Emerging Markets

It has lost clout because emerging economies reserves have ballooned.  Plus, the countries that count that matter now – whether big deficit countries like the US or big surplus countries like China or Saudi Arabia – are not exactly in the habit of taking policy advice from the IMF.  Private flows have nothing to do with it, despite the standard conventional wisdom -- convention wisdom that David Piling and Holly Yeager of the FT echo at the end of their article on the need to adjust IMF voting shares to reflect Asia’s rising economic clout (something that I fully support).    Representatives of private financial firms repeat this argument at every international conference – the official sector is small, global finance is now a matter of private capital flows. The IMF may be sort of small (though its financing can still be big relative to private flows to even a decent sized emerging economy like Turkey).  But private flows are not currently driving the global flow of capital.  Official reserve growth has exceeded the growth in private capital flows to emerging economies.  That means that the direction of the global flow of capital recently has been set by official actors, not by the private markets.  Private markets – at least before May – were dumping money into emerging economies.  Private markets wanted to finance smallish current account deficits in the the emerging world and the US in 2005.   But central banks in emerging economies decided that they didn’t trust market flows to continue through thick and thin, and instead opted to build up their reserves, lend the funds back to the US and finance an enormous US deficit. The decision to use private flows to build reserves -- not the resumption of private flows -- is why the IMF has lost a bit of clout in the emerging world.  Sorry about the rant.  This argument is one of my (many) pet peeves.Nor is the basic premise that large private capital flows reduce demand for the IMF obvious to me.   Large, stable flows would reduce demand for the IMF.  But large and volatile flows increase the demand for reserves.  And that can include the demand for reserves borrowed from the IMF.   Large and volatile capital flows, after all, led to explosion of IMF lending from 1995 to 2002. And it isn’t obvious to me that large and what now look to be still volatile capital flows won’t continue to lead to demand for IMF lending, at least in those countries that have not just used private capital flows to build up their reserves. Think of Turkey. It attracted big private capital flows in 2004 and 2005.   And even in the first quarter of 2006.   In the first four months of 2006, capital flows to Turkey totaled $21.6b – up from $11.8b in the first four months of 2005.    $7.5b of that was used to increase Turkey’s net reserves -- but it didn’t just use those capital flows to finance reserve accumulation.  It also had a big current account deficit.  And even though Turkey has a lot more reserves than it did in 2000 and foreign investors have taken on a lot more lira risk, it still isn’t in a position where it can easily walk away from the IMF.   Particularly if Erdogan wants to court his Islamist base in advance of the election …p.s. the January-April data implies that net capital inflows were running at a roughly $65b annual pace in the first four months -- a very impressive sum.  Well aver 10% of Turkey's GDP, probably more like 15%.   Two times the amount needed to finance a $30b current account deficit.  Net inflows probably stopped in May.  Or inflows turned to outflows.  Talk about a sudden stop.  Fortunately, there are real differences between Turkey today and Turkey in 2000/01 -- when the last "sudden stop" came along.    

Is the lesson of the most recent bout of turmoil in the emerging world “emerging market economies have changed, but the markets have not”?How have emerging economies changed since 1997, the last time money flowed their way in a big way?   Fundamentally, by saving rather than spending the commodity windfall, and by saving rather than spending the huge wave of capital that flooded emerging economies the past few years?   Obviously, there are exceptions – Eastern Europe, Turkey, India (now) and with oil prices high, Thailand and Korea -- all run current account deficits.   But in aggregate, the emerging world has a big current account surplus despite attracting (til the last two weeks) big capital inflows.Some countries in my view have taken prudence to such excess that their prudence has become a risk.  China won’t use long-term capital inflows from FDI, let alone short-term flows to finance a current account deficit.  As a result, its burgeoning reserves are contributing to a domestic credit bubble, barely restrained by administrative controls.  Too many oil exporters still budget for oil at $25 and, since they peg to the dollar, often have weaker real exchange rates now than in 1998, when oil was $15.   But there also have been real changes in places that needed real change.   Brazil has eliminated two of its three major vulnerabilities.   Its external debt is way down, its exports are way up.   It has basically eliminated its domestic dollar-linked debt (good move).   Alas, the combination of high domestic rates, lots of short-term debt and a relatively large fiscal deficit has proven a bit more intractable.   Turkey addressed one major vulnerability – its fiscal deficit is basically gone.   Of course, it also has a big housing and consumption driven current account deficit.   That too is a real vulnerability.  But with something like 70% of the Istanbul stock market in foreign hands, big falls in the lira and Turkish stocks now hurt London and New York more than the Turkish banks … at least one hopes.    Important changes, all.  The emerging world looks very different today than it did in say 1997, at the peak of the previous wave of capital inflows from New York, London and Tokyo.What of the markets?   Have they changed since the last emerging market crisis? Gotten better at differentiating the good from the bad?  In some sense, the answer to the question "Have the markets changed?" is obviously yes.   Just look at the growth in hedge fund assets under management (and hedge fund fees – see Edward Chancellor of breaking views) and credit derivatives.   In other ways, though, the answer seems to be no.Flows into emerging economies recently have seemed rather indiscriminate.   And flows out certainly have been somewhat indiscriminate.    Stock markets fell in oil importers and oil exporters, in countries with current account deficit and current account surpluses.   That suggests the core cause of the correction is to be found in the markets of the center, not the policies of the periphery.    Turkey’s big and growing current account deficit didn’t stand in the way of record inflows in 2005 and the first quarter of 2006.My post earlier this week had a rather provocative title, but as Jenny Anderson noted in Friday’s New York Times, adding a bit of exposure to fast rising stock markets in the emerging world was an easy way to boost returns over the past year and a half.  And those returns were far higher if a hedge fund had unhedged emerging market exposure.  Going long some Turkish stocks and short others did not generate the same returns as an outright long position.   There is nothing wrong with pure directional bets – relative value plays have risks of their own (see LTCM).  But it is also hard to perform well in good and bad times with a simple long position …   Getting in early and getting out early took some skill, chasing 2005 returns didn’t.   And earlier this year, it sure seemed like lots of folks – levered and not levered – chased past performance.Lex argues that the moves over the past two weeks reflect a general repricing of risk.  Steve Johnson of the FT made a similar point.  Rising volatility mechanically forces funds to cut back on risky positions to limit their value at risk – “The selling was indiscriminate in emerging markets … “ said Jonathan Garner, analyst at Credit Suisse.    The selling was largely driven by a sharp rise in volatility,with the Vix index, often referred to as Wall Street’s “fear guage” hitting a two-year high.  This increased the “value at risk” of leveraged investors such as hedge funds, forcing them to cut long positions.   Many of the assets that had made the strongest gains this year, such as emerging markets, fell most sharply as a result.”That story sounds a lot like 1998.Last week, rising volatility meant less appetite for emerging market risk.  But also risks of other kinds.   For example, holders of the most risky tranche of a synthetic collateralized debt obligation are demanding a lot higher premium to insure the holders of the other synthetic tranches against big losses  …  The connection between emerging markets and the most risky (repackaged) corporate debt?   Both appealed to common set of investors chasing returns in a low-volatility world …

