Brookings: Topics - Foreign Debt

If Europe Doesn't Stand Up After Cyprus

Carlo Bastasin — Wed, 20 Mar 2013 00:00:00 -0400

Editor's note: This article was originally published in Italian by Il Sole 24 Ore.

Like what happens to less intelligent creatures, there was also a sudden disavowel of paternityin the Cypriot mess. No one in Europe admits responsibility for the project of forced confiscation on all bank deposits, also the more modest ones. A proposal that, while necessary, will not survive to its temerity and is putting in danger the stability of the Euro area. On the other hand, the confusion about responsibilities is due to the unbalanced decision-making mechanism that has characterized the last years of the European crisis.

Facing an emergency, Berlin sets the political priorities; the Eurogroup decides the least tricky technical solution for the governments; the heads of state communicate the decisions to their citizens, attributing the responsibility to Brussels; finally the EU commission and the European Central Bank execute orders, at times sanctioning countries and almost always taking the blame.

The anti-European short circuit is assured because the level at which decisions are made is never at the level where democratic choice happens. In fact, the problems arise when a National Parliament meets, as happened yesterday in Cyprus. The citizens circle the Parliament and the parties accuse Brussels or Berlin, also hiding the national responsibilities.

Contrary to what is said, for example, the confiscation of Cypriot deposits is a national fiscal measure. It does not violate the insurance of balanced bank accounts in the EU, that spring into action when a bank fails. It is a tax that will be discussed at the European level and that is conditional on European support, but will be done at the national level. However, in a certain confusion of roles and in a certain mess of solutions it was easy for the government and the Cypriot Parliament to turn it down like an error committed entirely by others.

Clarifying to citizens the allocation of responsibilities between Cyprus and countries in the Euro area is difficult because the transparency of the European decision-making process is really poor: there exist no memos of the Eurogroup meetings, whose last leader was chosen because he was not very garrulous; the heads of government then agreed bilaterally over telephone; above all a true public confrontation does not exist, but there are 17 members and 17 borders.

The only common thing is the confusion of blame that, if it was not tragic, would be funny. Try to follow the thread: on Sunday, all accused the German minister Wolfgang Schaublre for the proposal of forced withdrawal. Schauble however claims that he is opposed, with the IMF, to withdraw on small Cypriot money savers. Berlin, in fact, unloads the responsibility on the government of Nicosia, that (for fear of a bank run) did not want high withdrawal on the rich. But it accuses also the EU Commission and the German member of the ECB, Joerg Asmussen, who had observed that a bank run was already happening and that they needed to freeze accounts. Cypriot president Anastasiades retorts that he was blackmailed by Berlin and by the ECB, which would have cut funds that keep the country's banks alive. The Commision denies having defined the proposal and finally the ECB denies directly and categorically: the blame is on the political negotiations held in Brussels. All the institutions, however - IMF, EU, ECB - are together on having had to put a limit of 10 billion on the assistance to Nicosia. Officially to not bring Cypriot public debt to over 140% of the GDP, but in reality to appease crediting governments and to limit their expenditure. Are you lost? You have reason to be.

But we are still far from having unraveled the tangle. Behind the negotiation with Cyprus, there are in fact others that are more complex. The most important regards relations with Russia which leads with around 20-25 billion Euros deposited in Cyprus, one of the most obscure financial markets in Europe. To not touch the small Cypriot depositors, there is a need to withdraw 15-16% of big deposits. But Moscow had just loaned 2.6 billion to Nicosia, which now, pushed by European partners, they have to withhold like a tax on Russian deposits.

The European relationship with Russia is based on big interests and huge suspicions. Berlin first wants to impose on Cyprus the closure of financial channels with Moscow. It is a negotation of such implications from having to be leader of leaders of government or of ministers abroad rather than financial ones. But Europe has no real common foreign policy, least of all in the Euro area. The result is that Cyprus will end up asking Moscow for help. Hypothetically, it could end by depending on Russia so much that it detaches from the Euro area, opening the gate to the first devastating exit of a country from the Euro. Yet a European political initiative was possible: a battle against off-shore finance would collect the consensus of the vast majority of European citizens and would be difficult for Cypriots, facing European support, defending the abuses of their banks. As is seen, whether in foreign policy or in institutional assets, denouncing the lack of European political unity is anything other than an appeal to abstract principles of a dated Europeanism. However the Cypriot crisis shows also that the will of Europeans to help themselves in exchange for common policy (for example the fight against money laundering) is exhausted and weak bringing into doubt also the solidarity that will be indispensable to constitute a bank union. That is the project with which is necessary to avoid, like in Cyprus, a banking crisis sinking a country. A project on which depends the survival of the Euro.

It is estimated that Cyprus has until June to choose to form a tie with Moscow or fail. A somewhat long time that may keep the Euro area in check and may also coerce it brutally to change its strategy one more time.

Authors

Carlo Bastasin

Publication: Il Sole 24 Ore

Image Source: © John Kolesidis / Reuters

Africa’s Odious Debts: How Foreign Loans and Capital Flight Bled a Continent

Mon, 19 Mar 2012 14:00:00 -0400

Event Information

March 19, 2012
2:00 PM - 3:30 PM EDT

Saul/Zilkha Rooms
The Brookings Institution
1775 Massachusetts Avenue, NW
Washington, DC 20036

New research indicates that trends in the misappropriation of foreign loans to African countries are even greater than previously projected. In fact, it is estimated that more than half of the money borrowed by African governments in recent decades was misdirected the same year, transferred in many cases to private accounts in offshore tax secrecy jurisdictions. In Africa’s Odious Debts: How Foreign Loans and Capital Flight Bled a Continent(Zed Books, 2011), Léonce Ndikumana and James K. Boyce reveal these intimate links between foreign loans and capital flight, exploring the human cost of fund transfers as well as mechanisms to promote more responsible international financial systems.

On March 19, the Africa Growth Initiative at Brookings hosted a discussion of the book, featuring co-author Léonce Ndikumana. He was joined by Hippolyte Fofack, a senior economist at The World Bank, and Raymond Baker, director of Global Financial Integrity, who provided a broader assessment of the consequences of capital flight as they apply to Africa’s economic growth. Visiting Fellow Osita Ogbu, former senior economic adviser to the president of Nigeria, moderated the discussion. Senior Fellow Mwangi S. Kimenyi, director of the Africa Growth Initiative, provided introductory remarks.

After the program, participants took audience questions.

Participants

Moderator

Panelists

Léonce Ndikumana

Andrew Glyn Professor of Economics, Department of Economics and Political Economy Research Institute (PERI)
University of Massachusetts at Amherst

Raymond Baker

Director
Global Financial Integrity

Hippolyte Fofack

Senior Economist
The World Bank

China's Currency Policy Explained

Arthur R. Kroeber — Wed, 07 Sep 2011 09:28:00 -0400

Arthur Kroeber expands upon a recent paper, answering questions about China's monetary policy on the valuation of the renminbi and the political issues this raises.

1. The Chinese currency, or renminbi (RMB) has been a contentious issue for the past several years. What is the root of the conflict for the United States and other countries?

The root of the conflict for the United States—and other countries—is complaints that China keeps the value of the RMB artificially low, boosting its exports and trade surplus at the expense of trading partners. Although the U.S. Treasury has repeatedly stopped short of labeling China a “currency manipulator” in its twice-yearly reports to Congress, it has consistently pressured China to allow the RMB to appreciate at a faster pace, and to let the currency fluctuate more freely in line with market forces. The International Monetary Fund, the World Bank and many economists have also argued for faster appreciation and a more flexible exchange rate policy. Partly in response to these pressures, but more because of domestic considerations, China has allowed the RMB to rise by about 25% against the U.S. dollar since mid-2005. Yet the pace of appreciation remains agonizingly slow for the U.S. and other countries in Europe and Latin America whose manufacturing sectors face increasing competition from low-priced Chinese goods.

2. What impact does exchange rate control have on the economy?

According to foreign observers, consistent intervention by China to keep its exchange rate substantially below the level the market would set is a price distortion that prevents international markets from functioning as well as they could. This price distortion also affects China’s own economy, by encouraging large-scale investment in export manufacturing, and discouraging investment in the domestic consumer market. Thus, it is in the interest both of China itself and the international economy as a whole for China to allow its exchange rate to rise more rapidly. However, Chinese policy makers do not agree with this view, and believe the managed exchange rate is broadly beneficial for economic development.

3. What is the Chinese view of their policies toward exchange rate control?

Chinese officials see the exchange rate—and prices and market mechanisms in general—as tools in a broader development strategy. The goal of this development strategy is not to create a market economy but to make China a rich and powerful modern country. Market mechanisms are simply means, not ends in themselves. Chinese leaders observe that all countries that have raised themselves from poverty to wealth in the industrial era, without exception, have done so through export-led growth. Thus, they manage the exchange rate to broadly favor exports, just as they manage other markets and prices in the domestic economy in order to meet development objectives such as the creation of basic industries and infrastructure.

Since they perceive that an export-led strategy is the only proven route to rich-country status, they view with profound suspicion arguments that rapid currency appreciation and markedly slower export growth are “in China’s interest.” And because China is an independent geopolitical power, it is fully able to resist international pressure to change its exchange rate policy.

4. What are some misconceptions about China’s large-scale reserve holdings and investments in U.S. Treasury Bonds, specifically the idea that China is “America’s banker?”

Because China’s central bank is the single biggest foreign holder of U.S. government debt, it is often said that China is “America’s banker,” and that, if it wanted to, it could undermine the U.S. economy by selling all of its dollar holdings, thereby causing a collapse of the U.S. dollar and perhaps the U.S. economy. These fears are misguided. China is not in any practical sense “America’s banker.” China holds just 8% of outstanding US Treasury debt; American individuals and institutions hold 69%. China holds just 1% of all US financial assets (including corporate bonds and equities); US investors hold 87%. Chinese commercial banks lend almost nothing to American firms and consumers – the large majority of that finance comes from American banks. America’s banker is America, not China.
It is more apt to think of China as a depositor at the “Bank of the United States:” its treasury bond holdings are super-safe, liquid holdings that can be easily redeemed at short notice, just like bank deposits. Far from holding the United States hostage, China is a hostage of the United States, since it has little ability to move those deposits elsewhere (no other bank in the world is big enough).

5. What are the implications for U.S. policy and how should policymakers react?

China’s exchange-rate policy is deeply linked to long-term development goals and there is very little that the United States, or any other outside actor, can do to influence this policy. Also, the same suspicion of market forces that leads Beijing to pursue an export-led growth policy generating large foreign reserve holdings also means that Beijing is unlikely to be willing to permit the financial market opening required to make the RMB a serious rival to the dollar as an international reserve currency.

In substantive terms, there is little to be gained from high-profile pressure on China to accelerate the pace of RMB appreciation, since the United States possesses no leverage which can be plausibly brought to bear. U.S. policy should therefore de-emphasize the exchange rate, and instead focus on keeping the pressure on China to maintain and expand market access for American firms in the domestic Chinese market, which in principle is provided for under the terms of China’s accession to the World Trade Organization.

Authors

Arthur R. Kroeber

Image Source: Â© Petar Kujundzic / Reuters

An International Financial System Adrift and Imperiled

Lex Rieffel — Fri, 12 Aug 2011 13:36:00 -0400

"None of the mature democracies in the world have come close to a sovereign default in the Bretton Woods era." —From Restructuring Sovereign Debt: The Case for Ad Hoc Machinery (Brookings Institution Press, 2003)

What was true then is not true now, and the world is worse off because of it.

In the primer on sovereign debt restructuring that I wrote eight years ago, I gave three reasons for why mature democracies had become immune to default: they had deep domestic capital markets (allowing them to sell bonds denominated in their own currency to foreigners); they had political systems that facilitate smooth transitions from one government to another; and they had an abiding nation-wide commitment to macroeconomic stability.

The first two reasons remain valid, but two elements of the essential commitment to macroeconomic stability have been lost since the Global Financial Crisis in 2007-08: monetary discipline and fiscal discipline. Monetary discipline assures households and businesses that their savings and investments will not be wiped out by inflation. Fiscal discipline avoids a debt build-up that will become burdensome to future generations. The mature democracies in Europe, the United States, and Japan have largely succeeded in suppressing inflation, but they have allowed their public sector debt to balloon to unsustainable levels.

Clearly, they knew better. When the European Union started down the path toward monetary union in 1992, the member countries committed to keeping their annual budget deficits below 3 percent of GDP and their stock of public sector debt below 60 percent of GDP. If the mature democracies had respected these limits, they would not be in the fiscal pickle they are today.

There is no simple explanation for why the mature democracies went off the fiscal rails. In some countries, aging populations could be the main cause. In others, extreme polarization of political opinion seems to have eroded the necessary social consensus. Perhaps the war on terrorism threw the whole global economy off-kilter. Or maybe the core problem was an international monetary system that allowed emerging market countries to maintain undervalued currencies. This undervaluation, combined with sharply lower barriers to international trade and investment, may have led to shrinking employment in the manufacturing sectors of the mature democracies, which could not be offset fast enough by new jobs in the service sectors.

