Brad Setser

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Cross border flows, with a bit of macroeconomics

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The Pain in Spain Is Easy To Explain

by Brad Setser

A few weeks back, the New York Times looked at the “mystery” of Spain’s high level of unemployment.

The article highlighted a real debate about the right level of job protection in Spain, and in Europe.

But the headline obviously stuck in my mind. I do not think there should be any significant debate over why Spain continues to have a very high level of unemployment.

Look at employment. It is down well over over 10 percent from its pre-crisis levels. Even with the current recovery, there are over 2.5 million fewer people at work in Spain today than in 2007 (18 million versus 20.7 million workers over age 15 using the harmonized EU data; the national data has a similar change but a slightly higher level)

And domestic demand is also down well over 10 percentage points.

No mystery.* If demand in the United States was 10 percent below its 2007 level, rather than roughly 10 percent above its 2007 level, I would certainly hope that there would not be much of a debate on the source of a weak labor market.

Employment vs. Demand

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The Case for More Public Investment in Germany is Strong

by Brad Setser

Last week, Greg Ip of the Wall Street Journal argued that Germany should focus on raising private wages rather than increasing public investment as part of a broader critique of Germany’s inclusion on the Treasury’s enhanced monitoring list. Ip: “Germany’s problem isn’t the public sector, it’s the private sector: Businesses need to invest more and workers need to earn more, and that can’t simply be fixed with more government spending.”

I have a somewhat different view: more public investment is a key part of the policy package needed to support German wages.

Ip is certainly right to highlight that Germany gained export competitiveness by holding down wage growth during the ‘00s. Wages and prices in Germany rose by a lot less than wages and prices in say Spain from 2000 to 2010, contributing—along with rise in global demand for the kind of high-end mechanical engineering that has long been Germany’s comparative advantage—to the development of Germany’s current account surplus. And that process now needs to run in reverse for Germany’s euro area trade partners to gain competitiveness relative to Germany. See Fransesco Saraceno, or Simon Wren-Lewis.

But the changes in German wages and consumer purchasing power needed to allow Europe to rebalance up, with shifts coming from strong wage and demand growth in Germany rather than weakness in wages and demand elsewhere, will not occur in vacuum.

To state the obvious, for Germany’s substantial external surplus to fall either exports need to fall or imports need to rise.

For Germany’s workers, many of whom work in the export sector, to have the confidence to demand higher wages while exports slump they need confidence that domestic demand growth will be there. Put differently, low nominal (Bunds out to 8 years have a negative rate) and negative real rates only will push up wages if either the private or public sector respond to low rates by borrowing more. The domestic side of Germany’s economy may need to run a bit hot to pull workers out of the export sector.

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It Has Been a Long Time

by Brad Setser

I stopped blogging almost seven years ago.

My interests have not really changed too much since then. There was a time when I was far more focused on Europe than China. But right now, the uncertainty around China is more compelling to me than the questions that emerge from the euro area’s still-incomplete union.

Some of the crucial issues have not changed. The old imbalances are starting to reappear, at least on the manufacturing side. China’s trade surplus is big once again—even if the recent rise in the goods surplus (from less than $300 billion a couple years back to around $600 billion in 2015) has not been matched by a parallel rise in China’s current account surplus. The U.S. non-petrol deficit is also big, and rising quite fast.

But some big things have also changed.

The United States imports a lot less oil, and pays a lot less for the oil it does import. That has held down the overall U.S. trade deficit.

Oil exporters have been facing a gigantic shock over the last year and a half, one that is putting their (sometimes) considerable fiscal buffers to the test. Even if oil has rebounded a bit, at $50 a barrel the commodity exporting world is hurting.

Looking back to 2006, 2007, and 2008, one of the most surprising things is that Asia’s large surplus coincided with rising oil prices and a large surplus in the major oil exporters. High oil prices, all other things equal, should correlate with a small not a large surplus in Asia.

The global challenge now comes from the combination of large savings surpluses in both Asia and Europe rather than the combination of an Asian surplus and an oil surplus.

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Too much of a good thing? Should global capital flows be pumped back up to their boom levels?

by Brad Setser

I tend to agree with the FT’s leaders – especially their leaders on the world’s macroeconomic imbalances — more often than naught. But not always. On Friday an FT leader warned about the risk of financial deglobalization:

“Finance is deglobalising out of fear and because of national policies. Neither will be fully undone without political choices that look unlikely, at least for now …. But unless policymakers come up with better global regulation that works we may have to settle for permanently less globalised finance.”
(emphasis added)

That didn’t ring true to me. At least not fully. The tone of the leader seemed to long for a return of the pre-crisis world, one where huge quantities of funds flowed across borders, albeit one with better global regulation. Yet just as trade probably rose to a level that could only be supported if US households continued to run up an unsustainable level of debt, cross-border financial flows likely reached levels that could only be sustained if the global financial system remained over-leveraged.

