See the link for all the nice graphs and links that are attached.
Stephanie Flanders | 12:20 UK time, Thursday, 23 December 2010
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"Whatever happens, we don't want to repeat the 30s." That has been the mantra of policy-makers since the financial crisis began. The last time the world had seen a banking crisis on this scale, the result had indeed been the Great Depression. But the reference point in thinking about the 1930s is always the horrendous experience of the US. We forget that in the UK, the Depression was not nearly as Great.
Nicolas Crafts and Peter Fearon remind us in the latest edition of the Oxford Review of Economic Policy that Britain's national output rose by 18% between 1929 and 1938. That's feeble. But in the US, output barely managed to grow at all (and the economy actually shrank, by more than 25%, between 1929 and 1933).
From p287 of the Oxford Review of Economic Policy, v26n3
From p287 of the Oxford Review of Economic Policy, v26n3
The 1930s were also a much worse time to hold US stocks: the value of the US stock market fell by nearly 40% over the decade. In the UK, share prices in 1938 were "only" 12% lower than in 1929.
Why this trip down Memory Lane? Because the most important reason the UK avoided a US-style fall in output in the early 1930s was that it avoided lasting deflation. In 1938, the UK price level was almost exactly where it had been in 1929; in the US, prices were more than 25% lower. And the main reason we prevented prices from falling is that we left the gold standard in September 1931, which caused a 25% fall in the value of the pound against the dollar.
In that crucial sense, Britain has indeed repeated the experience of the 1930s - and that is good news. The question now facing the Bank's monetary policy committee is whether they have done too good a job of avoiding America's fate in the 1930s, to the point where we risk a repeat of the 1970s instead.
The minutes of the last Monetary Policy Committee meeting, released yesterday, show that the Bank thinks the target measure of inflation, CPI, could well reach 4% in the next few months, and is likely to remain above 3% for the rest of 2011. If so, the governor would end the year having written a total of 13 letters to the chancellor.
As I've written many times in the past, the Bank has some decent explanations for the consistent overshoot. It's become known as the "Lemony Snicket" defence: a series of unfortunate events, like rising import prices and the switches in VAT.
Interestingly, we tend to talk in similar terms about the stagflation of the 1970s, which we always blame on an "external shock" in the form of the Opec oil price rise. In fact, as Spyros Andreopoulos points out in a recent paper for Morgan Stanley, the downturn in the global economy happened before the big oil price hike, not afterwards. And subsequent oil price rises, in the 1990s and after, didn't produce stagflation at all.
He thinks that stagflation in the 1970s was only partly due to Opec and other "unusual events". More important was a long period of loose US monetary policy, which the rest of the economy was forced to follow, at least until the 1971 collapse of the Bretton Woods system, which indirectly linked other countries to the dollar. On this view, it was loose US and global monetary policy that generated the conditions that allowed Opec to raise prices as high as it did. The Fed then loosened policy even further, in response to the oil price rise, thereby laying the ground for the Great Inflation.
There are important differences between now and then - not least, the fact that, outside of the UK, prices are flat and even falling in many of the largest economies. But you have to say the similarities are interesting. (I will have more to say about today's rise in commodity prices, and what it means for the advanced economies, in a future post.)
In the past two years the UK has applied the lessons it learned in the 1930s, and once again shown its capacity to devalue its way out of deflation. But we should probably also get clear what the lessons of the 1970s are - in case we start to repeat them as well.
The future: Even more imbalanced
Stephanie Flanders | 18:12 UK time, Tuesday, 21 December 2010
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The Bank of England's most consistently interesting economist had some bad news today for anyone worried about the problem of global imbalances. He thinks that those current-account imbalances are likely to get bigger, probably a lot bigger, in the next 10 to 20 years - and there may not be very much that anyone can do about it.
Andy Haldane, who runs the bank's financial stability division, has given some seminal speeches on the banking crisis over the past couple of years. In today's remarks at Chatham House he's branched out into international macroeconomics, to ask why global current-account deficits and surpluses grew so big in the lead-up to the crisis - and what is likely to happen to them in future.
His boss, Mervyn King has what you might call a keen interest in this issue. You'll remember that before last month's G20 summit in Seoul he warned that if the leaders didn't agree how to bring down these imbalances, "the next 12 months might be an even more difficult and dangerous period than the one we have been through." In the event, they agreed that they needed to agree, and that was about it. We'll probably see the same debate again next year, with China wanting a gradual path to lower Chinese savings rates and a stronger currency and America wanting more adjustment, more quickly.
The Seoul summit was disappointing, if not much of a surprise. But the message of Andy Haldane's speech is that even if the major economies were able to come with a "grand bargain" to resolve global imbalances, it might not make much of a difference.
Stepping back from the arguments in Seoul, he identifies some major long-term forces behind rising surpluses in the emerging market economies, and rising deficits in the West. Most of these trends will intensify in the next few decades - in other words, that the deficits and surpluses are going to get even bigger.
