Emerging Markets

Russia let the ruble appreciate against its euro/ dollar basket this week.   Not by all that much.   But this was also a week many emerging market currencies fell against the dollar, as part of a general retreat from risk.  There likely were modest capital outflows from Russia last week as well, as foreign investors sold their Russian stocks and then convert their rubles into dollars (The RTS is off its late July peak).  There certainly were small capital outflows in the first week of August.  However, Russia could easily meet the increased demand for dollars out of its reserves (Reserves fell in the first half week of August).  Russia now has way more reserves than it needs.No wonder Credit Suisse calls the ruble a safe haven:According to Credit Suisse, Russia’s ruble and Brazilian real are the safest assets to wait through forthcoming problems.  The New York Times also took note, earlier this week, of the fact that the Russian ruble is now a currency that a lot of folks -- Russians and foreigners alike -- want to hold.   Andrew Kramer of the Times wrote: Russian banks offer accounts in rubles, dollars or euros. Of the three, ruble accounts are attracting the most funds. Ruble-denominated personal savings accounts rose 6.8 percent in the first quarter of 2007, while foreign currency accounts were level, according to a report by Goldman Sachs.  ... Last summer, authorities eliminated all restrictions on ruble trading, making the currency fully convertible and easing the way for the capital inflow ....  In the first six months of this year, net private capital inflow into Russia was $67.1 billion — more than during the entire first decade after the collapse of the Soviet Union. In the same period last year, capital inflow was $14.5 billion. Strong demand for assets denominated in emerging market currencies from local and foreign investors alike calls into question the relevance of models that postulate that emerging markets are unable to create the financial assets demanded by the growing economies.  At least right now, that doesn't seem to be the case.   Central bank reserve accumulation doesn't reflect repressed private demand thwarted by capital controls; indeed, it often reflects the growing desire of the citizens of the emerging world to hold fewer dollars and euros and more assets denominated in their own currency.After all, oil is still above $70 -- far higher than the roughly $45-50 a barrel price Russia needs to cover its (rapidly growing) import bill.  The Times' ramer is entirely right to note that the ruble would be much stronger but for the ongoing intervention of the Bank of Russia.  Even more important, as measured by purchasing power parity, a gauge of a currency’s value based on the goods it can buy, a dollar should buy roughly 15 rubles today, according to a report Merrill Lynch issued in July. By that measure, the ruble remains the world’s second-most undervalued major currency, behind only the Chinese yuan, whose value has given policy makers in Washington headaches. Indeed, the ruble would be even more valuable today if not for the Russian central bank intervening to keep it from rising more.So would China's currency, despite the Economist magazine's ongoing arguments to the contrary.  But if oil stays around $70, I would bet that some GCC currencies are even more undervalued than either the RMB or the ruble.  The Gulf countries collectively have far fewer people and far more oil than the Russia – but currently have far weak currencies.   That is a puzzle worth explaining.  I consequently am eagerly awaiting an article on the weak Saudi riyal, UAE dirham, Qatari dinar and Kuwait dinar.  

Thanks to Henny Sender of the Wall Street Journal.    One reason why the Abu Dhabi Investment Authority (ADIA) has gotten so big so fast is that it had (and still has) a lot of money invested in emerging market equities.   “Analysts believe it [ADIA] may well be the largest investor in emerging economy stocks”  And those securities – unlike China’s huge holdings of US Treasuries and Agencies – have gone up in value.   A lot.  Turning an oil surplus into Brazilian and Turkish equities has been a better business model over the past say five years than turning a “manufacturing workshop to the world” surplus into US bonds. And then ADIA levered its oil surplus up.   Not directly.   But by investing in various private equity funds.   Think of it this way: ADIA gives a private fund some money to manage – and that fund borrowed some of the dollars that the Indians and the North African's have placed in the international banking system, as well as taking advantage of the liquidity generated by huge Saudi Monetary Agency and PBoC purchases of debt securities to gear themselves up.    Sometimes ADIA invested along side various private equity firms in specific deals as well.  “It [ADIA] has a long history of investing in private equity firms and investing along side them in some of their largest purchases.”More after the break. I would bet that the Saudi royal family – and other key families in the Gulf – have played a similar game.   Carlyle certainly manages the money of someone in the Gulf.  Sender: “Carlyle Group co-founder David Rubenstein was among the earliest and most frequent visitors to the Gulf to raise money.”London's "The Business" makes a similar point:"Many of the London-based hedge funds and private equity raiders are at least in part (often indirectly) being financed with petro-dollars"  Now it seems like ADIA may want a cut of private equity’s management fees.   Fair enough.   It has paid its fair share of those fees. If China can have its private equity fund, why shouldn’t ADIA have one too.  For that matter, ADIA and QIA may have quietly done in with China on Blackstone too. Sender: “Abu Dhabi and the investment arm of the government of Qatar are believed to have approached Blackstone for significant stakes before its public debut, according to people familiar with the matter .. “ One question:ADIA’s business model (along with the business model of Singapore’s GIC) seems to have been enormously successful.   It is now attracting a host of imitators.   But to what extent was its success due to the fact that it was playing a different game than the other big official institutions? The other big institutions focused on liquidity -- and building up a buffer against swings in capital flows and oil prices.   The consequently bought safe industrial country bonds.   ADIA, on the other hand, has long held more than enough assets to buffer against swings in oil prices.  It focused more on returns and, not unlike some private investors in advanced economies, bought emerging market equities and arbitraged the difference between the price of debt and equity in the advanced markets. Both bets paid off.  All the domestic liquidity created by the intervention of other central banks had to go somewhere -- and a lot went into equity prices.   And private equity firms mastered the art of turning official demand for debt -- or actually, demand for higher-yielding debt from private investors who sold their Agencies and Treasuries to central banks and thus were liquid -- into demand for equities.  However, if all of the big official players stop buying bonds and start buying emerging market equities, though, emerging market equities may not prove to be quite as a good an investment going forward.    Sure, that means new demand for emerging market equities.  But ADIA (and others) have already bid the price of emerging market equity up -- a lot of emerging markets aren't cheap anymore. Then again, I doubt dollar-denominated treasuries yielding 5% nominal offer China a very attractive RMB return.   Portfolio diversification alone suggests China should buy fewer US bonds and more of something else.   That is one clear lesson from ADIA’s portfolio.  It clearly has had a diverse portfolio for some time, not a portfolio concentrated in "safe" government and agency bonds from advanced economies.  Too bad we don't have a better sense of exactly what share was allocated to various kinds of investments, and what share was invested in more traditional safe assets ...  

