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Headquarters of Sberbank, one of the Russian institutions under U.S. sanctions REUTERS/Sergei Karpukhin

Have Sanctions Become the Swiss Army Knife of U.S. Foreign Policy?

by Robert Kahn July 24, 2017

The Congress takes an important, positive step to reinforce Russian sanctions, but are we at risk of overusing the sanctions tool? Read More

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Emerging Markets

Turkey’s Shaky Economy: a Local or Global Concern?

Turkey’s failed coup looks set to deliver a substantial blow to Turkey’s already wobbly economy. It could also renew concerns, post Brexit, about global emerging markets more broadly. Late Friday, f…

Blog Post by Robert Kahn July 17, 2016 Macro and Markets

Europe

Brexit’s Threat to Global Growth

Thursday’s Brexit vote wasn’t a “Lehman moment”, as some have feared. Instead, it was a growth moment. And that may be the greater threat. If policymakers respond effectively, the benefits could be s…

Blog Post by Robert Kahn June 28, 2016 Macro and Markets

G20 (Group of Twenty)

G20 Hopes for a Cure

Five things we learned from this weekend’s G20 meeting of finance ministers and central bankers. A desire for better. The communiqué candidly acknowledges growing threa…

Blog Post by Robert Kahn February 28, 2016 Macro and Markets

Budget, Debt, and Deficits

Venezuela on the Edge

The Venezuelan government has a $2.3 billion debt payment due this Friday. Most believe the government has the resources to make the payment, though it is hard to see a coherent economic reason to do…

Blog Post by Robert Kahn February 23, 2016 Macro and Markets

International Organizations

China’s Symbolic Currency Win

Earlier today, the International Monetary Fund (IMF) Board approved the inclusion of the Chinese renminbi (RMB) as a fifth currency in the special drawing rights (SDR), the IMF’s currency, as of Octo…

Blog Post by Robert Kahn November 30, 2015 Macro and Markets

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Budget, Debt, and Deficits

The International Economic Agenda Facing the New Congress

The initial post-election talk is understandably about whether the shift to a Republican controlled Senate makes it easier or harder to make progress on central economic challenges facing the United States, including energy, immigration, social spending, and infrastructure. There is understandable concern that this next Congress will face the same gridlock that we have now. But even before that, there is the mundane issue of what we borrow and spend. Partly out of fear of being seen as crying wolf one too many times, I have been wary to advertise my concern that we are facing a new series of economic cliffs. First up is a likely standoff on the budget (in December, and likely again in the spring of 2015). Then comes the debt limit, which will be reset on March 15, but given the usual and not-terribly-extraordinary “extraordinary measures” that are at the disposal of Treasury, they can likely pay the nation’s bills until perhaps the fall of 2015 before cash balances fall to zero. Of course, in the past deals have been done, often at the last minute, and we have not, with the exception of the 2013 government shutdown, gone off the cliff (though there have been a few unnecessary fender benders along the way). But with the Senate as polarized as ever, it is easy to see getting to deals on these issues will be difficult and potentially unsettling to markets. I am concerned that one cost of this focus on fiscal cliffs will be failure to deal with the long list of international economic issues that are in front of the Congress. Notably, there is a great deal of optimism that the Senate will now provide the President with trade promotion authority (TPA), which likely is essential to have any chance of meaningful agreements on the trade negotiations now underway, including the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP). This optimism seems to come from the historical Republican support for free trade, and recognition that it was Senate Democrats that were the primary hurdle to its passage till now. Perhaps such optimism is justified, and there is previously proposed legislation that should be able to garner bipartisan support. But do not underestimate the risk that negotiations could go off track. In the past, there has been pressure from both parties for tough language requiring any trade deal to address exchange rate misalignments, and that pressure is likely to mount if dollar strength becomes seen as a risk for the economy. Such exchange rate language could be a killer here. The debate over border policies and distrust between the parties also may complicate these negotiations. This is far from a done deal. The administration should also take the opportunity to reintroduce the proposed IMF reform package, which would slightly increase the resources available to the IMF and, far more importantly, increase the voice given to rising emerging market powers at the institution. Failure to do so will have substantial geopolitical consequences if it pushes those countries to attempt to operate outside of global institutions such as the IMF and World Bank. We are already seeing the effects of Congressional inaction on this issue with the Chinese launch of an Asian Infrastructure Investment Bank. The IMF also has signaled that it will develop new plans for addressing the demands of rising powers for a bigger say if we do not act by end year. (For example, there are proposals to proceed with a reform without full U.S. participation, but that would likely eliminate the U.S. veto over changes in the Fund’s articles, a major concession.) The end result if we don’t act will be a dilution of U.S. economic leadership and influence on global economic governance issues, something even Congressional critics of the IMF presumably do not want to see. A battle also is shaping up on the reauthorization of the Export-Import Bank, with temporary reauthorization set to expire in June 2015. I would not be surprised to see action blocked by a small, but passionate opposition to any governmental role in trade finance. There further will be a lot of debate over international financial regulatory agenda, as part of a debate over Dodd-Frank legislation, but whether that leads to legislation is uncertain. There does seem to be bipartisan support to take a new look at the impact of the global post-crisis reform effort on areas of strength and comparative advantage for the U.S. financial system, including insurance and asset management rules. Finally, I expect to see new sanctions legislation proposed relating to both Iran and Russia. On Russia, I have been opposed to legislation, concerned that it would make sanctions too sticky and hard to remove should there be a future agreement easing the crisis. But many in Congress want an even tougher approach than we have seen from the Obama Administration. Altogether, a long to do list, and not a great deal of reason for optimism that there will be substantial progress achieved. I hope I am wrong.

