Silver Linings for a Golden Age

Kishore Mahbubani

17 September 2013

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SINGAPOREAre prospects for global stability and prosperity improving or deteriorating? With enlightenment and progress in some parts of the world accompanied by atavism and stagnation elsewhere, this is not an easy question. But we can gain greater purchase on it by considering three other questions.
The first is whether the United States will regain its standing as a source of moral leadership. Despite its flaws, America did provide such leadership, beginning at the end of World War II. But the terrorist attacks of September 11, 2001, changed everything.
Americans’ anger following the attacks drove them to support policies that they once would have considered inconceivable. In the name of the “global war on terror,” they have tolerated torture; accepted – and even endorsed – the illegal invasion of Iraq; and allowed innocent civilians to become collateral damage of mechanical drone strikes.
In order to restore America’s moral leadership, President Barack Obama must make good on his early rhetoricexemplified in his speeches in Istanbul and Cairo early in his presidency – which demonstrated genuine regard for the oppressed. In 2007, during his first presidential campaign, he wrote that America “can neither retreat from the world nor try to bully it into submission. We must lead the world, by deed and by example.”
But Obama cannot do it alone – and, so far, neither the American public nor the US Congress seems committed to reconnecting with its moral compass. It should be unacceptable, for example, for Congress to block the release of 86 Guantánamo Bay detainees cleared by a committee of national-security officials. Not even the revelations by former intelligence contractor Edward Snowden that no one is exempt from the possibility of US surveillance have stirred Americans to demand a new approach.
The answer to the second major question shaping the world’s future – whether China will regain its economic momentumalso appears to beno,” at least in the short term, with most experts agreeing that China’s export- and investment-led growth model has all but exhausted its potential. Indeed, China cannot continue to rely on manufacturing exports when its major sources of demand – the US and Europe – are struggling and its labor costs are rising.
Likewise, China’s government cannot continue to waste resources on economic-stimulus packages that have led to industrial overcapacity and skyrocketing local-government debt. And China cannot move toward a more market-oriented, efficient, and innovative economy with bloated state-owned enterprises blocking the way.
Whether China can develop and implement a viable new economic-growth model in post-crisis conditions depends on whether President Xi Jinping and Premier Li Keqiang can revive the legacy of their predecessors, Deng Xiaoping and Zhu Rongji. In other words, China’s future – and that of the global economydepends on how committed its leaders are to overcoming vested interests and pursuing comprehensive structural and policy reform.
While many in the West contend (and perhaps hope) that China will not succeed in transforming its economy, Xi and Li are acutely aware of the previous growth model’s unsustainability – and the challenges that changing it will entail. For example, in March, Li said that implementing the needed market reforms “will be very painful, and even feel like cutting one’s wrist.” And both Xi and Li have indicated the government’s willingness to tolerate slower GDP growth in the short term for the sake of building a stronger, more sustainable economy.
The final question is whether Europe and Japan will recover their “animal spirits.” Given Europe’s current malaise and the waning impact of so-calledAbenomics” in Japan, it is difficult to believe that their economies, which fueled global output growth for several decades, will regain their former stature. Indeed, Europeans and Japanese have largely given up hope of doing so.
Although European Union leaders have managed to keep the eurozone intact, they lack a long-term strategy to lift their economies out of the doldrums. The seriousness of Europe’s situation is reflected in growing acceptance of the high unemployment – and youth-unemployment rates of over 50% – that some EU countries, including Spain and Greece, now face.
Meanwhile, the first twoarrows” of Japanese Prime Minister Shinzo Abe’s economic programradical monetary-policy easing and increased government spendingseem to have given the country’s long-stagnant economy a lift. But the third and most important arrowstructural reform – has so far had little impact. And, after more than two decades of political turmoil and economic decline, the Japanese public has become skeptical of official promises of economic revival.
Fortunately, the US and Chinese economies are underpinned by societies that remain dynamic, vibrant, and hopeful. Young people in other parts of Asia, especially India and the ten ASEAN countries, are similarly optimisticas well they should be. Asia’s middle-class population is expected to experience explosive growth in the coming years, rising from 500 million people in 2010 to 1.75 billion in 2020.
Africa, with its population of one billion, is also gaining economic momentum, contributing further to the rapid expansion of the global middle class, which is expected to surge from 1.8 billion in 2010 to 3.2 billion in 2020 and to 4.9 billion peoplemore than half of the world’s population – in 2030.
Despite the massive challenges that countries like Syria, Somalia, Egypt, and Afghanistan currently face, and global challenges like food security and climate change, the world has reason to be hopeful about the future. Notwithstanding today’s tragic and terrifying headlines, we may be entering a new golden age of human history.
Kishore Mahbubani is Dean of the Lee Kuan Yew School of Public Policy at the National University of Singapore. He is the author of The Great Convergence: Asia, the West, and the Logic of One World.