Regardless of the causes, it looks as though it will take years -- if not a generation -- for the mature democracies to achieve and sustain the budget surpluses required to bring public sector debt back to comfortable levels.

Still, this dismal outlook might not be the worst consequence of the debt crises in the U.S. and Europe. A greater concern could be that the world is just a small step away from not having a “risk-free” financial asset, leaving global markets adrift like a sailboat in the ocean that lost its keel.

Arguably, the health of the international financial system depends on the quality of its single most important product, the U.S. Treasury bond. While understanding that all financial assets have some risk, for decades market participants have viewed U.S. Treasury bonds as being “risk free” because no other financial asset appeared less likely to experience a default. All other bonds are issued in primary markets and traded in secondary markets at a premium (the “spread”) to U.S. Treasury bonds, which reflects the market’s perception of their greater risk of default.

If markets instead believe that the risk of default on U.S. bonds will rise and fall with the political and economic winds of the day—as it does with corporate bonds or emerging market bonds—then the impact will be debilitating for households and businesses around the world. In particular, both domestic and international investment will be depressed and as a result trade will languish and fewer jobs will be created. The loss of global GDP could be in hundreds of billions of dollars every year until fiscal discipline is restored in the mature economies.

Can rising powers like China and India provide an alternative risk-free asset? No they cannot. They may score well on their commitment to macroeconomic stability, but it is likely to take more than one generation for them to have deep capital markets and smooth political successions comparable to what the mature democracies have today.

It is impossible to put a value on preserving the role of U.S. Treasury bonds as the world’s benchmark risk-free asset — or their close rival Euro bonds. If the political leaders in the United States and Europe cannot do a better job of restoring confidence in their sovereign debt, then our children and grandchildren will suffer the consequences.

Authors

Lex Rieffel

Image Source: Â© Brendan McDermid / Reuters

Debt Buybacks and Backdoor Restructurings: Can Greece Pull an Ecuador?

Eduardo Levy-Yeyati — Fri, 29 Jul 2011 16:16:00 -0400

The latest European package includes, as a way to lighten Greece´s heavy debt burden, a debt buyback: the European Financial Stability Facility (EFSF) would lend the money for Greece to buy back its own bonds in the secondary market at a discount, imposing a loss on private creditors while avoiding an outright default.

There are, of course, Latin American precedents to this initiative: many casualty countries from the debt crises in the 80s conducted similar debt buybacks in the late 80s. Bolivia’s 1988 buyback of 46% of its defaulted sovereign debt, an operation funded by international donors, is a well researched example, which spanned a body of academic literature that concluded that, unless they were conditioned ex ante to significant concessions by participating debt holders, buyback would accrue mostly to creditors at the expense of the debtor –or, for that matter, the funding donors.

But the most relevant Latin American episode is more recent and less well known: Ecuador 2008, perhaps the first opportunistic default (that is, one triggered by unwillingness rather than inability to pay) in modern economic history. A widely foretold affair (debt repudiation was part of President Rafael Correa´s 2006 presidential platform), Ecuador used the default threat to depress bond prices in the secondary market, only to buy them back at bargain prices through the back door. The task was outsourced to Banco del Pacifico, which purchased the soon-to-be-defaulted Ecuadorian paper at prices above 20 cents on the dollar. When, after default was declared in December 2008, Ecuador launched an inverse auction for the defaulted papers, with the outstanding debt largely in friendly hands and the remaining bondholders forced to liquidate their positions to meet the massive post-Lehman Brothers withdrawals, the operation was a stunning success.

For the European case, Ecuador offers an obvious lesson: the crucial part played by the imminence of a default. Indeed, almost two years toying with the a potential default (which included a much publicized commission to evaluate the “legality” of the bonds, along the lines of the odious debt arguments) were not enough to induce a deep discount: Correa needed to move all the way to a credit event in December 2008 to purchase the bonds at fire sale prices. Panic (both due to Ecuador´s default and to the global crisis) was key for the success of the buyback.

Only a credible default ensures that the private sector takes a real hit. To see the “default matters” rule in practice, compare the market-friendly Uruguayan exchange in 2003 with the market-unfriendly Argentine restructuring in 2005. The first one reaped no nominal haircuts and only a minor debt relief; the second, nominal haircuts above 50%.

Moreover, markets do not seem to matter. As early as in late 2006, right before the government intervened the Bureau of Statistics and started tampering with the CPI used to index a big chunk of sovereign debt (in what markets interpreted as a implicit default), Argentine spreads were close to those of Brazil. And even opportunistic Ecuador, blessed by the 2009 recovery in oil prices, could have returned to the voluntary markets shortly after the exchange.

The same default rule, incidentally, seems to apply to the voluntary private sector involvement embedded in the latest Greek package (if the commitment by 30 financial institutions listed in a recent IIF document eventually materializes), which would deliver a Brady-style exchange into 15 or 30 low-coupon par bonds (with principal guaranteed by AAA-EFSF paper) or high-coupon 20% discount bonds –offering a meager debt relief that nonetheless would trigger, as in 2001 in Argentina, a selective default rating.

All this begs the question: Can Greece pull an Ecuador, by convincing markets to sell their bonds at a loss for fear of a default? Probably not. Because a credible offer from euro zone partners to fund the buyback of all Greek debt would eliminate the Greek premium (bailing out private investors in full), a buyback can only succeed (in the sense of sharing the losses with private creditors) if Greece can persuade the market that it is the last chance before a unilateral debt restructuring. In other words, from an ex ante perspective, a successful buyback can only be the preamble to default.

The underlying logic is simple. Small purchases at current panic prices are possible but remain a marginal effort that would not bring a substantive debt relief. By contrast, large purchases would drive secondary prices up making the whole operation unreasonably expensive. And the opaque Ecuadorian methods are out of the question, both because they are illegal and because a transaction of this size could be hardly disguised or outsourced.

Could the EFSF, instead, openly emulate Banco del Pacifico by funding the buyback of Greek paper up to a given threshold price? Again, the perspective is not encouraging. If the threshold is set low to get a good discount, then the stock of debt retired would likely be small, as the buyback facility simply limits the downside risk while preserving the upside risk, thereby creating incentives to hold to the bonds (a perverse effect that could be mitigated by opening the facility for a limited time –although a promise of this kind would hardly be credible in the current context). By contrast, if the threshold is set high to bring bond prices to more civilized levels, purchases will be realized at moderate haircuts, getting dangerously closer to a bondholder bailout.

The premise that only a true default can bring true debt relief to a country remains unchallenged. Ultimately, it appears that only a euro zone rescue (through permanent cash transfers or financial risk sharing, as in a true fiscal union) could avoid a Greek default.

Authors

Eduardo Levy-Yeyati

Debt Burden in Advanced Economies Now a Global Threat

Mengjie Ding and Eswar Prasad — Thu, 28 Jul 2011 15:16:00 -0400

Editor's Note: In this article, Eswar Prasad and Mengjie Ding discuss their in-depth analysis of the global debt burden. The Financial Times has produced an interactive online feature (free registration required) that shows the burden of public debt in countries around the world based on their research.

Our analysis paints a sobering picture of worsening public debt dynamics and a sharply rising debt burden in advanced economies. These rising debt levels combined with heightened concerns about fiscal solvency now constitute a major threat to global financial stability.

Recent events in Greece, Ireland, Portugal and other economies on the periphery of the eurozone show the risks of debt buildups that are not tackled. Bond investors can quickly turn against a vulnerable country with high debt levels, leaving the country little breathing room to balance its fiscal books and precipitating a crisis.

Overall, IMF’s latest Fiscal Monitor (FM, April 2011 and June 2011 Update) and World Economic Outlook (WEO, April 2011 and June 2011 Update) show that the level of aggregate net government debt in the world rose from $21,900bn in 2007 to an expected $34,400bn in 2011. IMF forecasts indicate the level will reach $48,100bn in 2016. The ratio of world net debt to world GDP rose from 42 percent in 2007 to 57 percent in 2011, and is expected to hit 58 percent in 2016.

Over the past year, there has been a modest improvement in the forecasts for U.S. debt levels relative to earlier forecasts thanks to stronger revenues and lower spending levels than expected. If the U.S. recovery remains weak and employment growth stalls, some of this apparent improvement may be reversed. Japan’s debt ratio is expected to worsen as a result of tepid output growth and the reconstruction costs following the earthquake and tsunami. Lack of growth has also worsened the debt positions of peripheral European economies.

Advanced economies account for the bulk of the increase in global public debt since 2007, both in absolute levels and relative to GDP. (See Figure 1 and Summary Table - pdf)

Aggregate debt of advanced economies will increase from $18,100bn in 2007 to $29,500bn in 2011, and is expected to rise to $41,300bn in 2016. The corresponding numbers for emerging market economies are $3,800bn, $4,900bn and $6,700bn, respectively.

The ratio of aggregate debt to aggregate GDP for advanced economies will rise from 46 percent in 2007 to 70 percent in 2011 and further to 80 percent in 2016. The corresponding ratios for emerging market economies are 28 percent, 26 percent and 21 percent, respectively.*

There is also a stark contrast between advanced economies and emerging market economies in their relative contributions to growth in world debt versus growth in world GDP. Emerging market economies contribute far more to growth in global GDP than to the growth in global public debt.

In 2007, emerging market economies accounted for 25 percent of world GDP and 17 percent of world debt. By 2016, they are expected to produce 38 percent of world output and account for just 14 percent of world debt. (See Figure 2-3 - pdf)

Emerging market economies account for 9 percent of the increase in global debt levels from 2007 to 2011 and are expected to account for 13 percent of the increase from 2011 to 2016. By contrast, their contributions to increases in global GDP over these two periods are 66 percent and 56 percent, respectively. (See Figure 4-5 - pdf)

The United States contributes 37 percent of the increase in global debt from 2007 to 2011 and 40 percent from 2011 to 2016. Its contributions to global GDP over those two periods are 8 percent and 18 percent, respectively. (See Figure 6 - pdf)

Another way to understand the burden of public debt is to examine the level of debt per capita. Richer economies can of course afford more debt but this is still an instructive calculation as it highlights the growing gulf between advanced economies and emerging markets. (See Figure 7 and Summary Table - pdf)

The average per capita debt in advanced economies is $29,600 in 2011 and is expected to be $40,400 in 2016. The burden of debt for U.S. citizens is $34,200 in 2011 and will rise to $49,100 by 2016. The debt burden for Japanese citizens will hit $85,000 in 2016, the highest level in the world.

Average per capita debt for emerging markets is predicted to rise gradually to $1,500 in 2016, far lower than advanced economy levels. In 2016, the debt burden will be $800 for China and $1,300 for India.

There is an even sharper contrast between advanced economies and emerging markets when we calculate the debt burden of the working-age population (ages 15-64). (See Figure 8 and Summary Table - pdf)

Among advanced economies, the average debt per working-age person will more than double from $27,600 in 2007 to $62,000 in 2016. Japan tops all countries and the United States will move into the third spot by 2016. U.S. debt per working-age person goes from $29,000 in 2007 to $73,300 in 2016. For Japan, it more than triples from $42,700 in 2007 to $140,300 in 2016.

For emerging markets, average debt-per working-age person rises to $2,200 in 2016, a level far lower than that of the advanced economies. For China, this measure of the debt burden will be $1,100 in 2016.

The path to reducing vulnerable debt levels is not an easy one. Advanced economy governments need to strike a delicate balance between supporting weak recoveries while laying out a clear strategy for bringing down their deficit and debt levels once growth picks up.

In the United States, this balancing act is complicated by the debt ceiling negotiations. U.S. politicians are playing with fire if they feel that their brinksmanship will have no major repercussions. The U.S. is large, special and central to global finance but the tolerance of bond investors surely has its limits. The debt ceiling negotiations are an opportunity for fundamental fiscal reforms rather than tinkering at the margin. If the government doesn’t rise to the challenge, the consequences could be dire—financial turmoil, a more sluggish recovery, and weaker long-term growth prospects.

Advanced economies need to learn the lessons of fiscal discipline that for so long they preached to the emerging markets.

List of Figures and Technical Notes (pdf)

Figure 1. World Government Debt
This figure shows the level of aggregate debt and aggregate debt-to-GDP ratios from 2006 to 2016

Figures 2-3. Global Distribution of Debt and GDP
This figure shows the global distribution of sovereign debt and GDP among major countries and country groups for 2007, 2011 and 2016

Figures 4-5. Contributions to Changes in World Debt and GDP
This figure shows the contributions to changes in aggregate sovereign debt and GDP among major countries and country groups from 2007 to 2011 and from 2011 to 2016

Figure 6. Cross-Country Comparison of Net Debt to GDP ratios
This figure shows country-specific data on net debt to GDP ratios for major economies in 2007, 2011 and 2016

Figure 7. Cross-Country Comparisons of Net Debt Per Capita
This figure shows country-specific data on ratios of net debt to population for major economies in 2007, 2011 and 2016

Figure 8. Cross-Country Comparisons of Net Debt Per Working-Age Person
This figure shows country-specific data on ratios of net debt to working-age population in the 15-64 age range for major economies in 2007, 2011 and 2016

Debt burdens of G-20 Member Countries

Summary Table

Technical Notes

* A note of caution on reported debt levels of emerging markets: in China, for instance, financial liabilities of provincial governments and contingent liabilities such as nonperforming assets held by the state-owned banking system imply a higher value of government debt obligations than suggested by official statistics. Of course, as the recent crisis has shown, advanced economy governments have similar implicit contingent liabilities if their big banks were to run aground or their public pension systems were to run out of money.

