House of Paine

Self ejected ivy imp Summers slides out a global investment scam

he starts off 
with a very 
 usual trumpet flourish 

"three elements,
 flow of capital from emerging markets 
to industrial countries,
 huge accumulation of reserves,
 and expected negative returns on reserves 
constitute what might be called

 the capital flows paradox 

in the current world financial system"

 okay blah blah

but after 

asty  larry's jag -ed  into 
 this  old  oaken bucket

he's got ...a proposition to make ...

hows'bout
an imf  managed
 diversified high yield
   investment account system 
for emerging 
 chump nations ...?????

sound kool ???


sorta  like the bushrod's SSS 
GOON BOGGLE 
but for 
 third rate states runnin big trade 
                        surpluses  

====================================


 third rate states 
  excess  forex reserves are mounting  

its up to
           $ 2 trillion 
and growing like a foot blister in a marathon
                               by larry's count 

his ultimo pitch


"hey you guys need a better return ...."

a return more like what we get for our funds at harvard 


but who wil trust ya ..right???




sooo

give it all to the imf to invest for you 

as a trusty trustee 


oh  hell here's the whole piece:


------------------------------------
Introduction

It is a pleasure to be here 
at the Reserve Bank of India .....
 


 I want to focus on some implications 
- both positive and normative -
 of what is to me the most surprising development
 in the international financial system
 over the last half dozen years.

 That development is 
the large flow of capital 
from the world's most successful
 emerging markets 
to the traditional industrial countries,
 and the associated enormous buildup
 of reserves in the developing world.

 To my knowledge it was neither predictable
 nor predicted 
and the implications are large
 and have not yet fully been thought through

 


The Current Global Capital Flows Paradox

Three aspects of global financial flows
 stand out as being without precedent: 

First, the net flow of capital
 is substantially from developing countries
 and emerging markets 
towards the industrialized world
 and principally the United States
 as the world's greatest power
 is the world's greatest borrower

  It is apparent that the United States 
is an overwhelming absorber of global savings
 while the rest of the world 
is a supplier of global savings

 While the combined current account surpluses 
of Japan and the non-European industrialized countries
 represents about 35 percent of U.S.
 net international borrowing,
 the remainder is financed overwhelmingly 
by emerging markets and oil exporting countries.

 This broad pattern, 
which has been going on for several years now
 and on current projections 
will continue for quite some time,
 runs very much counter to the traditional idea
 that core countries export capital 
to an opportunity rich periphery. 

Second, the buildup in U.S. net foreign debt
 is substantially mirrored 
in reserve accumulation by emerging markets.
 While claims flow in many directions,
 it is noteworthy that a large fraction
 of the buildup in foreign claims 
is represented by reserve accumulation.

  




 applying
the so-called Guidotti-Greenspan rule 
that reserves should equal
 1 year's short term debt
  demonstrates the spectacular increase
 in what might be thought of as excess reserves
 in emerging markets.

These reserves have grown from 
half a trillion dollars in 1999
 to over two trillion dollars today


Third, 
expected real returns on these reserves
 are very low.

 Assuming constant real exchange rates,
 reserves will earn the expected real return
 on primarily dollar 
and secondarily euro fixed income assets.
 Indexed bond yields or comparisons of interest rates
 and forecasted inflation rates
 would make 2 percent a somewhat
 optimistic estimate of expected
 real returns in international terms.

 If real exchange rates 
in emerging markets are likely to appreciate
 then domestic returns will be even lower
 and more risky. 

-------------------------------------

the capital flows paradox 
in the current world financial system. 


While borrowing and consuming 
is functional
for the United States 
and reserve accumulating 
and exporting is perhaps functional
 for many other countries,

 the sustainability and the desirability
 of the capital flows paradox
 seems to me to require careful thought.



Unsustainable and Problematic Dependence
 of the United States on Foreign Capital. 

The American current account deficit
 is unprecedented in our economic history
 or that of other major economic powers

. Today, it is currently running at a rate 
approaching 7 percent of GDP.

 Barring some discontinuity, 
most knowledgeable observers 
expect it to increase.

 Imports substantially exceed exports,
 the dollar appreciated over the last year,
 the income elasticity of U.S. imports 
exceeds that of U.S. exports,
 and so forth. 

International debt accumulation
 at these rates cannot go on forever.2 

Moreover, most of the classic indicators
 for deciding how serious a current account deficit 
are worrying. 