BIS veteran says global credit excess worse than pre-Lehman

Extreme forms of credit excess across the world have reached or surpassed levels seen shortly before the Lehman crisis five years ago, the Bank for International Settlements has warned.

By Ambrose Evans-Pritchard

2:24PM BST 15 Sep 2013

An employee of Christie's auction house manoeuvres a Lehman Brothers corporate logo, which is estimated to sell for 1500 GBP and is featured in the sale of art owned by the collapsed investment bank Lehman Brothers
Global credit excess has reached or surpassed levels seen shortly before the Lehman crisis, says BIS Photo: Getty Images

The Swiss-based `bank of central banks said a hunt for yield was luring investors en masse into high-risk instruments, “a phenomenon reminiscent of exuberance prior to the global financial crisis”.

This is happening just as the US Federal Reserve prepares to wind down stimulus and starts to drain dollar liquidity from global markets, an inflexion point that is fraught with danger and could go badly wrong.

“This looks like to me like 2007 all over again, but even worse,” said William White, the BIS’s former chief economist, famous for flagging the wild behaviour in the debt markets before the global storm hit in 2008.

All the previous imbalances are still there. Total public and private debt levels are 30pc higher as a share of GDP in the advanced economies than they were then, and we have added a whole new problem with bubbles in emerging markets that are ending in a boom-bust cycle,” said Mr White, now chairman of the OECD’s Economic Development and Review Committee.

The BIS said in its quarterly review that the issuance of subordinated debt -- which leaves lenders exposed to bigger losses if things go wrong -- has jumped more than threefold over the last year to $52bn in Europe, and jumped tenfold to $22bn in the US.
The share of “leveraged loansused by the weakest borrowers in the syndicated loan market has jumped to an all-time high of 45pc, ten percentage points higher than the pre-crisis peak in 2007-2008.

Share of high risk leveraged loans now greater than 2007

The BIS said investors are snapping upcovenant-liteloans that offer little protection to creditors, as well as a form of hybrid capital for banks known as CoCos (contingent convertible capital instruments) that switch debt into equity if bank capital ratios fall too low. While CoCos help shield taxpayers from losses in a banking crisis by leaving private creditors with more of the risk, the recent appetite for such an instrument is also a warning sign.

The BIS said interbank credit to emerging markets has reached the “highest level on record” while the value of bonds issued in off-shore centres by private companies from China, Brazil and other developing nations exceeds total issuance by firms from rich economies for the first time, underscoring the sheer size of the debt build-up in Asia, Latin Africa, and the Mid-East.

Claudio Borio, the BIS research chief, said the ructions in emerging markets since the Fed turned hawkish in May is a warning to investors that they must tread with care. Global financial markets have reacted very strongly. If there were any doubts about the strength of international policy spillovers, they have now been put to rest,” he said.

How Bernanke signal has pushed up long term rates

Mr Borio said nobody knows how far global borrowing costs will rise as the Fed tightens or “how disorderly the process might be”.
“The challenge is to be prepared. This means being prudent, limiting leverage, and avoiding the temptation of believing that the market will remain liquid under stress, the illusion of liquidity,” he said.

The BIS enjoys great authority. It was the only major global body that clearly foresaw the global banking crisis, calling early for a change of policy at a time when others were being swept along by the euphoria of the era.

Mr White said the five years since Lehman have largely been wasted, leaving a global system that is even more unbalanced, and may be running out of lifelines. “The ultimate driver for the whole world is the US interest rate and as this goes up there will be fall-out for everybody. The trigger could be Fed tapering but there are a lot of things that can go wrong. I very am worried that Abenomics could go awry in Japan, and Europe remains exceedingly vulnerable to outside shocks.”

Mr White said the world has become addicted to easy money, with rates falling ever lower with each cycle and each crisis. There is little ammunition left if the system buckles again. “I don’t know what they will do: Abenomics for the world I suppose, but this is the last refuge of the scoundrel,” he said.

