The 2008 financial crisis may be moving in a third wave that could devastate the Global South says Dr. Yilmaz Akyuz, Chief Economist of the intergovernmental organization, the South Centre
March 28, 2016 Produced by Lynn Fries
LYNN FRIES, TRNN PRODUCER: March of this year marks the 8th year since losses in the US subprime mortgage market mounted into full blown crisis at US investment bank, Bear Stearns, and months later at Lehman Brothers, a year of events that took the US subprime crisis global. A recent South Center briefing for delegates at the UN Geneva addressed concerns that the crisis is moving in a third wave to the South after having moved from the United States to Europe. These clips of South Center, Chief Economist, Yilmaz Akyüz, tell the story.
YILMAZ AKYÜZ, CHIEF ECONOMIST, THE SOUTH CENTRE: The US was the cause of the crisis but the US has come out better than anyone else in the advanced world and better than many developing countries. During the crisis there was a widespread perception that this was the end of US hegemony. It was end of the dollar as the major reserve currency. But when we look back now, we see that the US is strengthened a lot more as a result of this crisis. Not only vis-à-vis other developed countries – Europe, European Union or Japan – but vis-à-vis developing countries including China, in economic terms. The status of the dollar as a reserve currency today is unchallenged because of the crisis in Europe. And the US has become so confident that it is trying to rearrange the global economic order according to its own priorities through BITs (bilateral investment treaties), free trade agreements such as TPPA and its ratification of the IMF quota reform for me shows a sign of confidence of the US perhaps in preparation that some major developing countries will soon end up in the IMF. But the US economy is also fragile. Usually economic expansions are often followed by contractions. This is part of the capitalist system working – boom bust cycles. The US has had 24 quarters of expansion since the beginning of the crisis. And usually recoveries age and die. And a lot of people think simply on this observation that after 24 quarters of expansion US recovery or growth is supposed to come to an end on historical evidence. But apart from that? It’s very difficult to get out of the policies that it introduced in response to the crisis. It doesn’t know how to get out of the policy of easy money. It is very hesitant in raising interest rates. But on the other hand if there is a slowdown in the US and a contraction and renewed instability they don’t have any ammunition to respond to it. Because they used all their ammunition to respond to the last crisis and they are still using it except in bond purchases
We haven’t had a serious debt crisis in an emerging economy in the past 10, 12 years. But the risks are very serious now.The world is caught in a debt trap today.Why? Because the resolution of the European and American crisis – which was a debt crisis – the resolution of that crisis required cutting debt. But what we’ve seen is that the policies implemented to resolve that crisis have given rise to the accumulation of additional debt. In the US, the ratio of public plus private debt to GDP increased from 200% to 280%. In Japan it increased to 500%, in the Eurozone and China it doubled. And in developing countries today it is close to 200% of GDP on combined private and public debt. And I believe in the next global downturn – that is, when your income drops significantly – an important part of this debt will be unpayable. When you lose half of your income, you cannot keep on meeting your mortgage or consumer debt, particularly if interest rates have risen. Unfortunately policy space is much more limited today in developing countries than we had in 2009. At the time we had a very comfortable fiscal position because of the previous expansion. We had a very comfortable balance of payments position, reserve positions. Now we don’t have any of these.
The current situation has an uncanny similarity to the 1970s and 1980s. You will recall that developing countries had a boom in commodity markets in 1970s which was accompanied by massive international lending by banks recycling petrodollar oil surpluses. And this twin-boom in commodities and capital flows to developing countries in the ‘70s ended up with a bust when the United States raised interest rates in ‘79,‘80 with Volcker. And what we had was a debt crisis in the Latin America. And the situation now is someway similar. We had a twin boom in commodity prices and capital flows and now we have come to the end of this boom even without the US changing its monetary policy in a big way. And the question is if the outcome will be the same as in the 1970s?
We are highly vulnerable to the reversal of commodity prices and capital flows. The vulnerability to commodity prices nevertheless varies among developing countries because different types of commodities fell at different rates.Some developing countries benefit from commodity price declines but no developing country would benefit from tightening of the external financial situation. Now we cannot count on reserves. Traditionally we look at the reserve adequacy in terms of their volume relative to short-term external debt. But what happened in the past 15 years – and we examined that in some research papers in the South Center – there is a very large increase in the presence of foreigners in domestic equity, bond and deposit markets of developing countries. And it is them who are exiting. So therefore your reserves may be adequate to meet your short-term debt but if there is a massive exit from domestic bond, equity and deposit markets then your reserves will not be enough. Why will it not be enough? Because you accumulated these reserves in the first place from their entry into your economy.