They don't need the money.Deborah Solomon's interesting A1 Wall Street Journal story about the US Treasury's concerns that the world may not be quite as open to US direct investment as it used to be didn't mention that fact.   It focused instead on the "perception that the US -- the world's largest recipient of foreign direct investment -- is erecting new barriers to foreign capital."   But the fact that both China and Russia save more than they invest and are net lenders -- not net borrowers -- from the rest of the world seems rather relevant.  Both are, I suspect, growing tired of taking funds that foreign investors bring in looking for big -- 10, 15, or more -- returns and sending them back to the US where they get 5% in the Treasury and Agency market.    That kind of swap may generate dark matter for the US, but it isn't obviously in the interest of the world's emerging economies.   Of course, the fact that they cannot swap equity for equity, and use the funds brought in by private investors to the US to add to their state investment company's holdings of US equities may play a role as well ... One thing I consistently notice in these kinds of stories.  US officials -- and even more so US businessmen -- still tend to talk as if the US is an investor in the world, not the world's biggest borrower.   On a stock basis, that is still (sort of) true.  Total US external liabilities exceed total US external assets, but thanks to the strong performance of non-US markets over the past few years, US equity investments abroad are worth more than foreign equity investment in the US. On a flow basis, though, it is off.   The US borrows a ton from the rest of the world every year to finance its current account deficit, that is to say US investment that exceeds domestic savings.  Any additional US investment in the rest of the world has to be financed by borrowing even more from the rest of the world.*And you can sort of see why the United States' creditors might not think that is totally in their interest ...* footnote: US equity investment abroad could also be financed by foreign equity investment in the US.   indeed, that generally has been the case in recent years.  But in q1, US outward FDI topped inward FDI by about $50b, so the US really has financing its outward investment with debt, including a decent amount of debt placed with the Russian and Chinese government.UPDATE: A bit more from Naked Capitalism.   He raises several good points.  Opposition to leveraged buyouts isn't quite the same as opposition to greenfield FDI.  And, as Rodrik notes, there will come a point where sovereignty and further economic integration do come into conflict.  And for the US, the emergence of large sovereign wealth funds may imply that this point comes sooner rather than later.   After all, it is hard to see why Americans are likely to be comfortable with foreign governments taking large equity stakes in the US firms when they generally don't think the US government should take big equity stakes in the US firms ...  different models of capitalism and all.      

It seems like the rising cost of Bangalore software engineers is encouraging firms to produce more software in the US.Part of the (large) increase in the relative salaries of Bangalore software engineers reflects industry-specific demand.   There are only so many IIT graduates out there.   But part of the increase reflects the rise in the rupee's real value.  The rupee has appreciated in nominal terms -- particularly in 2007.  And Indian inflation has been higher than US inflation, leading to a significant real appreciation.In some ways, China and India are very similar.    India’s household savings rate, for example, is quite high – actually higher than China’s household savings rate (per Kuijs).   India is also experiencing an investment driven boom that has pushed its growth rate up.  Indeed, one of the big questions in India is whether India can sustain its current (high) growth rate.   Both the PBoC and the RBI have intervene rather consistently in the fx market, though the RBI is by no means as active as the PBoC. But there are also important differences.  India generally has run a modest current account deficit (India ran a small surplus in q1 on the back of lower prices/ strong export growth, but looks likely to swing back into deficit in q2).   And India’s success has led the rupee to appreciate in both nominal and real terms – as one would expect.     China is rather different.   The RMB is still well below its 2001 level in real terms, and China exports about four times as much now as it did then and has a much, much bigger external surplus.However, even in India there are limits.   The government let the rupee appreciate from 44 to 40 – but right now, it sure seems to be holding the line at 40.   Its intervention has stepped way up over the past four weeks.    The RBI added over $3b to its reserves in the last week of May, and has bought $1-$1.5b every week since … Pressure from exporters exists in India as well as China, though the interests that benefit from exports and artificially low domestic interests to help limit pressure on the currency do not seem to have captured Indian policy in the same way that they have captured Chinese policy … Appreciating against the US is one thing.  Appreciating against China is quite another.  Perhaps less for India, with its software industry, than for some other Asian economies that compete more directly with China.   But even for India, given its aspiration to other a credible alternative to China in a range of manufacturing sectors.   Consequently, I rather suspect that additional rupee appreciation that came in conjunction with a broader move in all Asian economies would be more politically acceptable than rupee appreciation in the absence of a broader move.

Via Felix Salmon and Marginal Revolution comes word that Yegor Gaidar thinks the Saudis -- not Star Wars -- broke the back of the old Soviet Union in the 1980s.Russia -- as has become very, very clear recently -- is a big energy exporter.  Back in the 1980s, the Saudis decided to defend their share of the global oil market even if meant lower prices.  That wasn't good for the old Soviet Union.  It quickly exhausted its commercial credit lines, and, well credit from Western European governments came with political conditions."Government-to-government loans were bound to come with a number of rigid conditions.For instance, if the Soviet military crushed Solidarity Party demonstrations in Warsaw, the Soviet Union would not have received the desperately needed $100 billion from the West." Apparently government-to-government bond purchases don't come with similar conditions.  Either that or China just is far more generous than Europe ever was back in the 1980s.   After all, Chinese purchases of Treasuries and Agencies currently provides the US with a wee bit more than $100b in credit annually, without either economic or political conditions.   For that matter, Russia -- the heir to most of the Soviet Union -- is on track to provide the US with a $100b credit line in 2007 as well.   Its reserve are currently growing at an annualized pace of over $200b a year (they are up $100b in the first five months of 2006), and about half are still in dollars.   Putin called for a new international economic order last weekend (via Drezner): "Mr Putin said the world needed to create a new international financial architecture to replace an existing model that had become “archaic, undemocratic and unwieldy." In some deep sense, I suspect Putin already has helped to create a new international financial architecture.   This new international order is just dominated by big national institutions -- SAFE and the PBoC, the Bank of Russia, the Saudi Arabian Monetary Agency, the Abu Dhabi Investment Authority and the like -- not big international institutions.  The international financial institutions of the old international economic order -- the IMF for example -- are still around.   But they don't have as much influence as they once did.     The IMF's total lending capacity is about $200b.   China will add at least twice that to its reserves (or to the state investment company) this year. That truly is a profound change in the world's financial architecture.   And it may auger future changes on the world's political architecture.  More on this later.

