I have written a blog post that Menzie Chinn of the La Follette School of Public Affairs has included in his well-known and respected blog, Econbrowser. The title is “Adjusting the Current Account,” and the link to it is here.
Joe Joyce
Japan’s current account surplus may not be a surprise to those of us who remember Japan as a major exporter. But a closer examination shows that the current account surpluses recorded today are not due to the trade account but rather the net primary income balance. Japan used the trade surpluses of the 1970s and 1980s to build up its holdings of foreign assets and prepare for the day when it would need income from abroad to pay for its aging population. Last year, according to The Economist, the country earned a net $269 billion on its primary income balance, equal to 6% of its GDP.
Mariana Colacelli, Deepali Gautam and Cyril Rebillard of the IMF examine Japan’s income balance in their 2021 working paper,“ Japan’s Foreign Assets and Liabilities: Implications for the External Accounts.” They point out that the surplus reflects Japan’s status as a net creditor nation, as shown by its Net Investment Income Position of $5.4 billion, which equals 63% of its GDP. The surplus reflects higher yields on its foreign assets than its liabilities , including both foreign direct investment as well as portfolio equity and debt assets. The U.S., on the other hand, has a surplus on FDI income but a deficit on its portfolio-related return.
Japan’s income balance is negatively corelated to its trade balance, and this relationship holds for other countries. They cite several factors that could be relevant in Japan’s case, including:
Colacell, Gautam and Rebillard also study the response of the income balance to changes in the real exchange rate in order to compare this with the response of the trade balance. An appreciation of the real exchange rate in a country like Japan with a large net creditor position would likely lead to a decrease in the income balance, reinforcing the expected trade response to an appreciation. On the other hand, a currency appreciation in a net debtor nation would most likely lead to an increase in the income balance, which would lead to an income surplus that could offset the trade response.
They present evidence of negative responses in the income balance to an appreciation. This result differs from that reported of Takahiro Hattori, Ayako Tomita and Kohei Asao in a new working paper from the Policy Research Institute of the Japan’s Ministry of Finance, “The Accumulation of Income Balance and Its Relationship with Real Exchange Rate: Evidence from Japan.” They use data from 1999 through 2020 and find that the real exchange rate does not have a significant impact on Japan’s real exchange rate.
They expand their empirical analysis to a panel of 39 countries, and find again that the estimates of the real exchange rate impact on the income balance are insignificant. These results are similar to those reported by Enrique Alberola of the IMF with Ángel Estrada and Francesca Viana of the Bank of Spain in their 2020 paper in the Journal of International Money and Finance, “Global Imbalances from a Stock Perspective: The Asymmetry between Creditors and Debtors.” (BIS working paper version here). They investigated the impact of the role of the net income balance on the adjustment of the current account via the real exchange rate using annual data from 1980-2015, but found no evidence of such an effect. I also looked at the response of the income balance to the dollar exchange rate in 26 emerging market countries during the period of 1998– 2015 in my 2020 paper in the Review of International Economics, “The Sources of International Investment Income in Emerging Market Economics”, and did not find evidence of an impact of the exchange rate.
Further evidence on this channel of transmission to current account imbalances via the exchange rate impact on the net income balance appears in Alberto Behar and Ramin Hasan’s of the IMF in their 2022 working paper, “The Current Income Balance: External Adjustment Channel or Vulnerability Amplifier?” They did find evidence of a significant effect of the exchange rate on income credits and debits. However, these effects are relatively small when compared with the impact on the trade balance.
Japan’s net income balance, therefore, may an outlier in terms of its size and position in that country’s current income. However, the increasing importance of net income balances and their impact on a country’s balance of payments will necessitate further work on this topic. In particular, the role of the exchange rate in determining the primary income balance canl be further examined.