Authors

Mengjie Ding
Eswar Prasad

Publication: Financial Times

Image Source: Â© Kim Kyung Hoon / Reuters

Small Economies, Big Problems, and Global Interdependence: Greece and the World Economy

Kemal Derviş — Tue, 19 Jul 2011 11:56:00 -0400

Greece’s GDP, at about $300 billion, represents approximately 0.5% of world output. Its $470 billion public debt is very large relative to the Greek economy’s size, but less than 1% of global debt – and less than half is held by private banks (mainly Greek). Barclays Capital estimates that only a few globally significant foreign banks hold close to 10% of their Tier 1 capital in Greek government bonds, with the majority holding much less.

So, at least on paper, Greece should not be a systemically important economy. Yet there are several reasons why the Greek crisis is having substantial spillover effects. Moreover, Greece is not alone in this respect.

First, in the Greek case, there is the fear of contagion to other distressed European economies, such as Portugal and Ireland, or even Spain and Italy. There are also substantial investments by American money-market funds in instruments issued by some of the exposed banks.

Then there are various derivatives, such as credit-default swaps, through which banks holding Greek debt have insured themselves against non-payment. If CDSs are concentrated in particular financial institutions, these institutions could be at risk – more so than the primary purchasers of Greek debt themselves. But no one knows who is holding how much of these derivatives, or whether they reduce or magnify the risk, because CDSs are not transparently traded on open exchanges.

Finally, Greece’s difficulties imply problems for managing the euro, as well as possible disorderly behavior in foreign-exchange markets, which threaten to augment uncertainty and negatively influence the already-weakening global recovery. Clearly, the world economy has a large stake in Greece’s recovery.

In the same vein, consider a completely different case, that of Yemen. Greece and Yemen have no relevant similarities, except the contrast between their size and possible spillover effects. Yemen’s GDP is only 10% the size of Greece’s, representing 0.05% of global output, and its economy is not significantly linked to the international financial system.

But Yemen’s population is close to that of Saudi Arabia, and its border is very hard to control. Chaos in Yemen, coupled with the growing strength of extremists, could seriously destabilize Saudi Arabia and threaten oil production. In that case, the price of oil could shoot up to $150 a barrel or more, dealing a heavy blow to the global economy.

One can find other examples of this kind. Recall that the 1997 Asian crisis started in Thailand – again, not a large economy. The strong trade, financial, and natural-resource-related interconnections that have developed in the world economy turn many otherwise small countries, or problems, into global systemic risks.

The implications for global economic governance need to be understood and addressed. At the Seoul G-20 summit in November 2010, the assembled leaders encouraged the International Monetary Fund to work with the Financial Stability Forum to develop an early-warning system for global financial risks, and to analyze spillover effects on “large economies” (China, the United States, the United Kingdom, Japan, and the eurozone).

The spillover reports are currently being discussed by the IMF’s board. A synthetic report by the Fund’s Managing Director is to be presented to the International Monetary and Financial Committee when officials from the IMF’s member states meet in September.

This step, if pursued seriously, would enable a deeper analysis of interdependence in the world economy. It could also increase the IMF’s legitimacy as an institution that is global not only in its membership, but also in its treatment of different types of members. So long as the IMF’s macroeconomic surveillance was in fact applied only to developing countries, with the G-7 and other rich countries evading a serious monitoring process, the Fund could not be perceived as fair and impartial.

As these examples indicate, however, systemic importance is not just a question of size. What matters is the interconnections that link a particular country, institution, or group of institutions (for example, Lehman Brothers and AIG) to the wider world economy.

Surveillance of systemic risk must proactively test and analyze these interconnections, and try to imagine the “hard to imagine.” After all, as we now know only too well, systemic risk can emerge in unexpected places.

Interdependence has become much more complex than it was even a decade ago. The IMF needs to be empowered to analyze the macroeconomic and macro-financial risks that have emerged, establish an early-warning system, and propose possible preemptive policy measures. The Fund’s almost universal membership and its staff’s technical expertise should enable it to carry out effective multilateral surveillance, provided that it accelerates its own governance reforms, so that surveillance is perceived as being in everyone’s interest.

Authors

Kemal Derviş

Publication: Project Syndicate

Image Source: Â© John Kolesidis / Reuters

Rebalancing the U.S.-China Relationship

Grace Gu and Eswar Prasad — Mon, 17 Jan 2011 10:16:00 -0500

China has become the world’s second largest economy, the main driver of global growth and an increasingly assertive economic power. The U.S. is by far the world’s largest economy and one of the richest. Even as their GDP levels gradually converge, a huge gulf remains between China and the U.S. in terms of their per capita incomes and their levels of institutional and financial development.

Nevertheless, China has used its growing economic might to gain enormous strategic advantage in a number of areas. It successfully seized the high ground in the debate on global imbalances by accusing the U.S. of taking irresponsible monetary policy actions that hurt other countries; this argument has resonated with many emerging markets that are bearing the brunt of capital flows fueled by cheap money in the U.S. and other advanced economies. China has also used its economic leverage to build partnerships with a number of advanced and emerging market economies that back China’s policies as they see its strong growth as important for their own success.

These developments have been aided by the defensive position that the U.S. has found itself in—as the epicenter of the global financial crisis and as a country with massive rising levels of public debt. The U.S. is also viewed as getting a free pass on its fiscal profligacy and excess consumption as it is the issuer of the main global reserve currency, a tenuous situation that persists perhaps only for want of alternative robust reserve currencies backed up by deep and liquid financial markets.

From the U.S. perspective, a number of irritants continue to plague its bilateral relationship with China. Chinese currency policy, which involves the central bank’s heavy intervention in the foreign exchange market to prevent the renmimbi from appreciating against the dollar and other currencies, has been blamed for making a major contribution to the U.S. trade deficit and to global current account imbalances. The U.S. has concerns that the Chinese government is blocking access of U.S. manufacturers and financial institutions to its fast-growing markets, unfairly subsidizing Chinese exporters, and hurting American manufacturers through its policy of indigenous innovation (which favors Chinese firms in government procurement of technology) and weak enforcement of intellectual property rights.

In recent months, the U.S. has sought to recalibrate its relationship with China by going on the offensive to regain control over the narrative on the sources of global imbalances and level the playing field with China. This approach culminated in a forceful speech by U.S. Treasury Secretary Timothy Geithner on January 12.

In his remarks, Secretary Geithner noted that China has become a major economic power and instituted many reforms. He pointed out that China still has a large reform agenda with elements that the U.S. cares about but are ultimately in China’s own interest. These elements include more open markets, fair trade practices, a more flexible exchange rate regime, and growth rebalancing to make the economy less dependent on exports and stoke private consumption.

Interestingly, Geithner also laid out a clear quid pro quo, noting that in order to attain its objectives in the bilateral relationship, China must adequately satisfy U.S. interests. China’s objectives include access to high technology products, investment opportunities and the same level of access to U.S. markets as “market economies”, a classification that has not yet been granted to China.

On currency policy, Geithner acknowledged that the renminbi has appreciated by about 3 percent in nominal terms relative to the dollar since mid-June 2010, when the currency was freed up after being frozen in place against the dollar during the two preceding years. Moreover, given the higher inflation rate in China relative to the U.S., the renminbi has appreciated more in real terms.

Notwithstanding this modest appreciation, Geithner stressed that the renminbi is far from being freely determined by market forces. He argued that this has adverse implications for China as it hampers effective and independent monetary policy, hurts the U.S. and other trading partners of China, and also has a negative impact on global financial stability by perpetuating global imbalances.

Two recent pieces of data portray a mixed picture on this issue. China posted a diminished trade surplus of $185 billion in 2010, well below its peak of $295 billion in 2008. On the other hand, accumulation of foreign exchange reserves in 2010 amounted to $448 billion, signaling massive intervention in foreign exchange markets to keep the renminbi from appreciating significantly.

The rhetoric from the Hill on this issue has recently eased up, as some key House Republicans do not currently view action against China on trade and currency policies as a legislative priority. There is likely to be continued pressure from Senate committees, where this is still a hot button issue. Much will depend on the jobs picture in the U.S., which is improving but still rather bleak.

Chances are the Chinese currency issue will continue to simmer but not come to a boil—unless the U.S. unemployment rate remains high, the bilateral trade deficit the U.S. runs with China begins to widen again, and U.S. firms make scant progress in getting greater access to Chinese markets.

On trade, the Obama administration has taken an aggressive approach. It has instituted unilateral trade measures against a few Chinese imports and has also taken a number of challenges of China’s trade policy to the World Trade Organization. More recently, the U.S. has taken direct actions to protect the competitive interests of its firms. For instance, to counter a Chinese company’s bid, the U.S. Export-Import Bank provided cheap financing to Pakistan Railways to boost General Electric’s bid to get a contract for supplying trains.

Such measures are intended to send a clear signal to China that the U.S. is willing to level the playing field by matching Chinese policies that run afoul of international norms and standards. With its actions and words, the Obama administration has signaled that it wants to deal with China on equal terms and will not back off from conflict where it feels that China is subverting the established rules of the game.

President Hu's remarks on the eve of his trip to Washington signal China's desire to develop a more productive relationship with the U.S. on equal terms. The remarks reveal a sense of growing confidence that, while China faces a number of domestic challenges in its own development, it is now in the driver's seat in global economic matters ranging from supporting world growth to pushing reforms of the international monetary system.

Hu's remarks show that China views itself as dealing with the U.S. from a position of relative strength. He makes it clear that China intends to move forward on opening its markets, freeing up its exchange rate and restructuring its political system, but at its own pace and will resist U.S. pressures for more rapid or broader reforms.

Hu acknowledges the potential flash points between the two countries but shows willingness to tackle these disagreements frontally in a spirit of broader cooperation rather than rancor. Whether the two countries can successfully manage the sources of bilateral tension remains to be seen but it is certainly a good omen that President Hu has chosen to take a conciliatory rather than confrontational tone before his meeting with President Obama.

The state of the China-U.S. bilateral relationship is important as it sets the tone for a number of global issues, including reforming the international monetary system, breaking the deadlock on trade talks and tackling climate change. Away from the limelight, cooperation between the two countries has actually been rather productive on a number of fronts. For instance, the G-20 agreement on coordinated fiscal stimulus during the worst of the financial crisis was strongly supported by both countries. The two countries have also played important roles in the governance reform and recapitalization of the International Monetary Fund. And of course both countries have a shared interest in keeping peripheral European economies from running aground and weakening the euro.

The leaders of the two countries clearly recognize the mutual benefits of a cooperative rather than conflicted relationship. Still, the relationship has to be tended carefully, by managing the sources of bilateral tension and emphasizing the long-term benefits of cooperation, in order to ensure that domestic political exigencies don’t trump rational collective policymaking on either side.

See more of the data and analysis on the U.S.-China bilateral economic relationship »

Prasad is the Tolani Senior Professor of Trade Policy at Cornell University. He is also a Senior Fellow at the Brookings Institution, where he holds the New Century Chair in International Economics, and is the former head of the IMF's China Division. Gu is a graduate student in the Department of Economics at Cornell University.

Note: This commentary, originally published on January 13, has been updated to reflect President Hu's remarks; the data have been updated in the PDF.

Authors

Grace Gu
Eswar Prasad

Image Source: © Jim Young / Reuters

The Top Economic Stories of 2010

Thu, 23 Dec 2010 12:21:00 -0500

The uneasy economy continued to dominate the headlines in 2010. Unemployment rates, climate change, the Federal Reserve and sovereign debt were among the top stories. Brookings experts Karen Dynan, Gary Burtless, Alice Rivlin, Henry Aaron, Donald Kohn, Douglas Elliott and Adele Morris weigh in on the year’s most compelling economic news and offer recommendations going forward.

The Fed's QE2 — Unsurprising Move but Surprising Reaction
Karen Dynan, Vice President and Co-Director, Economic Studies

With fiscal policy limited by our long-run federal debt challenges, monetary policymakers took action to address the lackluster economy in 2010. In early November, the Federal Reserve announced a plan to purchase $600 billion of longer-term Treasury securities by mid-2011. The plan has come to be known as "QE2" because it represents a second wave of the Fed's so-called quantitative easing program, the first installment of which involved purchases of up to $1¾ trillion in longer-term assets during 2009 and early 2010.