At least if you have borrowed dollars to buy stocks in emerging economies that are tanking. The series of crisis that rocked emerging economies in the 1990s were a formative experience for me.   So Monday’s big sell-offs has a rather familiar feel.  It sure seems like investors are running from all emerging economies, no matter what their vulnerabilities.     I can understand running out of Turkey’s 2008 lira bond.  Those who bought it were betting the lira would be stable and Turkish inflation would continue to converge toward European levels.    Neither assumption panned out so far this year.   Turkey’s fiscal and current account deficits also look to be bigger than expected.  But Indonesia isn’t Turkey, and it too sold off.And for a country like Brazil, the swing in sentiment was swift.   Brazil’s central bank was adding to reserves big-time in the first half of May (reserves grew by $7 billion between the end of April and May 15.  A few days ago real was close to 2.05; today it came close to 2.30 – what flowed in, flowed out.   Talk about sudden stopsTuesday has been a bit different.  With oil prices still high, investors moved back into Russia. Those who argued that in the new post-crisis world, emerging markets were no longer correlated but rather traded on their individual merits may need to reevaluate just a bit.   The money sort of flowed in everywhere earlier in the year, and right now it seems to be flowing out everywhere.  It sure feels like a large set of creditors is reevaluating emerging market risk in mass – as the one factor that links the country’s that have sold off is that they attracted flows from the same set of people.   The FT on Monday's moves:The MSCI emerging markets index was on track for a 10th consecutive decline, its worst run since August 1998, when the Russian default triggered worldwide market turmoil.Dealing in Indian stocks was suspended on Monday after the main index slumped 10 per cent in early trade. After a pause to calm the market, trading resumed and the benchmark index ended down 4.2 per cent.  Russian equities fell 9.1 per cent, the Turkish market dropped 8.3 per cent and Brazil  … was down 4.5 per cent in midday trade.Gerry Fowler, a strategist at Citigroup, said: “There is now higher demand for hedging – people are expressing more genuine concern that the liquidity crunch is not yet over. Last week, people were thinking that the sell-off would be short-lived.At the same time, there are huge differences between emerging markets today and emerging markets in the past.  Setting emerging Europe (including Turkey) and India aside, most emerging economies had current account surpluses, not big deficits.   Big inflows were financing reserve accumulation – not deficits.   And countries with deficits generally were getting more flows than they needed to cover their deficits.  Look at the growth in Turkey’s reserves from 2004 on.     Prices have corrected, but from very, very high levels.    I remember when the EMBI spread was well over 600bp a lot of the time; a spread of 223 bp hardly seems shocking.    Emerging market equities had risen to very high levels indeed.    A couple of analogies:  Oil at $70 is still rather high, even it isn’t $73.   And a reading of 20 for the VIX was pretty normal not all that long ago – even it that is a lot higher than 10 and its 8 point rise this year must be quite painful to some.   Remember, the VIX index hit 45 after Russia.  One thing still seems constant:  in times of trouble in emerging economies the US still acted a safe have.   Treasuries have rallied.  The dollar isn’t under the kind of pressure it was under two weeks ago.To me, at least, there is still something a bit strange about selling the currency of a country with a large current account surplus for the safety of the currency of a country with a very large current account deficit.  True, some surplus countries – like Brazil – don’t look that hot in other ways, at least not during the harsh light of a global correction.    But as Nouriel likes to remind everyone, the US has many of the same vulnerabilities as emerging economies like Turkey – or advanced economies like Iceland.Best I can tell, though, those fleeing emerging economies for the safety of the US are largely US and other dollar based investors – not the citizens of emerging economies.   Those who borrowed dollars to buy emerging market risk have a particular need for dollars.   They are in a slightly different position that say investors in emerging economies who have in the past looked to the dollar as an alternative to their own shaky currencies.  Like some others, I doubt that the unwinding of positions in emerging economies that originated in the US can provide an enduring base of support for the dollar.Let me try to explain why with a bit of data.In 2005, the “non-oil exporting” emerging economies – counting Latin America as a non-oil exporting region along with East Asia and Eastern Europe – ran a currnet account surplus of $122b.   Eastern Europe ran a deficit of $63b; Latin America and Asia ran a surplus of $185b (mostly because of China).These countries also attracted $203 billion in private capital flows.   Much of that was FDI, but, according to the IMF, $79b was “portfolio flows” of various kinds – portfolio flows that bid up the price of (thin) local stock markets the world over.The current account surplus and private flows combined to finance $302 billion in reserve growth (these numbers aren’t adjustd for valuation, so they are off in a few important ways, but the adjustments needed are complicated; actual reserve accumulation was substantially higher, which implies that capital inflows of various kinds were a bit higher) and $10b in net payments to official creditors.In broad terms, the money that flowed into the stock markets (and local currency debt markets) of emerging economies flowed back into German bunds and US Treasuries, as emerging economies used the inflows to build up their reserves.   And if investors sell their emerging market equities and flee to the safe haven of Treasuries and bunds, nothing much changes.    Reserve accumulation goes down, but that just reflects smaller inflows.  The net flow doesn't change much.  Money that was previously going into Treasuries through an emerging economies central bank now goes directly to the Treasury market.There only is a big impact on the overall pattern of global capital flows if the portfolio preferences of the private investors who used to love emerging economies differ dramatically from the portfolio preferences of central banks.   Ted Truman drilled this point into my head; he usually is right.  And during a flight to safety, private investors presumably have the same preferences as central banks, not different ones.The interesting question – at least for me – is what happens once the dash for safety ends.   Where does the money that got out go?And where does the oil money that was chasing yield in emerging economies go?   Home?  To the US? Or to the Euro?   Russia, lest we forget, added another $5b to its reserves in the second week of May.  Russia and Saudi Arabia aren’t short of cash with hovering around $70.

Taylor seems to really think his under his watch, the "Bush Administration ended the bailout habits of the IMF"As Taylor notes in the Journal, the Taylor-led US Treasury did say no to Argentina in late 2001.    But Taylor said no in December of 2001 only after saying yes to a horribly ill-conceived augmentation (increase in IMF lending) in the summer of 2001.    The IMF has stated that it intends to stick to its access limits.  Of course, it also has a policy that allows it to go over its access limits whenever it and its major shareholders decide they want to.  And every time a big emerging economy gets into trouble, they want to. The IMF hasn't given out any big loans recently, tis true.  But that is because no one has gotten into trouble, not because the IMF and its big shareholders have stuck to the stated lending limits under pressure.    Right now, the market in its wisdom will throw oodles of money at any emerging economy that offers a bit of carry.    Capital flows are back at their pre-Asian crisis peak.As for Taylor's real record, I think the facts speak for themselves.   He approved a large augmentation for Argentina, and large loans for Turkey, Uruguay and Brazil.    Look at the following graph.  The first peak in IMF loans outstanding occurred in  late 1998 and early 1999, after Asia, Russia and Brazil all turned to the Fund.  The second peak occurred in 2003, under John Taylor's watch.  IMF loans outstanding went from say $60b to $100b.   The IMF actually lent out more during that period to Argentina, Uruguay, Brazil and Turkey, but Russia and some Asian countries were repaying the fund over that period.  Facts are facts.   Taylor could take credit for the IMF's successes in Brazil, Uruguay and Turkey.   All three countries avoided default, regained access to markets, returned to growth and repaid the IMF. I would submit the current emerging market boom wouldn't have happened had Brazil defaulted in 2002 or early 2003.  And without the IMF lifeline, that is exactly what would have happened.  Taylor can even take credit for lending out the IMF's money to countries that subsequently repaid the Fund. But Taylor can not credibly take credit for scaling back IMF lending.Yet Taylor consistently refuses to claim credit for the successes he did have, and insists on trying to get credit for something he didn't do - scale back IMF lending!Of course, right now, the big debate around the IMF has nothing to do with lending.   The emerging markets of the world now generally have too many reserves, not too few.   That means that the IMF's core asset - its ability to lend reserves to countries that are short on reserves - is depreciating in value.  The IMF's problem isn't that it is "small" in relation to private capital flows, as is often argued.  In Turkey and Uruguay, I think you can make a good case that the IMF mobilized enough money (over 10% of each country's GDP) to overwhelm private markets in all but the most dire of scenarios.   The IMF's problem is that its resources increasingly look to be "small" relative to those of its emerging market members! The IMF has yet to find a way to engage meaningfully on the core challenges facing the current international monetary and financial system.  I would argue that is in large part because it hasn't been willing to try.   Though maybe its biggest members are also not willing to listen.   More on that later.