Blog Post by Robert Kahn November 5, 2014 Macro and Markets

Europe

Three Central Banks

Today’s central bank news tells us a lot about the risks and rewards of proactive central banking. The Bank of Japan (BoJ) surprised me (and nearly everyone else ) with a dramatic expansion of its unconventional monetary policy this morning, citing renewed risks of deflation. The BOJ announced (i) an increase in the target for monetary base growth to ¥80 trillion ($730 billion) per annum from ¥60–70 trillion; (2) an increase in its Japanese government bond (JGB) purchases to an annual pace of ¥80 trillion from ¥50 trillion; (3) an extension of the average maturity of its JGB purchases to 7–10 years (3 years previously); and (4) a tripling of its targets for the annual purchases of Japan real estate investment trusts (J-REITs) and exchange-traded funds (ETFs). In addition, and more controversially, the Japanese Government Pension Investment Fund (GPIF) will shift its portfolio away from government bonds and towards equities, both domestic and foreign, doubling the share of equities to 50 percent. As a general rule it’s not such a good idea to use government wealth funds as an instrument of monetary policy in this way, but given that government policy in the past has been so heavily tilted towards support of the bond market, it can be argued that this is a good move from a longer-run perspective, and it does arguably strengthen the near-term wealth effects of quantitative easing. It is also worth noting that the BoJ has followed the lead of other central banks and moved away from date-based guidance (achieving 2 percent inflation within two years of the start of the program, a target that was always optimistic and now quickly slipping out of reach) to a focus on balance sheet targets. That makes sense. There was a fair degree of attention paid to the fact that the vote was 5-4 for easing. For most central banks, such a closely divided vote would be a negative. Here, however, I see decisiveness. As long as we assume BoJ Governor Haruhiko Kuroda can command a majority on critical decisions, which I do, his willingness to move proactively as soon as a majority exists shows strength. There is some speculation in the markets that the BoJ move was given a green light when the U.S. Treasury did not mention yen weakness as a concern in its recent exchange rate report. I think this is oversold as an explanation. What I do see at play is a central bank that--while motivated by domestic considerations--is taking advantage of the Fed’s turn toward normalization to make a dramatic move that, by emphasizing the divergence of policy, ensures a substantial market impact. Today the yen reached a six-year low against the dollar at 112.4 and stocks rose sharply. That said, I would not be surprised to see exchange rate tensions intensify in coming months and feature centrally in upcoming G-7 and G-20 debates. The BoJ’s move could put additional pressure of the European Central Bank (ECB) to act when it meets next week, though few analysts expect a move to purchase government bonds (sovereign QE) until December at the earliest and more likely next year. There may well be a narrow majority for such a move, but in contrast to the BOJ, failure to act (combined with muddy messaging) ensures that monetary policy will continue to provide weak support for the recovery. Europe needs its own “three arrows”, as well as more aggressive action to deal with the crushing debt overhang. Finally, the Central Bank of Russia surprised markets with a 150 bp increase in interest rates, raising the benchmark rate to 9.5 percent from 5.5 percent at the start of the tightening cycle. With inflation at 8.4 percent and rising (against a target of 5.5 percent), and food inflation several points higher, the central bank was pressured to act. However, the currency sold off following the announcement, despite announcement of an oil agreement with Ukraine, reading the move as a sign of a sharply weakening economy and recognition of the limited commitment of the central bank to defend the currency. I think that is right. The economy is headed for a deep recession, capital flight is continuing, and sanctions are more likely to be intensified than eased in coming months. In sum, it’s hard not to expect that capital controls will soon follow.