QE2 was not a "big" economic event in the sense of being exotic. For some time, the Fed has not been able to increase monetary stimulus by lowering the short-term federal funds rate, its traditional policy lever, as that rate has been close to zero since late 2007. The next logical step has been to ease financial conditions by lowering still-positive longer-term interest rates; purchasing longer-term assets is simply a means to that end.

Nor was QE2 surprising. By law, the Federal Reserve has a mandate to set monetary policy so as to promote the dual goal of stable prices and maximum employment. With underlying inflation now well below the mandate-consistent target of 1½ to 2 percent and a gap between actual employment and full employment that is perhaps as large as 12 million, neither objective is currently being met. The Fed's decision to implement QE2, a policy designed to both spur economic growth and return inflation to a more desirable long-run level, represented a step toward meeting its dual mandate.

What has been notable about QE2 is the considerable backlash that it has spurred. Critics abroad have argued that the U.S. is exporting its economic problems, as quantitative easing (like traditional Fed policy) puts downward pressure on the foreign exchange value of the dollar and and upward pressure on prices of foreign assets. This is a particular problem for emerging market economies that have rebounded faster than industrial economies and are now at risk of asset price bubbles and overheating more generally. Domestically, some skeptics worry that the weaker dollar and larger Fed balance sheet could put the U.S. economy at risk of excessive inflation.

These concerns merit serious discussion but reasonable counter-arguments can be made. On the international front, a more vigorous and sustainable U.S. recovery would have important benefits for the rest of the world. With regard to the domestic concerns, falling inflation (and its capacity to foster economic stagnation) has been a larger concern than rapidly rising inflation.

The backlash to QE2 bears watching because it lends support to those who wish to reduce Federal Reserve independence. While the Fed should be held accountable for its actions, excessive political oversight of monetary policy could prove very harmful to the U.S. economy. It would open the door to attempts to win over with voters by boosting growth and employment over the short run at the cost of higher inflation over the long run.

A Growing Gap between the Outlook for the Employed and the Unemployed
Gary Burtless, Senior Fellow, Economic Studies

In 2010 the job market began to emerge from the most severe downturn since the Great Depression. U.S. employment is up, the layoff rate is down, and the average wage (after adjusting for inflation) has improved modestly. Progress toward full job market recovery has been achingly slow, however. The most striking feature of the past year has been the widening gap between the outlook for Americans who've held on to their jobs and their less fortunate peers who got laid off.

Hourly wages and the average work week have improved over the past year, boosting the pre-tax earnings of employees. Equally important for workers' well-being, the chances of a layoff have declined. Since the end of last year, weekly new claims for unemployment insurance have fallen 12%. Employers say they are reducing the monthly number of layoffs. Between December 2009 and October 2010 the reported layoff rate fell almost a fifth. Since the peak of layoffs in late 2008 and early 2009, the layoff rate has dropped more than a third. Workers who worried at the beginning of 2010 about their chances of keeping their jobs could breathe a little easier by year's end.

The improvement in employees' economic outlook has fueled a modest rebound in consumption, which in turn has boosted employers' need for workers. A sizeable fraction of this need has been met with temporary workers. Since December 2009 almost one-third of the net gain in U.S. payroll employment has been in the temporary help services industry. In addition, employers have added to the work week of employees who are already on their payrolls. The work week has increased a half hour since last December, or 1½%. Neither of these employer strategies helps laid off workers in their search for a permanent job.

The situation of the unemployed has not improved much over the past year. To be sure, the unemployment rate and the number of unemployed workers have edged down, but this is mainly because of the drop in the number of newly laid off workers each month. For workers who were jobless at the start of the year or who entered unemployment during the course of the year, chances of finding a job remain depressingly low. At the end of 2009, 40% of the unemployed had been without work for 6 months or longer. By November 2010, 42% of the unemployed had been jobless for at least 6 months. Unemployed workers can take consolation from the fact that this statistic is now heading in the right direction. Since late spring the average duration of on-going unemployment spells has dropped about 4%.

The prospects of the unemployed nonetheless remain bleak. In the years between 1945 and 2007, the number of jobless Americans with unemployment spells longer than 6 months never exceeded 26% of the total unemployed. In May 2010 the long-term unemployed represented 46% of the unemployed. Even though this percentage has fallen since May, it remains far higher than it was in the 1981-1982 recession, when the U.S. unemployment rate reached a post-war peak.

The basic problem facing job seekers is that employers are offering few job openings compared with the number of unemployed. The number of job openings has risen since the low point in early 2009, but job availability is not nearly high enough to put a major dent in unemployment. The Bureau of Labor Statistics (BLS) conducts a poll of employers every month to determine the number of job openings, new hires, and recent job separations. This survey offers the best gauge of U.S. job availability. Even with the recent improvement in job vacancies, the BLS survey shows that job openings are currently running almost one-sixth below the average rate over the 2000-2007 period. That 8-year period included a mild recession and a prolonged period of anemic job growth, so it should be clear that today's vacancy rate is too low to generate rapid gains in payroll employment.

In a couple of respects, laid off workers were provided better protection in this recession compared with earlier ones. The most notable difference is that Congress funded up to 73 weeks of extended unemployment compensation after workers exhaust the 26 weeks of regular unemployment benefits. The total duration of benefits - up to 99 weeks in the states hardest hit by unemployment - is considerably longer than the maximum provided in past recessions (65 weeks). For workers laid off between September 2008 and May 2010 the federal government also offered to subsidize two-thirds of the cost of employer-sponsored health insurance premiums for workers covered by an employer health plan. In no previous recession did Congress provide laid off workers with this kind of subsidy. For many unemployed workers the subsidy is not generous enough. A large proportion of laid off workers cannot afford to pay a third of the cost of their insurance premiums. When they lose their jobs, they lose their health insurance, too.

In sum, 2010 was a year of only slight progress for the unemployed but real gains for workers who still have jobs. Without a surge in demand for goods and services produced in the United States, it is hard to see much improvement in the outlook for the unemployed. The pace of economic growth must increase before we can see a sizeable drop in unemployment. The growing gap between the fortunes of those with and without jobs is matched by the widening divide between Americans who work for others and the businesses that employ them. Measured in nominal dollars, corporate profits now exceed their pre-recession levels. Business profitability has returned, but total wage and salary disbursements remain lower than they were before the recession began. The political danger facing the unemployed is that surging business profitability and the improving fortunes of employees will cause voters to lose sight of the daunting problems confronting the long-term unemployed.

Excerpt: The Return to Fiscal Sanity Began in 2010—Or Did It?
Alice Rivlin, Senior Fellow, Economic Studies

Historians of our era may describe 2010 as the year Americans finally woke up to the fact that their federal budget was on a dangerous course, hurtling toward a debt crisis that threatens American prosperity and international leadership. They may, but we won’t know until we see whether the political system responds with decisive action in 2011.

But once the election was history, the ultra-partisan rhetoric subsided and public discourse on fiscal matters shifted toward pragmatism. Two bipartisan commissions contributed to the more constructive tone by reporting compromise plans for bring deficits steadily under control and stabilizing the growth of debt. I was privileged to serve on both of them and the experience left me fairly optimistic that our political system can pull itself together and reach a bipartisan compromise in time to avert a debt catastrophe.

The National Commission on Fiscal Responsibility and Reform, ably led by Erskine Bowles and Alan Simpson, included a dozen high-ranking Senators and Representatives from both parties. (Brookings Trustee Ann Fudge and I were among the six public members). The Commission, appointed by President Obama, was charged with crafting a plan, to be released right after the election, for reducing the deficit to manageable proportions by 2015 and controlling future debt. The Commission with the support of a small staff spent months digging into the problem. Despite the fact that most of the members were busy campaigning, they came together in a constructive and collegial spirit to discuss a broad array of spending and tax options, including all the "third rail" political no-no's that pundits declare untouchable. Until the election was over, no votes were taken. Indeed, nothing was written down for fear some leaked draft document would be misused on the campaign trail.

Shortly after the election the co-chairs produced a bold draft plan for the Commission to discuss. It included all the "third rails"-cuts in domestic and defense appropriations, curbing growth in Medicare, Medicaid, and Social Security benefits, drastic reform of the corporate and individual income taxes to simplify the structure and raise more revenue. Commission members, all of whom disagreed with some elements of the plan, welcomed it as a courageous effort to find middle ground without copping out on the assignment. After vigorous interaction with the co-chairs a somewhat altered plan was adopted by 60 percent of the members. Most of those not voting for it, nonetheless expressed their admiration for the effort and some offered their own alternatives. There were no "deficit deniers."

What Lies Ahead for the Affordable Care Act
Henry J. Aaron, Senior Fellow, Economic Studies

Analysts disagree on whether the Affordable Care Act (ACA), signed into law by president Obama on March 23, 2010 should be regarded as a major economic event of 2010, the most important social legislation in decades, both, or neither. A good case can be made for each of these views.

The case for why the ACA was a major economic event is straightforward. Health care spending accounts for one-sixth of the U.S. economy. It has grown faster than income for half a century and is projected to continue indefinitely. Many billions of dollars each year go for procedures of little or no value, many of which cost far more to provide in the United States than they do in other countries. Projected increases in federal health care spending account for more than all of the anticipated increases in federal budget deficits. Thus, slowing the growth of spending and improving the efficiency of health care delivery is of enormous economic significance. The ACA sustains existing methods for slowing the growth of health care spending. It begins to implement virtually every major new idea for improving the efficiency of health care delivery and for slowing the growth of spending that analysts have proposed. To be sure, some of these ideas should have been pursued more aggressively than the ACA does. But the ACA is the law of the land. If implemented vigorously, it holds the promise of gradually slowing the growth of total and federal health care spending and reforming the way health care is delivered.

No one thinks that the spending slow down will come fast enough to avoid the need for tax increases or other reductions in government spending, but no other proposed strategy for controlling health care spending would do so either. No one thinks that the efficiency of health care delivery will improve rapidly. Thus, the ACA is just a first step-but an extremely significant one-in a long-term program to slow the growth of U.S. health care spending, something that is a necessary precondition for restoring long-term fiscal balance and an important component of a program to improve economic efficiency. That other steps will be necessary in no way diminishes the crucial role that the ACA can play.

The case for the ACA as landmark social legislation is equally strong. For nearly a century, presidents from both parties have sought to extend health insurance coverage to all Americans. The ACA takes a giant step toward achieving that goal. It promises to cut the proportion of Americans without health insurance by more than half. Every legal resident of the United States with income below the official poverty threshold would be insured either through Medicaid or private insurance. Those with incomes up to four times official poverty thresholds would be eligible for subsidies to hold the costs of health insurance below specified fractions of income. Everyone would be required to carry health insurance. Most businesses would be required to offer it to their employees as a largely-employer-financed fringe benefit. Limits would be placed on premiums that insurance companies could charge the elderly or those with preexisting conditions. They would be barred from cancelling insurance policies regardless of how much care the insured require. Given current budget deficits and the inescapable cost of extending insurance coverage-with attendant increases in use of health care services-the ACA went as far in extending coverage as current political and economic conditions would permit.

Of course, both of these claims for the ACA may be valid. There is no reason why the claims for the economic importance of the ACA should diminish its status as its status as social legislation. Paradoxically, however, both sets of claims may turn out to be if not false, then premature. The campaign to extend health insurance and reform the delivery of health care did not begin when president Obama announced his legislative program in 2009. Nor did it end with the signing ceremony on March 23, 2010 Rather, it will continue at least until 2013 and probably for many years after that.

Republicans fought vigorously to prevent passage of the ACA. They tried hard to persuade the American public that the bill was flawed. Public opinion polls indicate that they enjoyed considerable success. The ACA passed Congress without a single Republican vote. While Republican successes in the 2010 mid-term elections owed much to public dissatisfaction with the state of the U.S. economy, unease about health care reform also played a part. The Republican leadership has sworn to seek repeal of the ACA. That objective that is almost certainly out of reach as long as Democrats control the Senate and president Obama can veto any repeal legislation. But the ACA is likely to be a central issue in the 2012 elections. Should Republicans win the White House and a Senate majority, repeal may be possible. Meanwhile, the Republican leadership has pledged to stymie implementation. That goal may be achievable, as the House, which is now under Republican control, may be able to deny appropriations necessary to plan and carry out implementation.

Furthermore, even if funding is adequate, the administration and the states face extremely challenging obstacles in implementing the ACA. Success of the ACA hinges on the capacity of states to sign up 16 million new Medicaid enrollees and to assure that, once enrolled, they can find service providers. All fifty states need to set up health insurance exchanges to provide subsidies to millions of Americans. The federal government must design practical rules not only to guide the states in providing subsidies but also to enable the Internal Revenue Service to recapture over-payments made to people who turn out not to be eligible for them. This last challenge is particularly delicate, as subsidies will be paid to insurance companies on behalf of families and individuals deemed to be eligible based on current income, but overpayments must be collected from the families themselves based on their annual income.

