Still, China is heavily dependent on exports to the US, and a hard landing in the US would directly and indirectly have global consequences. If China’s economy slowed, global commodity prices might soften, and high commodity prices have helped to fuel growth in many parts of the world.
For the past six years, the US’s growth has been based on weak foundations of debt and an unsustainable real estate bubble, supercharged by financial instruments that were little understood by many market participants – and not just the poor and middle class Americans, who were induced to borrow with mortgages that were ill-suited to their circumstances and beyond their ability to pay.
The US’s consumption boom, with negative savings, is also not sustainable, and a return to more normal savings levels will take a lot of umph out of the US economy; if done slowly, it would mean years of slow growth; if done rapidly, it would mean a hard landing. It now appears that the latter is more likely than the former.
2. Is the renminbi overvalued or undervalued?
When the US started to complain about the renminbi being undervalued, about three years ago, it probably was not: the multilateral trade surplus was small, perhaps zero when taking into account problems of overinvoicing exports and underinvoicing imports. But since then, the rapid growth of the multilateral trade surplus suggests that today China’s currency may be somewhat undervalued. But that does not mean that a re-evaluation is the appropriate response. Such a re-evaluation would, for instance, lower rural incomes, and the growing disparity between rural and urban incomes is one of the key challenges facing China.
The US’s and Europe’s huge agricultural subsidies are harming developing country farmers all over the world. The imposition of an export tax is an alternative measure that would help to address the trade surplus and generate needed revenue for the central government, but would not have some of the adverse effects of a currency re-evaluation.
3. What should be the role of the IMF/World Bank?
The IMF should focus its attention on enhancing global financial market stability. Some of its policies (such as pushing premature capital market liberalisation) have had just the opposite effect. Although its recent efforts to address global financing market imbalances are welcome, with so much of the problem arising from the US and with the US having such a dominant position (with its veto), it is not surprising that the IMF’s efforts so far have not borne fruit.
It should begin work on the world’s most important structural problem, the global reserve system. The current system rests on the dollar, and confidence in the dollar is fraying. A move towards a two-currency reserve system (dollar and euro) could lead to even more instability. A fundamental reform is required.
The task of fighting global poverty is one of the most important problems facing the world, and the World Bank is the most important global institution in that fight. Good governance is important, but it is only one aspect of a growth and poverty agenda. The World Bank’s excessive focus on corruption – and the manner in which that agenda was pursued under its previous president – was a distraction from that broader agenda.
Moreover, the Bank and the Fund cannot be credible messengers of good governance, so long as their own governance (including and especially the manner in which their heads are chosen) remains so flawed. It is important that the World Bank should not return to the pursuit of the justly criticised ‘Washington Consensus’ – or even the ‘Washington Consensus plus’ policies – and that the Bank be restored to its role as an important advocate for the interests of the developing countries.
4. Are sovereign wealth funds to be applauded or feared?
There is much confusion about the risks and what should be done about them. Part of the reason for this confusion is the misplaced ideology that claims that ownership should not matter; anybody should have the right to purchase any asset in any country. China’s attempt to purchase UNOCAL and the attempt by a Dubai firm to purchase some ports in the US exposed the hypocrisy of the US position.
There may be certain assets for which there are regulations on use. Ports should be managed so that the risk of importation of prohibited items (such as arms or drugs) is limited, no matter who owns the port. If these regulations were fully effective, there would be no need to regulate ownership. But there is a concern that they may not be fully effective, and ownership may then matter.
Competition laws should ensure that the purchase of any firm by a sovereign fund would not have any adverse effect on the nature of the marketplace.
In short, if we have an adequate regulatory framework in place, sovereign funds are not to be feared. If we fear them, it is evidence that we do not have an adequate regulatory framework in place – or that we are being nationalistic.
5. Are emerging market crises a thing of the past?
Financial market crises are not a thing of the past; they have been with us since the beginning of capitalism. As we have learned how to manage risks better and as we have created new risk instruments for sharing and transferring risk, the market has taken on more risk. Some of these financial crises are likely to occur in emerging markets. (Even the best run economies have experienced financial crises.)
One thing has changed in the past decade, since the east Asia crises: most developing countries have accumulated huge reserves. Part of the reason is that they have said never again will they allow themselves to lose their economic sovereignty to the IMF. These reserves provide the wherewithal that allows them to handle a crisis; and because the market knows this, a crisis is far less likely.
Moreover, increasingly developing countries are borrowing in their own currencies, making them less vulnerable to changes in exchange rates.
Still, there are a few countries with high levels of short-term foreign borrowing in hard currencies, and a sudden increase in interest rates charged to developing countries could result in a crisis in those countries.