Brad Setser

Brad Setser: Follow the Money

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Do we live in a world dominated by private flows? Or official flows?

by Brad Setser
August 30, 2006

“The IMF has been asleep at the wheel in an era when private capital flows have been growing at an unprecedented pace” 

So says Tim Adams, the Treasury Under Secretary (in the New York Times).

I think it would be more accurate to say that:

“The IMF has been asleep at the wheel in an era when official capital flows have been growing at an unprecedented pace”

It is true that private capital flows to emerging markets have recovered, more or less, to their pre-crisis levels.   If they are now growing fast, it is only because they fell so far.  In absolute terms, they must be a smaller share of the world economy than in the mid-1990s. 

And what are those capital flows now used for?   In aggregate, to build up the emerging world’s reserves.   Private capital flows to the emerging world come back to the industrial world as official capital flows.   

I used to work for the Treasury, so I know that the notion that we live in a world dominated by private capital flows is part of the Treasury’s boilerplate.   But it is time to retire that boilerplate! 

The defining feature of today’s world economy is how big a role official actors – central banks and oil investment funds – play in the global flow of capital. Don’t believe me?    Look the WEO data.   The IMF may be a bit sleepy, but it usually gets its numbers right.

Try Table 35 of the WEO's statistical appendix.   Emerging and developing countries added $525b to their reserves in 2005.   That is the change in their reported stock of reserves.   Adjust for changes in the dollar/ euro and the real "flow" increase was well over $600b.   You also might want to add the $90b in “other official outflows” that appear in Table 33 from the Middle East to that total.   That presumably picks up on the activities of the Gulf’s oil investment funds.   

Compare that sum – it is about $700b – with the $250b net private flows to the emerging world the IMF reports in Table 1.2 in the WEO.   Incidentally, the IMF reports $580b in reserve growth here (I am not quite sure what explains the difference, as I don't think the IMF adjusts for valuation – it may be the IMF folks are including all the Saudi’s central banks foreign assets in table 1.2).  The sum of official outflows and reserve outflows in table 1.2  is around $720b.   

$700b in official outflows.  $250b in private inflows.  What is bigger? 

Think a bit.  Where are the big savings surpluses of the world now found?   China, Japan and the oil exporters.   Only in Japan are private flows the vector that carries those domestic saving surpluses into global markets.   China’s central bank invests the dollars generated by China’s current account (savings) surplus – along with the dollars coming in from private capital flows.    The Russian central bank manages most of Russia’s savings surplus.  T The Saudi surplus is managed by the Saudi Monetary Agency and a host of other quasi-official bodies.  No one knows for sure where the Emirates savings surplus is found, but the Abu Dhabi investment authority seems like a might good guess.

Russia’s reserves were up $15b in July.  The Saudi Monetary Agency’s foreign assets rose by $7b.    Annualize $22b a month.  It is real money.  And there are lots of other countries that produce oil too.

Or just read Martin Feldstein’s Jackson Hole comments.  He gets it. 

That said, I am being a bit unfair on my Treasury friends.   Their boilerplate is dated.  But their policy is not. 

China – and a host of other countries – do need to be given a larger stake in the IMF.  Otherwise they will opt out of the “system” even more than they have already.
Dan Drezner asked all the right questions earlier today.  I won’t repeat them.   The Treasury is gambling that increasing China’s stake in the institutions of international economic governance will prompt China to act like more of a responsible stakeholder – and be a bit less inclined to rely on exports and under-valued currency to drive its own growth.   It is a gamble though.

I’ll answer Dan’s last question directly.  Dan wrote:

If I had told you five years ago that Weisman would write the following sentence:

But because the I.M.F. has not recently had a major crisis, some economists joke that with little to do, board members have the luxury of squabbling among themselves for power over an organization with an ill-defined mission”

would you have believed me? 

The answer is no.    I should know.  I spent a year and a half writing a book about IMF crisis lending.  I thought it was an important issue.   It just happened to be published when the IMF stopped lending.  Bad timing.

Yet the next time trouble strikes, if nothing changes, it could well be that the IMF does NOT resume lending.   China might decide not to outsource crisis lending to the IMF, so to speak.   

One of more consequential decisions the US made in the 1990s was not to bailout lending itself, and instead rely on the IMF.    Make no mistake though, the US had the financial capacity to do big bailout itself.    The Bush Administration has shown that the Treasury can borrow big time to finance a war (and a remarkably unsuccessful reconstruction).  It certainly could borrow big time to finance crisis lending.   But after Mexico, the US decided to invest in building up the IMF’s lending capacity rather than creating the institutional mechanisms needed to do bilateral crisis lending.   China will likely be faced with the same choice at some point.  

That is one other reason why the debate over IMF governance matters.