The BIS quietly scolded Bank of England Governor Mark Carney and his eurozone counterpart Mario Draghi, saying the attempt to useforward guidance” to hold down long-term rates by rhetoric alone had essentially failed. “There are limits as to how far good communications can steer markets. Those limits have become all too apparent,” said Mr Borio.

September 16, 2013

The Next Fed Chairman’s Global Clout



The U.S. Federal Reserve remains the most powerful central bank in the world. Its policy actions reverberate in every corner of the globe, something no other central bank can claim. Even the hint of a “taper” — the withdrawal of easy money policies — has roiled emerging markets. The prospect of rising interest rates in the United States has led investors to pull back from riskier investments in those countries. Emerging markets like Brazil, India and Indonesia are facing plunging currencies and declining stock markets.
Low interest rates in the United States had led investors to look to emerging markets for better returns on their money, fueling booms in equity and real estate markets as well as higher inflation in some countries. For the previous two years, emerging markets had been complaining about how these inflows fueled by cheap money in the United States caused their currencies to appreciate too rapidly, hurting their export competitiveness. The fact that those same currencies are now tumbling has led to the opposite complaint that the Fed should back off more slowly from its earlier policies and better communicate its intentions to financial markets.
Given the global impact of the Fed’s actions, the choice of a replacement for Ben Bernanke as chairman of the Federal Reserve is being watched with keen interest. No matter who is chosen, there are important changes in store for central banks and financial markets the world over.
Despite the global economic crisis, financial markets are now more closely connected than ever before. China, India and other major economies have continued removing restrictions to capital flows, opening up their markets to cross-border investment. Given this increased mobility, actions by any of the major central banks have effects well beyond their own national borders.
Moreover, in the aftermath of the crisis, central banks have become even more important to economic management, taking on much of the burden of controlling inflation, improving financial stability and promoting growth. This is a difficult balancing act in the best of times. It becomes virtually impossible when fiscal and other policies are working at cross-purposes.
In the United States, for instance, short-term fiscal tightening (along with the uncertainty associated with deficit and debt-ceiling negotiations that repeatedly go down to the wire) has hobbled the recovery. Meanwhile, little has been done to tackle the longer-term fiscal problems, especially entitlement spending. The focus on short-term austerity has limited productivity-enhancing expenditures in such areas as infrastructure and education.
In India, the government has been unwilling to undertake politically unpopular reforms to tackle large budget deficits and structural problems such as stifling labor-market regulations. This has left it to the makers of monetary policy to do all the heavy lifting. Other emerging markets face similar issues.
The reliance on central banks to make up for the failings of other policies has created inevitable international tensions. The right monetary policy for one country might not necessarily be what is good for another. Unlike fiscal policies, whose effects tend to stay mostly domestic, monetary policies do affect currency values and financial markets in other countries through cross-border financial flows.
Whoever takes over from Bernanke, the reality is that the Fed chairman has a mandate to focus only on domestic objectives. Fair enough: No central bank in the world has anything but domestic objectives in its mandate. But when the Fed acts, it matters to the world in a way that no other central bank’s actions do.
In a report by a committee of academics and former central bankers in which I participated, we argued that the Fed and a small group of central banks from both advanced and emerging market economies should hold regular meetings and issue a report on their monetary policy intentions. Even if this procedure only exposed mutual inconsistencies in policy, it would be a way to bring broader pressure on politicians to stop relying on the crutch of monetary policy and prod them to take politically unpopular measures to improve productivity and the prospects of long-term growth while making global capital flows more stable.
So who would the rest of the world vote for to head the most important central bank? Now that Lawrence Summers has withdrawn from the race, the presumptive front-runner is Janet Yellen. Many central bankers view her as someone who is empathetic to the spillover effects of U.S. policies, someone who has enough credibility to soothe financial markets and ably steer the Fed.
In any event, no matter who gets the job, what many of the world’s central bankers are hoping for is a Fed that can go back to the more modest objectives of maintaining low inflation and financial stability. On that, at least, there is certainly international agreement.

Eswar Prasad is a professor of economics at Cornell University and a senior fellow at the Brookings Institution. He is the co-author with M. Ayhan Kose of “Emerging Markets: Resilience and Growth Amid Global Turmoil.”

09/17/2013 11:34 AM

Going Nowhere

France Opts for Meek Reforms and Hope

By Mathieu von Rohr
Photo Gallery: France Puts Faith in Pseudo Reforms
French President François Hollande's announced reforms have either been delayed or watered down so much that they will do little to address his country's pressing problems. Fearing unrest, he prefers hope over hardship.