First, 7 percent and growing 
is an unusually large deficit,
 as Figure 4 illustrates

 
Second,
the current account deficit 
is financing consumption
 rather than investment
 as the U.S. net national savings rate
 is now at a record low level 
of under 2 percent. 

Third,
 investment is tilted towards real estate 
and the non-traded goods sector
 rather than the traded goods sector 
and away from exportables. 


Fourth,
 the net flow of direct investment
 is out of the United States
 and the flow of incoming capital
 appears to be of shortening maturity 
and coming increasingly from official
 rather than private sources. 

This configuration,
 whatever its causes,
 raises obvious risks.
 There is the hard-landing risk.
 This is not just an American risk,
 but a global risk 
at a time when the U.S. external deficit
 is creating nearly an export stimulus demand
 approaching 2 percent of global GDP.

  it is hard not to imagine
 that there are geopolitical risks
 associated with reliance on
 what might be called
 a financial balance of terror
 to assure continued financial flows 
to the United States.

 Indeed, I was reminded about the geo-political issues
 that such dependence posed 
for the United States 
when I read recently about the effective 
American use of exchange rate diplomacy 
to force the hands of the British and French
 during the Suez crisis. 


the moment of maximum risk comes precisely
 when those concerned about sustainability
 lose confidence in their views 
as their warnings prove to have been premature 
and when rationalizations come to the forefront. 

 intangible investment as well as tangible investment
 in the United States has  declined
 even as our dependence on foreign capital
 has increased.

 Even if home bias is declining,
 there are surely limits on the tolerance 
of foreign investors for increased claims 
on the United States.
 And while arguments about "financial dark matter" 
or the U.S. ability to issue debt in its own currency
 probably have some force
 in thinking about what level of external debt 
is sustainable for the United States,
 they surely do not make the case
 for indefinite continued expansion of debt. 


U.S. Adjustment and the Global Economy

The massive absorption of global capital
 by the United States is 
of questionable sustainability
 and if sustainable,
 of dubious desirability.

 

 


one has to worry about getting 
what one wishes for 
in the form of a unilateral U.S. increase 
in national savings. 

There is one striking fact
 about the global economy 
that belies a dominantly American explanation
 for the pattern of global capital flows:
 real interest rates globally are low, not high.

 Whether one looks at index bond yields,
 measures of nominal interest rates 
relative to ongoing inflation,
 and yields on most assets, 
especially real estate or credit spreads,
 capital market pricing points
 to the supply of global capital
 tending to outstrip demand 
rather than vice versa.

real interest rates globally are low not high
 from a historical perspective.
 If the dominant impulse
 explaining global events 
was declining U.S. savings,
 one would expect abnormally high real interest rates,
 as with the twin deficits in the 1980s,
 not abnormally low real interest rates.

 America's consumption growth
 in substantial excess of income growth 
has been matched by substantial export 
led growth in the rest of the world. 

Imagine that somehow 
through some combination of U.S. policy adjustments,
 U.S. national savings 
were to substantially increase 
resulting in downwards pressure 
on U.S. interest rates and a sharp reduction 
in the U.S. current account deficit.

 The result would be a substantial
 contractionary impulse to the remainder 
of the global economy,
 an effect that would be magnified 
if other currencies appreciated 
against the dollar
 causing a switching of expenditure 
towards U.S. goods.

 Moreover, those countries seeking 
to peg their currencies as U.S. interest rates
 declined would have to further expand 
not just their reserves but their rate 
of reserve accumulation.

 An unwinding of global imbalances,
 if it is not to be recessionary 
for the global economy, 
thus requires compensatory actions 
in other parts of the world. 

What are these actions? 

As a matter of arithmetic,
 any reduction in the U.S. current account deficit 
must be matched by reductions 
in current account 
surpluses 
or increases elsewhere.

 If this simply takes place automatically 
as a consequence of reduced U.S. demand 
the result will be contractionary 
on a substantial scale.

After all, the U.S. current account deficit
 represents an impulse of close to 2 percent of GDP
 to global aggregate demand.

 What compensatory actions 
are appropriate? 
It is conventional to start such 
a discussion with the industrialized countries.
 their surpluses offset less 
than a quarter
 of the U.S. current account deficit. 

Japan at last appears to be recovering, 
though as is all too traditional,
 its growth appears to be export led.
 Unfortunately, given Japan's fiscal situation
 and the structural reality 
of an aging society and shrinking labor force
 it's not clear just how much scope 
there realistically is for a shift 
to domestic demand led growth. 