For all of these reasons, the 2010 signing ceremony for the ACA, although indisputably a historic moment, was the just one event in a multi-year drama that began decades ago and will continue for many years. Future historians may hail the signing of the ACA as an epochal achievement in extending health insurance coverage, initiating measures to improve the efficiency of health care delivery, and creating reforms to slow the growth of health care spending. They may see it as yet another failed effort to enforce changes in a system virtually all observers see as flawed and seriously dysfunctional. Which of these two stories comes to be written will depend on events to be played out over the next few years.

On Global Imbalances
Donald Kohn, Senior Fellow, Economic Studies

As the crisis phase of financial and economic turmoil receded in the latter part of 2009 and 2010 (though for an exception to this see the Forum posting on sovereign debt problems), attention of global economic policymakers turned increasingly to global imbalances-large and persistent current account deficits and surpluses. Continuation of these imbalances was seen as posing challenges for economic recovery and for the stability of employment and activity once economies returned to full employment. With many advanced economies hobbled by continuing balance sheet problems, full global recovery will require a greater push from domestic demand in emerging market economies. And, although global imbalances earlier in the 2000s did not directly cause the economic crisis as many had feared, and banking crises can readily occur in countries running large surpluses as Japan demonstrated in the 1990s, imbalances contributed to the conditions that led to the financial crisis in the United States and other industrial economies. The capital flows arising from the surpluses in emerging market economies held down interest rates in advanced economies encouraging leveraging and rising house and other asset prices. And the borrowing corresponding to the U.S. current account deficit was reflected in unsustainable increases in the debt of the household and government sectors here. Gaps and lapses in regulation and supervision in the United States and Europe allowed the resulting leverage, lax lending practices, and maturity transformation to build to dangerous levels that proved all too vulnerable to a softening in house prices and onset of borrower repayment problems.

There is broad agreement that the recovery of the global economy cannot rest on the U.S. consumer or on demand by governments in industrial countries. Financial and economic stability require a higher level of domestic saving in the United States by households and governments than we had a few years ago, balanced by higher investment and net exports. The other side of that coin is that other economies cannot rely on exports to U.S. and other industrial countries as the main drivers of increases in production and employment. Instead more global demand must come from increased purchases by the residents of those economies currently in large surplus positions, especially where those surpluses reflect not economic fundamentals but rather artificial restraints on exchange rates or capital flows. Fundamental shifts in saving and spending patterns will be required for rebalancing; government policies to encourage private and public saving in the United States and other deficit countries and to boost spending in surplus countries will be critical elements in achieving a more sustainable configuration of trade flows. But relative prices will also have to change to make exports by the United States relatively less expensive on world markets and those from the surplus countries relatively more expensive; it will be far less painful and disruptive to do that through movements in exchange rates than through inflation in surplus countries and deflation in deficit countries. In that regard, greater exchange rate flexibility by China is a critical element in fostering a smooth transition to higher levels of production globally and a more sustainable pattern of trade.

The uneven pattern of recovery from the "Great Recession" is straining global relationships. The sluggish growth of the advanced economies, coupled with the imperative for fiscal consolidation in many places, means that interest rates there are very low and are likely to be extraordinarily depressed for some time to come. At the same time, many emerging market economies are growing strongly, are much closer to full employment, and are concerned about inflation and asset price bubbles arising from the inflows of capital from the advanced economies. More flexibility in exchange rates will help with these problems too because these economies would be better able to tighten monetary policies as suited to their individual circumstances and investors will be faced with more tow-way risk in exchange rates. Nonetheless, the surplus countries could still encounter difficulties maintaining economic and financial stability in the face of large capital inflows. Still, they should guard against putting into place the types of capital controls that will distort the global allocation of resources over time; deficit countries for their part must resist any protectionist pressures that may intensify as unemployment remains high.

The G-20 has made dealing with imbalances a high priority and has enlisted the IMF in a Mutual Assessment Process to help countries understand the spillover effects of their policies and devise consistent strategies to advance the goals of higher, more balanced, and more sustainable global output. To date, they have been unable to move beyond agreement on obvious generalities. In fact, the global financial system is not well constructed to apply adjustment pressure to surplus and deficit countries alike. The French, who lead the G-20 in 2011, have made achieving progress on imbalances and on reforming the system a high priority for next year.

On Sovereign Debt Problems
Donald Kohn, Senior Fellow, Economic Studies

2010 was the year the difficult challenge of putting government debts and deficits on a more sustainable path over the long-run came much more clearly into focus. In the United States we saw several bi-partisan efforts to lay out paths to fiscal sustainability. But nowhere did the issues become more pressing than in Europe, where the governments of several countries faced growing doubts about their ability to meet their obligations now or in the future. These doubts resulted in sharply higher spreads on their debt and questions about their continued access to markets, precipitating a crisis that required intervention by other countries of the European Union, the European Central Bank, and the IMF.

The reasons for the actual and expected large borrowing needs and associated severe market problems differed somewhat across countries, but they included: revenue shortfalls and spending increases associated with the deep recession, which in some cases came on top of fiscal shortfalls even in the preceding good times; the pledge of governments to stand behind the debt of home-country banks that have mammoth losses from the bursting of housing bubbles in several European countries; long-run issues related the demands of an aging population on the social safety net; and the erosion of competitive positions in several peripheral countries after they joined the European Monetary Union, which made them dependent on external capital inflows while depriving them of devaluation as a way to restore competitiveness.

Intervention by European and international authorities was sparked by fears of contagion if one country was forced to restructure its debt. Channels for contagion included the potential for spreading doubts about the value of the debt of other European countries with stressed fiscal positions, and the losses that would be absorbed by many European banks if the value of a significant amount of European sovereign debt needed to be marked down. The forms of intervention included liquidity help for European banks from the ECB, which continued to accept sovereign debt as collateral even after it had been downgraded by credit rating agencies; ECB purchases of sovereign debt in the open market; and the establishment of back up facilities by the European Union and the IMF to lend to countries that lost access to markets. These back up facilities were activated for Greece and Ireland. The quid pro quo for this help was sharp cut backs in government spending and increases in taxes by countries in need of assistance; other countries moved pre-emptively in the same direction to head off market problems. Fiscal austerity by troubled countries would reduce government borrowing needs and over time level out debt-to-GDP ratios, and it also could help to restore greater competitiveness through decreases in government wages and pensions, which could spill over to reduce costs in the private sector as well. But it also implied higher odds on very weak economic performance in the short- to medium-term while austerity was being phased in.

As the year drew to a close, how these developments would play out remained in doubt. Spreads on the debt of a number of European countries continued to be very wide. And political backlash was in evidence--against austerity and associated economic weakness in the troubled peripheral countries, and, in Germany, against providing taxpayer support for these countries. Moreover the path to substantially increased competitiveness and reduced reliance on external credit for many of the countries was far from clear. The European authorities were devising structures to impose greater and more consistent fiscal discipline within the European Union and to make the back up facility permanent, albeit with the loses shared by the future holders of the debt of any country that needed to access the facility.

Many observers saw the European experience as underlining the need for the United States to take action now to put its own fiscal house in order. Acting expeditiously would reduce the risk that, like a number of European countries, it would be forced to take very harsh actions in a short period of time to avoid losing access to markets.

2010: A Year to Remember in Financial Regulation
Douglas J. Elliott, Fellow, Economic Studies, Initiative on Business and Public Policy

This year, America made the biggest changes in three-quarters of a century to how it regulates banks and other financial institutions, and the markets in which they operate. Not since the Great Depression has legislation so altered the rules of finance. Nor was this movement confined to the United States; most countries hosting major financial centers also moved forward, notably the United Kingdom and the European Union more broadly. (Please see http://www.brookings.edu/reports/2010/1007_atlantic_council_elliott.aspx for a detailed summary of changes in the United States and Europe.)

The United States passed the "Dodd-Frank Act" this summer, legislation which comprehensively rewrote the rules across a wide range of financial activities. There are far too many changes to even summarize here, but the breadth of change is as important as the long list of individual items. The terrible financial crisis, whose adverse effects we are still feeling, highlighted a host of flaws in finance and its regulation and therefore Congress found it necessary to tackle a myriad of problems in the form of the Dodd-Frank Act. The interconnections between these problems added further complications.

There are those who attack Dodd-Frank for doing too much and those who say it did too little. Many conservatives believe that government interference in the housing markets was the real core of the problem and that the financial system would have worked reasonably well if we had avoided the massive shock of the bursting housing bubble. There are respectable arguments for this, but they disregard the clear evidence of the myriad of other problems in the system. Even if we accepted that the government committed the equivalent of arson, the resulting fire still showed us a host of vulnerabilities that needed to be fixed. (Please see http://www.brookings.edu/papers/2009/1123_narrative_elliott_baily.aspx for a longer discussion of this.)

Many critics on the left argue that Dodd-Frank essentially preserved the current system -- one that they believe is rigged in favor of the banks and fraught with the danger of future blow-ups and taxpayer rescues. For example, they believe that the largest banks remain "too big to fail" and therefore free to take excessive risks, knowing they'll be rescued if real problems develop. There are respectable arguments here, too. The premise is clearly right in a key sense - the core approach to the financial system remains in place. I draw an analogy with Franklin Roosevelt's actions in the Great Depression. He reformed the relationship between business and government, but kept capitalism in place, rather than replacing it with socialism or fascism or some other "-ism." Similarly, Dodd-Frank rebalances and realigns the financial system, but does not switch to a radically different approach. At the same time, I would argue that the extent of the reforms is fairly massive and that it is a mistake to view the post-Dodd-Frank world as just the continuation of business as usual.

Overall, I was pleased with Dodd-Frank. It has its flaws, such as a failure to boldly realign the institutional structure of regulation by combining some of the excessive number of regulatory bodies that exist now. There are also aspects that do more harm than good, such as the Volcker Rule. However, the total effect is to buy us considerably greater safety at a relatively modest cost to the economy.

2010 Climate Change Policy Retrospective
Adele Morris, Fellow, Economic Studies

Some of the disparate moving parts of climate policy came to a halt in 2010, but other parts chugged on. Senate efforts to produce a cap-and-trade measure to control greenhouse gas (GHG) emissions failed, leaving a 2009 House-passed climate bill stranded. In an election year marked by persistently high unemployment, Republican opponents successfully characterized the effort as a "job-killing energy tax," despite Democrats hailing its potential to build a green-job-creating "new energy economy." Sadly, neither side made a case for a sensible, predictable, deficit-reducing economy-wide price signal on carbon.

The 2010 elections strengthened the ranks of opponents of climate change policy on the Hill, and Senate Majority Leader Harry Reid says cap-and-trade won't be on the Senate agenda for the next Congress. There are nascent signs of a bipartisan coalition for other energy legislation, such as a clean energy standard that requires electricity generation of at least a certain percentage from technologies with low carbon emissions, including nuclear power. However, the Tea Party caucus and other conservatives are likely to strongly resist such intervention.

In 2010, the U.S. Environmental Protection Agency (EPA) forged ahead with new climate regulations under the Clean Air Act, despite efforts by Senator Jay Rockefeller (D-WV) and others to kill funding for the work. Early in 2011, a rule takes effect that requires facilities that will significantly increase their GHG emissions to obtain Prevention of Significant Deterioration (PSD) permits. Among other things, these permits will require "best available control technology" limits on emissions. This permitting process is a major new responsibility for states and the EPA. In 2011, EPA plans to impose new standards for major emissions sources. However, EPA's ambitions in 2011 may be tempered by House efforts to limit its funding, question the scientific basis for its actions, and generally scrutinize the regulatory process.

Despite the recession, states continue to experiment with climate policy. For example, California's pursuit of implementation of its climate law, A.B. 32, survived a fall ballot measure that would have delayed the rules until the unemployment rate dropped to no more than 5.5 percent. A.B. 32 will spawn a multi-sector cap-and-trade program and possibly extend its reach to other state and Canadian provincial programs through the Western Climate Initiative.

Finally, international negotiations moved forward incrementally in 2010. The two-week meeting of the United Nations Framework Convention on Climate Change in Cancún, Mexico, ended in mid-December with a modest agreement to monitor and verify emissions pledges made under the Copenhagen Accord last year. The parties also agreed on measures to protect rainforests and share technology, and they established a fund to help poor countries lower emissions and adapt to climate change. Arguably one of the most useful ingredients to the pragmatic outcome was the low expectations that followed 2009's rancorous meeting in Copenhagen. Given the vast differences among the 200+ countries involved, few expect sweeping new commitments under the UN umbrella until the US adopts a domestic climate law, and perhaps not even then.

Authors

Image Source: © Morteza Nikoubazl / Reuters

The Rising Burden of Government Debt

Mengjie Ding and Eswar Prasad — Mon, 01 Nov 2010 00:00:00 -0400

Editor's Note: In this article, Eswar Prasad and Mengjie Ding discuss their in-depth analysis of global public debt levels. The Financial Times has produced an interactive online feature (free registration required) that shows the burden of public debt in countries around the world based on their research.

