One more sign we live in a new gilded age – Europe is once again the world’s financial center …
Back in the first Gilded Age, a booming America drew in capital from old Europe. The US ran current account deficits, Europe ran a surpluses. London was the world’s financial center, intermediating between Europe’s savings and the new world’s need for capital. Read Niall Ferguson.
In the new Gilded Age, America is once again drawing in capital from the old world.
Those funds are going to build houses, not railroads – but, well, that is the new way of the world. Those funds come, in aggregate, from Asia, Russia and the Middle East – not Western Europe. But Europe – strangely enough – is still the world’s financial intermediary.
That isn’t the way most economists here in the US see it. The US, they say, has a “comparative advantage” at finance, and specifically at generating financial assets the world wants to hold. I disagree. At least in part. The US certainly has a comparative advantage at selling debt to the world’s central banks. But Europe has had no trouble generating assets private investors want to hold. And Europe increasingly seems to have a comparative advantage at financial intermediation.
At least that is what the data (see table 1 of the data appendix) in the IMF’s global financial stability report tells me. Details and graphs follow.
Before I explain, let me note that there are two major net flows of capital going on in the world right now.
The one that I usually focus on is the uphill flow of savings from the emerging world and Japan to the United States. The emerging world means China. And it also means the oil exporters. They are not quite as flush with oil at $55-60 as with oil at $75, but $55 oil ain’t too shabby either.
There is another net flow: inside the institutional structure of Europe, capital flows in the “expected” direction. It flows from West to East and from rich to poor. Niall Ferguson would probably draw an analogy to the old British empire – which also created an institutional structure that allowed the rich and already developed to finance the poor and still developing.
The current world is a bit different. US imports savings. Indeed, without a massive net flow of savings from the rest of the world, the fiscal deficits associated with the Bush Administration's (now faded) dream of an American empire would not have been consistent with a (also fading) housing boom.
For the current global equilbrium, it doesn't really matter how the world's savings makes it way to the US. What matters is that the savings do get here, and come at relatively low rates. But it increasingly seems like a lot of the emerging market savings now financing the US reaches US shores after passing through the hands of our friends in Europe.
Why do I say that? Simple. An awful lot of emerging market money flowed into Europe in 2005. The data on global reserve growth shows a big increase in central bank flows into both the euro and the pound. Indeed, the growth in central bank euro reserves in 2005 far exceeded the Eurozone’s modest current account deficit.
But that isn’t all. Lots of money from private and quasi-private (oil investment funds) sources also flowed into Europe. Don’t take my word for it. Look at the IMF data. $1.64 trillion flowed into the Eurozone. $1.37 trillion flowed into the UK. Only $1.21 trillion flowed into the US.
Gross flows into both the UK and the eurozone topped gross flows into the US. The difference? The big inflows into the UK and Europe were used to finance equally big outflows, while the US used the vast majority of the funds coming in to finance its current account deficit. Put differently, Europe still saves enough to finance its own investment while the US has to import savings from the rest of the world to make up for its own lack of savings.
Consider the following graph. It shows cross-border financial intermediation – borrowing from one part of the world to invest in another. In other words, I charted the scale of financial inflows coming into a region that are used to finance capital outflows, rather than to finance a current account deficit.
Now look at a companion chart – done on the same scale. It shows net borrowing – i.e. the extent to which a region uses financial inflows to finance an external deficit.
Low and behold, the US tops that league table.
If I put financial flows from emerging markets on the same chart, they emerge as the key source of net financing for the US …
Europe, then, intermediates between the emerging world’s savings surplus and the United States savings deficit.
No wonder London is booming. It rather clearly is the global center for this kind of intermediation. London always seems to do well in a gilded age.
There is one key different though. This time around though, London is generally playing with borrowed money — not with the UK's own savings.
The interesting thing about globalization is that as far as where the capital of financial services go, it really doesn’t matter that much where the money comes from or where the money goes to. NYC and London are the worlds financial capitals because that is where the people with the skills are, and it’s trivially easy to move money there to be processed since everything is electronic anyhow.
Brad–London is clearly the most international financial market in the world. And as you mentioned, London is intermediating between excess savings of Asia and oil producers, and excess investment and consumption of the US. When London was the global financial center in 19th and early 20th century, London was playing with its own excess savings (of the order of 5-10% of GDP), mainly investing in the US (former colony), Canada, Australia, and India. But now, London is playing with borrowed money, investing in the US and globally.