The situation in Europe 
is in some ways less clear.
 Some European policy makers
 have taken the position that since Europe 
is in approximate current account balance,
 it has no major role to play 
in the global current account adjustment process.

 They urge U.S. fiscal contraction
 as a means for reducing the U.S. deficit
 but do not see any European movement
 into deficit as part of the global adjustment process.

 I find this view implausible. 
As long as there are going to be 
substantial structural surpluses
 in the oil exporting countries, 
it is hard to see why Europe,
 which is even more dependent 
on imported oil than the United States
 should not be comfortable running
 at least a modest current account deficit.

 Moreover there is scope 
for both microeconomic policies 
that reduce regulator barriers
 and macroeconomic policies 
to increase aggregate demand. 

Without the gift of prescience
 regarding oil prices,
 it is harder to prescribe 
for the oil exporting countries. 

The accumulation 
of significant current account surpluses 
in the face of a transitory increase
 in the price of oil seems 
rational 
and appropriate.

 And the long experience 
of natural resource exporters,
 including the experiences
 of oil exporters during the 1970s,
 suggest the dangers of being 
too quick about assuming
 that price increases will be permanent.


 There is a likelihood 
that over the next several years
 either oil prices will come down
 or oil exporters' contribution
 to global aggregate demand will increase.

 But in prescribing a path 
for overall global adjustment,
 caution is surely in order here. 

The net surplus 
of emerging Asia led by China 
exceeds the combined surplus 
of Europe and Japan.

 And given the magnitude and attractiveness
 of investment opportunities in emerging Asia 
it would be natural for it
 to run a current account deficit.


 This suggests that the primary source
 of global demand to offset
 increases in United States savings
 should come from the Asian consumer.

 India is a positive example here.
 It is noteworthy that consumption represents 
close to two-thirds of GDP in India,
 and significantly under one half in China.

 I will return in a few minutes 
to the question of reserve accumulation 
and to the potential for shifting 
to a more domestic demand led growth strategy 
in emerging markets. 

In addition to the benefits 
for the global system 
that a domestic demand led strategy would bring
 I suspect a less export oriented strategy
 would also contribute to ultimate financial stability.

 Looking back, it seems relatively clear 
that Japanese economic policy
 could wisely have supported 
more consumption sooner 
and in the process avoided the bubbles
 in asset prices during the 1980s
 associated with preventing 
yen appreciation
 that created such havoc 
in their financial system. 

The rest of the world is probably
 not in a position to make large contributions
 to the global adjustment process.

 Healthier policy environments 
in Latin America and Africa 
would reduce capital flight,
 tend to increase private capital flows 
and lead to somewhat larger investment
 driven current account deficits.
 Given the current euphoria
 reflected in emerging market spreads,
 it would be a mistake for policy makers 
to cheer this process along too rapidly. 


The Opportunity Cost of Excess Global Reserves

So far I have argued first
 that the U.S. current account deficit
 is unsustainable and dangerous,
 and second that managing its decline 
will require substantial adjustments 
in other parts of the world 
if a recession is to be avoided. 

I want to return now to the question
 of official reserve accumulation 
of which I referred to earlier.

 It is striking to estimate
 the cost to developing countries 
of reserve holding 
that goes beyond 
what is necessary for financial stability.


 Even if we used a standard
 more rigorous than any 
that has been proposed 
and treated reserves in excess of
 twice short-term debt
 as unnecessary for insurance purposes,
 these reserves,
 represent almost $1.5 trillion
 and are growing at several hundred billion dollars 
per year
 while earning what is likely to be 
a zero real return 
measured in domestic terms. 


This represents a substantial cost.
 If the wealth tied up in reserves 
were invested either domestically
 in infrastructure 
or in a fully diversified 
long-term way in global capital markets,
 6 percent would not be 
an ambitious estimate 
of what could be earned.


 The resulting gain would be close 
to $100 billion a year.
 Aggregating the 10 leading holders
 of excess reserves,
 the opportunity cost of these reserves
 comes to 1.85 percent 
of their combined GDP. 

As Dani Rodrik has pointed out
, this is comparable to the gains 
thought to be achievable 
from the next round
 of trade liberalization,
 to global foreign aid,
 or to spending on key social sectors 
in a number of countries. 

This idea of an excess 
of low yielding reserves 
in the developing world represents 
a radical departure 
from the problems that we have
 traditionally focused on 
in thinking about
the international financial system. 