The global financial crisis triggered a sharp increase in public debt levels, both in absolute terms and relative to GDP. The level of aggregate net government debt in the world rose from $23 trillion in 2007 to an expected $34 trillion in 2010. IMF forecasts indicate the level will reach $48 trillion in 2015. The ratio of world debt to world GDP rose from 44 percent in 2007 to 59 percent in 2010, and is expected to climb to 65 percent in 2015.

Rising debt levels pose risks to fiscal and macroeconomic stability and also imply transfers of wealth across generations. Our analysis shows that advanced economies (AEs) account for much of the increase in world public debt, putting their own as well as global financial stability in jeopardy.

To guide the debate on these issues, we analyze trends in the composition of world public debt and also calculate the burden of this debt—which we define as the ratio of debt to total and working-age populations. Our analysis is based on data from the IMF’s Fiscal Monitor (May 2010), the World Economic Outlook database (April 2010) and updated information from national sources.

AEs account for the bulk of the increase in global public debt since the start of the crisis. Relative to the size of their economies, debt levels in AEs are expected to continue rising in the next few years. By contrast, debt ratios will shrink for emerging markets (EMs).

Aggregate debt of AEs will increase from $19 trillion in 2007 to $29 trillion in 2010, and is expected to rise to $42 trillion in 2015. The corresponding numbers for EMs are $4 trillion, $5 trillion and $7 trillion, respectively. (See Figure 1 - pdf)

The ratio of aggregate debt to aggregate GDP for AEs will rise from 48 percent in 2007 to 71 percent in 2010 and further to 85 percent in 2015. The corresponding ratios for EMs are 30 percent, 30 percent and 26 percent, respectively. (See Figure 1 - pdf)

There is a stark contrast between AEs and EMs in their relative contributions to growth in world debt versus the growth in nominal world GDP (measured in U.S. dollars at market exchange rates). EMs contribute far more to growth in global GDP than to the growth in global public debt, reflecting an improvement in their fiscal positions while AEs experience a fiscal deterioration in both absolute and relative terms.

In 2007, EMs accounted for 24 percent of world GDP and 17 percent of world debt. By 2015, EMs are expected to produce 35 percent of world output and account for just 14 percent of world debt. (See Figures 2-3 - pdf)

EMs accounted for 10 percent of the increase in global debt levels from 2007 to 2010 and are expected to account for 13 percent of the increase from 2010 to 2015. By contrast, their contributions to global GDP over these two periods are 70 percent and 54 percent, respectively. (See Figures 4-5 - pdf)

The two biggest AEs are making a far greater contribution to the rise in global debt than to the rise in global GDP. The U.S. contributes 35 percent of the increase in global debt from 2007 to 2010 and 39 percent from 2010 to 2015. Its contributions to global GDP over those two periods are 13 percent and 19 percent, respectively. Japan accounts for 26 percent of the increase in debt from 2007 to 2010 and 22 percent from 2010 to 2015 while its contributions to global GDP increases are 17 percent and 5 percent, respectively. (See Figures 4-5 - pdf)

The traditional approach to evaluate debt levels is to examine the ratio of debt to GDP. (See Figure 6 - pdf) There is a widening gap between AEs and EMs in their debt to GDP ratios.

A different approach that gets at the burden of public debt is to examine the level of debt per capita. Richer economies can of course afford more debt but this is still an instructive calculation as it highlights the growing gulf between AEs and EMs. (See Figure 7 and Table - pdfs)

The average per capita debt in AEs was $19,400 in 2007, rises to $29,100 in 2010 and will go up to $41,000 in 2015. The burden of debt for U.S. citizens will rise from $19,700 in 2007 to $31,600 in 2010 and then to $48,000 by 2015. The debt burden for Japanese citizens will hit $75,900 in 2015, the highest level in the world.
Average per capita debt for EMs is also rising and will go up to $1,500 in 2015, far lower than AE levels. China’s debt burden will be $1,200 in 2015. China could in principle pay off its entire public debt by selling its stash of U.S. government bonds.

The burden of the public debt may ultimately fall on the working-age population rather than the entire population, though inflation that erodes the real value of debt would of course hurt everyone. There is an even sharper contrast between AEs and EMs when we calculate the debt burden of the working-age population (ages 20-64). (See Figure 8 and Table - pdfs)

Among AEs, average debt per working-age person will more than double from $31,700 in 2007 to $68,500 in 2015. Japan is tops among all countries by this measure and the U.S. moves into second position by 2015. U.S. debt per working-age person goes from $32,300 in 2007 to $79,200 in 2015. For Japan, it nearly triples from $46,200 in 2007 to $134,500 in 2015.
For EMs, average debt-per working-age person rises to $2,600 in 2015, a level far lower than that of the AEs. In the case of China, this measure of the debt burden will be $1,800 in 2015.

Our analysis paints a sobering picture of worsening public debt dynamics and a sharply rising debt burden in AEs. But perhaps the worst is yet to come. First, AEs as a group are experiencing little population growth. Second, they are facing rapidly aging populations. Third, their economies are likely to register slow growth, especially relative to the EMs. Fourth, entitlement spending on health care and pensions is likely to explode due to unfavorable demographics.

AEs had better get their fiscal act together once the recovery is better entrenched. It will take strong political will to tackle near-term deficits and then to control the growth in entitlement spending. In the absence of decisive action, ballooning public debt in the AEs could become a major threat to domestic and global financial stability.

List of Figures and Technical Notes (pdf files)

Figure 1. World Government Debt

Figures 2-3. Global Distribution of Debt and GDP

This figure shows the global distribution of sovereign debt and GDP among major countries and country groups for 2007, 2010 and 2015

Figures 4-5. Contributions to Changes in World Debt and GDP

This figure shows the contributions to changes in aggregate sovereign debt and GDP among major countries and country groups from 2007 to 2010 and from 2010 to 2015

Figure 6. Cross-Country Comparison of Net Debt to GDP ratios

This figure shows country-specific data on net debt to GDP ratios for major economies in 2007, 2010 and 2015

Figure 7. Cross-Country Comparisons of Net Debt Per Capita

Figure 8. Cross-Country Comparisons of Net Debt Per Working-Age Person

This figure shows country-specific data on ratios of net debt to working-age population in the 20-64 age range for major economies in 2007, 2010 and 2015

Summary Table
Technical Notes

Authors

Mengjie Ding
Eswar Prasad

Publication: Financial Times

Image Source: © Michael Caronna / Reuters

Moving to a Fiscally Sustainable Budget

Alice M. Rivlin — Thu, 11 Feb 2010 10:37:00 -0500

Editor's Note: On February 11, 2010, Alice Rivlin testified before the Senate Budget Committee.

Chairman Conrad, Ranking Member Gregg, and Members of the Committee:

I greatly admire this Committee for your persistent efforts to focus the attention of the Congress and the nation on the dangers of projected increases in the public debt and the importance of moving the budget onto a sustainable trajectory. It is a shame that the bill establishing the Conrad-Gregg Task Force did not pass and that the President’s announcement of a Debt Reduction Commission has not received strong bipartisan support. But those of us who care deeply about this issue must not give up! Hence, I appreciate the opportunity to participate in this hearing and hope to reinforce the Committee’s commitment to keep pressing for solutions to the most serious threat to America‘s economic security and leadership capacity.

The dangerous trajectory

On any reasonable set of economic assumptions, the U.S. budget is on an unsustainable track. There is no disagreement among the Office of Management and Budget (OMB), The Congressional Budget Office (CBO), The Government Accountability Office (GAO), and leading private forecasters on where the budget is headed if we do not change course. In the next decade and beyond, federal spending, driven by the impact of an aging population and rising health care costs on Medicare, Medicaid, and Social Security, will rise substantially faster than the whole economy can grow - faster than the GDP. Revenues, at any likely set of tax rates, will grow only slightly faster than the GDP. The gap between spending and revenues will keep widening. The growing deficit will be more and more difficult and expensive to finance. Ultimately, we will not be able to borrow enough to finance the widening gap between spending and revenues.

These projections are not new - they predate the financial crisis and the current recession. But two or three years ago, deficits, while inappropriate in a prosperous economy, were of manageable size. The deficit in FY2008, for example was 3.2 percent of GDP and debt held by the public at the end of that year was 40.2 percent of GDP - not especially high proportions by either historical or world standards. The warnings of this Committee and others about bigger deficits looming in the future were not gaining traction with a complacent public.

But the financial crisis of 2007-8 and the deep recession it precipitated changed the budget outlook dramatically. Revenues fell rapidly as the recession spiraled downward. Spending exploded as emergency measures were taken to keep the financial sector from melting down and to mitigate the effects of the recession. The deficit peaked at more than 10 percent of GDP and the debt soared to an estimated 64 percent of GDP this fiscal year. Deficits will recede as the economy recovers and temporary spending measures expire. However, deficits are not projected to return to previous levels and debt will keep growing rising faster that the GDP even as the economy returns to normal growth. Moreover, the double impact of aging and medical spending - once seen as a “long run” problem - is already driving deficits and debt higher and will accelerate by the end of the decade. Complacency about the fiscal threat is no longer possible. Unfortunately, complacency has been replaced by strident partisan blaming - not yet by a willingness to cooperate on crafting solutions.

But solutions must be found - and soon. As our debt mounts, the risk grows that our creditors, especially the foreign creditors who own half our debt, will lose confidence in our ability to get our house in order and will demand dramatically higher interest rates to lend us more. Rapidly rising rates would derail the economic recovery and balloon the cost of servicing the federal debt. Escalation of the debt has made near term action to reduce deficits more urgent than it would have been at lower debt levels. We no longer have the luxury of waiting for several years until we are sure the economy is growing strongly before taking action to stabilize the debt. We have to take action very soon to arrest the debt build-up before it threatens the confidence of our creditors. Moreover, while there are persuasive economic reasons for curbing the increase in our debt, the moral case is even stronger. It is unconscionable for today’s Americans to live persistently beyond our means and pass our bills on to future taxpayers.

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Authors

Alice M. Rivlin

Publication: Senate Budget Committee

Do Central Banks Have an Exit Strategy?

Kenneth Rogoff — Mon, 15 Sep 2008 12:00:00 -0400

A year into the global financial crisis, several key central banks remain extraordinarily exposed to their countries’ shaky private financial sectors. So far, the strategy of maintaining banking systems on feeding tubes of taxpayer-guaranteed short-term credit has made sense. But eventually central banks must pull the plug. Otherwise they will end up in intensive care themselves as credit losses overwhelm their balance sheets.

The idea that the world’s largest economies are merely facing a short-term panic looks increasingly strained. Instead, it is becoming apparent that, after a period of epic profits and growth, the financial industry now needs to undergo a period of consolidation and pruning. Weak banks must be allowed to fail or merge (with ordinary depositors being paid off by government insurance funds), so that strong banks can emerge with renewed vigor.

If this is the right diagnosis of the “financial crisis,” then efforts to block a healthy and normal dynamic will ultimately only prolong and exacerbate the problem. Not allowing the necessary consolidation is weakening credit markets, not strengthening them.

The United States Federal Reserve, the European Central Bank, and the Bank of England are particularly exposed. Collectively, they have extended hundreds of billions of dollars in short-term loans to both traditional banks and complex, unregulated “investment banks.” Many other central banks are nervously watching the situation, well aware that they may soon find themselves in the same position as the global economy continues to soften and default rates on all manner of debt continue to rise.

If central banks are faced with a massive hit to their balance sheets, it will not necessarily be the end of the world. It has happened before – for example, during the 1990’s financial crises. But history suggests that fixing a central bank’s balance sheet is never pleasant. Faced with credit losses, a central bank can either dig its way out through inflation or await recapitalization by taxpayers. Both solutions are extremely traumatic.

Raging inflation causes all kinds of distortions and inefficiencies. (And don’t think central banks have ruled out the inflation tax. In fact, inflation has spiked during the past year, conveniently facilitating a necessary correction in the real price of houses.) Taxpayer bailouts, on the other hand, are seldom smooth and inevitably compromise central bank independence.

There is also a fairness issue. The financial sector has produced extraordinary profits, particularly in the Anglophone countries. And, while calculating the size of the financial sector is extremely difficult due to its opaqueness and complexity, official US statistics indicate that financial firms accounted for roughly one-third of American corporate profits in 2006. Multi-million dollar bonuses on Wall Street and in the City of London have become routine, and financial firms have dominated donor lists for all the major political candidates in the 2008 US presidential election.

Why, then, should ordinary taxpayers foot the bill to bail out the financial industry? Why not the auto and steel industries, or any of the other industries that have suffered downturns in recent years? This argument is all the more forceful if central banks turn to the “inflation tax,” which falls disproportionately on the poor, who have less means to protect themselves from price increases that undermine the value of their savings.

British economist Willem Buiter has bluntly accused central banks and treasury officials of “regulatory capture” by the financial sector, particularly in the US. This is a strong charge, especially given the huge uncertainties that central banks and treasury officials have been facing. But if officials fail to adjust as the crisis unfolds, then Buiter’s charge may seem less extreme.

So how do central banks dig their way out of this deep hole? The key is to sharpen the distinction between financial firms whose distress is truly panic driven (and therefore temporary), and problems that are more fundamental.