More than skills:
“…even Gates might find it burdensome to guarantee, as the Merc does, the performance of every member on every trade…”
“…The surge in indebtedness has not been lost on our financial engineers. An immense market in corporate credit insurance has sprung into being… For the most part, these insurance contracts, known as credit default swaps, trade not on an exchange but over-the-counter. In OTC dealings, no clearing house guards against counter-party defaults. And there is no transparency… Plainly, the world needs a better idea. And it will certainly get one, perhaps in the shape of a liquid, accessible, exchange-cleared credit insurance contract. If so, it wouldn’t be surprising if the old Chicago Butter and Egg Board copped the prize…”
http://www.grantspub.com/articles/sidebyside/
Well I see the lastest game in favor of the U.S. Goldman, American Express, and Allianz just booked a lot of dark-matter profit for the West from the ICBC IPO. By my naive count, that’s 2 for the U.S. and 1 for Europe.
“…In 1999 the largest 50 companies in the S&P 500 traded at a 168 premium to the next 450 companies. Today the top 50 trade at a 5 percent discount to the next 450, and the big companies with strong balance sheets, globally diverse portfolios, high dividend yields and powerful brands are cheapest. Statistically, it looks like the largest companies are at the lowest relative valuations they’ve been at in 10 or 15 years…” http://www.davisfunds.com/pdf/SmrtMny0306.pdf
“…a quarter of the London’s financial district is owned by German, US and Japanese investors. But the report warns many of these foreign, “anonymous” investors could make the City financially unstable…” http://news.bbc.co.uk/2/hi/uk_news/england/london/5031136.stm
“…Foreign-owned institutions accounted for about 60% of foreign exchange trading in the capital…” http://business.guardian.co.uk/story/0,,1929771,00.html
“…Despite London’s global reputation, the study said Indian firms were building closer links with the US and Dubai. It found that Chinese businesses were also looking to the US…” ‘London ‘losing India and China” http://news.bbc.co.uk/2/hi/business/6079742.stm
Guest — how does the fact that large caps trade at a small premium here in the US relate to the theme of this post? If there is a connection, help us by spelling it out …
“No wonder London is booming. It rather clearly is the global center for this kind of intermediation. London always seems to do well in a gilded age.”
In other words, much of London’s prosperity, and by extension the UK’s, depends on the game continuing. The UK’s financial edifice is obviously as rickety as America’s.
Hi, en…I am a Chinese college student learning math. I heard ur blog from my classmate and interesting in what u said. I will keep paying attention to ur blog which is so excellent! Thx for ur work…Stop making nonsense…
re: “large caps trade at a small premium”
If the current run still has legs, to ask how that affect may be factored in over time. Also to add to the list of NYC hub attributes.
“…The Government has diverted a chunk of the country’s extraordinary foreign reserves, soon to hit $US1 trillion ($1.3 trillion) – accumulated at the price of the country’s hundreds of millions of poor, who dread the penury that sickness brings, and have to dig very deep to educate their children – to inject about $US300 billion to buy out bad loans from the big four banks. This has largely succeeded in covering the trail by which cadres and their families and cronies all over the country have “borrowed” from state banks – mostly using state-owned enterprises they control as vehicles – to acquire state assets, usually including real estate, and have become wealthy overnight, with no real intent to repay the loans. Government funding of these bad loan write-offs has concealed the extent of this massive process of theft…” The ICBC float will raise $29 billion: forget the bad loans, fraud and write-offs, writes China correspondent Rowan Callick http://www.theaustralian.news.com.au/story/0,20867,20626401-643,00.html
“…Chinese banks have piled up a mountain of bad debt after lending money to car buyers who can’t afford the payments…” http://news.xinhuanet.com/english/2006-10/24/content_5244005.htm
“…the growth of hedge funds in Europe over the past two years has outstripped that of the US. Much of this expansion is evident in Britain, which accounts for 80% of the European hedge fund market…”
http://business.guardian.co.uk/story/0,,1929771,00.html
“The captains of Western capitalism that made American Industry once great were Thomas Edison or Henry Ford of yesteryear”
Your ignorance about the age of the robber baron is only matched in intensity by your overweaning ethnocentricism.
“today those captains of Industry have been replaced by the fraudsters and banksters of New York”
Are yes, the same “fraudsters” and “banksters” (terms used on virtually every racist website on the internet – no surprise there) who created Microsoft, Oracle, eBay, Google, Cisco, Dell, Apple etc. etc. etc.
“The American economy based entirely on debt, consumption, and speculation will not have any future.”
This from a man who supports the most morally bankrupt and financially corrupt political and economic systems on the planet.