15 Comments

  • Posted by Stormy

    Brad,

    I think your link to Martin Feldstein’s comments may be incorrect; the link points to your and Nouriel’s book.

  • Posted by Stormy
  • Posted by Stormy

    China: My answer always has been that powerful entities—tnc’s, mnc’s—will fight against revaluation until the bitter end, possibly until it is too late. If China is to keep its FDI investors happy, the peg must stay. I would be surprised if some kind of quid pro quo has not been made.

    Additionally, threaten by India’s growing economic power and other Asian competitors (Vietnam on the horizon)–, China will release the peg only with great reluctance. .

    Saudi Arabia: it has enough internal poverty problems to keep it quite busy, provided it spends some of its wealth on its citizens. Additionally, one could argue that their peg to the dollar ensures the stability of its greatest Western supporter, the U.S. If the riyal were to rise precipitously, the price of oil would skyrocket in the states. The royal house of Saud travels on a limited tether, guarded by its protector the U.S. Best not to disable or anger its guardian. (Notice that we have not complained about the Saudi peg?)

    As for Russia, it has a bit more freedom and it indeed has talked of investing elsewhere.

    I am not saying that the dollar must not fall, but I am suggesting reasons why it has not. In any event, I think it important to flesh out the reasons why key players have resisted releasing the peg.

  • Posted by Guest

    There’s good reason to expect that the IMF will not start lending the next time there is a crisis. After all, some of the world’s biggest debtors are now English speaking (US, UK, and Australia). Can you imagine the IMF imposing sanctions on anyone in that crowd?

    As you note, China is only one country in a position to do crisis lending. Other players are emerging as well: Venezuela has been actively lending to help countries pay off IMF debts. Having paid off many of its debts, Russia reserves are increasing, as you mentioned, and they will soon be in a position to start lending. Other oil exporters will probably see the strategic value of this approach. Relations between many major oil producers and the West are strained, and to them it will make sense to diversify and put money where assets can’t be frozen. Loans can also be used strategically to make friends and influence people, contrary to the IMF, which seemed intent on brutalizing third world countries, forcing them to privatize their crown jewels and public utilities to give Western investors great deals at bargain basement prices. Given a choice, non-Western countries will prefer lenders who will help them develop while preserving their independence and strategic assets.

    To maintain its role, the IMF will need to attract not just China, but other emerging countries as well. This will require it to behave less as a Washington-driven institution and more as an impartial lender of last resort

  • Posted by Guest

    Brad–I think it is a gamble likely to fail that giving China a small increase in its IMF quota share could guarantee its responsible behavior. On the other hand, certainly even China may hesitate to go into large scale crisis lending. (Please note that even Japan hesitated to do so alone when the Asian currency crisis erupted in 1997, though it was more active than the US, and China did not provide any financial assistance to Asian countries except for Thailand in small amount.)

    Stormy–I tend to agree your pessimistic assessment of likely outcome in the near future, though this delay of adjustment would result in a violent unravelling of the global imbalances.

    Guest–Apart from Japan, probably only China has the ability to make significant crisis lending at this stage. But Japan is not likely to go into it unless IMF play a leading role. China is uncertain, though I think it may also be very cautious.

  • Posted by bsetser

    Stormy — my apologies for the crossed-up links; the Feldstein link should be correct now. The link was meant to go to his Jackson hole comments.

    Well-informed guest — yes, you are right — countries tend to be rather reluctant to do large-scale bilateral crisis lending. Japan could have made large scale loans to others in Asia back in 97/98. It generally didn’t (tho it did provide some funds to Thailand along side the IMF). Japan has to worry tho about its own historical legacy from the 30s/ 40s in East Asia (very relevant for say Korea). China traditionally has been rather conservative with its money, though it seems quite willing to do soft lending to help secure access to oil (The US was too, just in the 50s and 60s … )

  • Posted by OldVet

    I think Brad’s point that “China might decide not to outsource crisis lending to the IMF, so to speak” is correct, not only for China but for Saudi Arabia and Russia and the Emirates.

    Reason: the shifting balance of political power in both Asia and the Middle East. Iran has recently run a very public aid program in Lebanon, winning friends by having Heztzbollah organizers hand out $12,000 to Lebanese who lost their homes, within days of hostilities ending. Saudi Arabia may want to take a more active role in managing its crisis aid and crisis lending to counter the rising power of Iran (S Arabia is Sunni and never liked Iran; Iran is Shiite.)

    Likewise, Russia is restless after its loss of empire, and may decide to cement bilateral relationships with crisis money in what it considers its sphere of influence in Asia and Europe.

    The US is in no financial position now to win friends through crisis lending, and anyhow distrustful of international institutions these days. It’s going to have to stand on the sidelines and chews its fingernails during any major crisis in future, IMO.