Only rarely in a Western democracy does the head of state call together the country's business leaders to charge them with tasks for the future and to jointly evoke their country's greatness.
Precisely this, though, is what happened last week at the Élysée Palace in Paris, where President François Hollande got a tour of what French technology currently has on offer. The president held a robot, cast an approving glance at 3-D printers and electric vehicles, and received a run-down on such innovations as fuel-efficient "two-liter" cars and electric airplanes.

The high point of the day was a film shown in the presence of the president and his industry minister, Arnaud Montebourg. The dramatic string strains of Vivaldi's "Summer" accompanied images of things France has invented and "given the world" in the past -- among them the steam locomotive, the automobile, radioactivity and, finally, the high-speed TGV train and the supersonic Concorde plane.
The fact that all these innovations lie in the past serves to highlight the country's real problem: Over the last decade, French industry has lost over 700,000 jobs. Now the government has unveiled a new plan to encourage growth in 34 selected industry sectors, with the aim of bringing about a "third industrial revolution."

However, since the French government doesn't have the money to fund these projects, it is relying primarily on private investment. The "new industrial France" of Hollande and Montebourg is not a governmental investment program of the type seen in the past, although France does want to take the lead on industrial policy-making once again. Last week's event also seemed driven by the hope that recollections of a glorious past will provide the country with the courage it needs to pursue a better future. And, since France is currently faring so poorly despite some tentative signs of recovery, a better future is certainly needed.

Pseudo Reforms

The weeks following the summer recess were widely expected to be a time for Hollande to set a new course. The announcement of a coming large-scale pension reform was meant to demonstrate that the president was capable of taking decisive action on a fundamental issue. But that reform, which has now been unveiled, has primarily demonstrated one thing: that Hollande doesn't believe in large-scale reform.

The pension reform didn't touch France's retirement age or the special rules that apply to government employees. Instead, both employees and employers are to pay more contributions, with the number of years of contributions required before qualifying for a full pension being raised to 43 by 2035.

Making more profound change would bring with it "the risk that many people would take to the streets, without the certainty that we would be able to see the reform through to the end," Hollande told Le Monde in justifying his decision.

Instead, Hollande prefers to make small changes, as was also evident in his reform of French labor laws this spring. Now, on the pension question, all sides have been left unsatisfied anyway, with strikes and demonstrations taking place in Paris last week. Still, at least the issue is unlikely to lead to nationwide unrest.

This, though, leaves the precarious financial state of the country's pension fund beyond 2020 still unresolved. "The pension non-reform is a decision with far-reaching consequences," writes economist Élie Cohen, who usually supports Hollande. "It confirms that the president has no interest in making structural reforms and marks the end of any attempts at reform until the end of his term in office."

When European Economic Affairs Commissioner Olli Rehn criticized the slow pace of the reforms last week, French Finance Minister Pierre Moscovici issued a clear response: It's simply not possible to go any faster, he said.

New Tax Increases and Fees

In order to meet the Maastricht criteria limiting budget deficits to 3 percent of GDP by 2015, France plans to cut government spending by €15 billion ($20 billion). But a fundamental -- and urgently needed -- restructuring of France's bloated public sector, with its convoluted levels of government, is still not in the cards.

The government did promise the French people a "tax pause," but the very phrase seems to suggest a short period of rest that would then naturally be followed by new tax increases and fees. And, indeed, it emerged last week that the government is planning new surcharges on electronic cigarettes, energy drinks and sweeteners, and there are widespread fears that taxes will continue to rise, as well. In a prime-time interview on Sunday night, Hollande was seeking to reassure his fellow countrymen by promising there would be no new taxes whatsoever.

Meanwhile, the president is holding on to hope that economic growth will finally return to his country. At the moment, however, projected growth for 2014 is not even 1 percent.

What remains is a feeling of stasis, a general bad mood -- and serious concerns about upcoming local and EU-level elections next year. Politicians and polling institutes fear the current situation in France may lead to record results for the right-wing populist National Front.