The World Bank’s annual report on capital flows to developing countries highlights two facts that shouldn’t be much of a surprise: Developing economies – the World Bank’s definitions leaves out the rich oil exporting economies in the Middle East – attracted record amounts of private capital in 2006.  They attracted net private inflows of around $650b (see table 2.1).Developing economies also ran a large – over $350b – aggregate current account surplus.  The logical corollary of a 3% of GDP (aggregate) current account surplus and along with private capital inflows of between 5-6% of GDP is simple: the central banks of the developing world provided a record amount of financing to the US and Europe.   That is why reports that emphasize how private capital flows now trump official capital flows are incomplete.     (Net) private capital flows to the emerging world are far larger than (net) official capital flows from the rich world to the emerging world.    But (net) official capital outflows from the emerging world to the rich world are even bigger than (net) private capital flows into the emerging world.   Here, there is no disagreement between the IMF and the World Bank.  Once you adjust for differences in country coverage, the WEO data – see table 1.2 -- tells the same story.  Big current account surplus and big (net) inflows of private capital.Indeed, lots of countries are now attracting more money from abroad than they want.   Colombia just joined Thailand in imposing capital controls.   India and others are quietly making it a lot harder for banks to borrow from abroad …  I consequently think the answer to the question posed in Randy Kroszner’s recent speech, namely why does capital flow (on net) out of emerging economies is actually pretty simple: policy choices in emerging economies.    I don’t think – unlike some – it has much to do with private demand from savers in emerging economies for “safe” financial assets emerging market financial systems cannot supply.   Rather emerging market governments with large commodity windfalls have opted to save a decent (though falling) chunk of that windfall offshore, and nearly every emerging market central banks is currently resisting pressure for their currencies to appreciate in a massive way.   Right now, demand for “safe” US and European securities comes from governments, not private investors. I have a second objection to the oft-made argument that private capital flows are now more important than official flows.  The fact that emerging economies are unwilling to rely on private capital markets to finance current account deficit hardly represents a triumph of the market.   Emerging economies – at least those outside the embrace of “Europe’s” institutional structure -- seem to have drawn two lessons from the crises of the 1990s.  Massive reserves insure against the humiliation of turning to the IMF for financing – and the corresponding need to adopt the policies the IMF insists are necessary.   And private capital markets cannot be trusted to finance ongoing current account deficits.   Private markets provide tons of money at low cost when a country doesn’t need it (say when commodity prices are high), but very little money at very high costs when an emerging economy really does need it (say commodity prices are low).  The easiest way to protect against “sudden stops” is not to need the money to begin with. The irony:  outside of South and Eastern Europe -- and a new small islands (New Zealand, Iceland) -- the big current account deficits in the world are generally financed by official flows, not private flows.   The UK’s current account deficit is largely now financed by the growth of pound reserves.   And the more I look at the data from q1 and April, the more convinced I am that the world’s central banks are now adding to their reserves at a stunning $1.2 trillion annual pace.   Throw in another $100b from oil investment funds.    Pick the fraction you think is going to the US …  I wonder if the US will eventually conclude that large external deficits financed by official flows are almost as risky – though in a different way – as emerging markets found large  external deficits financed by private flows.   So far, though, it has been almost all good – at least for those who don’t work in manufacturing.Update: Stephen Roach is well worth reading today.   He believes that China's problems stem in part from expectations associated with the end of the RMB peg that have made the RMB a one-way bet; I would argue that the "excess" domestic liquidity stems at least as much from the rise in China's trade and current account surplus, something that seems to me to be tightly tied to China's decision to basically keep a peg to the dollar with a modest pace of appreciation.   But Roach no doubt is right to emphasize the growing internal challenges associated with rapid reserve growth, the counterpart to "official" financing of the US deficit.

Dani Rodrik poses an important question on his blog:“If forced to choose between a world in which developing countries are growing rapidly but there are global macro imbalances associated with it, and one in which current account imbalances are smaller but there is less growth in poor nations--which one would you pick? I would go for the first. Of course, the essential point is that we have to get the right mix between these two objectives. Arguably, we have sacrificed macro balances too much in the last few years. But as we go about redressing this, we better not forget the role that the level of the real exchange rate plays in developing nations, and not become too enamored of floating.” I do believe, as I think Dr. Rodrik does, that we have sacrificed global macro balances too much over the past few years.  And, like Dr. Roubini, I also worry that rapid reserve growth is creating a ever-larger internal imbalances in many countries.  Two examples: China’s stock market and dangerously low (negative actually) real interest rates in most oil exporters.I am not sure that countries like Russia and Brazil who attract very large capital inflows (in part because of interest rates than are higher than US rates) but just use the resulting inflow to add to their reserves are really doing much for their growth either.  In effect, they are borrowing from abroad at a loss to build reserves they no longer need.  Funds parked in central bank reserves are not invested in the local economy; they instead are lent back to the US and Europe.    Russia’s reserves increased an incredible $14b in the first week of May. Brazil’s reserves are rumored to have increased – counting off balance sheet intervention through the sale of reverse swaps – by something like $15b in the first two weeks of May and Brazil is still in the market.   Those are big numbers.   Reserve growth in the emerging world now seems to running at a $100b a month pace, if not slightly higher. As Martin Wolf notes, it is hard to square that kind of reserve growth with the argument that the emerging world currently floats.   Wolf writes:“The scale of the reserve accumulation demonstrates the obvious: these countries have refused to adopt the freely floating exchange rates many outside economists recommended. They have, instead, chosen to keep their exchange rates down. This, in turn, has generated current account surpluses. Sustaining such surpluses requires a stable excess of savings over domestic investment. One instrument they have used has been sterilisation of the monetary consequences of reserve accumulations, to prevent the normal expansion of money and credit, overheating, inflation and so loss of external competitiveness.”So I don’t think that there is much risk that too many countries will soon become “too enamored of floating.”   i certainly wouldn’t recommend that China move immediately to a free float.   A bit more controlled appreciation though would be very welcome! Yes, I do think that intervening to hold down the nominal exchange rate – if sterilized – can have a meaningful impact on the real exchange rate for an extended period of time.  In this week’s big blog debate, I side with Wolf, DeLong and knzn.That said, I have struggled to reconcile my obvious concern with the imbalances associated with very rapid reserve growth in the emerging world with another of Rodrik’s long-standing arguments – namely that we should allow countries enough policy space to find approaches that work for them, and not insist too strongly on a uniform approach to economic policy.    Rodrik's argument has long appealed to me.  I believe, for example, there should be room in the global economy for different approaches to health care and labor market regulation.   What then is wrong with allowing countries enough policy space to maintain undervalued exchange rates and add rapidly to their reserves if the result works for them?My tentative answer is that there are much stronger global spillovers from targeting an undervalued exchange rate than from different approaches to say labor market regulation.   China doesn’t just set its own exchange rate when it targets the RMB/ dollar.  It also sets the United States exchange rate with China.   And since many other countries feel forced to intervene to keep from appreciating by too much against China, China’s policy also influences the United States’ exchange rate with many of its other trading partners.That has one other implication:  I suspect that China’s desire to maintain sufficient “policy space” to keep the RMB at its current level has reduced the policy space effectively available to other emerging economies, not just to the United States.Josh Bivens wrote back in February:“the Chinese peg severely restricts the policy space available to the non-Chinese developing world in integrating with the global economy. The monetary authorities in a range of other East Asian nations have expressed the desire to hold fewer dollar reserves, but to keep from losing market share in the U.S. economy, they have to make sure their own exchange rate vs the dollar doesn't stray too far from China's, so, they are essentially forced by the Chinese policy into intervening in the exchange rate market. Brazil has begun intervening in the real/dollar market as well, as China has started sucking U.S. market share away from essentially all other developing countries, not just those in East Asia.Indeed, besides the institutions and policies of the Washington Consensus, the single biggest encroachment on the policy-making space of the developing world right now is the Chinese exchange rate policy.”Bivens goes a bit further than I would in some ways that i would.  I rather suspect that the “institutions” of the “Washington Consensus” -- notably the IMF, have a lot less influence on emerging market’s policy choices right now than they had in the past.  But I do think the impact China’s peg is having on a range of countries, not just the US, deserves a bit more attention.

