Unresolved Issues in Global Financial Imbalances G. (Tassos) Malliaris Mary Malliaris LOYOLA UNIVERSITY CHICAGO 11TH Biennial International Conference of the Athenian Policy Forum Chalkidiki, Greece, July 1-3, 2012

Focus of the Paper Trace Rapidly the Evolution of the Global Monetary System Emphasize the Persistence of Global Financial Imbalances Review the Global Financial Crisis Explain How Financial Imbalances Contributed to the Global Financial Crisis List the Unresolved Issues

Evolution of Global Monetary System Bretton Woods I Bretton Woods II Where Are We Now? A Need for Bretton Woods III ? What Needs to be Resolved?

Bretton Woods I Why Was Bretton Woods Developed? Keynes’ Incompatibility Thesis: Cannot achieve Simultaneously and Automatically Without Coordination Free Trade, Flexible Exchange Rates, Free Capital Mobility and Global Full Employment

The Gold Standard Period

“It is characteristic of a freely convertible international standard that it throws the main burden of adjustment on the country which is the debtor position on the international balance of payments.” Keynes, Post War Currency Policy, 1941, pp. 29-30

“An essential improvement in designing any international payments system requires transferring the onus of adjustment from the debtor to the creditor position. This transfer would substitute an expansionist, in place of a contractionist, pressure on world trade “ Keynes, Post War Currency Policy, 1941, pp. 29-30

1944 Bretton Woods Conference U.S. Major Creditor Europe and Japan Are Devastated Need to Grow Global Economy Presence of Economic Imbalances Keynes’ Estimate of $10 billion needed Dexter White proposes $3 billion Marshall Plan Over 4 Years: $13 billion

Bretton Woods 1947-1973 Stabilized Global Economy Promoted Growth Created New Global Imbalances Core or Center (U.S.) vs. the Periphery (European and Asian Countries)

Collapse of Bretton Woods I US Unable to Cope with Global Imbalances French Conversion of Imbalances into Gold U.S. Inflationary Monetary and Fiscal Policies August 15, 1971 U.S. Abandons Gold Convertibility

The Modern History of Gold *Non-Inflation adjusted prices Current Price: $1622/oz

The Global Monetary System After 1973 More Flexible Exchange Rates Exchange Rate Volatility and Uncertainty Accelerated Global Capital Mobility Independent Monetary Policy Several Currency Crises, leading to Banking Crises and often to Real GDP Declines

Major Facts of Bretton Woods II Flexible Exchange Rates Do Not Resolve Global Imbalances Several Currency Crises, Leading to Banking Crises and often to Real GDP Declines Such Crises Expected to Occur in Emerging Nations The 2007-09 Unanticipated Global Financial Crisis in U.S. and EU

The Dollar-coaster

Crisis Dates By Country: 1870-2008 From: Jorda, Schularick, and Taylor 2011

Major Developments of BW II 1989: Japanese Stock Market Crash and Japan’s Lost Decade Formation of the EU and EMU: Creation of the Euro Collapse of Former Soviet Union and the Emergence of China Internet Bubble and Housing Bubble

Collapse of U.S. Trade Balances

Global Imbalances Source: IMF World Economic Outlook 2010

Current Account Imbalances Current account balance as a percentage of GDP, US, China, OECD and BRICs Source: Economist Intelligence Unit, OECD, BEA-NIPA, State Administration of Foreign Exchange (China)

Review of Bretton Woods II 2003: Dooley, Folkerts-Laundau and Garber claim that Bretton Woods Is Revived Core: U.S. Dollar is Used as a Global Currency; Balance of Payments Deficits. Periphery: Export-led Growth Driven by an Undervalued Exchange Rate; Massive Accumulation of Reserves Can Such a System Be Maintained in the Long-run?

Inflation Source: Federal Reserve

The Global Financial Crisis of 2007-09 Started in September 2007 as a Subprime Mortgage Crisis with a $300 billion Potential Loss Developed into a Major Financial Crisis The Role of Easy Domestic Monetary Policies The Bernanke/Taylor Debate of Global Savings Glut: Role of Global Imbalances Aggressive Export Oriented Growth by China, Japan and Germany

Global Dimension of the Crisis

What Theories Guide Us? Standard Neoclassical: Stable Markets Return to Equilibrium Minsky-Kindleberger: Booms and Busts

Global Imbalances

Foreign Holdings of U.S. Debt Country Amount (billions) China 1145.5 Japan 1066.1 Oil Exporters 252.4 Caribbean Banking Centers 247.0 Brazil 246.7 Taiwan 188.3 United Kingdom 154.2 Switzerland 151.1 Russia 146.8 Belgium 141.0 Source: U.S. Treasury Data as of end of April 2012

U.S. Wealth

Housing price appreciation vs Housing price appreciation vs. current account accumulation, 1996 – peak of housing market Source: Economist Intelligence Unit, OECD, IMF, State Administration of Foreign Exchange (China), De Nederlandsche Bank, BEA. The area of each circle is proportional to 2008 GDP. 

Taylor Rule

Asset Bubbles

The Crisis of the Euro While the U.S. is Assessing the Impact of Global Imbalances in Its Financial Crisis The EMU, Viewed as a Bretton Woods System of a Smaller Scale, Experiences a Global Imbalances Crisis of its Own

Current Policies and Regulations Primarily National: US, EU, England, Japan, China, others The Emergence of the G20 as the Global Governance Group The Designation of the Global Economy Meeting as the Bi-Monthly Central Banks Monitoring Group The Reform and Expansion of the Financial Stability Board

Unresolved Issues Global Imbalances Persist Asset Bubbles in Equity, Bonds, Housing Burst Causing Bank Failures Sovereign Debt Crisis Austerity vs. Growth with 4% inflation

More Unresolved Issues Bretton Woods III: U.S., EU, An Asian Monetary Union? Continued Depreciation of the U.S. Dollar? Domestic Consumption Led Growth vs. Export- Oriented Growth? Central Banks as Lenders of Last Resort Importance of Hegemony: the Recycling of Accumulated Reserves

Total Reserves

Source: Federal Reserve, World Bank

Country Share of World GDP Percentage shares of selected countries and areas in world GDP, 1870-2050 (at2005 exchange rates) Sources: Angeloni et al (2011)