Income generated by foreign direct investments (FDI) has grown since the 1990s, and now represents a substantial portion of many countries’ current accounts. Some of these flows are routed through Special Purpose Entities in financial centers that multinational firms use to minimize their tax liabilities. We use IMF and OECD data to evaluate the impact of this income on the income share of the top 1% of households in the multinationals’ home countries. We distinguish between FDI equity income and FDI interest income arising from intra-firm lending. We also consider separately the effects in advanced economies rom those in financial centers. FDI equity income contributes to the income share of the top 1% of households in advanced economies, while FDI interest income has no impact in these economies. Similar results for these countries are recorded when we use the OECD non-SPE data. As a result, total FDI income reinforces the income share of the top 1% of households in these countries. While there is some evidence of a similar impact by FDI equity income on the top 1% of households in the financial centers, this result is not apparent when non-SPE income data are used.
See paper here.
I have not posted anything for several months as I have been kept quite busy with professional and family tasks. I would like to return to posting, even on a less frequent basis. So, the next post will be about a new journal article of mine.
I will be also writing about international investment income. These arise from FDI assets, portfolio equity and bonds, and “other” items, principally bank loans. I am preparing a monograph on the subject and will share some. of my findings.
The earnings of a country’s multinational firms appear in its balance of payments in the primary income component of the current income balance. Primary income includes the net flow of income received for the provision of a factor of production, such as labor, financial or other assets, to and from nonresidents. Investment income is usually the largest component of these income flows, and income from FDI appears there with income from portfolio and other types of investments (such as banks) as well as income from the central bank’s reserves.
The countries with the largest net flows of foreign direct investment income in 2021 were:
U.S. $348.9 billion
Japan $95.4 billion
Germany $90.4 billion
France $54.1 billion
Netherlands $34.7 billion
U.K. $25.6 billion
(The Netherlands data exclude income flows associated with Special Purpose Entities, which serve as conduits for FDI flows.)
The ranking of countries by FDI income receipts can be compared with the listing of countries by the number of multinational firms with headquarters located in their borders. Pizzola, Carroll and Mackie (2020) of Ernst & Young provide a ranking of countries by the number of Fortune Global 500 firms headquartered in their jurisdictions. The U.S., Japan, France, Germany and the U.K. all appear at the top of the list. But the country at the number one position with the largest number of multinationals is China. Why doesn’t China also appear in the list of top FDI recipients?
There are several answers. First, China does not report the values of the components of its primary income, so we do not know what its net FDI income is. But it does report total net primary income, and that balance has almost always been negative. If FDI income is the largest component of primary income as it is for many other emerging market countries, then it has been contributing to the primary income deficit.
Second, while China is a net creditor nation with an overall net international investment position in 2021 of $2.2 trillion, its direct investment assets are less than its liabilities: $2.79 trillion vs $3.60 trillion, or net $ -0.82 trillion, according to the IMF’s Balance of Payments data. Similarly, while China has become a major source of FDI outflows, FDI inflows are larger: $178.8 billion in the acquisition of assets vs. $344.1 in the acquisition of liabilities in 2021. As long as investments into China exceed its own foreign acquisitions, the flow of income derived from these activities will be negative.
Brad Setser of the Council of Foreign Relations has also written about China’s primary account. He is puzzled by is decline in the decline in the balance in the second quarter of 2022 at a time when foreign holdings of Chinese bonds were falling. He also writes that:
“China was locked down and its economy shrank—not an ideal environment for foreign firms to make large profits.”
Pizzola, Carroll and Mackie point out that the headquarters of the multinational firms have over time shifted away from the U.S. and other members of the Group of 7 nations (Canada, France, Germany, Italy, Japan, U.K., U.S.) While the U.S. still accounts for the second largest number of headquarters, its total declined between 2000 and 2020. Japan also registered a decline in the number of multinational firms headquartered there. As other counties become the headquarters of multinational firms, their FDI income receipts will rise as well
The primary account balance plays an important role in many countries’ current accounts. In China, for example, in 2022 the surplus in the current account of $401.9 billion was smaller than the trade balance surplus of $576.3 billion because of the deficit in the primary account of $193.6 billion. (Secondary income, which includes remittances, registered a surplus of $19.1 billion.) It would be useful to have the full data on primary income to understand what is driving this component of China’s balance of payments.
