Global Financial Imbalances:The Role of the Financial Crisis

A. G. (Tassos) MalliarisMary Malliaris

LOYOLA UNIVERSITY CHICAGO

19th Multinational Finance ConferenceKrakow, Poland

June 24 -27, 2012

Focus of the Paper

• Trace Rapidly the Evolution of the Global Monetary System

• Emphasize the Persistence of Global Financial Imbalances

• Review the Global Financial Crisis• Explain How Financial Imbalances Contributed

to the Global Financial Crisis

Evolution of Global Monetary System

• Bretton Woods I

• Bretton Woods II

• Where Are We Now? A Need for Bretton Woods III ?

Bretton Woods I

• Why Was Bretton Woods Developed?

• Keynes’ Incompatibility Thesis: Cannot achieve Simultaneously and Automatically Without Coordination Free Trade, Flexible Exchange Rates, Free Capital Mobility and Global Full Employment

The Gold Standard Period

“It is characteristic of a freely convertible international standard that it throws themain burden of adjustment on the country which is the debtor position on theinternational balance of payments.”

Keynes, Post War Currency Policy, 1941, pp. 29-30

“An essential improvement in designing any international payments system requires transferring the onus of adjustment from the debtor to the creditor position. This transfer would substitute an expansionist, in place of acontractionist, pressure on world trade “

Keynes, Post War Currency Policy, 1941, pp. 29-30

1944 Bretton Woods Conference

• U.S. Major Creditor• Europe and Japan Are Devastated• Need to Grow Global Economy• Presence of Economic Imbalances• Keynes’ Estimate of $10 billion needed• Dexter White proposes $3 billion• Marshall Plan Over 4 Years: $13 billion

Bretton Woods 1947-1973

• Stabilized Global Economy

• Promoted Growth

• Created New Global Imbalances

• Core or Center (U.S.) vs. the Periphery (European and Asian Countries)

Collapse of Bretton Woods I

• US Unable to Cope with Global Imbalances

• French Conversion of Imbalances into Gold

• U.S. Inflationary Monetary and Fiscal Policies

• August 15, 1971 U.S. abandons Gold Convertibility

The Modern History of GoldNew York Gold Price Per Ounce

$0.00

$200.00

$400.00

$600.00

$800.00

$1,000.00

$1,200.00

1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Year

$/oz

*Non-Inflation adjusted prices

Current Price: $1622/oz

The Global Monetary System After 1973

• More Flexible Exchange Rates• Exchange Rate Volatility and Uncertainty• Accelerated Global Capital Mobility• Independent Monetary Policy• Several Currency Crises, leading to Banking

Crises and often to Real GDP Declines

Major Facts of Bretton Woods II

• Flexible Exchange Rates Do Not Resolve Global Imbalances

• Several Currency Crises, Leading to Banking Crises and often to Real GDP Declines

• Such Crises Expected to Occur in Emerging Nations

• The 2007-09 Unanticipated Global Financial Crisis in U.S. and EU

The Dollar-coaster

Crisis Dates By Country: 1870-2008

From: Jorda, Schularick, and Taylor 2011

Major Developments of BW II

• 1989: Japanese Stock Market Crash and Japan’s Lost Decade

• Formation of the EU and EMU: Creation of the Euro

• Collapse of Former Soviet Union and the Emergence of China

• Internet Bubble and Housing Bubble

Collapse of U.S. Trade Balances

Global Imbalances

Source: IMF World Economic Outlook 2010

Current Account Imbalances

Current account balance as a percentage of GDP, US, China, OECD and BRICs

Source: Economist Intelligence Unit, OECD, BEA-NIPA, State Administration of Foreign Exchange (China)

Review of Bretton Woods II

• 2003: Dooley, Folkerts-Laundau and Garber claim that Bretton Woods Is Revived

• Core: U.S. Dollar is Used as a Global Currency; Balance of Payments Deficits.

• Periphery: Export-led Growth Driven by an Undervalued Exchange Rate; Massive Accumulation of Reserves

• Can Such a System Be Maintained in the Long-run?

Inflation

1998-01-01

1999-01-01

2000-01-01

2001-01-01

2002-01-01

2003-01-01

2004-01-01

2005-01-01

2006-01-01

2007-01-01

2008-01-01

2009-01-01

2010-01-01

2011-01-01

2012-01-01-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

China and U.S. inflation (percent change from year ago)

U.S.China

Source: Federal Reserve

The Global Financial Crisis of 2007-09

• Started in September 2007 as a Subprime Mortgage Crisis with a $300 billion Potential Loss

• Developed into a Major Financial Crisis • The Role of Easy Domestic Monetary Policies• The Bernanke/Taylor Debate of Global Savings

Glut: Role of Global Imbalances• Aggressive Export Oriented Growth by China,

Japan and Germany

Global Dimension of the Crisis

What Theories Guide Us?

• Standard Neoclassical: Stable Markets Return to Equilibrium

• Minsky-Kindleberger: Booms and Busts

Global Imbalances

Foreign Holdings of U.S. Debt

Source: U.S. TreasuryData as of end of April 2012

Country Amount (billions)

China 1145.5

Japan 1066.1

Oil Exporters 252.4

Caribbean Banking Centers 247.0

Brazil 246.7

Taiwan 188.3

United Kingdom 154.2

Switzerland 151.1

Russia 146.8

Belgium 141.0

U.S. Wealth

Housing price appreciation vs. current account accumulation, 1996 – peak of housing market

Source: Economist Intelligence Unit, OECD, IMF, State Administration of Foreign Exchange (China), De Nederlandsche Bank, BEA. The area of each circle is proportional to 2008 GDP.

Taylor Rule

Asset Bubbles

The Crisis of the Euro

• While the U.S. is Assessing the Impact of Global Imbalances in Its Financial Crisis

• The EMU, viewed as a Bretton Woods System of a Smaller Scale, Experiences a Global Imbalances Crisis of its Own

Current Policies and Regulations

• Primarily National: US, EU, England, Japan, China, others

• The Emergence of the G20 as the Global Governance Group

• The Designation of the Global Economy Meeting as the Bi-Monthly Central Banks Monitoring Group

• The Reform and Expansion of the Financial Stability Board

Current Difficulties

• Global Imbalances Persist• Asset Bubbles in Equity, Bonds, Housing Burst

Causing Bank Failures • Sovereign Debt Crisis• Austerity vs. Growth with 4% inflation

Future Possible Scenarios

• Bretton Woods III: U.S., EU, An Asian Monetary Union?

• Continued Depreciation of the U.S. Dollar?• Domestic Consumption Led Growth vs. Export-

Oriented Growth?• Central Banks as Lenders of Last Resort• Importance of Hegemony: the Recycling of

Accumulated Reserves

Total Reserves

19711973

19751977

19791981

19831985

19871989

19911993

19951997

19992001

20032005

20072009

0.0000

50.0000

100.0000

150.0000

200.0000

250.0000

300.0000

350.0000

U.S. Gold reserves 1971-Present (billions USD)

Source: Federal Reserve, World Bank

Country Share of World GDP

Sources: Angeloni et al (2011)

Percentage shares of selected countries and areas in world GDP, 1870-2050 (at2005 exchange rates)