Either that or he has a lot of time on his hands.The powerpoint slides that accompany his John Hopkins lecture series on the Global Economy are amazing.  And not just because they are all shaded FT pink.The first set covers financial flows to emerging economies and the crises of the past few years. The second covers emerging market (and central) financing of the US current account deficit and the global savings glut/ investment drought.The third covers Martin Wolf's policy recommendations - his suggests for changing the international financial system.  Video and audio links can be found here as well.Wolf thinks big, like Mervyn King and Larry Summers.    Geithner and Bernanke don't explicitly address the future of the "system," but they are also clearly thinking about how the US - and specifically US monetary policy - should respond to major changes in the global economy.Wolf believes there is a savings glut.   Or a shortage of demand.  But he also doesn't think emerging markets should be financing of the US.    Or that world growth should depend on continued expansion of the already large US current account deficit.  So he wants change.I generally agree with Martin Wolf's analysis of the current "conjuncture" and with his take on "what is to be done."   But even if you don't agree with his prescriptions, the data he has pulled together should lay the foundation for subsequent debate.It is worth remembering that private markets want to finance current account deficits in emerging markets.   Private capital flows to emerging economies were never higher than in 2005, according to the IIF.   The pattern of international financial flows - poor countries financing rich countries, and one rich country in particular - isn't a market outcome.  Private funds are flowing into China, not out of it.  That is my objection to Caballero's analysis (with Farhi and Gourinchas).  China's banks and firms have not had any trouble creating financial assets that Chinese citizens and those with money outside China alike want to hold ...  The Economist, for one, might want to take a look at Wolf's data before endorsing China's exchange rate regime.  Though I shouldn't tar all of the Economist's writers together - I suspect that their Economics and Finance team isn't completely of one mind on this question.I particularly recommend slides 19 and 22 of Wolf's second slide show.   They show that China's savings surplus comes from rising business savings (profits on exports after the RMB fell?  Or rents on mining and resource production and real estate development?) and rising government savings, not growing household savings.   Business savings (and profits) up in the US as well - the savings deficit stems from falling household and government savings.    Slides 16, 17, 18, 20 and 21 show changes in the savings and investment balance of Europe, China, Emerging Asia - China, Oil producers and the US.    Slides 39 and 40 are good too.  39 shows currency moves against the dollar since the end of 2002.  Japan and China have sat out the dollar's post .com bubble adjustment. 40 shows the enormous growth in the world's stock of reserves since 2000.Slides 52-53 look at the US trade balance.  52 shows that since 1990, export growth has averaged 5.1% and import growth 8.3%.    53 shows that since 1990, exports have remained roughly constant as a share of GDP (actually that is true since 1980), while imports have increased by about 6% of GDP.   Wolf's slide 53 highlights something I hadn't noticed before.  The expansion in the US trade deficit in the 1980s came because exports fell as a share of GDP; the expansion since 1990, however, stems from a rise in imports relative to GDP.   That isn't a good sign, in my books.  In the 1980s, the US has unused export capacity that could be brought back on line.   Right now, any rapid adjustment would most likely have to come through a fall in imports.   I don't think the US has the capital stock to export 15% of its GDP right now even if the dollar slid further -- and it almost goes without saying that investing in residential housing isn't the most obvious way to create new export revenues.I liked Wolf's analysis of China as well - he argues that China not only has a large ($150b) current account surplus, but that it would have a $300b surplus if savings rates remained high while investment fall to a more reasonable level.   That strikes me as a real risk.   Wolf also argues that on its current path, China's reserves will hit $3000b by 2015 - a huge sum -- and that China is too big to export its way to Germany or Japanese income levels.   Exactly right.    See slides 11-13, 19-20 and 29 of Wolf's third presentation.

Justin Lahart writes well; I stole the "feeding the hand that bites you" line from him.  It is a good one.The US tells China (oops, CNOOC) that it cannot buy Unocal, even though Unocal's energy assets were primarily in Asia and Chinese firms have far fewer overseas assets than American firms.   China responds by ... purchasing just as much US debt as before.In January, China increased its Treasury holdings by $5.9 billion or so, its holdings of Agencies by $3.4b, and its holdings US corporate bonds by $2.7b - for a total of nearly $12b.    Feeding the hand that bites you.The US criticizes China's exchange rate regime.   China gets annoyed that another country wants to tell it what to do with its exchange rate regime.  But private investors start to think that China just might let the RMB move a bit faster, so money starts to flow into China.    China has to intervene more heavily in the market, buys more dollars, and ultimately, buys more Treasury bonds.    Feeding the hand that bites you.We don't yet know how many dollars China bought in January, but judging from the TIC data, it was not a small sum.       The US needs about $80b a month to finance its current account deficit ($70b for its trade deficit).   That can come from the world's banks, from foreign direct investment (in excess of US investment abroad) or from the sale of long-term debt and US equities.   Recently, it has come from the sale of long-term debt.   And in January, net proceeds from the sale of debt (and equities) to private investors abroad fell well short of the sums needed to finance the US deficit.   Fortunately, central banks stepped up their purchases - helping to fill the hole.   So who is doing the buying?  China for sure.  Brazil too.   They bought dollars in January to offset all the foreign hot money chasing yield in Brazil. But also Dubai's sheik.    Abu Dhabi's investment authority (Abu Dhabi is another of the emirates).  Kuwait's investment authority.    And the central banks of Russia and Saudi Arabia.  OPEC increased its Treasury holdings by $11 billion in January. Folks with oil have tremendous sums to play with right now.  Think roughly $400b a year.   Split between central banks, investment funds and the private accounts of various sheiks,  princes and oligarchs.As Justin Lahart notes, the big money in the Gulf isn't terribly happy that the US isn't willing to let  Dubai Ports World operate US ports.The Emirates is talking of shifting $2 b in reserves into euros.   They don't want to keep on feeding the hand that just bit them.But I suspect, like the Chinese, they will find it is hard not to.Suppose they start buying up the (dollar-denominated) bonds of emerging economies, whether an emerging economy like Turkey with a current account deficit or one like Brazil with a surplus.  What then happens?   Well, Brazil and Turkey have more dollars - and both already are pulling in more funds that they need.  Both are already building up their reserves. So what ultimately happens?   The Gulf countries still end up with assets denominated in dollars (and thus are stuck with the risk that the dollar will fall).   And Turkey and Brazil have to invest the dollars that they have raised by selling dollar debt somewhere ...  The Gulf sheiks are still feeding the hand that just bit them, only indirectly.That is some sense is the story hidden in the January TIC data.  Private investors dumped money into emerging markets.  Emerging markets built up their reserves by something like $60b in January.  They bought $20b in long-term US debt.  Probably more actually.  And they build up their short-term claims on the US too ...  central bank holdings of short-term treasuries rose by $8.5 b.   That is a lot of financing from the world's central banks.Suppose oil sheiks start shifting into euros, big time.  Forget $2b of the Emirates $23b in reserves.   $2b is chump change; it is two days worth of the oil states combined oil windfall.    Saudi Arabia and Russia each add over $5b to their reserves (including all SAMA assets) each month.    A real shift would imply that the oil states, who are now buying maybe $10b a month in euros, would need to start  buying $20b a month in euros.  Remember that the oil states now have roughly $35b a month, maybe more, that they have to invest somewhere ... What happens if the oil states start buying euros?  The euro probably rises against the dollar.   A $120b swing is big, even in today's global economy.    The Gulf states all peg to the dollar.  So their currencies fall.  And their citizens external purchasing power falls.    The value of their existing stock of dollars falls (tough luck; what do you expect financing a country with a $950 b current account deficit?).    And since their currencies fall, they will import less.    Gucci ain't cheap, even with the euro/ $ at 1.20.   And save more.  And have even more funds to invest.How can these countries stop financing the hand that bites them?Spend more and save less, so they have fewer funds to invest abroad.And stop pegging to the dollar.But for now, they don't want to change their currency regimes.   China clings tenaciously to its (outdated) plan for a super-slow transition to more flexibility.   The Gulf states don't even want to talk about the (even more outdated) dollar pegs. And so they are all, in effect, opting to keep on feeding that hand that bites them.And if they are smart, they should realize that buying dollars and dollar bonds doesn't mean that they can trade their dollars for US companies.   At least not on a scale that it is at all comparable to the amount of financing that they provided the US.I would bet - if you include bonds bought indirectly through London - that emerging markets bought about ½, or $500b, of the long-term debt that the US sold abroad in 2005.   I would bet that emerging markets accounted for about $20b of the $120b or so of foreign direct investment in the US.  And maybe $20 b of the $80b or so in portfolio equity sold abroadThat is a pretty unusual ratio.  $500b in debt; $40b in equities.   I understand why China and the oil exporters might want more equity and a bit less debt.But I also suspect the US is far more willing to sell $500b in debt to China's central bank and the oil sheiks central banks than to sell $500b in US equities to Chinese state-owned firms and the oil sheik's "private" firms.   That's life.    Lectures on the virtues of cross-border takeovers from London investment bankers eager for their cut, Tom "Dubai not Iraq is the now the model" Friedman, the FT, US economists (even Nouriel Roubini and Brad DeLong) and the Bush Administration won't change that reality.At least that is my best political judgment.The US right now suffers from a bit of cognitive dissonance.  I suspect Americans have assumed that open capital markets meant that US firms would be able to profit from investing abroad (and maybe the US could profit from exporting its  "dark matter" to the rest of world).   Yet that isn't a full description of the world we live in.  The US doesn't save enough to finance investment in the US, let alone to finance investment abroad.   Yet the US still thinks of itself as, if not a creditor, at least an intermediary.   Not as a big net borrower that desperately needs financing from abroad.One example: Even though I know next to nothing about investing in ChinaI am occasionally invited to talk about investment opportunities in China for US investors.   These conferences are about opportunities for US investors, they assume that China needs financing from the US.  The macroeconomic reality, as we know, is rather different: right now China finances the US.   Yet I am never invited to talk about the opportunities created by Chinese demand for US assets.The US doesn't think of itself as debtor in part because the United States' creditors have been so kind.   Financing the US in dollars at low rates.   Taking debt and not asking for any equity.  And so on.And since the United States creditors have been so kind, the U.S. hasn't felt pressure to be kind to them.The only real question is whether those countries now financing the US are willing to change the policies that led them to buy $500b in debt from the US in 2005.  Otherwise, they had better get used to feeding the hand that bites them.