The goal shouldn’t be to return the boom years, but rather to return to a more sustainable level of cross-border flows — or at least a system without the excesses that contributed to the current crisis. Remember, the rise in cross-border capital flows prior to the crisis was associated with a rise in the amount of leverage in the system, as a host of institutions tried to support bigger balance sheets without increasing their equity. That rise in leverage sustained a lot of cross border flows.

To be concrete:

US financial institutions sponsored offshore special investment vehicles (SIVs) that often borrowed short-term from American investors to buy longer-term US debt. They were offshore largely because they were off balance sheet. If the same activity had been performed on the banks domestic balance sheet – with more short-term wholesale borrowing to support a larger securities book – cross-border flows would fall. But regulators also would have had a lot more information about the build-up of risks in the global system. Taxpayers might not think that is a bad thing.

European institutions seem to have been supporting bigger dollar balance sheets than they could finance entirely in the offshore “euro-dollar” market. Some were borrowing large sums from US money market funds – and then using the proceeds to invest in longer-term US paper. Sometimes securities insured by AIG’s now notorious credit products group, a little trick that allowed the banks to minimize the amount of capital that they had to hold against their dollar book. A bit less of this wouldn’t necessarily be a bad thing. AIG hasn’t worked out so well for the US taxpayer, and the big dollar books of European banks haven’t worked out so well for European taxpayers.

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A global stimulus shortage …

by Brad Setser

China doesn’t exactly want to make it easy to evaluate the size of its stimulus. Bragging about the small size of your fiscal deficit — especially in relation to the US deficit — suggests a rather modest effort. A bigger Chinese deficit afterall would allow the US to run a smaller deficit without shortchanging global demand. The IMF’s analysis – which looks at the change in the balance of the general government – puts China’s stimulus at about 2% of its GDP in 2009 and 2010, roughly the same as the US effort in 2009 and less than the US effort in 2010.

Given China’s current account surplus, its abundant domestic liquidity (the government – per Stephen Green of Standard Chartered) had deposits at the central bank equal to 9% of its GDP, and limited government debt (at least explicit debt), China could and should do more. And maybe it is: telling the state banks to lend to support local infrastructure projects could be considered a form of stimulus (the TALF could be considered such a stimulus too; both try to keep the flow of credit going to sectors that will spend or invest). It just isn’t the kind of stimulus that looks likely to spur China to consume more. And it isn’t clear how quickly those infrastructure projects will be started, and thus provide real support for activity.

At this stage, though, I would be happy if China just did enough to keep its current account surplus from rising. That is the acid test. So long as the surplus is rising, China is subtracting from global demand growth not adding to it. China could meet its 8% growth target without any contribution from net exports if all other parts of China’s economy kept growing at their previous pace – and with private investment growth slowing, that requires a surge in public investment or a big increase in consumption. But I would note that net exports can mechanically contribute to growth if imports fall faster than exports – not just if exports grow faster than imports.

But China isn’t the only part of the world that needs to do more. Europe’s economy contracted as fast as the US economy in q4. But Europe’s combined stimulus looks to be significantly smaller than either the US or Chinese stimulus. Bruce Stokes of the National Journal/ Congress Daily did the leg work:

The International Monetary Fund has called for a global fiscal stimulus of 2 percent of GDP. In 2009, U.S. and Chinese stimulus spending is likely to match or exceed that target. European stimulus will total less than half that amount. And spending in Brazil, South Korea and South Africa will also fall below the IMF goal, according to estimates by the IMF and J.P. Morgan. …

“In proportion of GDP,” Jean Pisani-Ferry, director of the Brussels think tank Bruegel, wrote on the National Journal economics blog last week, “the size of the stimulus packages put in place in Europe [is] at best half the size of the U.S. and, unlike [the American effort] several of them are rear, rather than front-loaded.” While Germany’s spending will amount to 1.4 percent of GDP in 2009, French outlays will total only 0.8 percent, and Italy has not put forward any meaningful fiscal boost at all …

“Any way you slice the numbers,” wrote Ted Truman, a senior fellow at the Peterson Institute for International Economics, on the National Journal blog, “policymakers are falling short of real ambition in the face of the worst global downturn since the Great Depression.”

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by Brad Setser

The thesis that China and America should be viewed as a single economy – or at least as a single currency area – is due for a comeback.