  • Posted by HK

    Brad–When the Asian currency crisis erupted in 1997, Japan provided $4 billion loans to Thailand, $5 billion as the second line of defence to Indonesia, and $10 billion as the second line of defence to Korea. Japan also proposed the establishment of an Asian Monetary Fund with its substantial contribution, though this proposal was turned down by the strong opposition of the US and the cool response from China. More importantly, in 1998-99, Japan provided quick-disbursing medium-term loans totaling $15 billion to 5 crisis affected countries under the New Miyazawa Initiative, while another $15 billion short-term loans under the Initiative was utilized only half for establishing swap arrangements for Korea and Malaysia.

    I don’t think there was any concern among Japan or Asian countries except China about Japan’s historical legacy. China was certaily an exception, providing little support to Asian countries and opposing to the AMF simply because they were initiated by Japan.

  • Posted by bsetser

    Second-line financing posed no problems. Incidentally, the second line was never used in korea or indonesia — though that was certainly not a Japanese decision.

    The real problem comes not with second line financing — or even first line financing that is disbursed along-side the IMF and piggy backs on IMF conditionality. The real problem comes with bilateral conditionality. Think of the US getting Mexico to pledge its oil revenues as collateral against the US bilateral loan from the Exchange stabilization fund in 95. Bilateral Japanese conditionality — particularly if somewhat harsh — woudl have posed (I think) major problems for the Koreans. Yet most countries are not willing to put up $20b or so unconditionally. Domestic problems would arise if the loan wasn’t paid back.

    and I think Chinese opposition to the AMF stemmed in part from the WW2 legacy …

  • Posted by Anonymous

    It seems important to make the distinction between net and gross flows. Central banks don’t really trade around so the net and gross flows are roughly the same. That obviously isn’t the same for the private sector. Q1 flow of funds in the US – net flows 950bn, gross flows more than double (sum of outflows and inflows). Zero net inflow with one trillion of inflow and one trillion of outflow is very different from zero net inflow with closed capital accounts. The global integration implied by gross private flows seems worthy of Adams’ attention.

  • Posted by bsetser

    anonymous — fair point. though my sense is some of the gross flows (particularly the bank flows) almost always net out — as they are part of broader transactions. but it also isn’t clear to me why the surge in gross flows is closely tied to the debate over the imf’s mission. for the IMF, the defining feauture of today’s world is not that the imf is small relative to (gross) private flows. the defining feature of the imf is that is now small in relation to the reserves held by many major emerging economies.

  • Posted by Emmanuel

    (1) From the NYT article:

    But Mr. Adams and other American officials say that rather than limit China’s influence at the I.M.F., they want to increase its role there and make the lending institution a more aggressive monitor of currency manipulation by member nations.

    Lemme get this straight: The US Treasury is asking China to become more involved in the IMF so that the latter can more effectively police [gasp! choke!] currency manipulation? They must be joking if they think this is viable policy. Not gonna happen–at least as described here.

    (2) Note that the proposal mostly moves power away from what Rummy would call “old Europe”. The proposed redistribution does not appear to eat into the United States’ share of over 15% which gives it the famed Stiglitzian “veto power”. In other words, change is welcome for the US as long as its relatively dominant standing remains the same. Mon ami–plus ca change, plus c’est la meme chose.

  • Posted by Guest

    Brad–I agree with you that China, which was not affected by the Asian currency crisis at that time, was more concerned about Japan’s leadership and the historical legacy than the crisis itself. However, Korea was not so much concerned about the legacy, although I admit that if Japan tried to impose its bilateral conditionality on Korea a serious difficulty would have arisen. So, like the US after the Mexican crisis, Japan avoided such an action, and provided assistance based on the conditionality imposed by IMF.

    So, I don’t think that China would go into crisis lending alone. At the same time, I don’t think that China would become so responsible to allow its currency appreciate singnificantly in a timely manner just because its IMF quota share is increased marginally.

  • Posted by HK

    The last post given by “Guest” was given by HK.

  • Posted by bsetser

    Emmanuel –

    on a) you are probably right, but so long as china is obviously underrepresented, they also have an easy excuse to ignore the imf.

    b) I am not one of those americans who has a thing against old europe — i rather like old europe. but old europe is clearly far more over-represented in the fund than the US, it just is split into a host of different national constituencies. Germany and France don’t vote together in the fund (at least not necessarily), California and New York do …

    at some point tho, the US will lose its veto power .. it won’t really matter. imagine the imf making a huge loan that the US opposes. If the US treasury secretary is credible, us opposition will doom the thing — the reality is that a credible US will always have de facto veto power. As would a unified Europe.

    p.s. if you go by gdp, the us is among those underrepresented in the fund.