The U.S. came out of World War II with the largest economy and a predominant place in the post-WW II international financial order. It was the only nation that could provide the international leadership that Charles Kindleberger wrote was necessary to avoid catastrophic events such as the Great Depression of the 1930s. But in return for stability the U.S. also received a degree of control, and that legacy is under attack today.
American financial hegemony evolved in the years following the end of WW II. Capital flows were severely regulated under the Bretton Woods regime so that national governments could maintain autonomy over national monetary policy and also to avoid destabilizing speculation. But as international trade picked up the dollar served as a vehicle currency, which led to the U.S. serving in the role of what Emile Despres, Charles Kindleberger and Walter Salant called the “world’s banker.”
In 1971 President Richard Nixon revoked the U.S. pledge to accept dollars from foreign central banks in exchange for gold. But the end of this linkage did not diminish the use of dollars as an international reserve currency. Private capital flows continued to expand as governments deregulated their capital accounts and the dollar had a central role in the growing international financial markets.
Andrew Sobel identified the attributes of a financial hegemon in Birth of Hegemony. These include large and liquid capital markets and openness to foreign capital flows. In addition, Kindleberger in his account of the role of an international financial leader in The World In Depression specifically referred to the need for international liquidity. U.S. government actions, including those of the Federal Reserve, have been consistent with these principles (see here). Capital flows are largely unregulated, while the Federal Reserve has used swap agreements to provide dollars to foreign central banks which in turn could use them to maintain dollar funding in foreign financial markets.
Consequently, while other currencies such as the euro and the Japanese yen have been considered as possible rivals for the dollar, no single viable alternative has emerged. But Serkan Arslanap of the IMF, Barry Eichengreen of UC-Berkeley and Chima Simpson-Bell, also of the IMF, have shown in their IMF working paper, “The Stealth Erosion of Dollar Dominance: Active Diversifiers and the Rise of Nontraditional Reserve Currencies,” that the composition of international reserves has shifted away from the dollar over time. This decline has been offset by a rise in what they call nontraditional currencies, including the Chinese renminbi but also the Australian dollar, the Canadian dollar, and the Swiss franc.
Two recent developments have reopened the question of the continued central role of the dollar. The first is the seizure of more than $300 billion of foreign currency assets of the Russian central bank in the wake of Russia’s invasion of Ukraine. This seizure, while not unprecedented, raises legal and political questions. To date the U.S. and its European allies have resisted confiscating these funds to assist the Ukrainian government, but the pressure to do so will mount as the war continues. The confiscation of the Russian central bank’s assets certainly causes other foreign central banks to reassess the composition of their foreign exchange holdings. Moreover, the People’s Bank of China has established its own swap lines to foreign central banks.
The second event is the debate that took place within the U.S. over the debt ceiling. This political theater was resolved, but the opposition of some Republican legislators to any increase in the U.S. Treasury’s borrowing authority triggered a reassessment of whether U.S. Treasury bonds are truly “safe assets.” When governments default on their debt, it usually is because economic conditions have curbed their ability to raise funds through domestic taxes or to roll over their debt. The U.S. situation is different: the government faced a self-inflicted attempt to force the Treasury into a position where it might not have made payments on its debt. Several bank failures had already, according to the IMF, shown the extent of U.S. financial fragility, and a debt default would have severely escalated the volatility.
Either of these events—the confiscation of Russian assets or the threat of a failure to raise the U.S. debt ceiling—is probably sufficient to increase the pace of currency diversification in central bank reserves. But replacing the U.S. dollar in the international financial system will be a more complicated task. First, as Michael Pettis has observed, the global role of the dollar allows the U.S. to offset the savings imbalances that exist in countries such as China, Saudi Arabia and South Korea. If the U.S. did not offset the current account surpluses of those and other countries, then either they would have to find a substitute or increase their domestic demand.
Second, international capital markets still deal in dollars. Bafundi Maronoti of the Bank for International Settlements points out in his examination of the international role of the dollar in the December 2022 issue of the BIS Quarterly Review that “About half of all international debt securities and cross-border loans issued in these offshore funding markets are denominated in USD.” It is difficult to imagine how any other currency could take the place of the dollar in these markets.