Translated from the German by Ella Ornstein

The Wisdom of Crisis Prevention

Mehmet Şimşek

17 September 2013

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ANKARARegardless of how differently governments may formulate policy, ensuring financial stability is their common responsibility. This calls for real and effective policy coordination and an overarching macro-prudential governance framework at both the domestic and international levels.
The simple truth is that the cost of preventing financial crises is much lower than the costs imposed by them after they erupt. After all, financial crises are directly linked to significant output declines and unemployment spikes; and, equally important, they often severely damage social cohesion.
Five years from its outbreak, the fallout from the financial crisis and recession triggered by the collapse of the US investment bank Lehman Brothers continues. In many advanced economies, real GDP remains lower than its pre-crisis level. Unemployment rates and budget deficits are higher, and public debt/GDP ratios are at record levels.
Macro-prudential policies are not a substitute for sound macroeconomic policies; nonetheless, they are essential to preventing large asset bubbles and distortions in financial markets, and thus to reducing the risk of adverse shocks to both markets and the real economy.
For example, Turkey’s 2001 financial crisis stemmed mainly from the lack of an effective regulatory and supervisory framework for the banking sector. The crisis led to a 30-percentage-point jump in the public-debt ratio. Real GDP contracted by 5.7%, and unemployment rose by 4.9 percentage points.
Since then, Turkey has focused on financial stability and structural reforms, which have strengthened economic performance and made the country more resilient to shocks. Indeed, Turkey did not have to spend a penny of taxpayers’ money on bank recapitalization or rehabilitation during the global financial crisis. But the cost of bank bailouts during Turkey’s self-inflicted crisis 12 years ago amounted to approximately 25% of GDP.
Thanks to Turkey’s strong fundamentals and macro-prudential framework in 2008, the global financial crisis has left no lasting impact on the Turkish economy. Recovery was rapid and strong, with real GDP growth averaging nearly 9% in 2010-2011. Turkey’s unemployment rate is currently at its lowest point in a decade, and the public-debt ratio is significantly below the pre-crisis level.
Turkey’s experience suggests that the design of a macro-prudential framework should take into account both domestic and international financial linkages. The international framework should, above all, capture the risks and spillover effects arising from systemically important financial institutions. The development and implementation of the Basel III banking standards are essential to introducing countercyclical capital buffers and additional loss absorbency for these institutions.
In terms of domestic measures, a country’s institutional architecture is a core element in ensuring financial stability and effective policy coordination and cooperation. Turkey has established a Financial Stability Committee to oversee effective and timely implementation of policies directly affecting the financial sector, and an Economy Coordination Board to monitor and evaluate issues concerning overall economic stability. Both bodies have served to enhance the operational design and implementation of macro-prudential policies.
For example, the inflation-targeting regime implemented by the Central Bank of Turkey has been revised to incorporate financial stability, and a new monetary-policy framework has been in effect since the end of 2010. Monetary policy is now drawing on a more comprehensive toolkit, such as the policy rate, the interest-rate corridor, required-reserve ratios, and the reserve-option mechanism.
Turkey’s Banking Regulation and Supervision Agency and other authorities have also adopted macro-prudential measures. In 2011, for example, the BRSA adopted a loan-to-value regulation on mortgages in order to limit rapid credit expansion stemming from growth in consumer loans. Earlier, in 2009, the BRSA adopted another important measure that barred households from borrowing in foreign currency, thus sparing them the effects of exchange-rate volatility.
Regarding the banking sector, stress tests have been applied since 2004, and a target capital-adequacy ratio of 12% has been maintained since 2006. Even during the crisis, banks’ capital-adequacy ratios were higher than the Basel II requirement of 8%, and their distribution of profits has been under the BRSA’s close supervision since 2008. As a result, ample reserve funds have been created on the banks’ balance sheets and return on equity has remained high.
Turkey has also amended its tax laws to penalize excessive external borrowing by non-financial firms and to introduce significant incentives aimed at encouraging long-term household savings.
Yet, despite these measures, the situation remains worrying. With the outbreak of the global crisis, major advanced economies employed unconventional monetary policies, leading to massive capital flows to emerging-market economies, which lowered borrowing costs and increased access to credit.
While emerging-market countries’ public-sector balance sheets are stronger than ever – with low deficits and debt accompanied by large foreign-currency reserveshousehold and corporate leverage have risen. This has increased the vulnerability of many emerging markets to a sharp reversal in capital flows.
This is particularly true of emerging countries that, like Turkey, have been running large current-account déficits. With Turkey’s external deficit equivalent to 6% of GDP, the authorities have adopted a macro-prudential framework that combines policies to reduce exchange-rate volatility in the very short term with measures to increase domestic savings and promote the real sector’s international competitiveness in the long run. It is a model that other emerging economies should consider as well.
Mehmet Şimşek is Minister of Finance of Turkey.