From the founding of the IMF 
to the creation of the SDR 
through discussions of expanded SDRs 
during the 1990s,

 the emphasis was on the need to find
 low cost ways of manufacturing insurance 
that reserves could provide capital 
importing developing nations.

It is a very different world 
when developing nations are accumulating reserves
 to finance the United States. 


Towards a Revised International Financial Architecture

The two new elements 
in the global financial constellation 
that I have been stressing 
- the U.S. current account deficits 
mirrored primarily by surpluses
 outside of the traditional industrialized nations,
 and the staggering accumulation 
of reserves by emerging market countries, 
both suggest the obsolescence of the G7/G8 
as the dominant forum 
for international financial discussion.

 It is neither in a position to discuss
 many of the most important domestic policy adjustments 
necessary for global stability
 nor does it include the largest official suppliers
 of cross border flows of capital.

 The G7/G8 finance ministers' process 
was started at a time when major issues
 of global demand and policy coordination 
involved only the industrial countries 
- when exchange rate policies 
were largely a matter of concern 
between industrial countries 
and when the only issues 
involving developing countries 
were periodic breakdowns 
in the flow of capital 
from rich country lenders 
to poorer country borrowers.

 None of these premises are currently met. 

Any attempt to manage jointly 
any increase in U.S. savings 
and an offsetting increase 
in global demand from global sources 
will clearly require a forum broader 
than the G7/G8. 

So also will any global attempt 
to think through the implications 
of the massive reserve accumulation 
on which I have commented. 

Just what process is right
 for addressing these issues 
is a delicate and sensitive political question
 involving aspects that I am no longer close to.

 There has been an explosion of financial fora 
involving emerging markets in recent years,
 including the APEC finance ministers, 
the Latin American finance ministers,
 the ASEAN finance ministers 
and most promisingly, the G20.

 It may well be the appropriate successor
 to the G7/G8, though I worry about 
just how much serious business will get done 
in a forum with 40 principals. 


What should not be in doubt 
is the importance of creating a forum 
that structurally has political clout 
over the international institutions 
and at least some ability 
to influence domestic policy decisions 
of individual countries.
 I would suggest three areas of focus
 in the next several years: 

First and most importantly,
 the formulation of a global strategy 
for managing the U.S. current account deficit
 downwards without excessive risk
 to global growth.

 I do not minimize the domestic difficulties 
in the United States here,
 nor am I falsely optimistic
 about the ability 
of any international forum 
to influence U.S. fiscal policy.

 Nonetheless I believe 
that much more frequent
 and intense discussions
 on a multilateral basis 
than have taken place to date 
will raise the prospects 
for a successful adjustment process 
and reduce the risks of either 
a hard landing or of dangerous unilateralist 
responses to current account imbalances.


 

Second, a new forum should look at
 the role and governance 
of the existing international financial institutions 
in the current environment.

 Clearly, the influence and governance 
of the major reserve accumulators 
need to be increased.

 More fundamentally,
 the IMF has always had as its raison d'�tre
 addressing imbalances,
 but its surveillance and indeed its lending 
has always been focused 
on those who are borrowing excessively.

 I used to quip that IMF stood for 
"It's Mostly Fiscal," 
though the fund's work in recent years 
has expanded much more broadly. 

But it must be acknowledged 
that the energy it devotes to current account deficits 
that need to be adjusted downwards 
dwarf the energy it addresses to current account surpluses
 that need to decline 
to facilitate smooth global adjustment 
or the energy it devotes to encouraging 
current account deficits 
where these can finance 
either consumption on attractive terms 
or productive investments. 

In a similar vein,
 the IMF has perhaps been too reluctant
 to criticize the exchange rate policies
 of its members.

 When exchange rates are overvalued, 
the IMF does not point it out publicly 
for fear of creating a panic.

 When exchange rates are undervalued,
 the IMF often does not see 
financial problems for the country 
in question and so does not raise an alarm. 


It has always struck me as ironic 
that the IMF, which is charged with maintaining 
the global financial system 
and therefore should be particularly focused 
on policy choices that affect multiple countries,
 is prepared to address domestic monetary 
and fiscal policy choices,
 which while they may have international ramifications
 are primarily of domestic concerns,

 but is so reticent about addressing
 exchange rate issues 
which by their very nature are multilateral.

 It is unlikely 
that the IMF will take on this role alone 
and so will very much need 
the encouragement of its major shareholders. 