There are legitimate questions, therefore, about the dominance of the U.S. dollar in international finance. Central banks will continue to diversify the currency denominations of their foreign exchange holdings. But the dollar’s central role in global financial flows will not be easily replaced.
The integration of markets across borders has slowed down, and in some cases, reversed. These changes come in the wake of the global financial crisis, Donald Trump’s embrace of trade restrictions, Great Britain’s withdrawal from the European Union, the disruptions in global supply chains during the pandemic, and the invasion of Ukraine. President Biden has shown a willingness to use trade and financial restrictions in response to what he views as Chinese and Russian threats to U.S. strategic interests, and there are responses to the use of sanctions and other tools of disruption. The fallout from this rift will take years to play out.
A team of IMF economists have written a Discussion Note on Geoeconomic Fragmentation and the Future of Multilateralism. They attribute the reversal of economic integration to national considerations, such as the desire of governments to increase their domestic production capabilities in particular areas. But the authors of the Note point out that while fragmentation may achieve some goals, it also imposes costs. These include: “higher import prices, segmented markets, diminished access to technology and to both skilled and unskilled labor, and ultimately reduced productivity which may result in lower living standards.” Moreover, fragmentation will slow down joint efforts to address global issues such as climate change.
The Discussion Note summarizes the results of several studies of the loss from geoeconomic fragmentation. In all the studies they cite, the costs are greater the larger the degree of fragmentation. Among the reasons for the losses in output are reduced knowledge diffusion due to technological decoupling. Not surprisingly, low income and emerging market countries are most at risk from a separation from the latest technological developments.
Pinelopi K. Goldberg of Yale and Tristan Reed of the World Bank Group (Goldberg is former chief economist of the World Bank) examine the prospects for global trade in their recent NBER Working Paper “Is the Global Economy Deglobalizing? And if so, why? And what is next?” They find that “slowbalization” is a better description of the recent trend in international trade than “deglobalization.” Foreign direct investment and migration have exhibited relatively less slowdowns. But the authors also document changes in U.S. policies and public attitudes that represent a marked shift away from the liberalization of trade. They attribute these reversals to various factors, including the impact of imports on U.S. labor, concerns over the resilience of global supply chains, and national security considerations.
Goldberg and Reed conclude their analysis with some projections of the consequences of deglobalization. They point out that the previous regime of the last three decades led to growth and technological progress They warn that global innovation will be particularly slowed by a decoupling of the U.S. and China Reconfiguring production supply chains will slow growth as well. These reversals and changes raise the possibility that the recent decline in global inequality will halt, with low-income countries most at risk.
Trade, of course, is not the only component of international commerce that has undergone changes in how it is organized. Chapter 4 of the IMF’s most recent World Economic Outlook analyses the geoeconomic fragmentation of FDI. The authors point to an increase in the “reshoring” and “friend-shoring” of production facilities domestically or to countries with similar political alignments. They estimate a model of the impact of geopolitical alignment on FDI flows, and find that geopolitical factors account for part of the shift in bilateral FDI to countries with governments with similar views to the home country. This could presage a shift to more FDI among advanced economies, rather than emerging markets and developing economies that may differ on political issues.
The Fund’s economists also analyzed the output costs of FDI fragmentation. They utilized different scenarios of geopolitical alignment, such as a world divided into a U.S.-centered block and a China-centered block, with India and Indonesia and Latin America and the Caribbean as nonaligned. In this scenario, the impact of smaller capital stocks and less productivity cumulate with long-term output losses of 2%. Other scenarios allow for the diversion of investment flows to some areas that could offset a decline in global economic activity. However, the chapter’s authors also warn that nonaligned nations may face pressures to choose one side over the other. They conclude from their analysis: “…a fragmented global economy is likely to be a poorer one. While there may be relative—and possibly absolute—winners from diversion, such gains are subject to substantial uncertainty.”
Other forms of capital flows are also subject to fragmentation, and the IMF’s economists examine these trends is a chapter of the latest Global Stability Report. In their analysis, geopolitical tensions can lead to instability through two channels. The first is a financial channel that could respond to increased restrictions on capital flows, greater uncertainty or conflict. The second channel is a real channel, due to disruptions in trade and technology transfers or volatile commodity markets. These two channels can reinforce each other. Restrictions in trade, for example, could discourage cross-border investments.
