W.Münchau wisely remarked recently about the European Union, they would rather create a new problem than try to resolve the ones pursuing the Euroland for decades. Have you hear anything about the assessment by that meeting of Finance ministers of the work of the FSB, specifically tasked by the G20 ? Just saying..
Let’s put this in perspective – “Foreign Manufacturing and Financial Surrogates” (MNC’s financed by America’s Printing Press) are todays decade norm through a generation of planned (methodically) parenthood? We (USA) are now a service orientated economy…is that a good thing or bad thing? You would think it’s a (zero sum gain) wash, but wait…the empirical evidence shows that wages have decreased in the past twenty years whereas their now negative (the consumer can’t even keep up with deflation) and America’s GDP (2011-12?) is shrinking precipitously. Europe’s “EU” is in a funk other than Germany, with England having to deal with the “Bank of Scotland” on the precipice of failure, and Japan deflating itself into oblivion with the Japanese publics money being flushed down the sewer into the sea of China won’t make for happy bedfellows? The G-20 is America’s (IMF / WorldBank) offspring of old, but the changing of the guard is upon the west tradewinds favoring the east! Please note Elizabeth (Consumer Czar with budget being slashed dramatically as I write) Warren mentioning yesterday that the american consumer has no financial parachute for the next “Financial Collapse” debacle…they’re (consumers) tapped-out, period! What has made America strong is still within us all, we are just evolving too fast and furious because of the enormous appetite of Financial Networks around the world which are the “Dirty Dozen” whom must be reigned-in with the rewriting a modern, and realistic (let’s start here in America) Glass-Steagall Act (21st Century Version), and gutting the Financial Modernization Bill, while getting rid of the idiotic Sarbanes-Oxley Act (paper tiger used only when needed to control the uncontrollable progressives?) Thankyou Simon and James, and never stop your endless “great digging for America’s sake” :-)
http://en.wilipedia.org/wiki/List_of_countries_by_GDP_sector_compostion
http://www.voxeu.org/index.php?q=node/5376
http://www.safehaven/article/14166/mustard-seeds-for-deflation-the-deflation-cycle-full-monty
http://en.wikipedia.org/wiki/Financial_services
http://www.mybudget360.com/middle-class-financial-serfdom-top-us-job-sectors-service-low-wage-jobs-now-two-income-trap/
Sorry: Google @ “Mustard seeds for Deflation: The Deflationary Cycle Full Monty”___Ref: “Mybudget360” alternate link:
http://www.banderasnews.com/1006/edat-financialraid.htm
“The “reserve currency” status of the dollar means just that – private and public sector investors around the world hold their rainy-day funds in dollars. Traditionally, at least, this arrangement has been seen as a major economic advantage and source of political power for the United States.”
Glad you are focusing attention on the reserve currency issue. For several decades, we were able to export debt as a product. This peaked in 2006/2007, with the export of not just federal debt, but municipal and mortgage-backed debt.
If you view the dollar as a form of debt (which it is), this becomes obvious – we exported the world’s most important store of value. A thing that became valuable in and of itself, because it had a history of value and was embedded in transactions and existing contracts. As such, the currency diverged from the traditional source of value – the ability of the underlying economy to buy back dollars with real goods and services.
Those who see the dollar’s decline as CREATING weakness for the US economy have their causality precisely backwards. The dollar’s decline is merely reflecting weakness, and much of that weakness was created by a prolonged period of excess valuation for the dollar which was supported by other countries importing our dollars and exporting us their goods.
Eventually, they didn’t want so many dollars, and we had nothing much to sell them. Everyone’s been talking about this for 20 years in the context of trade gaps and fair trade, etc. Yet the free market prophets deny that such a gap could be bad (if countries trade, we MUST benefit not just today but across our time-discounted utility framework) and the markets seem to have a true predictive capacity of about 6 months. Moreover, the rise of the FIRE sector created political momentum to keep the dollar strong and allow the gutting of the real economy.
The sooner we lose this albatross, the better – but it means we’re going to need to restructure our economy to live within our means, cut some entitlements, cut our huge military/intelligence complex somewhat as well, graduate more people in professions that do real things, and generate some meaningful real infrastructure investment on a massive scale.
Team Obama – sad to say – has done NONE of these well. After criticizing the past administration, it’s found the strong-dollar debt-finance drug just as addictive.
OK, not as bad as BushCo, but still bad.
Stats,
Your well stated and accurate comment, for no specific reason, caused the term: ‘Triffin Dilemma’, to pop into my thoughts. It was all just a matter of time until the US economy created an accounting identity paradox. That is what I think is beginning to expose itself more openly now. I suspect it was always there but hidden in the global net flows that left some nations poor while supporting the conspicuous consumption of other nations. But now the paradox is being expressed in the losses that will come as a result of a depreciating dollar. As the dollar depreciates the diminished value of global purchasing-power that is held in dollars is in direct conflict with increased exports from the US. How does a nation increase exports if all importers are in aggregate less wealthy? I’m not sure if this is exactly as Triffin described his paradox but it is most certainly an accounting-identity contradiction. Simply put, the US economy can only improve at the expense of the global economy and vice versa. And if the US prevails prices must rise in the global aggregate, and so, everyone losses but the feudal few. But of course this could also lead to their demise, eventually.