After a period of massive expansion during which the financial services sector nearly doubled in size, some retrenchment is natural and normal. The sub-prime mortgage loan problem triggered a drop in some financial institutions’ key lines of business, particularly their opaque but extremely profitable derivatives businesses. Some shrinkage of the industry is inevitable. Central banks have to start fostering consolidation, rather than indiscriminately extending credit.

In principle, the financial industry can become smaller by having each institution contract proportionately, say, by 15%. But this is not the typical pattern in any industry. If sovereign wealth funds want to enter and keep capital-starved firms afloat in hopes of a big rebound, they should be allowed to do so. But they should realize that large foreign shareholders in financial firms may be far less effective than locals in coaxing central banks to extend massive, no-strings-attached credit lines.

It is time to take stock of the crisis and recognize that the financial industry is undergoing fundamental shifts, and is not simply the victim of speculative panic against housing loans. Certainly better regulation is part of the answer over the longer run, but it is no panacea. Today’s financial firm equity and bond holders must bear the main cost, or there is little hope they will behave more responsibly in the future.

Authors

Kenneth Rogoff

Publication: Project Syndicate

Addressing our Nation’s Fiscal Future

Wed, 18 Jun 2008 11:00:00 -0400

Event Information

June 18, 2008
11:00 AM - 12:00 PM EDT

Room 210
Cannon House Office Building

Washington, DC

On June 18, the Brookings Institution hosted Representative Paul Ryan (R-Wisc.) and Representative Jim Cooper (D-Tenn.) to discuss different approaches to correct the unsustainable path of our current fiscal policies. Rep. Ryan is the ranking Republican on the House Budget Committee, and discussed his recent proposal, "A Roadmap for America’s Future," which aims to bring government spending under control by restructuring the tax code, Medicare, Medicaid and Social Security. Ryan represents Wisconsin’s First District and has devoted his five terms in the House of Representatives to addressing the long-term fiscal crisis.

Rep. Cooper is a Democrat on the House Budget Committee who represents Tennessee’s Fifth District. A member of the Blue Dog Coalition, Cooper recently introduced the “Securing America’s Future Economy Commission Act” or SAFE Act, which would establish a commission to address the long-term fiscal outlook.

Brookings Senior Fellow Isabel Sawhill, director of the Brookings’ Budgeting for National Priorities Project, provided introductory remarks and moderated the discussion. Members of the Brookings-Heritage Fiscal Seminar, who co-authored "Taking Back Our Fiscal Future," discussed the proposals. After the program, the panelists took questions from the audience.

Video

Participants

Moderator

Panelists

The Honorable Jim Cooper (D-Tenn.)

United States House of Representatives

The Honorable Paul Ryan (R-Wisc.)

United States House of Representatives

Cutting-Edge Development Issues for INGOs: Applications of an Asset Accumulation Approach

Caroline Moser, James Pickett and Pamela Sparr — Sun, 01 Jul 2007 00:00:00 -0400

INTRODUCTION

What analytical frameworks and operational strategies do international nongovernmental organizations (INGOs) use to address poverty in developing countries? Which strategies work best? What are the cutting-edge issues on poverty reduction in development practice and thinking? Are INGOs willing to collaborate in new ways to handle their work in a dramatically changed operating environment?

These were among the questions explored by 40 senior staff members from the headquarters, field offices, and partners of 22 U.S. and U.K. INGOs at a workshop in Washington, D.C. May 30–31, 2007. The workshop, "Toward a New Poverty and Development Agenda: Contributions of the INGO Community," sponsored by the Brookings Institution and the Ford Foundation, was organized by Caroline Moser, Senior Fellow in the Brookings Global Economy and Development Program. The event was designed to discuss findings of a research study of the practices of 22 INGOs (box 1) and to examine the usefulness of Moser's new asset accumulation analytical framework for INGO operating strategies. The workshop was a follow-up to an earlier meeting held at Brookings in 2006 to review and debate the asset accumulation framework and identify its applicability in different development settings (Moser 2006, 2007).

An asset accumulation policy is a new approach to poverty reduction. It focuses directly on creating opportunities for the poor to acquire, keep, and pass on wealth to the next generation. This approach complements other poverty-focused strategies developed over the past decade, particularly sustainable livelihoods and social protection (table 1). Just as poverty reduction strategies are changing, so too is the situation in which INGOs operate. Among the major contextual shifts are the emergence of new donors and funding strategies, a mounting insistence on proof of aid results among donors, an increasingly unpredictable operating environment due to climate change and sociopolitical developments, and a rebalancing of power relations among INGOs in the North and South.

To encourage a wide-ranging dialog about operations in this fluid context, representatives were invited from organizations spanning a broad continuum of INGOs— from relief through development to conservation organizations. The participants came from 13 countries (see appendix). The workshop structure and content took shape during consultations between Pamela Sparr and staff from 21 INGOs. All the INGOs were eager for a chance to get together with colleagues to talk about the complexities of their daily "antipoverty" work, encompassing advocacy and practical implementation. Some of the more innovative ideas explored at the workshop pushed everyone's thinking about the connections between assets and human rights and the convergence of environmental and development concerns.

This Asset Debate Paper presents highlights from plenary presentations and conversations in small, breakout groups. It is not meant to be a comprehensive review of every issue discussed.

To promote debate, conversation was considered confidential. Therefore, comments and presentations during the event are synthesized without attribution. Quotations are included to illustrate the flavor of the discussion and underscore certain points. In a few instances, acknowledging particular intellectual contributions was considered necessary. Material attributed to specific individuals and institutions was reviewed and approved by them.

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Authors

Caroline Moser
James Pickett
Pamela Sparr

Foreign Holdings of U.S. Debt: Is Our Economy Vulnerable?

Kenneth Rogoff — Tue, 26 Jun 2007 00:00:00 -0400

With the United States running a current account deficit at 6 percent of national income, foreign nationals have been accumulating U.S. assets at a spectacular rate. Taking into account recent stock market gains, foreigners now hold well over $14 trillion of U.S. assets, more than a 100 percent of U.S. gross domestic product. Foreigners, mainly foreign central banks and government investment funds, hold more than $2.5 trillion in U.S. Treasury securities alone. Incredibly, the United States absorbs roughly 70 percent of all net saving produced by the world's current account surplus countries, including China, Japan, Germany and the oil exporting countries. Borrowing on this scale by any large country, much less the world's pre-eminent economy is unprecedented in modern world history.

Many observers are asking whether U.S. indebtedness to foreigners might pose any subtle hidden threats to the U.S. economy or even to U.S. national security. With China alone holding $1.2 trillion in reserve assets and foreigners collectively holding more than twice that in U.S. Treasury securities, is there any risk that the United States might be subject to economic blackmail? What about the rapid proliferation of so-called sovereign wealth management funds, most famously China's $3 billion investment in the private equity group Blackstone? Sovereign wealth funds now control nearly $2 trillion in assets, more than stand-alone hedge funds. Is there a risk that foreign governments will use their financial relationships to compromise U.S. security? Is there any danger of exotic "Goldfinger"-like scenarios where foreign governments might use their massive leverage to precipitate a wholesale financial collapse in the United States?

The short answer is these more extreme risks are unlikely to materialize, but the United States continued dependence on foreign borrowing is a significant vulnerability in the event of shock, such as a collapse in U.S. housing prices, or an extreme national security breach, that might slow the inflow of new funds into the United States. In this testimony, I will first discuss why the more extreme scenarios are relatively implausible, then go on to discuss where the real vulnerabilities lie.

When a Debtor Is Big Enough, it's the Banks' Problem: The United States and China

As foreign wealth continues to explode in a number of transparency-challenged countries, we are likely to see some spectacular financial debacles. Governments have a long tradition of losing massive amounts of money in financial markets. This tradition is not likely to end anytime soon, which is good new for global private investors, some of whom continue to reap huge profits at governments' expense. However, any attempt by a well-heeled foreign government to use its financial leverage to upset the U.S. economy will almost certainly backfire. The U.S. economy will not wilt, and the foreign instigator will either lose a bundle of money immediately, or get caught and be forced to forfeit the gains. The key to U.S. resilience is our country's credibility in debt markets; the U.S. governments' credibility in international debt markets is so great that it is virtually impossible for any such crisis to precipitate a default. Absent, this risk, it is very unlikely for a foreign-instigated financial crisis to spin beyond the control of the Federal Reserve and other regulators.

For example, were China to suddenly reallocate a large share of its predominantly dollar portfolio into Euros, the ensuing dollar decline would inflict a massive capital loss on the Central Bank of China. A 20 percent drop in the dollar against the Yuan would cost the Chinese Central Bank well over a hundred billion dollars. Fundamentally, when a debtor owes the bank a large enough amount, the debt becomes the bank's problem. China, whose reserves amount to 50 percent of its GDP, faces risks far to great to ever seriously consider this option. Of course, over time, one can expect China to significantly diversify out of dollar assets, but the time frame will be one that markets can easily accommodate.

Risk Posed by Sovereign Wealth Funds

One should entirely dismiss the risks posed by the recent trend towards riskier investment strategies by sovereign investors, notably the so-called "sovereign wealth funds." With deep pockets and the potential to draw on vast credit lines, sovereign wealth funds can potentially take larger and more leveraged risk positions than even the most aggressive private hedge funds. Given many of these funds weak governance and lack of transparency, global regulators are rightly concerned that one of these funds may precipitate a significant financial crisis. An ill-considered massive bet by a sovereign wealth fund, or perhaps the actions of a rogue trader within a sovereign wealth fund, could cause a massive price fluctuation in a financially-sensitive part of the global economy. Here again, however, the big loser would be the government that owned the sovereign wealth fund, and would ultimately have to foot the bill for a catastrophic loss. True, there could be substantial collateral damage as in international financial crisis, but again, given the solid fundamentals of the U.S. financial system, prompt response by regulators and the Federal Reserve should be able to contain the problem.

Goldfinger Risk

Yes, one can imagine more far-fetched and devious schemes to upend the global financial system. In the James Bond movie "Goldfinger," the villain aims to bid up the value of his own gold holdings by irradiating the gold in Fort Knox, thereby cornering the market. In the real world, the Hunt brothers were accused of cornering the futures market in silver in the early 1980s. Given today's spectacular explosion in global financial assets, it is easy to imagine financial fraud and crime surpassing all previous benchmarks. Yet, in the scheme of things, deeper financial markets probably make things safer not riskier. It is far harder to corner a commodities market today than it was 25 years ago. Rather than resisting financial globalization, the right approach is to continue to promote better corporate governance at home, and greater transparency on the part of financial entities, including sovereign wealth funds. In pursuing these goals, the United States should continue to work closely with multilateral agencies, such as the International Monetary Fund or the Bank for International Settlements.

The United States Is a Big Winner from Financial Globalization

In contemplating any policy actions, it is important to recognize that the United States is a massive winner from financial globalization. Although it is true that the United States is a large net debtor (with roughly $3 trillion in net debt), the cost to the United States has been relatively modest because, on average, Americans have earned a significantly higher return — about 1.5 percent higher — on their holdings of $10 trillion in foreign assets than foreigners have earned on their holdings of $13 trillion in U.S. assets. This differential has met that U.S. net debt accumulation has been significantly less rapidly than our $800 billion trade balance deficit might suggest, typically half as much. U.S. financial firms are the envy of the world, they arguably constitute the United States' most successful export industry. Any attempt to block foreign entities from engaging in the United States could lead to retribution that backfires and hurts U.S. interests.

Although a Simpler, Fairer Tax System Is Needed

Of course, this does not mean that US should give privileged tax treatment to hedge funds and private equity any more than it should give better treatment to other export or import-competing industries. But a patchwork fix could prove highly counterproductive. Faced with the rapidly changing winds of globalization, the United States needs -- now more than ever -- a much cleaner and simpler tax system. A flat tax with a large exemption at low incomes would likely prove far fairer and more efficient in practice than the current labyrinth of taxes.

The Massive United States Current Account Deficit Still Poses Real Vulnerabilities that should be Addressed

I have argued that growing international indebtedness does not seriously expose the United States to any of the more extreme doomsday scenarios. This is not to say that we should greet the U.S. current account deficit with equanimity. It is a significant vulnerability that could significantly amplify the effects of growth crisis precipitated either by economic factors (say, a historic collapse in housing prices), or geopolitical factors (a terrorist attack of unprecedented dimensions on U.S. soil.) If the United States were forced to cut back the flow of its new borrowing by say, a half — to $400 billion per year, the trade-weighted dollar could easily fall 20-25 percent, and interest rates could rise by close to one percent across the board.¹ On impact, it is quite possible that financial markets would overshoot.