I was going to write about how the markets have concluded that risk does not exist.After all, early last week, the market thought that dollar bonds issued by emerging economies were not that much more risky than dollar bonds issued by the US, even though emerging economies (unlike the US) cannot print dollars.  Admittedly, many do have lots of dollars in the bank.  That is one reason why the spread on the EMBI (the leading index of emerging market sovereign bonds) was at record low levels.  Mark Gilbert defined spread as:The number of additional basis points of yield you used to be able to squirrel away by shunning government debt and instead piling into corporate bonds or emerging market bonds. Now archaic. Risk appetite was quite high.Even the Bush Administration's Undersecretary of the Treasury for Domestic Finance, Randy Quarles, was worried.  He noted on March 1 that the Treasury market was perhaps a bit too quiet:Moreover, it is clear that financial markets have a great deal of confidence about the future.  Last week ... Merrill Lynch's MOVE Index of Treasury bond implied volatilities hit all time lows.  A long period of low realized credit losses, lower volatility in GDP growth, and low and stable inflation have led to expectations of more of the same, and thus contributed to a general reduction in risk premia across a wide range of asset classes.But, like you, we at the Treasury are among those paid to consider the alternatives, and some risks can be found even in what are prima facie signs of strength.  Low volatility can create incentives for riskier trading strategies, to maintain return.  And currently there is little cost to highly leveraged trading strategies.  Swap spreads are at pre-LTCM levels.  Financial institutions are facing a flat or inverted yield curve and credit spreads across a number of asset classes are historically tight.  This, too, forces market participants to dig deeper to find returns.  [Full disclosure: I worked for Quarles in 2001, when he was on the international side of the Treasury]Things seem a bit different this week.Treasuries moved from 4.5 to 4.75 - presumably because of a sense that it was going to become a bit harder to make money borrowing in yen to buy dollars.   As Mark Whitehouse and Serena Ng reported on Tuesday in the Wall Street Journal, "bond market professionals attributed the move, which came amid a dearth of economic data, to expectations that strengthening economies will central banks in Europe and Japan to raise short-term rates."If you import as much capital as the US does, changes elsewhere in the world can have a big impact on markets.Rising rates in the US, in turn, are reverberating around the world.The high-flying Turkish stock market wobbled this week.   The Turkish lira too.   Good thing that - the lira is quite strong, Turkey's current account deficit is hardly small and the latest industrial production data suggest that lira strength is cutting into Turkey's manufacturing sector in a big way.Actually, all the high-carry currencies ran into a bit of trouble today - including our friend from last week, the Icelandic krona.The consensus seems to be that all these moves are just modest corrections.    Treasury rates moved up, but US interest rates won't move up much more.    After all, any move that really started to bite would slow the economy.   And a slowing economy would generate expectations that the Fed will change course.    Mark Whitehouse and Serena Ng:"Some economists believe that they are limits to just how high U.S. rats will go .... Higher long-term rates could create pressure on consumers to retrench ... [And] if slackening consumer spending cools the economy, long-term rates should fall, because investors would expect less inflation and would expect the Fed to keep short-term interest rates lower in an attempt to keep the economy going."All this, I would point out, assumes that foreign investors won't go on strike.  Should foreign investors ever lose their appetite for US bonds, US long-term rates might rise even as the Fed started to cut short-term rates.   Foreign investors now own the majority of all marketable treasuries, and they should care far more about the dollar than inflation.And emerging markets are just taking a pause after a big run.   No one wants to buy Turkish lira or Brazilian real just before it falls, but maybe some folks will want to buy in after a (still relatively small) fall.   The carry, after all, is still attractive.So at least argues Hans Redeker in the FT:Hans Redeker, head of currency strategy at BNP Paribas, saw scope for a two-month reversal in the emerging market bull run as investors reassessed risk, but argued that a correction would be a "disturbance prior to the return of another wave of risk appetite once prices become appealing again."Or just maybe, something really is changing.    Maybe the rest of 2006 won't be like 2005.  Maybe bets on stable treasury prices, shrinking credit spreads and high-yielding currencies may not work quite as well as they did.  As Dan Drezner would say, developing ....

As, I suspect, does Joseph Quinlan of the Bank of America- the source of much of Kempe's analysis.   Kempe's core argument: consumers in emerging markets are driving global demand.   His evidence: imports from emerging markets constitute a rising share of global imports. The problem with his argument: he only looks at half the equation - imports - and ignore exports. Emerging markets are importing more because they are exporting more.  China, obviously.    The oil and commodity exporters too. But emerging markets in aggregate are not yet driving global demand growth.  After all, consumption is the opposite of savings (not exactly - investment figures in too), and if there is a global savings glut, it pretty clearly is in emerging markets.  Remember, many emerging economies have surging savings surpluses.   Current account surpluses are rising even as investment is rising - which implies savings is growing even faster than investment.  China's current account surplus rose substantially in 2005 despite strong investment growth.   The oil exporter's current account surplus soared even more. Kempe's argument works for Eastern Europe - which does have a large current account deficit, and has been supporting demand growth in the rest of Europe.  It works for India. But not for China.  And not for emerging markets as a whole.Yes, their consumption is growing.  But their income is growing even faster.  So consumption/ income is falling.  In China.  And in the oil exporters.    The savings glut, remember. The next stage of globalization may be characterized by the spending of the Shanghai factory workers and the Bratislava machinist.     But we aren't there yet. The current state of globalization is characterized by the savings of the Shanghai factory worker, the savings of Russian tycoons (and the Russian state) and the savings of the Saudi, Abu Dhabi, Dubai and Kuwaiti royal families - and by an absolutely phenomenal surge in reserve accumulation in emerging economies. Adjusting for valuation and counting all the foreign assets of the Saudi royal family, reserve accumulation by emerging economies set a record in 2005 - and it looks to be accelerating in 2006. Basically, there is one simple way of fact checking Kempe's overall thesis - the overall current account balance of the emerging world.  The IMF conveniently does the calculations for any economist who cares to look.   And it is moving in the wrong direction.  Demand growth has been slower than income growth in the emerging world (and faster than income growth in the US). An aside: for a nice overview of the investment drought/ savings glut debate, see Gilles Moec and Laure Frey of the Banque de France. Other key facts Kempe leaves out: Chinese exports to Europe have absolutely exploded since 2002.  That has contributed to global growth.  Europe has offset a growing deficit with China in part by exporting more to Eastern Europe, the Middle East and the real engine of global demand growth, the US (Richard Berner calculates that US consumption surged 10% in the November-January period ) . Europe's overall trade certainly remains far more balanced than that of the US.  But there is no doubt that the Euro's rise against the dollar since 2002 has contributed to increased global demand for Asian manufactures - and thus helped to spur growth in emerging Asia.  The fact that Chinese exports to Europe grew faster (in dollar terms) than Chinese exports to the US in 2003 and 200 doesn't fit the story Kempe (or Quinlan) wants to tell.  But facts are still facts. In 2005, US exports to Europe grew faster than US exports to "emerging asia" - 9% v. 8%.   US exports to old Europe - the eurozone - grew as fast as US exports to emerging asia (8% v 8%).  For emerging asia, I am using the Pacific Rim - Japan. Germany is not Europe.  Sure, German demand growth has been weak.  All that corporate restructuring and wage restraint to make Germany competitive.  But not Spanish or even French demand growth.  As I constantly add, the exchange rate matters as well as the growth rate.  Chinese exports to Europe started to surge when the dollar-renminbi depreciated significantly against the euro, making sourcing production for the European market in China rather profitable (China's membership in the WTO helped as well).  Europe's contribution to demand demand for imports is a function of domestic growth and the exchange rate.  Europe has lagged on one aspect, but led on the other. Finally, complaints about China's massive intervention in the foreign exchange market are a bit more than just protectionism.  China's government after all, is actively impeding market pressures for its exchange rate to appreciate - market pressures that just might help to make China into the force for global demand growth that Kempe postulates.   Joseph Quinlan of Bank America has long thought that trade deficits do not matter (so long as US firms are producing and selling abroad through their affliates).   The markets seem to agree, at least so far.  But it is pretty hard to argue that China's peg (along has not been an impediment to global adjustment.  Not the only impediment to be sure.  but an still an impediment.