The speech is worth reading in full [311Kb PDF].
He starts by pointing out that the imbalances we have seen in the past few years are larger than any we have seen in the last 100 years, and they seem to have been driven by (a) more integrated global capital markets and (b) changes in national savings rates. The difference between what America invests as a nation, and what China and other emerging economies invest, is roughly the same as it always was. What's changed is that China and the rest are saving much more, and America and other deficit countries have been saving a bit less. With a more integrated global capital market, it's become easier for differences in national savings and investment rates to turn into different current-account positions.
Here's the question, as Haldane puts it: "Is the problem impatience in the West, or excessive patience in the East?" His answer is both - and neither.
Some say it is cultural differences: Asians have a "savings culture", maybe even a savings gene, whereas Americans have a deep cultural propensity to spend. But there isn’t much evidence of this. In one academic study, 68% of American students were willing to sacrifice a short-term pay-off, to get a larger long-term reward. The figure for Chinese students was 62%.
The two more important factors behind high Chinese savings rates are that Chinese companies retain profits, whereas American companies prefer to distribute them to shareholders, and Chinese households must save more of their income, to pay for their family's education, health and old age. As I pointed out in another post, the repressed Chinese financial system plays a big role here - giving companies no alternative way of raising funds to invest, and giving households such a bad return on their money, they have to save more and more of their income to keep up.
Switch to the US, and you can see that the American financial system has been all too efficient at getting financing to US companies - and US households - without anyone having to take the trouble to save. Housing equity withdrawal alone accounted for 4% of personal disposable income in the US in 2005, up from less than 2% in 2000. This rise was primarily due to poorer households getting greater access to finance: as Haldane says, "liberalisation fed impatience".
Intriguingly, Haldane thinks that rising income inequality in the US has also lowered the savings rate among poorer households, as families strive to "keep up with the Joneses". Among rich countries, it's striking that a higher level of income inequality seems to go with a larger current-account deficit. (see the chart below).
chart15_211210.jpg
All of this is very interesting, you might say, but does it tell us anything about the future? The answer is yes - but perhaps not in the way you think. In talk of a "grand bargain", the focus has been on the level of real exchange rates (particularly China's) and long-term structural reforms, for example, developing a social safety net and a health system in China, to encourage households to put less of their income aside. Those things could be helpful, but they sound like small beer, relative to the deeper global trends that have taken current-account imbalances to such highs.
On this analysis, sweeping structural reform of the Chinese financial system would probably help more - especially if it made it easier for funding to flow to companies, and reduced the incentive for them to hang on to every yuan they can. However, that would involve the Chinese giving up control over the banking system. The current leadership will find it a lot harder to do that than to build a Chinese NHS.
And... even if they did both, Haldane argues that the combined effects of global capital market integration and demographic change are likely to make global current-account imbalances bigger, not smaller, in the years ahead.
First, emerging market economies are likely to get richer in the next few decades, and as they get richer they are likely to expand their external balance sheet - that is, to acquire more foreign assets. Assuming (and it is a big assumption) that the G7 economies maintain roughly the same ratio of foreign assets to GDP, Haldane reckons that the Brics would catch up with the G7, on this measure, by around 2035. By 2050, over half of all G20 external assets would belong to the Brics, compared with around 9% today. The US share would fall from 28% to 12% (see the chart below).
chart18_211210.jpg
This may be an extreme case - for one thing, you'd expect the G7 countries to be increasing their stock of foreign assets, as a share of GDP, over this period (see my post from October). But, looking around the world, we are looking at a period of dramatic shifts in global financial power, and that could have some thorny consequences. As Haldane notes:
"If this path were to be even broadly followed, it would have implications for the scale of global imbalances, which will tend to rise as gross capital flows outpace GDP growth. It would have implications for financial stability, as the scale of gross capital surges (fuelling bubbles) and reversals (fuelling crises) increases. And it may also have implications for the dollar’s reserve currency status."
chart21_211210.jpg
Second, there's our old friend, demography. As the chart above shows, there will be a rising proportion of "prime savers" in developing countries for at least another 20 years, while the share in the advanced countries continues to go down. Other things equal, that means savings in rich countries will continue to fall, while savings in emerging countries keep going up. The forecast is that demographics alone could increase India's savings rate by 10 percentage points of GDP by 2050. By that point, China could account for half of all global savings - the US, a mere 5%. If things are not so equal - the retirement age goes up in rich countries, perhaps, or the emerging market economies develop their welfare systems - that could slow down these trends, but it's unlikely to reverse them.
So where does all this leave us? I think it leaves the world facing a very difficult choice in the next few years, and it's not whether and how to revalue the Chinese currency. If Haldane is right, we either have to learn to live with large current-account imbalances, and all the destabilising swings in capital flows that go with them - or we have to stop having a fully integrated global capital market. It may really be that simple.