Geopolitical affinities affect cross-border capital allocation, and the evidence reported in the chapter indicates that recent events have reinforced this impact. The empirical analysis based on a gravity model finds that a rise in geopolitical tensions can trigger sizable portfolio and bank outflows, particularly in developing and emerging market economies. Geopolitical fragmentation can also lead to a loss in international risk diversification, thus leaving countries more vulnerable to adverse shocks and a sizable welfare loss.
All these analyses from multilateral institutions warn of the negative economic consequences arising from the decoupling of trade and financial ties. But the most threatening effects may come from the deepening division of the world into different blocs. As the dividing lines become solidified, the chances of discord extending beyond economic interactions increase. All this friction arising when climate warming already poses a clear threat to our existence only intensifies the dangers we will face.
Ten years ago Cambridge University Press published my book, The IMF and Global Financial crises: Phoenix Rising? I had written a series of journal papers on the IMF and used the format of a book to summarize what I had learned about the Fund. I also made some evaluations and projections about the IMF and its reputation; a decade later, how has the IMF done?
The book reviewed the history of the IMF from its founding at Bretton Woods through the global financial crisis. One of the theses of the book was that the IMF had paid a high price for its handling of the Asian financial crisis. The Fund had formulated programs for Indonesia, South Korea, and Thailand that proved to be controversial. Among the charges levied against the Fund was:
In the aftermath of the Asian crisis as well as subsequent crises in Russia, Turkey and Argentina, the global economy entered a period of steady real growth and moderate inflation rates. The demand for the Fund’s assistance declined, and the IMF used the occurrence of relative stability to undertake post-mortem reviews and changes in its recommended policies. These included a retreat from its advocacy of full capital decontrol, and a reassessment of the purposes and scope of conditionality.
When the global financial crisis of 2008-09 occurred, it was an opportunity for the IMF to show that it had learned the lessons of the previous crisis and could adapt its playbook. The IMF set up 17 Stand-By arrangements during the period of September 2008 through the following summer. The policy conditions attached to these programs were based on an understanding that the contractions in economic activity in the program countries were the result of falling international trade that followed the financial collapse in the advanced economies. Subsequent reviews of the programs found that credit was disbursed more quickly and in larger amounts than in past crises.
In addition to providing financial resources, the IMF called for a coordinated response to the crisis and the use of fiscal stimulus to offset its effects. The Fund’s economists completed its turnaround in its position on capital account regulation and acknowledged that capital controls could mitigate financial fragility. The IMF’s activist stance was acknowledged by the newly formed Group of 20, which approved an increase of the IMF’s financial resources, and called upon it to institute surveillance of their economies.
The IMF, therefore, came out of the global financial crisis with its reputation as a crisis manager restored. The whimsical subtitle of my book came from a line in Don Quixote that referred to a phoenix that rose from the ashes of a fure. How the IMF used its reputation and handled new crises, however, could only be revealed with the passage of time.
The IMF does much more than serve as a crisis lender. The results of its surveillance of the global economy are published in reports such as the World Economic Outlook, and updates to its economic forecasts are widely reported. The IMF’s Managing Director, Kristalina Georgieva, has a high public profile, and speaks out a range of global issues. The research of its economists has grown to include work done on income inequality, gender and climate change.
The next major challenge the IMF faced was the Greek debt crisis, when it joined the “troika” of the European Central Bank and European governments in arranging a resolution. The loans extended to Greece were controversial because of the conditions the Greek government had to implment. As the crisis deepened, the IMF differed from its troika partners in advocating for debt relief. Greece eventually repaid its loans from the IMF two years earlier than planned, but in retrospect the IMF’s inclusion in the troika constrained its ability to set sustainable debt levels.
