Benn Steil


A graphical take on geoeconomic issues, with links to the news and expert commentary.

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Showing posts for "Capital Flows"

Can China’s Bond Market Support a Global RMB?

by Benn Steil and Dinah Walker

On April 24, the Australian central bank announced that it would raise the proportion of its reserves devoted to Chinese financial assets from 0% to 5%, likely among the highest such allocations among world central banks.  Will other major central banks follow suit? Read more »

Where Have All the Profits Gone? Karl Marx Could Have Told You

Labor and Dividend Income

Since 2009, labor’s share of income in the United States has plummeted while personal dividend income as a percentage of disposable income has soared. This is not surprising for the early stage of a recovery in which firms are earning more with less and the stock market has been buoyant. The divergent trends between the two over the last 30 years, however, is notable and important. The small upper-right figure shows that dividend income as a percentage of after-tax corporate profits leapt markedly and permanently in the early 1980s. This corresponds with a general upward trend in corporate profits as a percentage of gross domestic product since that time; a time in which labor’s share of income has fallen almost continuously. Dividend income, not surprisingly, accrues largely to the stock-owning wealthy, as the small bottom-right figure shows. The fuller picture is one of growing inequality; one for which the globalization of business is frequently fingered as a primary culprit. But globalization itself makes the data difficult to parse. When an American firm uses components provided by foreign firms they appear from the data to have no labor content.

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Eurozone Bank Deposits Are Fleeing for Germany

by the Center for Geoeconomic Studies

PIGS vs. German Bank Deposits

The eurozone leadership is finally coming around to accepting that a major continent-wide bank recapitalization program is necessary.  Germany wants each country to take care of its own banks.  This approach could buy time, but it won’t work for long.  National bank backstops are untenable in a common currency area, as each sovereign has its own credit risk profile.  Depositors will simply flee toward the better backstops.  This can already be seen in the correlation between bank deposits in Germany and the PIGS (Portugal, Ireland, Greece, and Spain).  Before the financial crisis, those deposits were tightly correlated, as shown in the graphic above, but over the past two years the correlation has flipped – deposits are fleeing the PIGS and flying into Germany.  A stable eurozone banking system will require a unified regulatory, resolution, and rescue regime. Read more »

China’s “Helping Hand” Won’t Help Germany

by the Center for Geoeconomic Studies

Chinese Premier Wen Jiabao recently hinted teasingly that China might buy more risky-country European debt; a “helping hand,” he called it.  Yet even if China follows through, it is unlikely to increase its intended purchases of European debt but rather just change the composition.  China’s euro purchases have increased dramatically over the past two years (we estimate these to be ¾ of reserves purchased in excess of the change in China’s U.S. asset holdings).  Most of this can be presumed to have been invested in German bunds, Europe’s closest thing to U.S. Treasurys.  Chinese euro purchases over the coming twelve months equivalent to those of the previous twelve months could cover the entire 2012 net financing needs of Portugal, Ireland, Italy, Greece, and Spain (PIIGS), as the figure above shows.  Every euro China invests in new PIIGS debt, however, can be expected to come at the expense of bunds.  Such a diversion would push up German interest rates—precisely what Germany wants to avoid by resisting eurobond issuance—without giving Germany any greater say over eurozone fiscal policies.  Chancellor Merkel therefore gains little, if anything, in making political concessions to secure Wen’s “helping hand.”

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China’s Imbalances Are Bigger than Reckoned

by the Center for Geoeconomic Studies

“How China’s external current account surplus will evolve in the coming years is one of the key questions on the economic outlook for China and the global economy both,” said a World Bank official in Beijing recently. The IMF presented its own answer to that question in a July 2010 report on the Chinese economy, forecasting a gentle, steady rise in China’s current account surplus, relative to its GDP, as shown in the top figure above. The forecast comfortingly shows the surplus staying well below its 2007 peak. Yet since China’s economy is growing much faster than the world economy, the IMF understates the upward trajectory of China’s growing imbalances with the rest of the world. This we show in the bottom figure, which projects China’s surplus relative to world GDP using the IMF’s own assumptions. By this measure, China’s surplus will surpass its 2008 peak within two years. If China continues to recycle dollars abroad at this pace, the global economy will become considerably more vulnerable to shocks from capital flow reversals.

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Sovereign Credibility and Bank Runs


In the midst of the financial crisis of 2008, governments helped to prevent bank runs by guaranteeing bank debts. Yet as sovereign solvency itself becomes an issue, such guarantees quickly lose their value. If Ireland provides a rule of thumb, bank runs can be expected once sovereign credit default swap yields pass 3%. The figure above shows that when Irish government CDS yields first passed 3% in early 2009, foreign deposits fled the country. This happened again in late 2010. Now that Spanish CDS yields have broken the 3% threshold, there is reason to be concerned about the stability of Spanish bank deposits as well. Read more »

Luck of the Irish Hinges on Banks


The EU-IMF Irish bailout gives Ireland a window of opportunity to solve its problems, but how large a window is it? Although the €85 billion headline number appears to be very large, at over 50% of Irish GDP, the funds must be benchmarked against what they are being earmarked for. €50 billion is tagged for public finances, which will cover two years of public debt refinancing and deficits. This provides a significant window for Ireland to achieve fiscal improvement. However, the window provided by the €35 billion tagged for banking sector recapitalization is much smaller. Over €34 billion of foreign deposits fled Irish banks in September 2010 alone. Over the past two years, Irish banks’ balance sheets have shrunk by over 9%, while their funding reliance on the European Central Bank has increased from 5% to 9% of total liabilities. This suggests that any Irish bailout plan, to be credible enough for the markets, must ensure that the Irish government ceases adding bank debt to its public debt. That will almost surely involve a restructuring – that is, a significant partial default – on the bank debt. Such a restructuring, however, will raise a slew of new bailout questions, since German, French, British and other European banks holding Irish bank debt may themselves require public assistance to remain acceptably capitalized. Read more »

P.I.G. Government vs. Corporate Debt


The risk of corporate debt is often measured by looking at the spread between its yield and similar ‘risk-free’ government debt. The higher the spread, the greater the risk. However, when government credit comes into question, this spread is no longer suitable as a measure of corporate risk. The spread does, nevertheless, tell a story about relative risk. In Greece, Ireland, and Portugal, a number of sectors have negative corporate spreads, suggesting that firms are either less likely to default than their governments or will have higher recovery rates if they do default. The sector that stands apart as being much riskier than the government is financials. If these governments partially default, the guarantees they have made to the banking system are no longer credible, and the credit losses may be severe. Read more »

Greek Debt Crisis – Apocalypse Later


The difference between Greek and German government bond yields can be used to estimate the market’s view of the likelihood of a Greek default. The chart above shows these probabilities over different time frames on three different dates. On April 30th, no European plan was yet in place to address the ballooning Greek debt, and default was considered a real possibility in the short term. On May 11th, just after the European Stabilization Mechanism (ESM) was announced, markets sharply cut their view on the odds of default across all time horizons. However, the market’s analysis of the ESM has become much more nuanced since then. On September 1st, the market’s view of the probability of default within two years was lower than before the ESM was announced, but higher over longer time frames. Read more »