And monetary policy now faces a major dilemma. In order to stimulate demand and growth we have to cut interest rates but if you cut interest rates you can trigger capital outflows. So you have a dilemma between growth and stability. So if we face a liquidity crisis – that is we no longer have enough reserves to meet our imports and stay current on our debt payments and keep the capital account open – what do we do? Business as usual? Borrow from the IMF? Keep the capital account open? Continue allowing capital to run out, using reserves and the borrowing from the IMFand using austerity? Now I think there is a strong misgiving vis-à-vis the IMF among the developing countries. And I am sure they will do their best to avoid going to the IMF in the event of a serious liquidity crisis. I am not referring to a solvency crisis – default – I’m talking about simple liquidity crisis when you don’t have enough foreign exchange to meet your current account needs and debt payments. Then what do you do? Of course, the unorthodox response is you use your reserves to support your economy, imports, not to support capital outflows. Are we prepared to impose controls over capital outflows? Are we prepared to impose temporary debt standstills? Are we prepared to impose austerity on creditors and investors rather than austerity on the people? These are the issues.
Are there alternatives to the IMF in the provision of international liquidity? We have had some initiatives in the past two decades. One is the Chiang Mai initiative in Asia. The other is the contingent reserve arrangement established by BRICS. But when I look at the design and their size, they are both inadequate. They are very small. No one has ever used Chiang Mai facilities. And they are actually designed as a supplement not as a substitute to IMF facilities. And in fact, they require IMF programs to have countries access these facilities. Then we have swaps. Do we have swaps among central banks of developing countries? The only country that has swaps with other developing countries is China. China has about 30 swaps but most of it is with advanced economies and only one of them, the swap in Argentina, is designed to supplement reserves if Argentina comes under attack. And all other swaps that China has are designed to facilitate Chinese exports and investment abroad. Can we do it without borrowing from the IMF? One way of doing it is through a massive SDR allocation. We had it in 2009. In the South Centre we advocated this even before it happened. We can have a massive SDR allocation but the question is would the major shareholders of the IMF agree to it.
In conclusion, even if we avoid a fully fledged financial crisis, the prospects are for sluggish, erratic growth and heightened instability in the global economy. Why? Because of financial excesses we have had in the past 8-9 years. And you cannot easily restructure your balance sheets; that is the problem. We need to have a better policy mix than we have been using. I have basically four suggestions. First, stop relying on easy money – which is no good except for speculation in advanced economies, abandon fiscal orthodoxy, invest in infrastructure and create jobs and create demand. Secondly, we need better control over international capital flows not only by recipient countries but also by source countries. Because they are most destabilizing.They are at the heart of the current difficulties that we face. Third, we need a mechanism for adequate provision of international liquidity and finally we need effective and equitable debt resolution mechanisms.
Now these issues should be studied and debated extensively particularly at the current juncture. But unfortunately Bretton Woods institutions are not the best place to do that – neither to understand the fragilities nor to resolve the problems. The IMF has missed one of the most serious crises in the world since the 2nd world war, the subprime crisis. The IMF at the Secretariat level is not very efficient in providing early warnings to countries about the global economic situation. And this is not just a technical expertise issue; it’s also a political issue. Because such an early warning – an effective projection of the difficulties in the world requires a critical examination of the policies of countries which exert significant impact on the world economy. That means it would require criticizing US and European economic policy. The IMF Secretariat cannot do that. That is why they cannot really predict these kinds of difficulties, warn countries in advance, warn them during the expansions so that they do not get into trouble. When we were writing the rise of the South was a myth, in 2009, 2008 the IMF was promoting that the South was becoming a locomotive for the world economy. And they changed their mind only in 2013. Secondly the IMF is not very bold in innovation. These difficulties are serious ones and you need bold measures. They are not bold in the reform of the international financial architecture. Why? Because the IMF is part of that architecture and that requires the reform that very same institution…So I believe that these matters should be discussed and debated among developing countries and in other fora such as UNCTAD, which has a much better record in anticipating these difficulties and providing proposals, which eventually became part of the mainstream
FRIES: We have to leave it there. For viewers who would like to dig deeper please see the context link (for audio and/or transcript of the full statement by Dr. Akyüz) to this story. Special thanks to Yilmaz Akyüz and the South Centre and thank you for joining us. From Geneva, this is Lynn Fries for The Real News Network.
Dr. Yılmaz Akyuz, Chief Economist of the South Center, was formerly the Director of the Division on Globalization and Development Strategies at the United Nations Conference on Trade and Development (UNCTAD) when he retired in August 2003. He was the principal author and head of the team preparing the Trade and Development Report, and UNCTAD coordinator of research and support to developing countries (the Group-of-24) in the IMF and World Bank on International Monetary and Financial Issues. He taught at various universities in Turkey and Europe before joining UNCTAD in 1984 and after his retirement, and published extensively in macroeconomics, finance, growth and development. He is the second holder of the Tun Ismail Ali International Chair in Monetary and Financial Economics at the University of Malaysia, established by Bank Negara.
Originally published at TRNN