Treasury Under Secretary Tim Adams thinks the IMF should take exchange rate surveillance more seriously.   So do IThe IMF annual check-ups were originally focused on a country's exchange rate and its exchange rate regime.  But over time, they evolved into a report on pretty much every aspect of a country's economic policy except its exchange rate regime.   Adams: These reviews were originally designed to enable the IMF to exercise "firm surveillance" over the exchange rate policies of its members.  ...  My central point is that the pendulum has swung too far in Article IVs. In its bilateral surveillance, the Fund focuses very heavily on domestic economic developments and policies, especially fiscal policy, and addresses structural, demographic, and longer-term factors in considerable detail. These items are admittedly important. But increasingly what is missing is a thorough assessment of exchange rate issues. A couple of examples.China's economy is vastly more productive than it was in 1997, or even in 2001.   It exports about three times as much as it did in 2001.  But don't look to the IMF's annual check-up on China for a clear opinion on whether China's exchange rate should have appreciated by more than 3% or so against the dollar over the past five years.  Or for an opinion on whether it made sense for the renminbi to depreciate against the euro from 2002-2004.The IMF hasn't been willing to go further that calling for greater flexibility.  Yet it is hard for deficit countries to reduce their deficits unless surplus countries reduce their surpluses.   That implies more than just flexibility - it implies a renminbi appreciation.The IMF's statements on China though are far from the most egregious example of the IMF tendency toward silence on exchange rates.  The Fund has not even called for Saudi Arabia to move toward greater flexibility.   Or to peg to basket that includes oil.  Saudi Arabia has the same exchange rate today that it had back in 1998.  And oil is worth just a wee bit more.   Why is the peg that was right for Saudi Arabia when oil was at $15 also right for Saudi Arabia when oil is $65-70?    Don't look to the IMF's report on Saudi Arabia for an explanation.I certainly am no fan of the Bush Administration.  But so far, Tim Adams has handled the China portfolio relatively well.   He has sought to broaden the US-Chinese economic dialogue to include steps that China should take to increase its domestic consumption.   He has been pragmatic about the policies that China needs to adopt to stimulate consumption as well - the Bush Administration likes social insurance in China more than social insurance in America.     And I have long thought that it made sense to multilateralize the discussion about China's exchange rate.  China's peg is not just an item of concern to the US.   It is an impediment to effective global adjustment.  It shouldn't just be a subject of heated discussion between the US and China.Adams willingness to call for stronger IMF is also a bit of a change.  The IMF is a multilateral institution after all.  His predecessor, John Taylor, certainly did not hesitate to use the IMF to provide big bailouts loans during his time at the Treasury.  See Turkey, Argentina,  Brazil and Uruguay.  Yet before he came to the Treasury, Taylor had argued that IMF should be abolished.  He always seemed a bit embarrassed that he had ended up backing the big rescue (or bailout) loans he had criticized as an academic.  I suspect Taylor would have been far more reluctant to encourage the IMF to take an active role in exchange rate surveillance.   Taylor didn't particularly like the IMF, and he didn't like criticizing other countries' exchange rate regimes either.   The IMF, of course, shouldn't confine its attention simply to countries running balance of payments surpluses either.  The deficit country - read the US -- also has a role to play in the adjustment process.   The US current account deficit can be thought of as US savings deficits.  Or more precisely, a shortage of savings relative to investment.  If the US government doesn't reduce its fiscal deficit, either private savings has to rise or private investment has to fall to reduce the overall current account deficits.  Adams mentioned that the US is committed to reducing its fiscal deficit.  So did President Bush in his state of the union.  But Bush is also committed to making the tax cuts permanent, and staying the course in Iraq.   Last I checked, both cost money.  And I suspect those commitments are far more credible than Bush's commitment to reducing the fiscal deficit. Yes, the deficit fell in 2005.  But it is heading back up in 2006.   The weakest part of Adams speech?  The section discussing what the US itself is willing to do to help bring about a more economically balanced world.

Or spread compression when spreads have already compressed. As David Altig kindly noted, I was quoted in Clint Riley's Wall Street Journal story about the impact of a flat yield curve on bank earnings: There is a very flat yield curve globally for different reasons, even in some emerging markets," said Brad Setser, head of global research for the Roubini Global Economics Monitor, a New York-based economics Web site. "I really don't see where the easy money is. No matter how sophisticated you are, you can't get away from the basics of banking: Borrow short, lend long." Why no easy money?   Here is what I see:A flat yield curve in many advanced economies.  There is no money to be made borrowing short and lending to the US government, for example.   The globally flat yield curve probably has a thing or two to do with oil - with oil at $65, the big oil exporters could earn something like $830 billion on their oil exports this year (assuming OPEC and Russia produce about 45 mbd of crude and similar product, and consume maybe 10 mbd, leaving 35 mbd in net exports).  And a lot of that money is being saved, not spent.  Thin credit spreads.  Last year, William Pesek spoke of Kate Moss thin credit spreads.  That hasn't changed much.    Low spreads mean that the banks cannot make much money by taking on additional credit risk - and are exposed to losses should credit spreads widen (if they mark to market). A flat yield curve in many emerging economies.   There is no money to be made taking in short-term deposits in say Brazilian real and then buying longer-term real denominated bonds.    Yes, you can make money if long-term real rates fall.  But it not so easy to make that bet when the Brazilian yield curve has inverted, and you lose money waiting for long-term spreads to fall.  Brazil's over night rate is 17.25%, one-year Brazilian bonds yield 16.1%. Where is there money to be made?   Well, by taking on a bit of currency risk. Borrow short-term in dollars, euros or yen, and buy high yielding Brazilian real, among other things.   But there are limits (one hopes) on the banks' willingness to take on currency risk.  Commercial banks are not central banks. Still, there is a reason why money poured into Brazil in 2005, and earlier this month. The scale of these flows to a range of emerging economies is rather remarkable.   As is the scale of the resulting increase in the reserves of many emerging markets. By my rough calculations Brazil added something like $25 billion to its reserves in 2005.  A bit more actually.  See Gray Newman.  The central bank's intervention does show up in Brazil's headline reserves because Brazil paid back its entire IMF loan last year.  But Brazil's net reserves (reserves - IMF loans outstanding) soared from $27.5 b to roughly $54 b during the course of 2005.   And it looks like Brazil added another $3 b to its reserves this January. Turkey's net reserves increased by something like $23 b in 2005.  And Turkey, unlike Brazil, is running a current account deficit - which makes its reserve increase all the more impressive. Argentina added something like $13 billion to its net reserves in 2005.  That's why it was able to repay the IMF. All told, the net reserves of Brazil, Argentina and Turkey increased by about $60 billion in 2005.   For comparison's sake, that is just about as much as the IMF lent out to these three countries in 2001 and 2002.    And those were very big loans by the IMF's standards.  No doubt, the fundamentals of these countries have improved.   All have far better fiscal stories now than in 2000 - or 1997.   But it is also hard to avoid the conclusion that these recent flows have been driven in large part by developments in the advanced economies.   Right now, there is no shortage of appetite for emerging market paper. All three countries needed to build up their net reserves, which were on the low side.  They are not China.  But looking ahead, they will have to balance the benefits of higher reserves against  the costs.  Those costs are higher -- or at least more visible -- if local interest rates are high. Brazil's central bank loses money when it sterilizes its growing reserves even if the real/ dollar stays stable. China's central bank only loses money if the RMB appreciates.