After flirting with change, the RMB is once again pegged tightly to the dollar. 6.85 is the new 8.27. I would not be surprised if China’s external surplus and the United States deficit prove to be roughly equal in size in 2009 The obvious argument is that while the US runs a big deficit, Chimerica doesn’t. East Chimerica’s surplus offsets West Chimerica’s deficit. No worries. At least so long as China’s government is willing to finance the US.

The fact that the Chimerican currency union required unprecedented growth in China’s reserves was always my main objection to the Chimerica thesis. A currency union in theory shouldn’t require that kind of government intervention to keep in balance.

But Chimerica never was really financially integrated. Back when the RMB was (correctly) considered a one way bet, China erected capital controls to keep American (and other) capital from speculating on its currency. And for most of this decade, the net outflow from China to America came not from a desire on the part of Chinese savers to hold dollars but rather from a desire of China’s government to hold the Chinese currency down against the dollar. That policy required that China buy dollars in the foreign exchange market, and in the process finance the US deficit.

However, another objection may be more important. The argument that Chinese and America formed a perfect union – with US spending generating demand to offset Chinese savings, and Chinese savings financing the borrowing associated with US spending – hasn’t quite worked for the past couple of years. It leaves out Europe. And Europe, not the US, was the big spender in the world economy in 2006, 2007 and the first part of 2008.

My colleague at the Council’s Center for Geoeconomic Studies, Paul Swartz, has produced a clever graph (available on the CGS website) showing that the growth in Asian exports hinges on the growth in US and European imports. Makes sense. Paul also plotted Asian export growth against American import growth and European import growth separately — and the chart of European import growth against Asian export growth highlights just how large Europe’s contribution to Asian export growth has been recently.

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Will the US current account deficit fall faster than the IMF forecasts?

by Brad Setser

The authors of the IMF’s World Economic Outlook have a difficult job. They have to forecast the trajectory of the global economy — itself not an easy task. Their forecast will be judged and evaluated in real time. But the work according to a schedule set by the need to consult the IMF board and the demands of physical rather than virtual publication. In practice, that means that the forecast never fully reflects the most recent data. “IMF Board” time, “internet” time and “market” time are all very different things.

Sometimes that doesn’t matter. But right now is one of the times when it does. A lot happened this September. And I suspect that much of what has happened isn’t reflected in the IMF’s forecasts.

Specifically, I now expect a larger fall in US output and a larger fall in the US current account deficit — and for that matter, the combined current account deficit of the US and the EU — than the IMF currently forecasts (see the WEO’s data tables).

In the past I have argued that the IMF has had a tendency to forecast problems like the US current account deficit away, and in effect assume that the US current account deficit would tend to shrink even if neither China nor the US adjusted their policies. The IMF has also tended to downplay the role the official sector has played in financing the US.

Now I suspect that there will be more adjustment than the IMF expects.

Specifically, the IMF now forecasts that the 2009 US current account deficit will fall to $485b in 2009 (around 3% of US GDP)– well below its 2006 peak of $790b, and down from an estimated $665b in 2008. The deficit has been running at around $700b, so the IMF is forecasting a fall in the deficit in the second half of the year (see Table A10).

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Europe, engine of global demand growth …

by Brad Setser

If I had too pick two stylized facts about the global economy that I thought were under-appreciated, the first would be the enormous increase in emerging market reserves.

The IMF’s WEO data (remember, I like to start by looking at the IMF’s numbers, not its words) indicates that the emerging world added $1236 billion to their reserves.   Throw in another $149b in official outflows (think sovereign wealth funds) for $1385b increase in the government assets of the emerging world.   That total includes some valuation gains, but it excludes the increase in the government assets of the Asian NIEs (Hong Kong, Korea, Singapore, Taiwan), the increase in the foreign assets of China’s state banks and the increase in Japan’s reserves.    Back in 2001 and 2002, the increase in the foreign assets of the emerging world was in the $125-200b range.

Emerging market governments now drive the global flow of funds – and allow the US to sustain a large deficit even as private demand for US assets (relative to US demand for foreign assets) has collapsed. But, as Steve Waldman has pointed out, this rise in official flows has been the core theme of this blog – so it shouldn’t be news.

The second fact is the extent to which Europe – yes, not-so-sclerotic Europe – has replaced the US as the engine of global demand growth.

By demand growth, I mean demand growth in excess of supply growth.   That disqualifies China, as Chinese supply has grown faster than demand.   Not so for Europe as a whole, or at least the countries that are part of the European Union (i.e. Norway is not counted).     Between 2005 and 2007, the IMF estimates the United States balance of payments deficit shrank by $16b, while Europe’s expanded by $170b.