More recently, during the pandemic the IMF was active in providing financial assistance to its poorest members. Some of its funds were given through new facilities, such as the Rapid Credit Facility and the Rapid Financing Instrument, with (at most) minimal conditionality. Brad Setser of the Council of Foreign Relations pointed out that lending from the IMF and the World Bank to lower middle-income countries rose just as private credit flows fell. Setser observed:
“Such a surge made financial sense, and was a moral imperative as well. The Bank and the IMF, and thus President Malpass and Managing Director Kristalina Georgieva, deserve credit for making it a reality. The system, in a sense, worked. Low income countries had to struggle through the pandemic, but they didn’t lose access to new financing at the same time.”
But not all agree that such lending by the IMF is consistent with its core missions. Kenneth Rogoff of Harvard, who was chief economist at the IMF from 2002 to 2003, points out that the Fund, unlike the World Bank, is not an aid agency. It uses conditionality in part to ensure that it is repaid so that it can continue to lend. He also argues that “forceful IMF conditionality is essential to establish financial stability and ensure that its resources do not end up financing capital flight, repayments to foreign creditors, or domestic corruption.”
More recently the IMF has become involved with a number of developing nations that can not meet their debt obligations, including Egypt, Sri Lanka and Pakistan. According to The Economist, this work is likely to escalate:
“Debt loads across poorer countries stand at the highest levels in decades. Squeezed by the high cost of food and energy, a slowing global economy and a sharp increase in interest rates around the world, emerging economies are entering an era of intense macroeconomic pain… All told, 53 countries look most vulnerable: they either are judged by the imf to have unsustainable debts (or to be at high risk of having them); have defaulted on some debts already; or have bonds trading at distressed levels.” The Economist, 7/20/2022
The Fund recently published a Staff Discussion Note on “Geoeconomic Fragmentation and the Future of Multilateralism.” The authors of the Note point out that the pace of globalization slowed notably after the global financial crisis, and geopolitical tensions have led to a reversal of economic integration. They examine the consequences of fragmentation on international trade, the diffusion of technology and the international monetary system.
Could the IMF be replaced? It is difficult to imagine how a new global organization could be organized. On the other hand, regional blocs may become more widespread. For example, the IMF’s Note on fragmentation notes that global liquidity has four sources: central bank reserves, bilateral swap agreements, regional financial arrangements, and the IMF. Bilateral swap lines and regional arrangements have grown rapidly, leaving the Fund as the only provider of universal coverage. Further growth of regional arrangements based on geopolitical blocs would increase their coverage, but it would be uneven across blocks and could be inadequate to deal with large shocks.
I argued in my book that it is crucial to remember that the IMF is an agent for its 190 principals. Its ability to address global challenges depends on the willingness of the sovereign members to use the IMF to organize responses to the challenges. A world that is divided by U.S.-China frictions gives the IMF limited scope to play the role it seeks to have.
Every year we name a book the “Globalization Book of the Year” (aka the “Globie”). The prize is (alas!) strictly honorific and does not come with a monetary award. But announcing the award gives me a chance to draw attention to a recent book—or books—that are particularly insightful about globalization. Previous winners are listed at the bottom of the column (also see here and here).
This year’s recipient is Money and Empire: Charles P. Kindleberger and the Dollar System by Perry Mehrling, Professor of International Political Economy at the Pardee School of Global Studies of Boston University. The book is an intellectual biography of Charles Kindleberger, who came to MIT in 1948 after having served at the U.S. Treasury, the Federal Reserve Board, the Bank of International Settlements and the U.S. Department of State. He was the author of a number of articles and books on international macroeconomics and economic history that have retained their relevance long after their initial publication date. In his work he often focused on the policies needed to achieve international stability in a world of different national currencies and policies. He had a insightful perspective on the circumstances that led to the Great Depression, and what needed to be done to avoid a repeat of that catastrophic occurrence.
Among the topics that Mehrling covers is the evolution of Kindleberger’s views on the global economic role of the dollar. The dollar became the international reserve currency under the Bretton Woods regime, which was designed to avoid a repeat of the relative chaos of the 1930s. Foreign central banks held dollars to stabilize the value of their currencies, while the U.S. stood ready to exchange these dollars for gold. What had been a dollar shortage in the period after World War II became a dollar glut in the 1950s and 1960s, however, and the stability of the link to gold was questioned by Robert Triffin and others.
