Globalization and crises - World...

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Globalization and crises

Luis Servén

The World Bank

Kuala Lumpur, November 2016

Kuala Lumpur November 2016 -- Luis Servén

2

Plan

Stylized facts

1. Financial globalization

2. Currency crises

3. Bubbles

4. Sovereign debt and default

5. Financial crises, propagation and policy responses


3

Some stylized facts

Fact 1: Big increase in the degree of international

financial integration since 1990


4

How is the growth of financial integration

measured?

De jure: Widespread removal of barriers to international

financial transactions.

De facto: Massive growth in cross-border asset

holdings.

[Some hybrid measures sometimes used as well; see

Quinn, Schindler and Toyoda 2011 for full details]


5

Leading de jure measures (all based on IMF AREAER):

• Chinn and Ito (2007) KAOPEN: first principal component of

individual 0/1 restriction indicators from AREAR table

• Underlying indicators are dichotomous (yes/no), hence rough

• Quinn (1997, updated) index of restrictions on financial

transactions – based on coding of text of AREAER; separates

current and capital account.

• Schindler (2009) KA index – more finely-graded version of Quinn

w/ details by asset transaction type.

• Fernández et al (2015): update and extension of Schindler to 10

asset categories, adding 4 new ones

• Derivatives, comercial credit, financial guarantees, real estate


Quinn index of capital account liberalization, by income group

Source: Reinhardt et al (2013) Kuala Lumpur November 2016 -- Luis Servén

0.2

.4.6

.81

0.2

.4.6

.81

1970 1980 1990 2000 2010

All

Advanced

Emerging

Developing

Ind

ex

Year

Chinn-Ito index of financial openness

(group averages)

0.2

.4.6

.81

0.2

.4.6

.81

1970 1980 1990 2000 2010

World

Advanced

Emerging

Developing

Ind

ex

Year

Chinn-Ito index of financial openness

(group averages)

Source: Milesi-Ferretti and Tille (2011) Kuala Lumpur November 2016 -- Luis Servén

.15

.2.2

5

.3.4

.5.6

.7

1995 2000 2005 2010 2015

World HI (rhs) UMI

LMI LIC

Ind

ex

Year

Fernandez et al (2015) index of capital controls

Controls on inflows(averages across 10 assets categories)

.1.1

5.2

.25

.3.4

.5.6

.7.8

1995 2000 2005 2010 2015

World HI (rhs) UMI

LMI LIC

Ind

ex

Year

Fernandez et al (2015) index of capital controls

Controls on outflows(averages across 10 assets categories)

12Kuala Lumpur November 2016 -- Luis Servén

13

The various de jure measures are fairly highly correlated


14

De facto: Massive increase in cross-border asset holdings

• speeds up after 1990

• especially large in advanced countries

• slows down after the global crisis (“deglobalization”)

Most popular summary statistic: the sum of gross foreign

assets and liabilities relative to GDP.


Source: Gourinchas and Rey (2013)


External Assets and Liabilities (percent of GDP)

16 CEMFI September 2016 -- (c) Luis Servén

010

020

030

040

0

0

10

020

030

040

0

1970 1980 1990 2000 2010

Assets

Liabilities

A + L

% o

f G

DP

Year

World



010

020

030

040

050

0

0

10

020

030

040

050

0

1970 1980 1990 2000 2010

Assets

Liabilities

A + L

% o

f G

DP

Year

OECD

050

10

015

020

0

050

10

015

020

0

1970 1980 1990 2000 2010

Assets

Liabilities

A + L

% o

f G

DP

Year

Rest of the World



050

10

015

020

025

030

035

0

050

10

015

020

025

030

035

0

1970 1980 1990 2000 2010

Assets

Liabilities

A + L

% o

f G

DP

Year

USA

020

40

60

80

10

012

0

020

40

60

80

10

012

0

1970 1980 1990 2000 2010

Assets

Liabilities

A + L

% o

f G

DP

Year

China



020

040

060

080

0

0

20

040

060

080

0

1970 1980 1990 2000 2010

Assets

Liabilities

A + L

% o

f G

DP

Year

Eurozone

Source: Prasad (2012)Kuala Lumpur November 2016 -- Luis Servén

22

Fact 2: the composition of assets and liabilities

differs systematically across advanced and

developing countries.


23

In particular: advanced economies tend to be long in

risky assets, other economies short.

Rich countries hold equity assets, developing countries

hold reserves.

