Archive for August 9th, 2007

Global Imbalances: IMF Strategy to correct it

August 9, 2007

First, what do we mean by Global Imbalances?

  • US spends more than it saves resulting in huge current account deficits (Basics are here). Ideally the dollar should depreciate to correct the huge current account deficit (Note I mention ideally, in reality it may not happen. This research shows for US current account to correct, US needs to save and dollar depreciation may not work; but then it is just research) . But dollar does not depreciate or in other words US continues to finance its current account deficit. How?
  • China runs huge current account surplus (on account of its exports) and the surplus is mostly invested in US treasuries. Which means demand for dollars continues and the dollar does not depreciate but appreciates.
  • High inflows in US are also from Oil exporting nations especially middle east counties that invest their pertodollars in US treasuries
  • Another source of demand for dollar is South East Asian Nations like Korea, Indonesia etc which are maintaining huge forex reserves, a learning from the crisis in 1997.
  • Then you have problems in Japan like yen carry trade which have global implications
  • As Europe continues to struggle (now, it is showing resurgence post Germans showing strong growth), it cannot take much of the pressure from the US. As US assets are still considered to be safer most surplus money from China, India, Middle-east etc continues to be parked in US and not in Euro. But after Euro adoption, Euro Region is as big as US and has some developed economies, but has not taken off. There are some reforms needed as factors of production (labour, capital) are still not fully mobile in Euroregion.

As imbalances continue, how does one solve the problem? As it is a global program we need coordination of all involved.

IMF has come out with this approach which it calls as Multilateral Consultation on Global Imbalances. In this it brings all the top policymakers of the countries/regions involved in the imbalances. It began in June 5 2006. The press release says:

The first multilateral consultation will focus in a comprehensive and collective way on the issue of global imbalances and involve several systemically important members and groups of members—China, the Euro Area, Japan, Saudi Arabia and the United States—all of which have agreed to participate in this first consultation.

“These economies are either ones with large current account surpluses or deficits, or they represent a large share of global output,” Mr. de Rato noted, adding, “Their cooperative action can play a major role in the orderly unwinding of these imbalances and in sustaining global growth as savings, consumption and investment patterns adjust.”

IMF just came out with its latest report on the same which is pretty good as it summarises what those imbalances are and what each country/region is doing to correct the imbalance.

So what is each country doing about it:

  • China : indicated that the reduction of external imbalances had been elevated to a major national objective in 2007. In this connection, they are pursuing measures to boost domestic demand—particularly rural consumption; to reform the trade system; accelerate financial sector reform; and gradually increase exchange rate flexibility.

  • Euro area, the authorities are pressing ahead with structural reforms across a broad front to strengthen competition and productivity. In product markets, the main planks the implementation of the Services Directive and the development of more competitive network industries in individual countries. In labor markets, steps are being taken to foster greater labor utilization and productivity and the mobility of labor. Financial market reforms include measures to facilitate mergers and acquisitions, and implementing a range of initiatives aimed at harmonizing and integrating financial markets.

  • Japan: the authorities plan to advance structural reform to strengthen competition and enhance flexibility. This included additional steps to enhance labor mobility; facilitate inward foreign direct investment, including through reform of the tax treatment of mergers and acquisitions; broaden the application of deregulation already in force; reform and privatize some government-owned financial institutions; and further advance fiscal consolidation to sustain domestic confidence.

  • Saudi Arabia: the authorities intend to continue to increase spending on social and infrastructural investments in key areas, including expanding oil sector capacity. As these investment programs have a high import content, their execution would significantly reduce the current account surplus in the coming years.

  • United States: authorities plan to raise national saving through further fiscal consolidation over the medium term, including the achievement of a balanced unified federal budget by FY2012, accompanied by measures to reform the budget rocess and slow the rate of growth in health care costs; and measures to support private savings, as well as to enhance energy efficiency, strengthen capital market competitiveness, and ensure the United States remains an attractive environment for foreign investment.

  • Excellent stuff this. Read it to develop good understanding of the issues involved.


What is Sub-prime market? Some Basics

August 9, 2007

All problems in financial markets and economies are attributed to sub-prime mortgage markets.

To get a good understanding of what is this all about there is some good material. One is a speechby Bernanke and the other is a simple conceptual paper from St. Louis Fed.

There is another recent paper from IMF Staff which discusses whys and hows of sub-prime mortgage markets.  This paper could have been much simpler. It explains a lot of jargon used in housing markets but not convincingly though. Could have added a bit of graphs.

After a number of warning signs, the U.S. “subprime mortgage crisis” became a headline issue in February 2007. Notwithstanding the bankruptcy of numerous mortgage companies, historically high delinquencies and foreclosures, and a significant tightening in subprime lending standards, the impact thus far on core U.S. financial institutions has been limited. This paper reviews the history and structure of the subprime market. The results suggest that new origination and funding technology appear to have made the financial system more stable at the expense of undermining the effectiveness of consumer protection regulation. Potential solutions to the management of this trade-off are then explored.

Read on.

Assorted Links

August 9, 2007

1. WSJ Blog compares 2007 with 1998. In all measures we seem to be better off today except for US economy. It was better placed in 1998.

2. In US know-how about economics needs to be improved. Read the WSJ Blog posting.

3. WSJ Blog says European Central Banks won’t bail out the imprudent investors.

4. Mankiw explains some basics of international economics.

5. Financial Rounds has some interesting links. Lot of spelling mistakes which could have been avoided.

6. Free Exchange points out to an excellent article on how Kishore Biyani run stores (Big Bazaar etc) have built their success by mimicking the chaos and grime of traditional Indian markets.

7. TT Ram Mohan in ET says financial markets may be in a state of bother but economic conditions continue to be sound. Only time will tell.

8. Shankar Acharya in BS shares his piece of mind on current exchange rate problems.

9. Percy Mistry respondsto Shankar Acharya’s comments on MIFC.

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