Plenty of signs suggest that a fair amount of money is leaving Japan to look for higher yields elsewhere.    More and more of those outflows seem to be coming from leveraged investors who borrow yen to buy other currencies – look at the excellent analysis by Hali Edison and Chris Walker in the IMF’s Asian regional outlook (box 1.4). But it doesn’t seem like much of it going to the US.  At least not directly.  There are plenty of places that offer higher yields than Japan that don’t even have current account deficits – the eurozone for one (its deficit is very small).   Brazil for another.   Russia too. There are places that offer higher yields than the US but run smaller deficits.   The UK comes to mind.   India too.  Australia perhaps fits here – its overall deficit is about the same size as the US deficit (though its composition is different; Australia has a smaller trade deficit but a large deficit in investment income)  And then there are places with bigger deficits than the US.    New Zealand.   Iceland.   Turkey.   All offer higher yields than the US. So how then has the US managed to finance its deficit?   After all, current ten year Treasury yields don’t suggest “foreign flight”?  Let’s start in Sao Paulo (or Brasilia).    Brazil’s reserves rose by $4.6b last week.    The workers in Brazil’s central bank were on strike last week; foreign investors were not.    The central bank was back in the market again today, to no one's surprise. $4.6b in a week works out to an average of $0.9b a day -- just under $1 billion.  $1 billion a day is a China-like pace of reserve growth.  Or at least it used to be a China-like pace – I suspect China has raised the bar this year.  Its reserve growth has likely accelerated from about $20b a month over the past couple of years to around $30b a month, if not more.  Brazil still runs a current account surplus, but its current account surplus maybe explains $1-2b a month of reserve growth.  Not $1b a day.   Brazil is attracting large amount of foreign capital. Let’s assume that that the money flowing into Brazil comes from a hedge fund that borrowed yen from a bank in London that itself borrowed yen in the interbank market in Tokyo.    That is an assumption, but not a totally implausible assumption.  In practice, I suspect a lot would be done through derivatives, with banks hedging their derivative position generating a lot of the “actual” flows.   No matter.  What counts is that Japan’s spare savings is effectively channeled, with a bit of help from the world's banks and a few hedge funds, to Brazil.   The logic of this trade is easy to understand.  Real-denominated debt pays 12%.  Borrowing at 1-2% in a depreciating currency and getting 12.5% in an appreciating currency is fun.  But Brazil doesn’t actually need the money.  It has a current account surplus.  It saves more than it invests.    Its central bank doesn’t want to cut rates (which might encourage more investment) and it doesn’t want the real to appreciate (Brazil has a manufacturing sector that competes with China as well as a commodity sector that sells to China).   So it buys the dollars and sterilizes by selling central bank bills at high rates.   The central bank effectively ends up paying the 12% interest rate in real to foreign investors.  And what does it do with the dollars is buys with the real-denominated debt it issues to sterilize the inflow?   It sends them to the US, and probably has the New York Fed invest them in Treasury securities, financing the US government in DC.    We know that Brazil’s holdings of Treasuries are rising rapidly, and I would assume that the BCB accounts for some of the rapid growth in the Fed’s custodial holdings.    What does it get on its Treasuries?   A bit less than 5%.   Brazil's central bank effectively borrows in real at 12.5% to build up reserves that earn less than 5%.  I can see why Brazil needs around $100b in reserves (10% of its GDP is a reasonable benchmark for reserve adequacy).  But not $200b.  Yet unless its pace of reserve growth slows, it will hit $200b rather quickly.  Well before the end of the year.  If last week’s pace continues, it could hit $200b in about four months (think $1b a day *83 working days) … That is how a portion of the US deficit is now financed.  Tokyo-Rio-New York though isn’t the only route that brings Japan’s spare savings to the US.   Tokyo-Mumbai-New York also works.  The RBI though likes euro and pounds, so it sends almost as much to London and Frankfurt as to New York.   It isn’t the most efficient routing.  Tokyo-Moscow-New York has the same problem.    It really is Tokyo-Moscow-London-New York, and some funds never make it all the way to New York.Beijing-New York-DC is more efficient. Brazil reports its reserve growth with a very tiny lag, so we know more or less what its central bank did last week.       India and Russia report with a week’s lag, so we only know what they did in the second week of April.  India’s reserves increased by $2.8b.   The euro rose by about 1% that week and the pound by a bit less than 1%, so the rising dollar value of India’s existing euros and pounds explains maybe $1b of that increase.  The rest came from intervention, as the central bank resisted pressure for further rupee appreciation. Russia’s reserves increased by a whooping $10.3b in the second week of April (after increasing by $7.6b in the first week of April).   Russia has a lot of euros and pounds, but the rise in their value explains at most $2b of the increase.    Russia’s current account surplus explains at most $2b – and probably far less – of the increase.   That implies at least $6b, if not a bit more, in net capital inflows to Russia …Suppose that after adjusting for valuation, India added $2b to its reserves in week, Russia $8b and Brazil $4-5b.   China is now adding at least $5b a week.  Since the PBoC had to drive the RMB down against the euro and pound in the second week of April, I wouldn’t be surprised if it bought even more.    Say $10b.     The BRICs then are currently adding $20-25b a week to their reserves.  $20b a week is $1 trillion a year.   $25b a week is $100b a month, $300b a quarter, $1.2 trillion a year … That truly is unimaginable large. If you think that scale of reserve growth can continue, there is little reason to worry. But in my view there is an interesting race going on now.    Will private investors (re)discover their appetite for US assets before the world’s central banks loose their appetite for US assets?  Or will the central banks lose their appetite for dollars before the private market regains their appetite?    On the surface, you can say little has changed since the 2005.     The US is still running a large deficit.   It still finances that deficit by selling bonds.  Treasury bonds still yield between 4.5 and 5%.  Under the surface though something has changed.   In the later part of 2005, the world’s central banks were adding about $175b a quarter to their reserves, and putting a pretty high fraction of those reserves into euros and pounds.  Their dollar reserves rose by only about $100b a quarter.   Now they are adding almost twice as much to their reserves.  If they are trying to keep the dollar share of their reserves constant – or just finding it hard to sell dollars without moving the market – the pace of their dollar reserve growth has increased by even more.  I am truly stunned by the pace of reserve growth that I am seeing in the emerging world right now.   Emerging market central banks are potentially adding to their dollar reserves at a pace sufficient to finance the entire US current account deficit.

