In addition to weighing surcharges for too-big-too-fail banks, the latest edition of the IMF’s Global Financial Stability Report, has an interesting chapter on the 2007-2009 global liquidity expansion.
The basic premise is simple enough: the low interest rate policies being operated in certain weaker economies, are leading to hot money inflows into stronger ones. The IMF analysis looks at 41 countries specifically — classifying them into liquidity-givers and receivers. Can you guess which are which?
From Annex 4.1 of the paper:
Asia-Pacific: Australia, China, Hong Kong SAR, India, Indonesia, Japan, Korea, Malaysia, New Zealand, Pakistan, Philippines, Singapore, Sri Lanka, Thailand, and Vietnam.
Europe, Middle East, and Africa: Bulgaria, Croatia, Czech Republic, Estonia, euro area, Hungary, Iceland, Latvia, Lithuania, Nigeria, Norway, Poland, Romania, Russia, Saudi Arabia, South Africa, Turkey, and the United Kingdom.
Western Hemisphere: Argentina, Brazil, Canada, Chile, Colombia, Mexico, Peru, and the United States.
The liquidity givers are Japan, the eurozone, the UK and the US. Or, basically, the G-4.
And, unsurprisingly given the terminology being used, the paper argues that much of the liquidity-receiving countries’ inflows came from the four liquidity-giving countries in the period . . .
. . . viz portfolio equity inflows, reserve accumulation, and higher asset prices:
And that of course, is where the fear comes in. The fortunes of the liquidity-receiving economies’ are now very much intertwined with the monetary policies being operated by the liquidity-giving ones.
From the paper:
A number of policymakers worldwide are asking what would be effective policies in managing capital inflows and are considering the applicability and effectiveness of capital controls. The argument is that (1) recent capital movements have been partly generated by the low interest rate policy in the G-4 and abundant liquidity in the global financial system; and (2) capital inflows can come to a sudden stop once monetary policy in the G-4 is tightened. Not only is there uncertainty about the timing and speed of future tightening—in itself a significant policy challenge in countries receiving inflows—but the inflows may in the meantime lead to exchange rate overshooting and risks to financial sector stability. Indeed, policymakers in the G-4 need to be cognizant of the potentially adverse effects of a prolonged accommodative monetary policy stance.
Things like capital controls, the IMF says, can help mitigate the effects of the global liquidity surge, but they’re not without their own costs, notably simply directing inflows into the next `hot country.’
The main section of the IMF report, which is due out next week, will reportedly deal with the wave of liquidity in more depth.
Until then, we recommend liquidity-receiving economies start making sacrifices to their liquidity-giving overlords. Offerings of USTs JGBs gilts eurobonds virgins and slaughtered cows should do the trick.
Related links:
IMF warns capital controls may cause economic distortions – Dow Jones
Capital surges can be difficult for recipient countries -IMF summary
IMF adds weight to big bank surcharges – FT