The world has too many currencies.   The dollar is too good a currency not to be shared.    The US has a clear comparative advantage in central banking.   National pride - and a desire to maintain "monetary sovereignty" -- should not stand in the way of outsourcing monetary policy to Ben Bernanke.So says Benn Steil of the Council of Foreign Relations in a Financial Times oped (free link) and in a new book with Bob Litan.Most macroeconomic problems in emerging economies - according to Benn -could be solved if countries just abandoned their local currencies and either adopted the dollar or another sound currency.  Benn has no problems with the euro - just with various pesos, liras, dinars, reals and rupees. Maybe RMB too.For Benn, Ecuador is the model.   It dollarized back in 1999 (after a huge devaluation).   And it grew faster than anyone else in Latin America in 2004.  Benn attributes Ecuador's star performance to dollarization.   Dollarization is a surefire way to generate counter cyclical capital flows and lower interest rates.  It is a fair to say I have a somewhat different opinion.  On Ecuador.  And on dollarization.  I suspect Ecuador's strong 2004 performance had more to do with the price of oil than its use of the dollar.   And Ecuador certainly has not enjoyed low interest rates after dollarizing - Ecuador's (dollar) debt trades at a wider spread than the dollar debt of just about any other emerging market.   Market chatter suggests Iraq's new dollar bonds - when they are issued - will trade at a lower spread that Ecuador's dollar bonds. Hardly a vote of confidence in Ecuador.Dollarization certainly doesn't end the risk of default on dollar-denominated debt.  Ecuador's dollar bonds carry a juicy coupon, unlike Iraq's bonds.  That's part of the problem in a sense: it isn't clear that Ecuador would pay that coupon if oil ever should fall back to $40, let alone $30.   Dollarization doesn't actually eliminate currency risk either. A country that unilaterally dollarizes could unilaterally dedollarize.Dedollarization is harder than dropping a peg, but it is not entirely theoretical either.  Argentina came close to depesifying (if such a word exists) back in 2001, as Argentina's provincial governments started issuing their own currencies when peso revenues fell short of peso spending. Benn thinks emerging economies that export oil should dollarize; I don't think they should even peg to the dollar (see this Economist article as well).   Differences over international economic policy don't get sharper than that.There are circumstances when the monetary policy that is right for an oil importer like the US will be wrong for oil exporters.    The dollar could well depreciate to help keep the US trade and current account deficits from widening further, and countries with massive oil-induced current account surpluses hardly need weaker currencies.  More generally, a flexible currency can help oil states manage oil price volatility.A concrete example:  Saudi Arabia had a difficult 98 and 99.  Oil tanked against the dollar.  That was a drag.   And that drag was compounded by the fact that Saudi Arabia pegged to the dollar.  At the time, the dollar was soaring.    Saudi Arabia was hardly alone.  Ecuador and Russia faced a similar set of problems back in 1998, but with less oil and smaller cushions. Both pegged to the dollar.  Both ended up devaluing their currencies.  Both ended up in default.A repeat of 1998 is not the only possible scenario.  Right now, the opposite seems more likely. Oil could soar even as the dollar tanks.  My point is that oil exporters probably don't want the same monetary policy as the United States - or Europe for that matter - as the United States. I suspect that Ecuador is more likely to dedollarize than the rest of Latin America is to dollarize.  Benn's cri du coeur hardly seems likely to sway a Latin America that has grown disenchanted with Washington -- and perhaps parts of the Washington consensus.Or to convince Nestor Kirchner to give up the peso.   I suspect  Benn - like Kurt Schuler --  thinks Argentina should have dollarized back in 2001.  I don't.A few months ago, Econ Journal Watch published a Schuler broadside that accused a host of international economists of malpractice.  One of his accusations: too many economists argued that dollarization in Argentina was technically impossible back in the fall of 2001.I plead not guilty to that charge.  I have no doubt dollarization was technically possible Argentina had enough dollars (including dollars borrowed from the IMF) to replace all pesos in circulation.  I just think dollarization would have been a bad idea.Following an exchange at Macroblog, Econ Journal Watch graciously invited David Altig and me to respond to Schuler's various charges - and gave Kurt Schuler a chance to reply.   Among other things, my paper fleshes out why I think Argentina's dollar peg - its pseudo-currency board - was wrong for Argentina back in the 1990s.  And why I don't think dollarization late in 2001 would have averted Argentina's default, allowed Argentina to avoid a bank holiday or eliminated the need for a painful real depreciation.   Dollarization just would have assured that the depreciation came about through falling prices, not a fall in the currency.  And rather than having frozen peso deposits, Argentines would have had frozen dollar deposits.  Argentina had enough dollars to back all the pesos in circulation - but no where near enough to pay its debts, or allow all Argentines with short-term dollar and peso deposits to take their money out of the banks!Full disclosure. I know Benn from my time as an International Affairs Fellow at the Council in 2003.  We have a long-standing agreement to disagree on dollarization.