OK, I probably should strike “world” and insert “the world’s governments” instead.  It is pretty clear that central banks and oil investment funds provided the bulk of the financing the US needed in 2006 (see Table 1.2 on pp. 8-9 of Chapter One of the WEO).   However, at least one important government doesn’t think that it makes sense to add to its existing dollar holdings.  Xia Bin (an economist with China's Development Research Center), a few days ago:'Everyone knows that they should try to cut their US dollar assets. But, of course, if China wanted to make such a move, a big cut, our losses would be large as well. That would be very difficult to do,' he saidTrue.  But adding to your reserves doesn’t reduce the ultimate loss.  It defers the realization of the loss, but it also increases the size of the ultimate loss.   But the key point Xia Bin raises is the first sentence – the idea that “everyone” knows that they want to hold fewer, not more, dollars.Bin's statement is also hard to square with the fact that China's reserves increased by $135.7b in the first quarter alone.   Only about $5b of that likely came from the rising dollar value of China's existing euros and pounds.   A a $130b quarterly increase (ona  flow basis) is a $520b annual pace of increase -- a truly stunning sum.    China almost certainly added about $100b, if not more, to its dollar holdings in the first quarter alone.Two trends seem to be to be in tension.Trend one: The world’s key central banks have concluded that they have more reserves than they need, and are rapidly losing interest in adding to their dollar reserves.    China’s central bank has made it known that it thinks it has enough reserves.  Some in China think the PBoC already has far more reserves than it needs. Korea’s central bank has indicated -- at various points in time -- that it has more than enough salted away.  The ADB agrees.   So does the World Bank, the IMF, and for that matter, the US Treasury.   With good reason.    Read Olivier Jeanne and Romain Rancierre.    The argument that Asia is building up reserves as insurance against crises no longer holds water.  The Asian central bankers themselves recognize they don’t need more reserves for prudential reasons.   Their external balance sheets are rock solid.  The domestic economic and financial risks that they worry about are augmented by continued reserve growth. Trend two:  A slowing US economy may well need to rely more – not less – on central banks to finance its deficit.   The available data suggests that private investors are willing to finance a US current account deficit of $400-500 billion when times are good and US financial assets offer a bit of a yield pickup (and, for that matter, when the US offers a tax break that encourages US firms to bring their foreign assets home).     In 2006, net private flows were more like $200-250b by my calculations -- which infers net private flows from the gap between the US current account deficit and estimated official asset growth rather than relying on the US data.   The net point is important -- private actors bought a lot of US corporate bonds, but US investors also bought a lot of foreign securities.   Moreover, I am effectively assuming some private purchases of US debt were indirectly financed by the growing offshore dollar deposits of the world's central banks -- the accounting can get a bit messy.However, if US should ever start to cut rates -- and that seems a bit less likely now than a few weeks ago -- and the dollar lose its "carry" over the other big currencies, net private inflows might well fall.   Back in 2003 and 2004 they fell to $100b or so by some measures.   Yet even a slowing US economy leads the US trade deficit starts to trend down, I suspect the US will need to borrow about $900, maybe a bit more, to cover its ongoing trade deficit and a rising income deficit.     That works out to an “official” financing need of up to $800b in a really bad case scenario. Trend 1 and trend 2 conflict with each other.   So far, the tension hasn’t produced any policy changes.  All available data suggests that central banks – despite all the talk about tiring of dollars – actually increased their dollar reserve accumulation in the first quarter.   Look at the growth in the Fed's custodial holdings.It takes a brave man (or woman) to forecast that this will change. I rather clearly underestimated central bank’s willingness to finance the US back in early 2005.   While central banks took advantage of the dollar’s strength in early 2005 to scale back on the their dollar purchases, all the available data suggests that emerging market central banks dollar reserve growth increased substantially in 2006.   We know that emerging market central banks that report data to the IMF added about $230b to their dollar reserves in 2006, up from $130 in 05, $120 in 04, $95b in 03 and $35-40b back in 2002.   And the group that reports data to the IMF doesn’t include China or a lot of the oil exporters.    Add in an estimate of Chinese and Saudi flows (which could well be off … ) and total emerging market inflows to the US – proxied by the growth in dollar reserves -- have clearly remained on an upward trend (this chart comes from my recent paper with Christian Menegatti; RGE subscription required).Actually, there is a third trend.  OK, this isn’t yet a trend.   It is more of a prediction.   Emerging markets increasingly will be financing not the expansion of the US trade deficit, but the expansion of the US income deficit.   If the average interest rate on US debt rises from 4.3% to 5.2% over the next two years and returns on FDI and US lending abroad remain unchanged, the total deterioration in the US income balance over the next two years will be close $200b.    The current account balance would consequently deteriorate by $200b even if the trade deficit stayed constant.   Exporters in emerging economies -- and real estate developers who have benefited from the rapid money and credit growth that has often accompanied rapid reserve growth -- have been the obvious "winners" from the current international monetary system.  They are a strong constituency that supports the status quo.  I have consistently underestimated the power of China's export lobby.   China too has its interest group politics.But increasingly the emerging world will be financing a US whose imports from the emerging world aren’t growing.  Remember, the trade deficit has to stabilize at some point.   The costs associated with financing the US won’t shrink.   But the obvious benefits will.Rather than financing export growth emerging market central banks (and the Japanese Finance Ministry) will increasingly be financing interest payments to themselves.   At the end of 2006, I estimate that the world’s central banks – counting SAMA’s foreign assets and China’s hidden reserves -- held around $3.7 trillion in dollar reserves.   On current trends, that easily could rise by another $1.3-1.4 trillion over the next two years.   if the average interest rate on their dollar holdings rises to around 5%, they will receive a bit under $200b in interest from the US in 2007 – and that total will rise to around $250b in 2009.   By 2009, counting all its foreign assets (not just its reserves) and counting euro and pounds as well as dollars, China should get close to $100b a year in interest payments.   By then its total foreign assets will top $2 trillionI am starting to wonder what China’s exit strategy is.  On current trends, China will, after all, account for a very large of the growth in the world's dollar holdings over the next few years.  China is now as deeply entangled in the messy business of financing the US as the US is deeply entangled in the messy business of governing Iraq.   And as a share of China’s GDP, China is spending more subsidizing US consumption than the US is spending in Iraq.  The surplus in China’s basic balance (net FDI inflows + the current account surplus) is now close to 15% of China’s GDP (the IMF estimates China's 2007 current account surplus will top 10% of its GDP, and their estimate looks low to me, given the q1 data).   That finances the buildup of foreign assets by various parts of the Chinese state.   And if the expected  appreciation of the RMB against a dollar heavy basket of euros and dollars that replicates China’s reserve portfolio is about 33% (which seems reasonable), the expected capital loss on the incremental increase in China’s foreign assets – one measure of the implicit export subsidy – is around 5% of China’s GDP.    That is at least a rough estimate of the annual cost of China's current policy: a full accounting would look at the interest differentials, which right now offset some of these costs.I think I know what the People’s Bank of China’s exit strategy is.   But a new People’s Investment Company just shifts the accumulation of dollars from one part of the Chinese government to another.   That doesn’t eliminate the loss, only shifts the loss to another part of the government.Update: China's reserve rose by $135.7b in Q1, to $1.202 trillion.   Say $5b came from the rising dollar value of China's euros and pounds.  That leaves a $131b (roughly) increase.   The q1 trade surplus was $46.5b -- and the current account surplus is usually about $15b a quarter larger.  Call it $62 b.   That leaves a $69b gap between reserve growth and the current account -- which implies large capital inflows.  Say net FDI inflows were around $15b.  Then non-FDI inflows were around $54b.    Q4 reserve growth was lower than the estimated current account surplus plus estimated net FDI inflows.   So something changed.    Presumably the faster pace of RMB appreciation in q4 led folks to try to move into RMB, as expectations for RMB appreciation picked up (the stock market was also a draw).   But even so, the swing is huge -- I would guess that for some reason the PBoC stopped using swaps or doing other things to mask the pace of its reserve growth, so more of the growth in China's total foreign assets showed up on the central bank's balance sheet in q1.    That though raises another question -- why would the PBoC suddenly stop shifting some of the incoming dollars to the banking system?   It is a bit of a mystery.   The implied swing in non-FDI inflows between q4 and q1 is truely enormous.   Macroman has more as well.