And the difference in portfolio composition between

both groups of countries has widened over time


Source: Prasad (2012) Kuala Lumpur November 2016 -- Luis Servén

These changes in the structure of countries’ portfolios reflect

the shifting composition of capital inflows and outflows

since 1990

• FDI dominates inflows to emerging markets.

• Inflows to advanced countries are dominated by

portfolio capital and banking flows.

• Emerging-country outflows have expanded greatly –

especially in middle-income countries – and they are

dominated by reserve accumulation.

• In contrast, reserves play a minimal role in advanced-

country outflows.


Source: EIU

Emerging economies hold the bulk of international reserves

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,0001

98

0

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

USA EU-15 Japan Emerging Asia China Oil Exporters LAC-6

International reserves around the world (US $ bn)


Why the massive reserve accumulation by emerging

markets?

Reserves as a hedge against external volatility (such

as sudden stops) – a strategy validated by the crisis,

so likely to persist

‘New mercantilism’: defend exchange rate targets

to support an export-oriented growth strategy (e.g.,

China and some East Asian countries)

Adjustment lags to terms-of-trade windfalls

(commodities)


Fact 3. Valuation effects – capital gains and losses on

gross foreign assets and liabilities – account for an

increasingly large part of the dynamics of countries’ net

foreign asset positions


Large, heterogeneous gross asset positions create a big

exposure to changes in asset prices and/or exchange

rates

The U.S. has consistently enjoyed very large valuation

gains.


Source: Gourinchas and Rey (2013)Kuala Lumpur November 2016 -- Luis Servén

In most countries, the variance of the valuation effect is

about as big (about 90% on average) as the variance of the

change in net foreign assets.

The correlation between the current account and the

change in the net foreign asset position is fairly low

If changes in net asset positions are increasingly driven

by valuation effects, and net flows are dwarfed by gross

flows – does the current account still matter?


Fact 4. Capital flows (and also the prices of risky

assets) show a high degree of synchronization around

the world


Kuala Lumpur November 2016 -- Luis ServénSource: Rey (2013)

Kuala Lumpur November 2016 -- Luis ServénSource: Barrot and Servén (2016)

Table 2 Average cross-regional correlations, 1979-2013

(a) Gross capital inflows by foreign agents (CIF)

(b) Gross capital outflows by domestic agents (COD)

North

America

Latin America

and Caribbean

Asia and

PacificEurope

Middle East

and North

Africa

Sub-

Saharan

Africa

North America 0.047

Latin America and Caribbean 0.129 0.083

Asia and Pacific 0.127 0.090 0.062

Europe 0.251 0.003 -0.003 0.247

Middle East and North Africa 0.148 0.109 0.124 0.153 0.077

Sub-Saharan Africa 0.057 0.142 0.074 -0.099 0.021 0.082

North

America

Latin America

and Caribbean

Asia and

PacificEurope

Middle East

and North

Africa

Sub-

Saharan

Africa

North America 0.102

Latin America and Caribbean 0.238 0.088

Asia and Pacific 0.236 0.167 0.078

Europe 0.401 0.234 0.218 0.242

Middle East and North Africa 0.247 0.152 0.111 0.283 0.089

Sub-Saharan Africa 0.132 0.106 0.074 0.154 0.093 0.014

Kuala Lumpur November 2016 -- Luis ServénSource: Barrot and Servén (2016)

Table 2 Average cross-regional correlations, 1979-2013

(a) Gross capital inflows by foreign agents (CIF)

(b) Gross capital outflows by domestic agents (COD)

Advanced Emerging Developing

Advanced 0.170

Emerging 0.128 0.090

Developing -0.060 0.098 0.061

Advanced Emerging Developing

Advanced 0.216

Emerging 0.276 0.091

Developing 0.159 0.130 0.033

Common factors (global and/or regional) account for a

major share of the observed variation in asset prices and

flows around the world.

• A ‘global financial cycle’ – asset returns move in

unison across countries.

• Strong international propagation of financial

disturbances and market turbulence


Mundell’s ‘trilemma’: a country cannot have all three of

• An independent monetary policy

• A nominal exchange rate objective

• An open capital account

The global financial cycle reduces it to a dilemma:

exchange rate flexibility does not grant monetary

independence


Fact 5. Large global imbalances (big current account

gaps of opposing sign) opened up over the globalization

era – and grew bigger up to the global crisis.