As a result, a rise in Europe’s deficit not a rise in the US deficit is offsetting the rise in the emerging world’s rising surplus.

Consider the following graph, which shows the US external deficit, the aggregate external deficit of the European Union and the aggregate surplus of the emerging world (plus the Asian NIEs).   I have inverted the sign of the US and EU deficit – a bigger deficit is consequently a bigger positive number.


That is a change from the 2002-2005 period – when a $295b rise in the US deficit balanced most of the $382b rise in the emerging world’s surplus.   It also implies that if the “rich advanced economies” are looked at as a whole, there has been less adjustment than might be expected.    The overall deficit of Europe and the US continues to rise – which has allowed an ongoing rise in the overall surplus of the emerging world.    In that sense, the world hasn’t adjusted.


The IMF forecasts the recent trend will continue in 2008 – with the US deficit falling by $124b (even with oil at $92b) and Europe’s deficit rising by $92b.   Today’s trade data suggest that may be a tad optimistic.   The nominal trade deficit for q1 could be larger than the nominal deficit in q4.

If the US oil import bill remains at its current level, the US petroleum deficit (imports net of exports) would deteriorate by about $110b.    Consequently, the US non-oil deficit would need to fall by $235b or so to bring the US deficit down to the level the IMF forecast.   That is possible – though only if non-oil imports don’t continue to jump up expectedly (as they did in February; non-oil goods imports were $140.8b – well above their levels last fall).     The fall in US interest rates should help the US income balance, but bringing the overall deficit down as quickly as the IMF forecast requires a bigger change in the trade balance than has appeared in the data so far this year.  (more follows)

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If the UK wants to increase financial transparency …

by Brad Setser

Gordon Brown argues that the ‘transparency deficit" in the global financial system needs to be corrected.

I have a couple of specific suggestions for UK policy makers looking to flesh out the Prime Minister’s vision.

1) The UK could insist that sovereign funds looking to set up shop in London meet a high standards for disclosure. If the forecasts from banks like Merill Lynch are to be believed, sovereign funds may soon be adding $1 trillion a year to their assets. At that pace, to paraphrase a Ken Rogoff quip, sovereign funds quickly will become the global financial system. Even if those forecasts don’t pan out, some black boxes look set to get big fast. A lot of them seem to have large operations in the UK. Without a bit more (retroactive) disclosure of the broad contours of their portfolios (of the kind in the IMF COFER data), it will be hard to assess their contribution to any future "underpricing of risk."

2) Upgrade the UK’s balance of payments statistics to match the US statistics. Specifically, the UK could provide a breakdown of the geographic origin of inflows to the UK and the official/ private split. As more and more global flows move through London, the absence of more detailed data increasingly impedes real time and historical analysis of global capital flows.

The UK’s data is here. Best I can tell, even in their comprehensive annual publication, the UK only provides a geographic breakdown for the current account, not for the financial account.

If competition among financial centers for sovereign fund business precludes any effective pressure on sovereign funds to increase their transparency, if the political systems of the home countries of many key sovereign funds limit domestic pressure for more transparency and if sovereign funds get big fast, the world will soon have a new transparency deficit …

Conversely, if Singapore starts disclosing the same kind of information as Norway, it would be a lot easier to begin to assess how sovereign portfolios impact a range of markets. Tony Tan of the GIC suggests that change is afoot:

""We have already decided that the circumstances have changed. The right thing to do is to move to a path of more disclosure.

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The booms in Spanish and Irish real estate make the US real estate boom look timid

by Brad Setser

I have outsourced Thanksgiving blogging to Charles Gottlieb of the Center for European policy studies in Brussels.   (Charles.gottlieb at

His topic: The Spanish and Irish housing booms (or bubbles).   The Spanish and Irish economies are even more housing-centric than the US economy … and potentially are even more exposed to a housing slump.  


 Red alert in the Euro zone-periphery – some are still riding the housing bubble

 As argued all along the housing euphoric “literature”, global factors have greatly fuelled housing prices in Europe.  The historical lowness of interest rates has played a great role, but also the development of financial systems that allow people to borrow against their future income and the home’s value.

Yet even amid a global housing boom, Spain and Ireland stand out. France –which has experienced very strong home price appreciation recently seems bound to cool (see my previous contribution).  But Ireland and Spain are still rocketing, with home price growth of around 10% yoy (INE and CSO) over 2006 … (UK too, though after a pause).  These two EU periphery countries exhibit the biggest housing price hikes, highest residential investment (relative to GDP) and most jobs in construction sector.  They are consequently among the most housing-centric economies in the entire world ….

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