1. The spread (over Treasuries) on Brazil’s dollar bonds is now 120 bp.     I remember when … 2. Brazil added close to $25b to its reserves in a single quarter ($23.7b if you want to be precise).    Reserves rose from a tad over $85b to just under $110b.    Back during Brazil's most recent crisis, it often had -- after netting out IMF borrowing -- less than $20b in the bank.  At the end of 2004, a little more than than two years ago, Brazil only had $27.5b or so net of its IMF loan.   The IMF’s total commitment to Brazil back in 2002 chalked in at a bit over $30b.   It was considered huge at the time.   And it wasn’t all disbursed in a quarter either.    The biggest quarterly disbursement was “only” $6.3b.   Yet without the IMF loan, Brazil would have almost certainly defaulted on its external debt.    The big “China” surge in commodity prices wouldn’t have come along quickly enough to save Brazil from default.     A country that needed a huge credit line from the IMF to avoid default five years ago now borrows in US dollars for only a bit more than the US Treasury.   Talk about multiple equilibria.The foreign currency balance sheet of Brazil’s government has been completely transformed over the past five years.   Brazil used to have far more dollar debt than dollar reserves, and, to top it off, Brazil’s central bank sold a lot of insurance against further falls in the real when the real was under pressure.    The government was effectively short dollars and long real -- its balance sheet deteriorated when the real fell.  Now Brazil's government is long dollars.   It borrows from the world in real to buy dollar reserves ...  The carry trade, you know.  It hasn’t gone away.  Who doesn’t want to borrow yen to buy real?   And if the central bank is going to step up its intervention to keep the real from appreciating further (the real is back to where it was in 2001, before the 2002 crisis), well, volatility in the real/ dollar should fall -- making it easier to lever the size of the trade up.  There is nothing like getting a 12% or so spread (see Truman's slide 15) lending to a country that doesn’t need the money.  Brazil, remember, runs a current account surplus.   It doesn’t need to borrow Japan’s savings. There isn’t much evidence that the pace of Brazil's reserve growth is about to slow either.  Unless something changes, $50b, or even $100b, in reserve growth for the year isn’t entirely out of the question.      Brazil isn't the only emerging economy that saw its reserves soar in the first quarter.  Russia added $35b in the quarter;  India $20.2b (with one week left);  Malaysia $6.1b  Korea $5b and so on.  If only China would provide some indication of just how fast its reserves are growing ...