Both Brazil and Argentina now want to repay the IMF before the end of the year.  Call it contagion of a different sort.  Turkey may not be far behind, given how much private money is now flooding into Turkey. Kirchner announced on Thursday that Argentina would pay its entire $9.8 billion debt to the International Monetary Fund by year's end. Two days earlier, Brazil pledged to pay its $15.5 billion to the lender this month.  "Let's be sincere. If Brazil hadn't taken the first step, Argentina wouldn't have been able to advance on its own," Kirchner is quoted as saying to leading newspaper Clarin.  The Peronist leader said wiping out the IMF debt was the "most important" thing he had done since taking office in 2003, adding that it had "vast internal and external consequences."Paying the IMF offers obvious political benefits for both Brazil's Lula and Argentina's Kirchner.  The IMF is not terribly popular in Brazil, let alone Argentina -- even though Brazil would almost certainly joined Argentina in default without the IMF.  The whole idea behind IMF lending to countries facing financial pressure is to provide a bridge to the return of financial stability.  Brazil got a ton of IMF money in 2002 and 2003.  It should be paying it back now.  By the end of 1997, Mexico had repaid most of the money it received in 1995.  In Bailouts and Bail-ins, Dr. Roubini and I used repayment of the IMF as a sign of success.   The IMF lends in bad times, and should get paid back in (relatively) good times.   The problem comes when the IMF doesn't get paid, not when it does!Argentina got a ton of money in 2001, and after it defaulted, many wondered when it would be in a position to repay the Fund.   But with $27 billion in the bank, Argentina is now in a position where it can pay.That too is a success of sorts.  It also means that the IMF will not be in a position to shape the Argentina's future policies.  That will disappoint some - particularly those who were hoping that IMF pressure would force Argentina to reopen its exchange and give those still holding Argentina's defaulted bonds a second chance to go into the deal. On the other hand, the IMF has not played much of a role shaping Argentina's policies over the past few years in any case.   The IMF backed the wrong horse back in 2001, when it lent to support Argentina's (quasi) currency board.   And the IMF lost even more influence when it bet that Argentina would print pesos to finance fiscal deficits after the (quasi) currency board collapse an Argentina defaulte.   That too proved to be the wrong bet:  Argentina ran an responsible fiscal policy after its default, and ended up stabilizing the peso on its own, with no help from the IMF.  Kirchner certainly doesn't believe Argentina's current success comes from following the IMF's advice.  And to date, predictions that Argentina's growth would fizzle out have not been born out.  Argentina is growing far faster (around 9% y/y) than Brazil right now.But I am still worried. In 2002 - and indeed for most of the period that followed - Argentina maintained its independence from the IMF in part by pursuing a responsible fiscal policy.    That was the irony: Argentina's government ran the primary fiscal surplus the IMF wanted, even as the government positioned itself as an opponent of the IMF.Now, though, some of the pressure that demanded a responsible fiscal policy immediately after the default is dissipating.   Spending rose prior to the election, helping to drive Argentina's current growth.To be clear, Argentina still has a primary fiscal surplus, unlike the US.  Any relaxation in fiscal policy is relative.  But the government also has refused to let the peso appreciate, and has not wanted the central bank to sterilize (at least not fully) the resulting increase in Argentina's reserves either.  Sterilization requires selling central bank bills to take the pesos issued to buy dollar reserves out of circulation, and extensive sterilization would drive interest rates up.   And the government neither wanted higher rates nor a stronger peso.But now inflation is ticking up; it is now well above 10% y/y.   That could auger future trouble.   Of course, if Kirchner's IMF-free policies scare capital off, that will reduce the central bank's need to intervene to keep the peso from rising.   And that may mean less money creation.   Freeing Argentina from the IMF also may offer Kirchner a way to sell continued fiscal surpluses.  You never know. One thing will be clear though.  If Argentina ends up making a new set of economic policy mistakes - mistakes that this time will come in part from buying dollars to defend a weak peso, not from selling (borrowed) dollars to defend an overvalue peso - Argentina's government will bear full responsibility for those errors.The IMF though must be asking what its role will be in world where, generally speaking, emerging economies are financing the US and (in some cases) running up large reserves in the process.  I think it is premature to argue that the era of large IMF rescue loans to emerging economies is over for goo - emerging economies are tested when times are bad and the money flows out, not when times are good and the money is flowing in.    But the IMF's role in many emerging economies certainly is shrinking - at least for now.Venezuela's financial influence though seems to be rising. Chavez is not terribly keen on lending Venezuela's oil windfall back to the US.   Rather than buy US Treasury bonds, he will buy Argentine Treasury bonds.  Reuters:The government will draw from the Central Bank's foreign reserves, which on Friday totaled $27.3 billion, to make the payment, but says the money will be quickly replaced, with a little help from a strong budget surplus and a promise by Venezuela's Hugo Chavez to buy government bonds."Between now and the first half of next year we will have revenues: $2 billion from the 2005 budget, another $2 billion from the fiscal surplus and $2.4 billion from the bond purchases Venezuela will make," the president said. China's financial influence is also rising, particularly in countries with oil.  But that is a topic for a different time.

Before working on the US current account, Chinese reserve accumulation and petrodollars, I spent most of my time thinking about financial crises in emerging economies.   In early 2004, I worked primarily on two projects.A paper on the political economy of Argentina's crisis  for Oxford's Global Economic Governance Programme.  The paper tries to explain why there  never was a political consensus in Argentina to do anything other than find new sources of external financing to avoid default and hold on to the (quasi) currency board until Argentina has absolutely no other choice.  And, as a visiting scholar at the IMF, I was one of many who worked to develop a template for assessing the national and sector balance sheets of key emerging economies.    That work has been gathered together in an IMF occasional paper.I am proud of my contribution to the IMF's balance sheet project.  I also remember when much of the Fund did not exactly embrace balance sheet analysis.   The standard complaints: it took too much work, and it required too much data; it was not "mostly fiscal;" and it wasn't created here.It did not really take off until some folks in the IMF's PDR division started to use some of the ideas we developed in their country work.   See, for example, Christian Keller and Chris Lane's assessment of Turkey's balance sheet risks, which was published as part of another IMF occasional paper.  Rough balance sheet analysis often did not take tons of data so much as using existing data differently.  An example: take domestic bank deposits denominated in foreign currency and add in the banks external liabilities, and you generally have a pretty good estimate of the size of the banking system's fx balance sheet ...    The board applauded their work.  People noticed.  And so on.   I just noticed that BNP updated the IMF's data in their Turkey analysis, which suggests that at least a few people in the markets also found the IMF's work useful.  