CEMFI September 2013 -- (c) Luis Servén43

Global imbalances(1980-2014)


Global imbalances are not a new phenomenon – they were

already seen in the 1980s, for example.

But in the recent episode the magnitude was much larger.

And there were new roles:

• Industrial countries (especially the U.S.) ran the

biggest deficits

• Emerging countries (especially China) supplied

most of the financing


Imbalances have narrowed post-crisis

• The U.S. has scaled back its deficit – with the

unwinding of the fiscal stimulus

• China’s surplus has declined

But they still remain large

• The U.S. still shows the biggest deficit (>0.5% of

world GDP)

• Germany’s surplus (about 0.4% of world GDP) now

exceeds that of China


Are global imbalances a concern for world economic

stability?

• Did they cause the global crisis?

• Risk of a ‘sudden stop’ on high deficit countries

• Not the experience of the U.S. in the global crisis!

No Risk of a ‘sudden stop’ on high deficit countries


Large imbalances might pose a (global) risk due to

externalities / spillovers:

– A sudden stop on a large deficit country (the U.S?) could

propagate to the rest of the world.

But the opposite happened during the crisis – ‘flight to safety’

– Big surpluses in large countries detract from global demand – and

augment the deflationary effect of adjustment by deficit countries

near the Zero Lower Bound

CEMFI September 2013 -- (c) Luis

Servén48

Fact 6. The incidence of crises tends to be higher in

times of higher international capital mobility


Different varieties of crises:

Sovereign default

Exchange rate crashes

Financial / banking crises

Inflation explosions

Often occur in combination; sometimes all at once.

Crises do not happen at random times – they typically follow

booms in credit, asset prices, and/or capital flows


Capital mobility is historically associated with the incidence

of banking crises.


Source: Reinhart and Reinhart (2008)Kuala Lumpur November 2016 -- Luis Servén

Defaults following capital flow surges


0

5

10

15

20

25

1824 1834 1843 1852 1865 1873 1890 1897 1914 1929 1938 1979 1991 2011

Per

cen

t

Peak 1-2 years later Size of boom

Share of new defaults at

peak capital inflows (stripe)

Share of defaults

1-2 years post-peak (pale)

Magnitude of capital

inflow boom (dark)

Source: Reinhart, Reinhart and Trebesch (2016)

However…

…not all capital flow booms (or broader financial

booms) end up badly – just some do

The question is how to identify ‘bad booms’

• Scale? Persistence? Other features?

• And what are other contributing factors?


An aside: can we really trust the data on countries’

foreign assets and liabilities?

Measures of global liabilities from conventional sources

(e.g., IMF, Lane-Milesi) exceed those of global assets

– the world is a net debtor.

Measures of global investment income show that reported

payments exceed reported receipts every year.

This points to significant amounts of unrecorded assets

and unreported asset income.

The ‘missing wealth of nations’: mainly assets held by

households in tax havens (Zucman 2013) .


International investment statistics are based on the

‘residence principle’: what matters is the residence of

creditor and debtor, no the location of the custodian.

Custodians located in tax havens cause a blind spot – e.g.,

U.S. securities entrusted by a French creditor to a

Swiss bank show up in the U.S. IIP but not France’s.

One way to overcome this would be to use data reported

by the custodian country on the residence of offshore

asset holders.

Switzerland does this since 1998; no other tax haven does.

It also reports the nationality of bank deposit holders.


In other advanced countries, most foreign securities held

at custodian institutions are owned by residents

Source: Zucman (2013)Kuala Lumpur November 2016 -- Luis Servén

The large share of bank deposits attributed to tax havens reflects the

use of sham corporations to hide the true beneficial owners.

Most deposits likely belong to EU residents in reality – there is a clear

negative correlation those from tax havens (particularly at the

time of the 2005 Savings Directive).


To estimate global hidden assets, compute the difference

between global recorded liabilities and recorded

assets. It is positive every year.


The discrepancy is larger for equity assets than for bonds


Source: Zucman (2013)

Overall, the hidden assets amount to 5-6 percent ($6 trn) of households’

global financial wealth – double the total net debt of rich countries.


The ownership of tax haven wealth is unknown, but likely

overall hidden wealth likely makes the rich world a

net creditor (as long as it owns at least 50% of all

hidden wealth).

In reality, the EZ is very likely a (major) net creditor,

while the U.S. is a (modest) net debtor

Net asset position (% GDP) under alternative scenarios, 2001-2008 average

Eurozone U.S.


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