The phrase the “uphill flow of capital” seems to have caught on.  It is a vivid way of describing a world where poor countries finance rich countries.   Or, a bit more accurately, China and some no-longer-all-that-poor oil exporting countries finance the US.     I wonder if the term “reverse globalization” will also catch on.  Nasser al-Shaali, chief executive of the Dubai International Financial Center (DIFC) Authority, recently used the term "reverse globalization" to describe one likely long-term consequence of the uphill flow of capital: Emerging markets will be buying companies – not just bonds – in the developed world. "Reverse globalization - when you have emerging market players going out and acquiring developed institutions - is a tide that no matter how you try to swing against it, will be very very prevalent in the years to come," he [Shaali] said. You can quibble about the term.  Globalization as a term could easily describe a two-way flow of funds around the globe.  Call it financial integration.    That is basically how the transatlantic economy works.  US firms invest in Europe.  European firms invest in the US.  Their respective positions basically balance each other out.    But “globalization” has not been perceived as a two-way flow of equity investment between the developed and the emerging world, either in the developed or the emerging world.  In the emerging world, globalization meant opening up to US and European and sometimes Japanese firms and capital.  It didn’t mean buying up US or European firms.   It meant letting local firms (including local banks) be bought by US and European firms. And in the US and Europe and Japan, globalization often meant the export of US and European and Japanese capital and know-how to the emerging world.  Globalization was often interpreted a process that would lead the rest to adopt US-style market capitalism.    For example, Frank Lavin – the US under secretary of commerce – recently indicated that China would benefit if it imported more of  the know-how and management savvy of US private equity firms.    Asked about US equity fund Carlyle’s drawn-out negotiations to buy a stake in Xugong, China’s leading machinery maker, Lavin said China needed such investments to help well-performing firms become internationally competitive by improving their technology and management.  ”The controversy shouldn’t be Carlyle-Xugong,” he told reporters. ”I think China needs 100 Carlyle Groups to come in and buy 100 Xugongs.”  No doubt there are many Chinese firms with too little debt and too much equity in their capital stock.  But the downhill flow of management and equity control is arguably at odds with the uphill flow of capital.    US firms investing in China are effectively investing money that the US has borrowed from China, at least in some grand global sense.  The US, remember, doesn’t save anywhere near enough to finance all US domestic investment, less alone to finance US investment abroad. At some point, China – and others – might conclude that rather than lending to US firms at low rates so US firms can make big returns on their investment in China, they would be better off just doing the investment themselve.    No more offshore intermediation.  Read Yu Yongding.   But it goes beyond that.   When a private equity firm borrows dollars in London (or borrows dollars in New York that the New York institution borrowed from someone in London) to take a US firm private (something that is happening rather frequently right now), the private equity shop is often effectively borrowing Gulf or Chinese savings to help leverage up their returns.    At some point, investors in Gulf and in China might decide to try to play this game themselves.  Rather than lend their money out to American and European investors -- or take a stake in US private equity firms, as some Gulf families are known to do -- some emerging market economies might use their own funds to go shopping for American and European firms.  It isn't hard to find signs that the big emerging market creditors want to try their hand at getting some of really big returns that have accompanied the “global asset shortage.”   Or at least try to get a better return than they have been getting lending out their funds on the cheap.   And rather than hire American or European managers, they may conclude that they kind find better management-value-for-their money at home.  US CEOs are not exactly cheap by global standards. That would be a change.  And for the US, a potentially very big change.   The US came to accept Japanese FDI – and some Japanese management practices – in the 1980s.    But the potential shift of control should the current “uphill”  flow of capital from the emerging world become the”uphill” flow of equity capital from the emerging world is far, far larger than anything that happened then.    Remember, creditors – not debtors – traditionally have set the rules of the global financial game.   Right now the US is a debtor – a big one.  But the US still expects to set the rules, more or less.   My guess is that most US business circles still think globalization means something close to the global Americanization of finance and business.   It may.  But it also may not.  Reverse globalization may not be a bad term. 

The similarities between China and India have seized many (see Martin Wolf's column and the resulting discussion).   Both China and India have enormous populations -- and enormous scope to increase their urban labor force as their absolutely enormous rural population migrates towards urban areas.   Both have grown very rapidly recently. Indian growth is now close to Chinese levels.   Both have grown on the back of strong investment.   Both have experienced strong credit growth.  Both have booming stock markets -- though the timing of their respective booms hasn't always coincided perfectly.   Both have experienced rapid reserve growth.And both have the potential to exert an enormous influence over the global economy.   China, for that matter, already does.Still, I have been far more struck by the differences than the similarities.  And not just the obvious ones -- China's modern infrastructure is often contrasted with India's crumbling infrastructure, China's supposedly efficient version of bureaucratic capitalism (and the absence of political reform) is often contrasted with India's democratic but sometimes more chaotic political institutions.     No, what has struck me is that India's recent acceleration is having a lot of the effects that one conventionally would expect -- rapid credit and investment growth have led to inflation and current account deficits -- while China's recent strong growth hasn't had the effects one would expect.  Jon Anderson of UBS has argued that China is one massive economic puzzle for conventional macroeconomists.  He is right.   India isn't.  Or at least as big of a puzzle.India has experienced a massive credit boom over the past few years, well detailed by in a highly recommend Global Economic Forum piece by Chetan Ahya of Morgan Stanley.  Bank credit has grown in relation to GDP -- and relative to deposits.   The surge in credit has contributed to a boom in investment.  Indian household savings are comparable to Chinese household savings. Indeed, Louis Kuijs found that household savings are a higher share of India's GDP than China's GDP.  But India's government and private sector have far more need to borrow these savings than China's government and private sector.   As a result, Indian savings lag Indian investment, leading to a current account deficit.Strong credit growth has also been one factor pushing up inflation.   Higher rates of inflation, in turn, have led the RBI to push up interest rates.   Inflation is now in the 6.5% range -- faster than in the US or Europe, so India's real exchange rate would appreciate even if the nominal exchange rate stayed stable.   And nominal interest rates are now 7.5%.   That is lower than nominal GDP growth -- but I suspect the gap between India's nominal interest rates and India's nominal GDP growth isn't as big as the comparable gap in China.Higher interest rates are pulling in foreign capital.  As Andy Mukherjee continues to note, India has emerged as a popular carry trade destination.  India's capital account isn't fully open, but it seems to be open enough.   Strong inflows led to very rapid reserve growth in February. Those inflows seem to be creating trouble for the RBI.   Sterilization isn't easy.  This week, India's efforts to tighten liquidity to slow credit growth seem to have gotten in the way of the need for cash to make tax payments, pushing up short-term rates and the rupee and pulling foreign money in.  Those are the kind of difficulties, in a sense, that one would expect from large scale capital inflows and rapid reserve growth in the context of a fixed exchange rate.And yes, I do think India, like China, should allow its exchange rate to appreciate.  Some Indian analysts do to.  A stronger rupee would help contain inflation -- and, at some point, reach a level that reduces India's need for sustained reserve growth.Contrast India with China.    Credit growth in China also has been strong -- faster than GDP growth.  Bank credit to GDP is rising - and rising from a very high level.   But as fast as credit has grown, it hasn't kept up with deposit growth.  So the lending to deposit ratio in China's banking system is falling (note DeLong's ballpark math; China's banks are increasingly lending to the central bank rather than state firms).   Even after the recent rate hike, Chinese interest rates are far lower than Indian rates.No doubt they are -- as the Economist argues this week -- too low.    Denise Yam of Morgan Stanley thinks so.  She writes:The interest rate rises so far have left rates still way below the neutral level consistent with the pace of economic growth, fostered speculation in asset markets, and left China vulnerable to a rebound in excessive investment.China keeps lending rates well above deposit rates, so the banks have a strong incentive to lend their spare cash out to private firms at 6% and change rather than lend to the central bank for 3.25% (less for shorter maturities).   Since the banks have plenty of cash on hand, they should be lending even more at current interest rates.China's government, however, doesn't let the banks lend out as much as they want.    Administrative controls keep credit growth below lending growth -- creating a built-in market for central bank paper.  But even so, sterilization has been partial.   China's ability to combine a massive investment boom with an even bigger boom in savings and thus a rapidly rising current account surplus is a puzzle -- investment booms usually lead to current account deficits, or at least smaller surpluses.  But perhaps the biggest puzzle of all -- as Brad DeLong notes -- is how China has been able to combine stupendous reserve growth, partial sterilization and low inflation.   Theories abound.   The reservoir of labor in China's countryside is part of the answer.   But perhaps not the entire answer.  India also has a reservoir of labor in its countryside, yet a boom - combined with rapid reserve growth -- is still generating inflation there.  Like Martin Wolf, I think the restrictions on bank lending -- combined with the government's own high rate of savings -- have been crucial to China's ability to hold down inflation and thus sustain an undervalued exchange rate.  The government has effectively locked up a lot of Chinese savings in the banking system where it is lent to the central bank at low rates.  And since the RMB is expected to appreciate, Chinese savers have been willing to keep a large fraction of their funds in the banking system despite the low deposit rates.Still, the absence of more inflation in China is a puzzle.  India's reserve growth -- even, I think, in relation to its GDP -- hasn't been comparable to China's reserve growth.  But India's reserve growth has coincided with far more visible signs of overheating, far higher inflation and far more obvious difficulties with sterilization than China's reserves growth.      At least that is how it seems to one external observer. UPDATE: John Makin of the AEI on Chinese monetary policy.  By comparison, I am a model of restraint!