“James Glassman says his seven-year- old prediction that the Dow Jones Industrial Average will rise to 36,000 wasn’t wrong, just early… “Dow 36,000” held that stocks were safer than bonds over the long term. When investors recognized this, the Dow would triple in value, the authors wrote…”
http://www.bloomberg.com/apps/news?pid=20601109&sid=atovhd65yQxc&refer=home
Reply to Guest,
At the very least, Thomas Edison and Henry Ford during the last Gilded age actually produced something of economic value to society. Today’s “robber barrons” don’t care to produce a single damn screw or bolt. In another example of privileged access to information, leading Enron-style corporate governance, Robert Rubin of the New York Bankster cartel used his position of power as the Vice Chairman of Citicorp to pressure all of the bond rating agencies not to downgrade Enron bonds even when it was clear the corporation was facing serious financial problems. William Greider in the Nation magazine documents the abuse of power. The “efficient market theory” promoted by all those Neo-liberal economists doesn’t hold true when most of the available information to the general public is problematically biased and distorted. Wall Street Hedge funds commonly commit market abuse using privileged information to make substantial capital gains with certainty.
Regards,
One of the lessons of history, I believe, is that great powers typically see their mature productive sectors decline as the finance industry becomes dominant. As other countries build their productive capacity, they emerge as great powers, accumulate wealth and ultimately supplant the reigning financial power. Genoa, for example, was a great financial power after its other economic sectors withered. Britain through much of the 20th century followed the same pattern. Is there any reason the US shouldn’t be following this pattern now? Why wouldn’t Japan, China, and the Gulf States learn to dispense with the need for intermediaries and consign New York and London to the dustbin of history?
“Nikkei reports that a Spanish financial institution that offers yen denominated mortgages to its European customers, reminding of course that such loans, after the yen are converted to euros, carry exchange rate risks but an attractive interest rate, less than 2.5% vs around 6% for a euro denominated mortgage according to MIN Apparently, there are about $1.6 tn of loans extended by Japanese banks to overseas borrowers… money is still easy and plentiful when it comes to Japan. This is why the Federal Reserves job is not solely US monetary policy…” Andrew B. Busch, October 20th, 2006
other guest – it’s completely counterproductive to respond to the DC posts. He will keep repeating the same fabricated propaganda slogans over and over and over again. that’s what he’s conditioned to do. any direct response simply encourages more.
Swiss franc mortgages in hungary, yen mortgages in Spain, when will there be yuan denominated mortgages in the US …
funny.
John H. Interesting observation. I suspect you are right — but I also suspect that ending London based intermediation will take some time. It seems to have captured a very large share of the offshore petro$ market (see the growth in london $ based hedge funds). And, well, it has lots of advantages that will be hard to replicate quickly …
But I also think it rather unlikely that the US will retain its financial preeminance; the rules of global finance are not usually set by debtors.
Reply to Guest,
Of course, the Chinese and other Asians always cheat. That’s why everything sold at Walmart is made by the Chinese, and all the cars on the road are made by Japanese. Of course, the Bush Administration never lies about Weapons of Mass Destruction in Iraq, and Saddam Hussein’s personal ties to terrorist Osama Bin Laden. President Bill Clinton would never lie about Monica Lewinski, Whitewater S&L embezzlement, genocide in Yugoslavia, or the chemical weapons factory in Sudan. Thanks.
Regards,
Tell that to LBO funds…
“…One of private equity’s most remarkable characteristics is the way it makes lenders – the ones with the money, remember – feel like they have to beg for a seat at the table…” http://www.ft.com/cms/s/3c959fdc-531d-11db-99c5-0000779e2340.html
There are two articles on London’s emergence as the world’s financial centre in the current issue of The Economist -
How to protect an industry
The City’s success shows that exposing it to foreign competition is the way to do it
Britain’s most lucrative industry owes its dynamism to many things, including globalisation, innovation and the good fortune to be based in an old imperial trading city that sits handily between Asia and the Americas. But there was nothing pre-ordained about London’s success as a financial centre: it happened largely thanks to an inspired piece of state intervention 20 years ago that opened the doors to foreign talent and foreign capital.
On October 27th 1986, pressed by Margaret Thatcher’s government, the City blew apart the closed shop of the London Stock Exchange in a reform known as Big Bang. Out went minimum commissions and other restrictions, and in came a stampede of foreign firms. The government stood by and watched as they swallowed the old British firms that had previously dominated the City.
Capital City
Twenty years ago London embarked on a remarkable transformation to become a global financial centre. It now has to keep its lead
That revolution was called “Big Bang” because new ways of trading shares came into effect on one day, October 27th 1986. Just as the universe exploded after Big Bang, so the City has burst from its former boundaries around the old “square mile” of the Lord Mayor’s domain and, in the process, redrawn the capital’s skyline.