Blog Post by Robert Kahn October 31, 2014 Macro and Markets

Europe

European Banks: Balance Sheet Clarity But A Cloudy Future

The European banking assessment results, released yesterday, were generally well received by markets. The test looked like earlier U.S. and Spanish stress tests in terms of structure, the results were in line with market expectations, and the report provided enough detail to keep analysts busy for weeks. This morning, the euro is firmer and European stocks were up a bit before weak data clawed them back. Will this test succeed where previous efforts have failed and ultimately restore confidence in European banks? I suspect that your answer to this question depends on your outlook for the European economy. Without growth, Europe remains over-indebted, its banks undercapitalized, and a crisis return looks likely. European Central Bank (ECB) led the review and identified a capital shortfall of €25 billion at 25 banks, which was reduced to €9 billion (13 banks, none designated as systemically important) after taking account of capital raised so far this year. Italian and Greek banks had the most problems, unsurprisingly. Assuming promised remedial actions fill about half of the remaining gap, the remaining capital shortfall is a modest €4.2 billion at only 8 banks, according to Morgan Stanley. However, using new, tougher capital rules (e.g., on goodwill and deferred tax assets) that will go into effect in the next few years raises the “fully-loaded” capital hole significantly and as many as 35 banks would have failed, according to several market analysts. The capital hole reflects a cleaning up of the balance sheets and a stress test, in roughly equal measure. The asset quality review (AQR) at the core of the exercise identified valuation problems at 130 banks, resulting in a markdown of the balance sheet by €48 billion. The ECB blamed poor valuation of commercial loans for much of the problem. It further criticized national regulators for underreporting non-performing loans (NPL) by €136 billion. That is a huge number, though on the positive side the move to a common, accepted standard for NPLs across the euro zone is a encouraging step. The stress test that was then applied to these cleansed balance sheets was a shock that depleted banks’ capital by €263 billion, reducing core capital by 4 percentage points from 12.4% to 8.3%. By comparison, the hit to capital in the well-received earlier Spanish stress test was 3.9 percent. Many analysts, including Nicolas Veron, argue that the exercise overall passes the smell test (though noting that we need to wait for the bank’s own reports next year to know for sure), while Philippe Legrain argues that it’s a whitewash. I have some sympathy for Legrain’s argument—the review covers less than half of risk weighted assets, in part because it did not address problems at smaller banks (around 20 percent of euro area assets), notably German savings banks, and the macro stress test looks less stressful now (in light of weak recent data) than it did when they decided on it. The stress test does include serious market and growth shocks (though not litigation costs that are likely to be a material headwind for the major banks). However, the inflation numbers in the stress test are above current levels, which seems surprising given broad concerns about low inflation (if not deflation) in the euro zone. This suggests that the macro scenario is faulty if very low inflation creates a risk to bank balance sheets beyond the conventional stresses that were addressed. The bottom line is that those of us that have been critical of Europe’s macro policies, and concerned that the baseline growth scenarios are too sanguine, are unlikely to draw much comfort from this stress test. Even a successful stress test is unlikely to restart the flow of credit quickly. Europe remains too bank-centric, too little is being done to restart credit to small and medium enterprises, and broader demand support is needed. Absent these moves, inadequate monetary and fiscal policies may quickly render this stress test, like the earlier ones, unconvincing.

Blog Post by Robert Kahn October 27, 2014 Macro and Markets

Sanctions

October Monthly: Breaking the Sanctions Code

At last week’s World Bank and IMF meetings, I heard sharply divided views about the future path of sanctions and what lessons should be drawn from their use against Russia. Have they been successful, and at what cost to the West? Should sanctions be extended to the payments system, which enhances their power but risks damaging a global public good? What signal does it send to other countries? With growing evidence that sanctions are materially damaging the Russian economy, concerns have been raised that sanctions could become too easy an option for U.S. policymakers. My October monthly (here) looks at the question and suggests strategies for convincing other countries (and markets) that this new weapon will be reserved for combating serious violations of international norms and not used as leverage in conventional commercial disputes. Better communication of the principles involved in applying sanctions would help. There may also be a case for announcing a guiding set of principles or codes for their use. Other examples of voluntary codes for economic purposes, including the Santiago Principles for sovereign wealth funds and OECD export credit codes, could provide some guidance.