I will be away from the office for a few days.  I will be talking about the design of the IMF’s proposed reserve augmentation line – a proposal intended to help emerging economies with solid but not perfect policies manage volatile markets without necessarily holding huge stockpiles of reserves.  Or perhaps to help those countries that have yet to accumulate their huge stockpile of reserves manage market volatility.I also intended to discuss the huge wave of capital that flooded most emerging economies in the first part of February – and the craziness of a world where emerging economies (at least some) borrow funds at 12 to 13% only to lend the money back to the US at 5%.   One of my points (RGE subscription required for the link; sorry) was going to be that emerging economies should not base their policies on the expectation that if they just resist appreciation for long enough, investors will suddenly lose interest in the emerging world.   China has tried that policy for some time now – even holding Chinese rates well below US and European rates to discourage inflows -- without much success.   But I rather suspect that recent turmoil will give emerging economies new hope that private investors won’t be quite so willing to send money their way – and make them even more reluctant to count on steady inflows of private capital from abroad to finance higher levels of investment than can be supported from their own savings.    One of the ironies of today's world is that two of the biggest current account deficits – those of the US and the UK – are financed in large part by the (net) flow of official capital.Finally, please take note of RGE's new comments policy.  I want to thank all those who have commented here in the past -- the tone on this blog has consistently been civil even in the absence of these kinds of controls. That is a tribute to all of the participants.  I sincerely hope that this policy doesn't impede future discussion.   

I usually talk about the growth of the foreign exchange reserves of key emerging economies, but another feature of the past few years has been the fall in their external sovereign debt.   Joanna Chung of the FT not only has the story, but covers it extremely well. I completely agree with one of the more controversial points she makes.  After the crises at the late 1990s (and 01-02 in Turkey and Latin America) the government of emerging economies decided that borrowing abroad, usually in foreign currency, wasn’t worth the risk.    Issuing a bond governed by New York was once seen a real achievement, a sign of new found financial strength.   Not any more.   The governments of emerging economies are not borrowing -- at least not in foreign markets -- even through the money is there for the taking.   At rather attractive rates too. Chung:   The reluctance to accumulate foreign debt also appears tied to a change in attitude toward global capital markets, which just a few years ago were seen as the quick route to jump starting economic growth.   ….   [the succession of financial crises from 1982 on] have taught steadily taught developing countries that a reliance on volatile world capital market is has serious consequences.   When the world economy is strong and liquidity is plentiful, bankers and bond investors alike have been happy to lend money to developing country governments.  But when times have turned tough and when governments have really needed the money, the markets have denied them access to finance.” The US, as we all know, has no such concerns about its reliance on global capital markets.  It borrows in its own currency, which certainly helps.  But it also has never encountered a time when it needed money and the market wasn’t there ….  Then again, the US doesn’t really rely on private capital markets.  The US has a much bigger official lifeline than the IMF ever provided emerging economies (and I don’t here the Wall Street Journal railing against the resulting moral hazard).  The world’s central banks – the key ones -- have been willing to finance the US when private markets aren’t willing to do so.  Without any conditions, political or economic. At least so far. Incidentally, I thought it was interesting that total emerging market debt – expressed as a share of GDP – peaked in 2003 (See the FT's chart).   External debt was heading down, but domestic debt was rising (thank Brazil and Turkey …  ).    The trend didn’t look particularly good.  The IMF was worried.   And, well, Dr. Roubini and I were worried too.  We wrote a book about responding to financial crises in emerging economies.   We had the good sense to focus on the vulnerabilities created by domestic liability dollarization and domestic debt, not just external bonds.   But we did, well, assume that their would still be crises. Our timing could hardly have been worse.   There haven't been any crises since then.  Debt levels have done nothing but fall.   Unless something changes, and fast, it looks more likely to serve as a history of how the emerging market crises of 1995-2003 were handled than as a guide for how to handle future crises.

CFR’s Jagdish Bhagwati says U.S. must alter its approach to developing nations.