Brad Setser

Brad Setser: Follow the Money

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The faster the rise, the bigger the fall?

by Brad Setser
July 26, 2009

Cross-border bank claims – according to the Bank for International Settlement (BIS) — shrank in the first quarter, though at a slower pace than in the fourth quarter. That basic storyline also holds for the emerging world: the total amount the major international banks lent to the world’s emerging economies fell in the first quarter, but not at quite the same rate as in the fourth quarter.

The fall in cross-border flows is often presented as evidence of the dangers posed by financial protectionism – as governments that are now forced to backstop global banks aren’t inclined to backstop “their” banks global ambitions.

But there may be a simpler explanation for the fall in cross-border claims: the boom was unsustainable. Cross-border loans to the emerging world grew at an incredible clip from 2005 to mid 2008. Total lending more than doubled in less than three years, rising from a little under $1.4 trillion to $2.8 trillion.

bis-gross-claims-on-ems3

Some of that rise was offset by a rise in the funds emerging economies had on deposit in the international banking system. Emerging market central banks in particular were putting some of their rapidly growing reserves on deposit with the big international banks. But there was still a huge boom in lending — one that probably couldn’t have been sustained no matter what.

Bank loans to emerging economies did fall sharply in q4 2008 and q1 2009, as one would expect given the magnitude of the crisis. For all the talk about financial protectionism, I suspect that they would have fallen far faster if governments hadn’t stepped in to stabilize the international banks — and to mobilize a lot of money for the IMF so the IMF could lend more to emerging economies, reassuring their creditors.

Cross-border claims are falling at a bit faster rate than in the 1997-98 emerging market crisis. Claims on emerging economies are down by about 20% from their June 2008 peak. But cross-border claims also rose at a far faster rate in the run-up to the current crisis.

Looking only at the pace of the fall — and ignoring the speed of the rise — strikes me as a mistake.

From the end of 2006 to mid-2008, the net position of emerging economies in the international banking systems changed dramatically. In December 2006, emerging economies, in aggregated, had about $400 billion more on deposit in the international banking system than they had borrowed from the international banking system. In other worlds, emerging economies were net suppliers of funds to the big global banks. By June 2008, emerging economies had borrowed close to $400 billion more than they had on deposit with the big international banks. They had become net borrowers rater than net lenders.

bis-net-claims-on-ems1

There is certainly a case that emerging economies should be borrowers not lenders from the major international banks. The flow of funds from poor to rich is perverse.

But the 2006 to mid-2008 swing in emerging economies’ net position in the international banking system was incredibly fast. With the benefit of the hindsight, the size and pace of the shift should was a signal that vulnerabilities were building. Especially as the swing reflected extremely rapid growth in cross border lending to the emerging world, and a lot of those loans were quite short-term …

10 Comments

  • Posted by Too Much Fed

    “There is certainly a case that emerging economies should be borrowers not lenders from the major international banks. The flow of funds from poor to rich is perverse.”

    I don’t think that is quite correct. Is it more like the flow of funds from the spoiled and the rich in the emerging economies to the lower and middle class in the high wage countries to counteract negative real earnings growth from cheap labor and perhaps cheap oil is perverse?

    Back to the Atlantic article.

    http://www.theatlantic.com/doc/200801/fallows-chinese-dollars/3

    “At no point did an ordinary Chinese person decide to send so much money to America. In fact, at no point was most of this money at his or her disposal at all. These are in effect enforced savings, which are the result of the two huge and fundamental choices made by the central government.”

    “The result, while very complicated, is to keep the buying power earned through China’s exports out of the hands of Chinese consumers as a whole. Individual Chinese people have certainly gotten their hands on a lot of buying power, notably the billionaire entrepreneurs who have attracted the world’s attention (see “Mr. Zhang Builds His Dream Town,” March 2007). But when it comes to amassing international reserves, what matters is that China as a whole spends so little of what it earns, even as some Chinese people spend a lot.”

    “This is the bargain China has made—rather, the one its leaders have imposed on its people.”

    And one that the fed has imposed on the lower and middle class in the USA thru congress for the benefit of themselves and the spoiled and the rich in the USA?

    Does something similar happen in the Middle East oil exporters that peg to the dollar?

    I hope that is not too many quotes this time.

  • Posted by Too Much Fed

    “But there may be a simpler explanation for the fall in cross-border claims: the boom was unsustainable.”

    Replace “boom” with “debt boom”?

    Don’t tell that to paulson, bernanke, greenspan, and the rest of the fed because they don’t believe that such a thing is possible.

    Aren’t they trying to reinflate the lower and middle class debt boom right now?

  • Posted by Too Much Fed

    “Especially as the swing reflected extremely rapid growth in cross border lending to the emerging world, and a lot of those loans were quite short-term …”

    Did something similar happen during the Great Depression? Maybe Smoot-Hawley gets too much of the blame for the fall in global trade back then?

  • Posted by D Gross

    Don’t forget there was a lot of private investor money (wealthy or connected Brazilians, Russians, etc) that was in Miami, NY, Switzerland and Cyprus sitting in hard currency. As the boom got underway, these locals got confident in their home currencies and began investing in their home markets, taking money out of Dollars and Euros.

    Their central banks bought these Dollars to stop the local currencies from rising. I would guess that perhaps up to $100 billion of the impact is just a shift from international banks holding private deposits from EM investors looking for safety to international banks holding deposits for EM central banks forced by their mercantilist policies to intervene.

    For decades it used to be hard to find anyone more bearish on Brazil than a wealthy Brazilian (non-government or non-academic). That all changed over the last 5 years.

  • Posted by bsetser

    D Gross — the increased confidence of the wealthy elite of key EMs in their own countries economies and currencies is certainly part of the story. That inflow normally would lead to a currency appreciation.

    that outflow also would show up as a flow out of the international banking system in most cases. though in some EM coutnries, I have heard that some businesses/ individuals that own busniesses like to have offshore accounts and then in effect lend their own money back to their own business via the int. banking system, so a rise in confidence in the home country might show up as more lending (i.e. more bank claims on EMs), not fewer EM deposits in the int. banking system.

    of course if the inflow gets recycled back into the reserves and thus into gov. deposits in the int. banking system, a rise in lending by the banks to EMS is offset by a rise in EM deposits in the banks.

  • Posted by Yoda

    http://www.rgemonitor.com/roubini-monitor/257362/my_interview_with_ferguson_and_zuckerman_on_fareed_zakarias_gps_program_on_cnn#readcomments

    daisy chain comment -> avoid dollar and usa local/state/gov short/long debt. you will get burned.

  • Posted by Yoda

    may be stupid China is too slow to realize this. Treasury is issuing quarter Trillion a week, 8 weeks+ will issue enough to cover 2-3 Trillion debt we owe to China. another 4-5 weeks, Treasury will issue enough to cover all debt from Russia or Japan. That will mean absolute loss for debt holders.

  • Posted by jonathan

    I find BIS material kind of painful to go through, not to mention that I don’t have the time or energy to go through their unreally long publications. Do they break the net position down by region / country?

  • Posted by bsetser

    they have data on banks claims on various countries and bank liabilities to various countries, so one can calculate the net.

    but it isn’t the easiest data set to use

  • Posted by Michael

    2009 is shaping up so far as a huge year for new gov’t debt issues by the EMs. This is partly to cover their own stimulus and subsidy practices (much like the U.S., etc), but also to take advantage of low interest rates and bounceback appetite for investment in EMS (who are at least growing).

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