Third, the group should take up 
the question of deploying the reserves
 of developing countries. 



the composition of currencies in which reserves are held
is obviously a sensitive subject for everyone,
 but as long as the ex ante 
returns on dollar assets and euro assets
 are relatively close together 
it may not be a matter
 of welfare significance. 

Of greater concern 
is the risk composition 
of the assets
 in which reserves are invested. 

When reserves were held at levels
 that represented self-insurance 
against possible financial crisis,
 the case for their investment 
in maximally liquid,
 maximally safe form was compelling

. When reserves are far greater 
there would seem to be a case 
for more aggressive investment
 either in support of imports 
that have a high social return 
or in a much richer menu 
of international assets. 

By investing in a global menu
 of assets U.S. institutions 
have earned substantial real returns 
over the years.

 Indeed the average large higher education 
U.S. endowment fund 
has earned a real return approaching
 10 percent over the last decade or two.

 It is natural to ask whether 
the excess national reserves 
of emerging markets should 
not be invested with an aspiration 
in this direction. 

If India, for example, 
were to follow this course, 
the result would be extra returns 
that would amount to between 1 and 1-1/2 percent
 of GDP each year. 

This figure, which dwarfs the seigniorage 
considerations that traditionally played
 so large a role in monetary theory,
 represents an amount greater than the Indian
 public sector spends on health care each year.


 Annuitized and valued as a stock, 
it is comparable to 40 percent of the market value
 of all the traded stocks 
on the Bombay Exchange.

 And India is not an extraordinary case.
 Reserves as a share of GDP 
are actually very substantially 
larger in China, in Taiwan, 
in Russia, and in Thailand than in India. 

In principle,
 decisions about reserve investment
 can be made domestically.

 But I suspect that there are at least
 two important roles 
for international discussion and coordination.

 There are important risks 
for any central bank 
that attempts to go in this direction. 

It is likely to reap much more disfavor
 in years where investments go badly 
than favor in years when investments
 go well.

 And the opportunities for mischief 
in picking assets,
 in exercising control rights,
 in misvaluing assets are likely 
to be very large. 

Some form of legitimated international scrutiny 
and monitoring of central bank reserve investments
 could help to overcome these problems. 

Perhaps it is time for
 the IMF and World Bank 
to think about how they can contribute
 to deploying the funds 
of major emerging markets 
rather than lending to major emerging markets.

 More ambitious than simply providing 
surveillance and monitoring 
that would support most ambitious investments
 by emerging markets
would be the creation of an international facility
 in which countries could invest 
their excess reserves 
without taking domestic political responsibility 
for the process of investment 
decision and ultimate result. 

If such a facility
 was able to attract even a limited fraction 
of excess reserves
 and to charge even a relatively modest fee
, the sums of money available
 to support the concessional 
and grant aspects of global development 
would be significant.

 For example, globalizing $500 billion
 at a fee of 100 basis points 
would produce $5 billion 
a year that could go towards global public goods,
 multilateral grant assistance 
or debt relief. 

There are many problems here.
 As we have found with state pension funds
 in the United States 
any large investor cannot completely
 escape political issues. 

There is the question of how central bank profit 
contributions to government budgets
 should be handled when returns vary.

 There are issues of assuring integrity.
 I don't minimize any of these difficulties,
 which might prove insuperable. 

But it is an irony of our times 
that the majority of the world's poorest people
 now live in countries 
with vast international financial reserves.

 The problem for these countries
 is not being supported 
in borrowing from abroad -

 and so it seems appropriate 
that some part of the focus 
of the international financial architecture 
move towards the challenge
 of deploying their large reserves 
as effectively as possible. 


Conclusion

Just as India's remarkable development
 over the last 15 years 
comes with both great opportunities 
and challenges,
 so too the dramatic changes
 in the pattern of global capital flows
 come with remarkable challenges and opportunities. 

I don't think any of us have the answers.
 I will have served my purpose today
 if I have induced you to reflect 
on the future of a global economy 
increasingly defined by a large flow 
of official lending from developing nations
 to the world's largest and richest economy. 

Thank you. 





Table 1. 

Excess Reserves Beyond Greenspan-Guidotti Rule Country Excess Reserves (millions of US$, Q3 2005)) Excess Reserves as a % of 2004 GDP 
China  724,080 41% 
Taiwan  210,134 69% 
Korea  136,711 18% 
Russia  118,154 20% 
India  107,703 15% 
Malaysia  58,613 50% 
Algeria  50,518 60% 
Mexico  47,083 7% 
Thailand  35,489 21% 
Saudi Arabia 73,897 29%