Thus, in a crisis, the United States' position as a big net borrower could prove an Achilles' heel that considerably amplifies the magnitude and duration of a crisis. Although this risk has not materialized even after years of very high U.S. deficits, it remains a concern. Policies to raise U.S. public and private savings would be a helpful step towards ameliorating these risks. So, too, would be more flexible exchange rates in Asia and a greater reliance on domestic demand for growth in Europe. Coordinated policies have been advanced by the International Monetary Fund for many years now, though with relatively little traction, especially in China but also in the United States. While it is true that U.S. current account is showing signs of stabilizing this year, the "soft landing" scenario will take at least a decade to fully materialize, leaving the U.S. vulnerable to a "hard landing" scenario in the interim.

In sum, the United States, with its superior legal system and transparency, is a big winner in financial globalization. Integration of global financial markets has helped lead to lower interest rates and a more stable U.S. economy. Foreign investment in the United States has to be viewed in the context of the larger picture, which takes into account the enormous success of U.S. investors abroad. Doomsday scenarios, while theoretically possible, seem remote. However, although these extreme risks are remote, the United States massive dependence on foreign borrowing remains an important vulnerability. Any global macroeconomic or geopolitical shock that leads to a sharp contraction of the U.S. current account deficit is likely to produce a massive dollar drop, and possibly a sharp interest rate rise, that would considerably amplify the adverse effects of the shock on the U.S. economy. It would be far better to take steps to gradually close up the United States massive borrowing gap than to wait for such a crisis.

¹ For calibrations on how a closing up of the US current account might affect the trade weighted US exchange rate, see Obstfeld and Rogoff (2005, Brookings Papers on Economic Activity, and 2007, National Bureau of Economic Research.)

Authors

Kenneth Rogoff

Publication: House Committee on the Budget

Funding Global Health Needs: Will the Global Fund Debt Conversion Make a Difference?

Wed, 28 Feb 2007 14:00:00 -0500

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February 28, 2007
2:00 PM - 4:00 PM EST

Stein Conference Room
The Brookings Institution
1775 Massachusetts Avenue, NW
Washington, DC

Despite recent increases in official development assistance, financing needs for AIDS, tuberculosis and malaria are still lacking. Health spending on these and other issues remains far lower than required to meet the health-related Millennium Development Goals by 2015. To address these critical financing needs, many within the international health community are advocating the use of global fund debt conversion, a mechanism designed to convert old government debt into new resources to tackle HIV/AIDS, tuberculosis and malaria.

On February 28, the Brookings global health financing initiative hosted a discussion on the global fund debt conversion proposal and its pilot program, Debt2Health, with featured speaker Ngozi Okonjo-Iweala, Brookings distinguished visiting fellow. Participants included Brookings scholar Homi Kharas; Paul Zeitz, co-founder and executive director of the Global AIDS Alliance; and Kingsley Chiedu Moghalu, head of global partnerships at the Global Fund to Fight AIDS. David de Ferranti, director of the global health financing initiative, moderated this discussion.

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20070228globalhealth

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Moderator

David de Ferranti

Senior Fellow, The Brookings Institution

Panelists

Kingsley Chiedu Moghalu

Head of Global Partnerships, Global Fund to Fight AIDS

Paul Zeitz

Co-founder and Executive Director, Global AIDS Alliance

Why Bad Loans Are Good For Africa

Lex Rieffel — Tue, 13 Feb 2007 00:00:00 -0500

Chinese President Hu Jintao has just wrapped up an historic and well-publicized visit to eight African countries, including Liberia, Sudan and Zambia. In each of the countries visited, President Hu has pledged or confirmed generous amounts of aid. You might think that Africa's "old" aid donors, especially the United States and the EU countries, would welcome this new source of aid.

After all, they have been straining to find the money they believe is necessary to pull Africa out of poverty and into the global middle class. But you would be wrong. They have been grumbling and whining.

China ignores standards

The flak directed at China's plans to boost aid to Africa springs from three distinct concerns.

One is that China's aid is propping up oppressive regimes in countries like Sudan and Zimbabwe.

Another is that China is winning contracts for large projects against well-known companies from the old donor countries by ignoring internationally recognized environmental and labor standards.

A third concern is that China is saddling poor countries with debts they will be unable to pay, fresh on the heels of a decade-long initiative by the old donors to write off billions of dollars of bad loans they made in the past.

China's debt concerns

The object of the initiative was to allow debtor countries to use their limited budget funds for education and health and other poverty-alleviation programs instead of for debt service.

The third concern seems particularly hypocritical, or disingenuous — or simply naïve. Instead, the question the old donors should be asking is why the amount of lending being committed by China — $3 billion over three years — is so small.

A new age of creditors

A springboard for the debt-related concerns of the old donors was the joint IMF-World Bank report issued in November 2006 on "the debt sustainability framework for low-income countries".

The report called attention to a group of "emerging creditors" led by China, Kuwait, Saudi Arabia, South Korea, Brazil and India — and put the debt owed to China by low-income countries at $5 billion at the end of 2004. It also called for "outreach" to the new creditors "to encourage responsible lending."

Old donor grief

The concerns of old donors are hypocritical because the Chinese are only doing what the old donors did in the 1970s and 1980s.

The concerns are disingenuous because the write-off initiative that began in the 1990s (Heavily-Indebted Poor Countries-HIPC Initiative and Multilateral Debt Relief Initiative) was all about debt owed to the IMF, the World Bank and the African Development Bank — all of which insisted on being treated as preferred creditors.

It was not about bilateral debt, which the old donors had started writing off through the Paris Club process a decade earlier.

Some debt disappears

Here is the nub of the issue: Bad loans made by the old aid donors can be rescheduled, reduced or written off in a coordinated fashion in the Paris Club. By contrast, bad loans made by the multilateral institutions are not eligible for debt relief — because of the practice started 50 years ago of exempting these institutions from Paris Club operations.

As a result, the old donors and the low-income debtor countries have had to jump through a mind-boggling set of hoops to discharge these debts, without writing them off, when they became unsustainable in the late 1990s.

China leads emerging creditors

Is China asking to be treated as a preferred creditor? Not at all. Part IV, Section 2(8) of the "Africa Policy Paper" issued in advance of President Hu's trip (and thoughtfully posted in English on the website of the official Chinese news agency) says that China is "ready to continue friendly consultation to seek solution to, or reduction of, the debts they owe to China."

More Chinese lending simply means more projects will be completed. How can that be bad for the African countries? If the countries have trouble repaying the loans — and the odds are high that a number of them will — then they can be reduced or written off. No big deal.

The more interesting question is whether China — and the other "emerging creditors" — will decide at some point to join the Paris Club. The door is open, but only for countries prepared to accept Paris Club rules.

Future for relief

One of the most hallowed rules of the Paris Club is to link debt relief to satisfactory performance under a stand-by or other conditional arrangement with the IMF. China, however, has stressed that its lending is unconditional.

Who will blink first? Will the Paris Club start doing unconditional debt relief deals for the next wave of low-income country cases in order to draw China into the Club? Or will China discover the virtues of conditional relief as a step that low-income countries will have to take on the road to becoming responsible middle-income debtors?

Authors

Lex Rieffel

Publication: The Globalist

A Harmonious Socialist Society or Bust: China's Quest for Sustainable Development

Wing Thye. Woo — Fri, 01 Dec 2006 00:00:00 -0500

Introduction

The 6th Plenum of the 16th Central Committee of the Communist Party of China (CPC) concluded on October 11, 2006 with the passage of a resolution to establish a harmonious society by 2020. The obvious implication from this commitment is that the present major social, economic and political trends within China might not lead to a harmonious society or, at least, not lead to a harmonious society fast enough.

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Wing Thye Woo

Publication: Carnegie Endowment for International Peace

Debt Relief

Peter Blair Henry and Serkan Arslanalp — Sat, 01 Apr 2006 00:00:00 -0500

Abstract

The G-8 Multilateral Debt Relief Initiative (MDRI) is the next step of the Highly Indebted Poor Countries Initiative (HIPC). There are two reasons why MDRI is unlikely to help poor countries.

First, the amount of money at stake is trivial. The roughly $2 billion of annual debt payments to be relieved under MDRI amounts to roughly 0.01 percent of the GDP of the OECD countries—a mere one-seventieth (1/70) of the quantity of official development assistance agreed to by world leaders on at least three separate occasions (1970, 1992, 2002). Second, the existence of debt overhang is a necessary condition for debt relief to generate economic gains. Since the world's poorest countries do not suffer from debt overhang, debt relief is unlikely to stimulate their investment and growth. The principal obstacle to investment and growth in the world's poorest countries is the fundamental inadequacy in these countries of the basic institutions that provide the foundation for profitable economic activity. In light of these facts, the MDRI may amount to a Pyrrhic victory: A symbolic win for advocates of debt relief that clears the conscience of the rich countries but leaves the real problems of the poor countries unaddressed.

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Peter Blair Henry
Serkan Arslanalp

Don't Rush to Reform the Fund (and the Bank)

Lex Rieffel — Thu, 23 Mar 2006 00:00:00 -0500

Pressure is building on the G- 7 finance ministers to act decisively this year to fix the International Monetary Fund, but the time is not ripe for one compelling reason: The IMF's major shareholder — the United States — the only one with a voting share large enough to block fundamental changes, is not ready to act and will not be ready until 2009.

Is it possible to reform the IMF without the support of the U.S.? And is it possible for the Bush administration to propose a set of reforms acceptable to a high majority of the IMF's member countries and also the U.S. Congress? The answers to both questions seem to be no, which suggests a lack of political realism in the current flurry of interest in IMF reform.

Some worthy reforms proposed by Governor of the Bank of England Mervyn King and Institute for International Economics Senior Fellow Edwin Truman can be implemented without any change in the IMF's constitution (Articles of Agreement). However, the most critical reforms—related to voting and representation— will require amendments to the IMF's Articles.

Only three amendments to the Articles have gone into effect since the Fund was established in 1945. Each time, the United States has played the lead role in the amendment process. A fourth amendment has been in limbo since 1997 because the voting majorities in the U.S. Congress required to ratify it have not been forthcoming.

The main obstacle to a U.S. initiative to reform the Fund this year is the Bush administration's lack of credibility, both at home and abroad. Regardless of its content, the rest of the world is likely to respond skeptically to any proposal advanced by President Bush or Treasury Secretary John Snow. One reason for this skepticism is the Bush administration's single-minded pursuit of the war on terrorism and regime change in the Middle East to the neglect of other issues of priority for the rest of the world.

Even if there were broad international support for an IMF reform initiative advanced by the United States, it would not fly domestically. The president's approval rating is on the floor. Republican control of both houses of Congress is likely to be sharply eroded, if not lost, in the November elections. The country at large seems sharply divided on most domestic and international issues.

The best chance for successful reform is to orchestrate an informed debate within the United States in the context of the presidential election in November 2008. The goal would be to have an IMF reform plank in the platform of each major party that can be acted upon in the first year of the next presidency. To be credible these planks must contemplate bold changes such as giving up the exclusive veto power of the United States. Actively seeking the views of other countries on the future role of the Fund will also be necessary to ensure success.

An IMF that has the capacity to identify weaknesses in the international financial system and generate effective pressure on member countries to address them can make an enormous contribution to global well being. No other country today has as big a stake in implementing the reforms required for the Fund to perform this role. No other country is in a position to provide the leadership required to push through a reform package. That is why it is critical to create the political space for the next president of the United States to stop the current drift and propose changes that will be seen as good not only for 300 million Americans but also for the other 6 billion co-inhabitants of this world.

A similar approach would set the stage for fundamental reforms at the World Bank, where the urgency of reform is even greater. While shutting down the IMF would leave a serious gap in the international financial system, shutting down the World Bank would not. To remain relevant for another 60 years, the World Bank will probably have to move its headquarters out of Washington, disperse its staff to offices in the countries where it operates, select a non-American president, and untangle itself from the IMF. The Bank will be scarred by such reforms, however, if they are resisted by the United States. A public debate is the best way of building support for these and other changes that appear radical now.

Authors

Lex Rieffel

Publication: The Examiner

Brookings: Topics - Foreign Debt

If Europe Doesn't Stand Up After Cyprus

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Africa’s Odious Debts: How Foreign Loans and Capital Flight Bled a Continent

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China's Currency Policy Explained

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An International Financial System Adrift and Imperiled

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Debt Buybacks and Backdoor Restructurings: Can Greece Pull an Ecuador?

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Debt Burden in Advanced Economies Now a Global Threat

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Small Economies, Big Problems, and Global Interdependence: Greece and the World Economy

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Rebalancing the U.S.-China Relationship

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The Top Economic Stories of 2010

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The Rising Burden of Government Debt

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Moving to a Fiscally Sustainable Budget

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Do Central Banks Have an Exit Strategy?

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Addressing our Nation’s Fiscal Future

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Cutting-Edge Development Issues for INGOs: Applications of an Asset Accumulation Approach

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Foreign Holdings of U.S. Debt: Is Our Economy Vulnerable?

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Funding Global Health Needs: Will the Global Fund Debt Conversion Make a Difference?

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Why Bad Loans Are Good For Africa

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A Harmonious Socialist Society or Bust: China's Quest for Sustainable Development

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Debt Relief

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Don't Rush to Reform the Fund (and the Bank)

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