Blog Post by Robert Kahn October 17, 2014 Macro and Markets

Europe

When meetings matter—The World Bank and IMF Convene

There are many reasons cited for this week’s market turndown and risk pullback, including concerns about global growth, Ebola, turmoil in the Middle East, and excessive investor comfort from easy money. What has been less commented on is the role played by last weekend’s IMF and World Bank Annual Meetings. Sometimes these meetings pass uneventfully, but sometimes bringing so many people together—policymakers and market people—creates a conversation that moves the consensus and as a result moves markets. It seems this year’s was one of those occasions. As the meetings progressed, optimism about a G-20 growth agenda and infrastructure boom receded and concerns about growth outside of the United States began to dominate the discussion. The perception that policymakers—particularly European policymakers—were either unable or unwilling to act contributed to the gloom. Time will tell whether macro risk factors that markets have shrugged off over the past few years will now be a source of volatility going forward. But if that is the case, perhaps these meetings had something to do with it. A few other thoughts on the meetings. Markets are ahead of policymakers on European QE. Europe is divided on whether quantitative easing is needed, and if tried, whether it will be effective. While most market participants seem to expect the ECB to soon extend its program of quantitative easing to buying government bonds, current and ex-central bankers at presentations I attended signaled a greater degree of uncertainty. Part of the concern is whether the usual channels through which QE works—including a wealth effect on portfolios—will work as well in Europe’s bank dominated system as it did in the United States, but the greater concern is gridlocked politics. This was highlighted by the public disagreement between ECB head Draghi and Bundesbank President Weidmann, as noted by several commentators. The risk is that the easing of policy comes late, and doesn’t pack the punch that is needed to restore growth. We know from the U.S. experience that a potentially important channel for unconventional monetary policy comes from the forward guidance it provides that easy policy will be sustained. True, the ECB has some tools the Fed does not have (e.g., long-term fixed rate lending facilities) to signal that rates will stay low for a long time. Yet, at a time when policymakers elsewhere are increasingly focused on the challenge of exiting that guidance, the hesitancy of the ECB to clearly articulate its goals for and commitment to an expansion of its balance sheet and increased liquidity can only undermine the impact of current monetary policy. The policy response to divergent monetary policies is starting to take shape. Much of the policy discussion tried to anticipate a world in which the Federal Reserve began to normalize policy while the Bank of Japan and ECB expanded their use of unconventional monetary policies. Exchange rates, particularly emerging market exchange rates, were seen as a source of future volatility. In this regard, I was surprised I did not hear more about the risk of protectionism (in the United States for example if the dollar rises sharply) or capital controls (in emerging markets) if we have a normalization nightmare, following on the taper tantrum of last year. The continued criticism of the Fed by Indian central bank governor Rajan seems to have less to do with policy (the Fed’s actions having supported global growth and its possible exit well communicated) as much as it may suggest preparation to resist the market pressures that will result. The outlook is deteriorating for Russia and Ukraine. There is increasing anecdotal evidence that pressures on the Russian financial system are mounting and extending to non-sanctioned banks. The recent depreciation of the rouble and capital outflows have intensified concerns, and notwithstanding substantial central bank and government support it seems clear that Russia has dropped into recession. Most of the market forecasts still see positive growth this year, but I expect that to change after these meetings. Meanwhile, I didn’t need the meetings to tell me that the IMF’s program for Ukraine is collapsing, a victim of continued Russian destabilization, a deep recession, and ridiculously optimistic initial IMF assumptions. What surprised me was the weak defense put up by the official community at these meetings. The IMF team that will go to Kiev in early November, after Parliamentary elections, has little choice but to positively conclude its review and disburse the roughly $2.7 billion due Ukraine in December, given rising cash needs of the government heading into winter. But I suspect (and hope) that the review will acknowledge the large and growing financing needs of the country and the limits of the Fund’s ability to meet these needs and introduce sustainable economic reform in the midst of a conflict. The Fund should signal that it may have to step back as soon as the next review (in March), and that bilateral support from the United States and European governments needs to fill the gap. That new package (with a private debt restructuring to extend maturities) needs to be in place by March, if not sooner.

Blog Post by Robert Kahn October 16, 2014 Macro and Markets