I agree with Ted above regarding this being an interesting post, and yet a less than appreciative number of responses. Perhaps those here who did respond, did so with enough quality to offset the lack of quantity. In either case, I thought I’d add a humorous piece that I wrote a couple of days back:
Sometimes, usually on Tuesdays, God gets bored. This is when he does his polling. Naturally, God is able to read everyone’s mind simultaneously. This only takes a minute or two and He finds the results very useful in planning natural disasters. These are of course for thinning purposes.
This past Tuesday God decided to analyze economists due to the number of complaints He has received lately (profane blasphemies). What God decided to check for in this particular poll was whether there were any economists who actually believed, genuinely, that the US Government was not devaluing the dollar intentionally. God has a fondness for the ‘almighty dollar’ and so… He had been following this issue on CNN.
As it turned out, when God looked into the minds of all economists there was only one exception: Tim Geithner. This meant that a natural disaster would be unnecessary and so this pleased God, natural disasters are not as easy as some might think. And so, being relieved, He decided to give Tim a second chance. God then looked into Tim’s mind exclusively. Fortunately for Tim, God discovered that the Economist Geithner was merely repeating the words: “The US is not deliberately devaluing the dollar”, over and over again. Which is exactly as he had been instructed to do by Ben Bernanke; and what Tim had done each morning before reporting for duty for the past few weeks. Tim knows full well not to make Ben Bernanke angry.
God pitied Geithner-the-Economist but mostly God was concerned about the almighty dollar, but He couldn’t remember if the words IN GOD WE TRUST were still in play or not, and He remembered that there had been some related controversy, so, having more important things to do, God decided to let it all go. “Economists”, He said while shaking his head in disgust, “I should probably deal with them the next time they congregate in some comprehensive way.” And for a moment He considered checking His weather plan for Jackson Hole and for Davos but then He noticed what time it was. It was 10:00am and God cursed thunderously for not having accomplished anything of substance that morning, and, as a result of the thunder, there was some minor flooding in one of the areas inhabited by Heathens. God glanced down and saw people scrambling for high ground and this amused God for a fleeting moment, and this took God’s mind off of economics and all was good again. Then God turned on His gigantic TV and watched His favorite morning programs.
“Quite frankly, they don’t care whether their nations or populations even survive, let alone thrive. I have heard that the level of greed now existing at the upper levels of wealth are substantially caused by addiction to the dopamine response. That may be true. We may be seeing the result of faulty biology at work. Sure, drugs and alcohol kill, both directly and collaterally, but, I would argue that the addiction to the dopamine response kills more effectively by a more global process. It’s like we have entered a new Dark Ages where the plague is not some microorganism, but a flawed human response.”
Yes, “stuff” happens in “nature” that can be viewed as flawed. Wonder why no one ever studied the chemical brew in the head when people “feel” justice has been served with fairness and mercy? And what is the chemical brew that is in the head when justice is never served?
But the bottom line is the bottom line, you will survive if you have the correct response to real danger.
How much time does one have to yaddayadda about the diet and environment and chemical brew in the head of a rabid raccoon heading for your ankle?
Not much, right?
A human being stops being a human being when they no longer have FREE WILL.
“Protocols” are on it – presenting FREE WILL as a fiction compared to DOPEamine “science” and “math”.
I would like to encourage Simon to continue in his work as well as he is now. It is refreshing to read his very insightful opinions. If I had the money or qualifications Id be enrolling in an MIT phd program and looking for Simon as an advisor.
Thanks for linking to Yamaguchi paper, I’ll check that out. I’d note there’s a difference between the government funding its deficits without debt and the government creating a debt-free monetary system. The former by coining money physically or I suppose electronically, Tsy sells coins to the Fed at face value and books seigniorage profits as revenue (The Fed’s payment of interest on reserves would keep the federal funds rate from falling to zero). The latere by (as the American Monetary Act calls for) requiring banks to keep 100% reserves for all loans.
Of course, since the 3 month Teasuries rate is lower than IOR (and FFR) rate, it’d actually be cheaper to just borrow the money than to create sovereign money and then use IOR payments to (functionally) drain reserves. As for the 100% reserves “Chicago plan, as it was called during the Depression, was advocated by Henry Simons, Irving Fisher, Paul Douglas and years later, Milton Friedman.
Note*: Problem with top link Wikipedia (2009 GDP’s)…*China,** Malaysia, and ***South Korea (Manufacturing/ Industrial)
Google @ “List of countries by GDP sector composition”