Twenty years ago, Canary Wharf was a wasteland in east London’s docklands. Now it sprouts skyscrapers, including Britain’s tallest, that provide palatial premises for global banks with giant trading floors. There are now almost as many financial staff working in just this one area as in the whole of Frankfurt, London’s main European rival, says George Iacobescu, Canary Wharf Group’s chief executive.
Hi you all,
I’m writing from Spain. I’m following RGEmonitor since the beginning of the year and I am in the hard landing side of Dr. Roubini.
I think that the housing bubble is bigger in Spain than in USA, and the crash will be harder here.
Some comments about Nikkei reports about yen mortgages in Spain, and spanish housing and mortgages (sorry my poor english):
1.— I have no news of yen mortgages in Spain, but it could be possible. Googeling a bit shows you that UK people have lots of options to have such options. So, I’ve no news about that. But it’s not mainstream.
2.— The mortgages made in Spain are 99% in variable rate, at about 0.5 points higher than “euribor” index. This means that most of people are paying now 4.25 or 4.50 interest rates. Not a 6%.
3.— Mortgages in Spain became very cheap in year 2000, because Eurozone set the rules and the ECB interest rate was established at 2% (while spanish inflation was at about 3,5%). I remember that we were used to 16% rates in 1990. Consequence: everybody got indebted to the end.
4.— Everybody saw that buying a house was a better investment than having the money in a bank (because hause prices never go down!). This was the logic.
5.— ECB and the spanish central bank are saying that the median household debt is getting out of common sense and banks are taking too many risks with very “exuberant mortgages habits” and so on (here are common now 50 year mortgages, when almost nobody is working before 25-30 years.
6.— Spain, although having very big deficits, is a little bit save under the euro umbrella, from foreing attacks.
7.— Spain is a great place for german and british old people to get retired in. Good wheater, cheap prices, better health services than in UK (for free), and so on.
8.— About one million of inmigrants were legalized last year (mostly from Marocco and South America). And there are probably much more illegals. They have to live somewhere: they buy a flat of 60 square metters to live at dozens inside. Sharing legal papers between similar faces.
9.— Housing is out of hand anywhere, but all big housing companies and banks are already out of mortgage business. But —at the same time— buying lots of energy markets in financial institutions.
10.— Today, the minister of economy in Spain said that, although he has no problem with housing companies buying energy companies, he doesn’t like the last move of this companies buying banks.
All this is happening in a moment that all european countries are playing hard to preserve their energy companies from foreing buyouts, and quite frightened I think of Putin’s last moves.
I hope that, out of the line, this will help or give some light to someone to understand spanish housing bubble madness.
Go on, brad.
This website is the best in economics…
When Dave speaks, it sounds like someone just dropped a drawer of silverware.
-Evans
I usually outsource European housing questions to Charles Gottlieb, but from what I know, Spain looks like its even further down the path toward becoming a housing-centric economy than the US. The residential investment to GDP ratio was off the charts last I checked in with Charles.
Tho I guess selling housing to brits and Germans is an export of sort.
re: “US financial preeminance”
my problem with this is that I tend to see it more as the ongoing evolution and global integration of a system – and not the domination of one nation over another.
london is looser then new york
its not about firms many “the city” are american ..new york based
but hot money
arab money and russian money all like loose
the city is a whore to whores
Brad,
I see big moves in “other” inflows to UK and Europe and declines elsewhere. Any idea where and into what the outflows are going?
Recycling or redirecting, short term liquid or longer term less liquid?
Most of the money from the banks went to pay unemployment and social welfare benefits for people laid off by the SOE’s, but that’s letting facts get in the way of a good story. The rule in these sorts of news stories is that there always has to be an obvious “good guy” and an obvious “bad guy,” never mind that reality is not that simple. Trying to figure out what is really going on is just too confusing and doesn’t allow for the moral indignation that sells papers.
There are a few scheduled Asian IPO’s in NYC in the next year. The age of the mega-IPO is almost over, and the new IPO’s will be small/mid sized companies. What really hurt NYC was the collapse of Worldcomm and Enron left a bad taste in people’s mouths.
NYC and London will be world finance capitals for a long time. What matters is not where the money is coming from but where the expertise is. As long as the expertise stays in NYC and London, the money will go there to find it.
One other thing is that the trend in IPO’s is multiple listings. It costs about the same to list in one place as in two, and in listing in two you get some advantages. For example a dual HK/Shanghai listing gets you the domestic capital of the Shanghai market while at the same time getting the “seal of approval” of the HK securities regulators.
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