financial system could be heading for even bigger shocks in the future, particularly in places such as the UK, Hong Kong and Switzerland.
today’s financial turbulence might be merely a precursor of something even worse in the years ahead. For while global imbalances helped to create the recent financial crisis, these imbalances have not declined; on the contrary, the paper argues, they are likely to get considerably bigger – not smaller – in the coming years.
This means that the financial system could be heading for even bigger shocks in the future, particularly in places such as the UK, Hong Kong and Switzerland. But it could also force a policy shift. Most notably, “faced with further increases in the magnitude and/or volatility of capital flows, it is likely that some countries will choose to introduce capital controls,” the paper warns. Call it, if you like, Back to the Future.
The logic that has sparked this analysis starts with the observation that the size of emerging market countries is likely to swell dramatically in the next few decades, both in terms of economic output and capital markets activity too. That will leave the “Brics” – Brazil, Russia, India and China – with more money to invest, the bank warns, and much of this is likely to head overseas.
Crisis fears fuel debate on capital controls
By Gillian Tett
Is the world stealthily sliding towards capital controls? That is the question which is starting to hover, half-stated, on the edge of policy debates, as financial anxiety spreads across Europe.
But now, a new salvo has been fired into this debate from an unexpected source: the Bank of England. Earlier this week, the Bank released a paper on global capital flows written by three of its economists, William Speller, Gregory Thwaites and Michelle Wright, which draws heavily on earlier research by Andy Haldane, the Bank’s head of financial stability.
It garnered little attention amid the eurozone dramas. But the message is sobering, important – and timely. For what the paper argues is that today’s financial turbulence might be merely a precursor of something even worse in the years ahead. For while global imbalances helped to create the recent financial crisis, these imbalances have not declined; on the contrary, the paper argues, they are likely to get considerably bigger – not smaller – in the coming years.
This means that the financial system could be heading for even bigger shocks in the future, particularly in places such as the UK, Hong Kong and Switzerland. But it could also force a policy shift. Most notably, “faced with further increases in the magnitude and/or volatility of capital flows, it is likely that some countries will choose to introduce capital controls,” the paper warns. Call it, if you like, Back to the Future.
The logic that has sparked this analysis starts with the observation that the size of emerging market countries is likely to swell dramatically in the next few decades, both in terms of economic output and capital markets activity too. That will leave the “Brics” – Brazil, Russia, India and China – with more money to invest, the bank warns, and much of this is likely to head overseas.
This point might sound self-evident. After all, we have already seen this trend at work. Just think about how China has been gobbling up Treasuries (and eurozone debt.) Indeed, the Bank estimates that between 2002 and 2007 annual gross international capital flows rose from 5 per cent to 17 per cent of global gross domestic product, while global current account imbalances rose from 3 per cent to 6 per cent, partly due to the rising Bric power.
But the key point to grasp is that this trend has further to run: using complex simulations, the paper suggests that by 2050, more than 40 per cent of all external assets will be held by Bric countries, and non-G7 capital outflows will be twice as large as G7 outflows. That will not occur in a uniform way: India is expected to become the main surplus country in 2050, while China’s surplus will shrink amid demographic trends, (and, alarmingly, the deficits swell further in the US and UK.) But taken as a whole, the critical issue is that global current account imbalances – ie, the sum of deficits and surpluses – will keep swelling, to hit some 8 per cent of GDP, twice their level before the last crisis hit.
Now, these are, of course, merely simulations; and since they rely on numerous assumptions, they could turn out to be wrong. But if nothing else, they should spark a bigger policy debate. Back in the halcyon pre-crisis days of the late 20th and early 21st centuries, it was taken as self evident that financial globalisation was a good thing. After all, free capital should enable money to flow to where it is most needed, at the best price; or so the theory goes.
But the subprime crisis and eurozone dramas are shaking that belief. Never mind the fact that imbalances amid globalisation can stoke up bubbles; what is the bigger risk now – particularly in the eurozone – is that financial globalisation has created a system that is interconnected in some dangerous ways. This makes it highly vulnerable to contagion, and booms and busts, of the sort that occurred in 2008 when global capital flows collapsed to a mere 1 per cent of GDP. And if globalisation increases, these swings could potentially get worse.
Is there any solution? The Bank points out – quite sensibly – that the only real answer is tighter cross-border policy co-ordination. And some of this is already on display; the dollar swap agreement between central banks two weeks ago, for example, was one response to a problem created by cross-border flows and interdependencies (in this case, eurozone banks’ dependence on dollars). But these are mere baby steps. As a separate Bank paper notes, what is really needed now is something akin to a new Bretton Woods style governance structure to enable policymakers to keep pace with the globalisation of capital flows.
But the chance of this emerging in today’s world looks distant; after all, policymakers cannot even co-ordinate themselves within the single eurozone. Little wonder, then, that the Bank concludes that some countries may eventually resort to unilateral “macro prudential” policy measures, such as those capital controls. The only question – which the Bank tactfully ducks – is who might go first?
gillian.tett@ft.com |