Two weeks ago I would have expected Brazil's Finance Minister to be forced out before Argentina's Finance Minister...   However, Palocci is a close ally of Brazil's Lula; Argentina's Lavagna has never been all that close to Argentina's Kirchner.  Rather, Lavagna has long been both a key ally and a potential rival to President Kirchner.   After today, he is just potential rival. Lavagna predated Kirchner in some sense; he started in the Economy Ministry before Kirchner was elected President.  After Kirchner's big (proxy) win in the fall elections, Kirchner apparently decided he no longer needed Lavagna.  The new Finance Minister -- Felisa Miceli - lacks Lavagna's independence.  She clearly is Kirchner's choice.   The governor of the central bank (Redrado) is a Kirchner pick too.  I do not follow Argentina as closely as I once did.  But I have a bit more confidence in Lavagna than Kirchner, so, like many, I am interested to see if Kirchner and Miceli will adopt different policies than Kirchner and Lavagna.Yes, Lavagna took a hardline in Argentina's restructuring negotiations.  But after Argentina's quaisi-currency board collapsed, Argentina had far more debt than it could realistically pay.   Realistically, Argentina needed to both reduce the stock and reduce the coupon on that debt.   And I also think Lavagna's (and Kirchner's) core calculation was right: after Argentina's default, the international sovereign bond market was not going to be central to financing Argentina's future development.But Lavagna's tough line in the debt negotiations was combined with a vision that potentially allowed Argentina to exit from its cycle of debt and default.    Under his leadership, Argentina consistently took in more in tax revenues than it spent on items other than interest (i.e. Argentina ran a primary surplus).    That was an enormous change.   Back when Argentina was the market's darling in the late 90s, it never ran primary surpluses.   Sustained primary surpluses -- along with continued growth -- offered the prospect of sustained reductions in Argentina's debt levels.In broad terms, under Lavagna. Argentina reduced the cash that it promised to pay bondholders through its restructuring, but it also adopted policies that increased the odds that they would get paid what they were promised.  Lavagna also deserves immense credit for helping to stabilize Argentina's economy in the dark days after Argentina's devaluation and default.  The IMF at the time more or less expected that Argentina would start running the printing presses.  Argentina did not do so, largely because of Lavagna's fiscal policies.  Yes, not paying its bonds helped.  But default hardly guaranteed basically balanced budgets, let alone significant primary surpluses.   For more on this period, see my recent paper (with Anna Gelpern) on Argentina's Pathway through its 2000-02 crisis; a paper I did for a project sponsored by University College Oxford's Global Economic Governance Programme. Lavanga of course did not act alone - Kirchner deserves credit here too.  But  Lavagna seemed to understand that Argentina's recovery was based on both on some relatively heterodox policies (Argentina's aggressive negotiating stance in the debt restructuring) and some rather orthodox policies (conservative fiscal policy).  Without Lavagna, the balance between heterorthodox and orthodox may change.  And while Kirchner's new team faces some real challenges.    Finding a coherent response to rising inflation is likely to be the most urgen challenge.   The recent rise in inflation doesn't stem fundamentally from loose fiscal policies -- or greedy supermarket owners.  Rather it has been fueled by Argentina's policy of resisting upward appreciation of the peso. Argentina's central bank has been buying up dollars all year, in part because capital has been flowing into Argentina.  But it has resisted sterilizing (selling local currency bonds) its rising reserves, since sterilization risks driving local interest rates up.  Rather it has been adding to the stock of pesos. (see this Wells Fargo report for basic data on Argentina)The not entirely surprising result of a weak peso and (relatively) loose money has been rising inflation.    Argentina's central bank governor may not think it is raining pesos -- see his letter to the Wall Street Journal - but it does seem that inflation is heading up, not down, in Argentina.Letting the peso rise a bit is an obvious policy response, one that makes more sense than trying to convince the supermarkets to keep prices down.   And Argentina could let the peso rise a bit without returning to its old policy of keeping the peso systematically over-valued through the peg as a bulwark v. any inflation.  Remember, Argentina's real exchange rate is getting stronger right now because of high inflation even if the peso is not getting any stronger ...  Ironically, if Lavagna's ouster reduces confidence in Argentina and capital stops flowing in, that might ease pressure on the central bank.  Today the central bank seems to have intervened to keep the peso from falling - not to keep it from rising.Figuring out Argentina's future fiscal policy course is challenge two.   Before the elections, spending was rising faster than revenues a trend, that if sustained, would gradually erode Argentina's post-crisis fiscal framework.  The FT:One uncertainty concerns Argentina's fiscal performance. Under Mr Lavagna, the country posted record primary surpluses (before taking into account debt interest payments). He told the FT recently that he had done so by "saying no to the vested interests". Some analysts worry that Mr Lavagna's successor may not be as tough, particularly given mounting pressure from trades unions for wage rises.Government spending has risen 24 per cent this year, a jump that many associate with Mr Kirchner's long and expensive political campaign ahead of legislative elections last month. Mr Kirchner's supporters in the centrist Peronist party scored a big victory at the polls, increasing their representation in the legislature. And I would argue that finishing the restructuring remains a key policy challenge.  This has several dimensions:The big debt restructuring in the spring took care of most of Argentina's external sovereign debt, but there is still roughly $20 billion (face) in unrestructured bonds outstanding.   The post-restructuring deal with Argentina's holdouts (assuming there is eventually a deal that lets the initial holdouts go into the exchange at a discount) will be one of the largest sovereign bond restructurings on record, exceeded only by Argentina's earlier restructuring and Russia's 2000 restructuring.   Argentina still needs to reach agreement on final "restructuring" terms with its domestic utilities.  That means reaching agreement on current prices, and in a sense on how large the utilities losses during the crisis will be - and figuring out how future investment will be financed.  Argentina won't be able to rely on the infrastructure that was built before its crisis forever - at some point future growth will require new investment in some basic infrastructure (power, gas, water and the like).  And getting that investment required doing a few deals ... And less obviously, I think that over time, the terms of the post-crisis restructuring of the debt held by banks will need to change.   That can happen naturally, if old bonds are refinanced with new bonds.   Argentina's banks will remain hobbled so long as their primary asset is Argentine government bonds that pay real interest rates of 2%.   Argentina's domestic bonds often are indexed to inflation, with the inflation indexation added to bonds principal value.  That reduces the amount of cash the government has to pay on its bonds.  It also leaves the banking system in a weak position should domestic deposit rates rise.    And at some point they will need to rise.   Addressing this problem need not involve a formal restructuring - a fair amount of Argentina's domestic debt needs to be refinanced in any case, so its terms can evolve naturally.  But it does suggest that Argentina still has plenty of difficult decisions to make - higher real rates on Argentina's domestic debt or higher cash payments and less capitalization, for example, both would have implications for Argentina's budget. And many of these decisions will be made in a broader political context where Latin America's disillusionment with Washington is obvious - and in many places, that disillusionment seems to extend to Washington consensus economic policies.   I don't think the Washington consensus has worked as advertised.  But I also don't think that heavily indebted Latin economies can easily abandon relatively prudent fiscal policies without paying a price.

One of the things that has fascinated me is that US-Latin America relations have soured so much under Bush's watch.  I think I am fascinated in part because I don't really buy the standard explanation: I don't think the US has entirely turned its back on Latin America after 9.11.  The Bush Administration did not ignore financial crises in Latin America in 2001 and 2002.   It backed a large increase in Argentina's IMF program in 2001.  The IMF's 2002 bailout of Brazil is very similar to the IMF's 1995 bailout of Mexico - a big loan that enabled a key country to avoid a potentially very disruptive default.  And as I argued in my previous post, if money is a measure of love, the Bush administration showered Latin economies with IMF love between 2001 and 2002. OK, Paul O'Neill said an undiplomatic thing or two before signing off on the IMF loan to Brazil, and the US was not banging on the IMF's door trying to convince them to make the loan.  But bottom line, the US did not stand in the way of a large IMF loan for Brazil.  The US played a very active role getting IMF (and World Bank) support for Uruguay, and was quite involved in various IMF decisions on Argentina as well.  So what went wrong?Part of it is that the Bush Administration has always seemed embarrassed that it relied on a Clinton-era tool - big IMF loans - to give substance to its relationship with much of Latin America.  As a result, the Bush Administration has not really claimed much credit for even the successful IMF bailouts that took place under its watch -- Brazil and Turkey are prime examples.   Instead of embracing big IMF loans and arguing that the IMF has a key role to play in managing the risks that come with financial globalization, the Bush Administration preferred to talk about limiting future IMF lending.  That was true even when the Administration was busy signing off on big loans.  Lula is also rather embarrassed that his initial success also hinged heavily on support from the IMF.   The IMF's success in Brazil is consequently something of a political orphan.  Part of it is that the US has done little other than not stand in the way of IMF lending.  The Bush Administration has not led a serious discussion about the financial risks that led to the crises, or contributed much to the dialogue about financial globalization.  Some said the Clinton Administration -- and the Clinton Treasury -- talked of little else.   Consequently, after the Brazil crisis passed, the US and many Latin countries have had little to talk about.  Plus, there is a widespread perception that the Administration's policy is Chavez-centric (if not international criminal court centric).  Sebastian Edwards:  "Nothing has changed from the past ... It's still the neglected backyard.  This administration couldn't care less about the region, except for Chavez."  Part of it is that much of the Bush Administration's broader agenda is at odds with social and political currents in Latin America.  Its "more markets and less taxes" bromides ring a bit hollow- Latin America feels like it tried that strategy in the 1990s, and found the results disappointing.  One can debate whether Latin America let the Washington Consensus down, or the Washington Consensus let Latin America down.  But there is little debate that Latin America expected more from its "market reforms" than it got.  Larry Rohter of the New York Times: The feeling among many Latin Americans is that the United States is coming with little to offer other than the usual nostrums about free trade, open markets, privatization and fiscal austerity, the same recipe that has vastly increased social inequality throughout Latin America during the past decade. "We've almost all of us been down that road, and it didn't work," said a diplomat from one South American country, speaking on condition of anonymity so as not to offend the Bush administration. "The United States continues to see things one way, but most of the rest of the hemisphere has moved on and is heading in another direction." The funny thing is that both the Latin left and the Latin right are at odds with the Bush Administration.  Many on the right fault W for not offering Latin market reformers the same level of support that they got from his father.  See Domingo Cavallo -- though it should be noted that Cavallo did get a decent amount of cash from 43.  And those on the left don't relate with Bush's social, foreign or economic policies. My favorite line comes from Riordan Roett, director of the Latin American studies program at the Johns Hopkins School of Advanced International Studies, also in the New York Times.  He doesn't have any money to offer, so the president doesn't really have any cards to play ... Nobody among the crop of fiscally conservative but socially progressive presidents that we now have around the region is going to go to his defense. Bush, in contrast, is socially conservative and fiscally ... liberal? reckless? Pick your adjective.   Today, the US runs a primary fiscal deficit, while Argentina and Brazil run primary fiscal surpluses (the primary balance is government revenues - government spending on items other than interest). To be clear, because Brazil pays a lot more interest on its debt than the US does, Brazil runs an overall deficit despite a primary surplus.  Argentina generaly has had an outright budget surplus.    And today it is the US, not Argentina or Brazil, that has a large and potentially troublesome current account deficit ...