Kindleberger, on the other hand, believed that the dollar was serving an important international function as a key currency, as the pound had done in the pre-WWI ear. The responsibility of the U.S. was to set monetary policies that took account of the state of the world economy. In 1966, he joined with Walter Salant and Emile Despres in writing an article for The Economist, “The Dollar and World Liquidity: A Minority View,” which advanced the view that the U.S. served as the “world’s banker,” i.e., as a financial intermediary with respect to Europe that issued short-term deposits and invested long-term capital around the world. The result was an unplanned but functional international monetary system. In that perspective, gold was an unnecessary distraction.
The debate over the architecture of the international monetary system seemed to end when Richard Nixon terminated the exchange of gold for dollars in 1971. The U.S. and the European nations also began the transition away from fixed exchange rate regimes, although the Europeans would move to their own “fixed currency” with the euro. But the dollar did not recede into the mix of the international monies. The end of Bretton Woods also meant the end of the acceptance of capital controls, and capital began to flow more freely, first among the advanced economies and then to the emerging market nations. Private capital flows rose in importance in financing corporate and government debt, and in the cases of external finance these debt instruments (particularly of emerging market economies) were denominated in dollars.
By the 2000s the existence of a “global financial cycle”, based on U.S. monetary policy, became widely accepted. The dollar was indeed the international currency, although this was decided by private markets as much as governmental decrees. Pierre-Olivier Gourinchas of UC-Berkeley and Hélène Rey of the London Business School, in explaining the central role of the U.S., updated the 1966 title given to the dollar by Kindleberger and his associates to the world’s “venture capitalist.”
One of Kindleberger’s most well known contributions came from his analysis of the Great Depression. Previous work usually placed the blame on the outbreak and/or duration of the crisis to misguided national policies. Kindleberger realized that there was an international dimension: the lack of a country that acted as a leader in providing the international public goods needed for stability. These included maintaining an open market for distress goods, providing long-term lending and overseeing a stable system of exchange rates, ensuring the coordination of macro policies among nations and acting as a lender of last resort. In the 1930s Britain was no longer able to act as the global leader, while the U.S. was not willing to accept that roel. Kindleberger’s insight became the basis of a body of work known as “hegemonic stability,” one of the tenets of international political economy.
Kindleberger offered yet another perspective on financial instability in his Manias, Panics and Crashes. As the title implies, the book is an account of financial crises dating back over time and their common elements. The book was first published in 1978. Robert Aliber took over the job of updating the book after Kindleberger’s death, and the latest edition (the eighth) has Robert N. McCauley as the newest co-author.
In the book Kindleberger extended Hyman Minsky’s model of financial instability, which was a domestic model, to include an international dimension. Minsky had proposed that credit expansion and contraction followed a cycle of initial displacement, boom, euphoria, profit taking, and panic. In a global context, this cycle can be amplified by short-term international capital flows, that increase the amount of credit that is available during the early stages of the cycle. But the money is rapidly withdrawn by foreign investors when doubts arise about the solvency of the projects they have financed. The withdrawal of foreign capital exacerbates the instability of the last stages of the cycle. Kindleberger’s adaptation of Minsky’s work proved to be remarkably prescient during the emerging market economies’ crises of the 1990s, such as the Asian crisis, as well as the global financial crisis.
Mehrling, therefore, has done a valuable service in explaining Kindleberger’s contributions to our understanding of the global economy. Because his analyses were not based on mathematical models or econometric testing, Kindleberger did not receive the same degree of respect as did his colleagues at MIT and elsewhere who used these tools. But the passing of time demonstrates that Kindleberger possessed a keen understanding of how capital and credit flows functioned, and the need for some form of governmental oversight. Any lack of attention to this work at the time when Kindleberger was active tells us more about the blindfolds of economics than it does about Charles Kindlberger.
“Globies”
2016 Branko Milanovic Global Inequality
2017 Stephen D. King Grave New World: The End of Globalization, The Return of History
2018 Adam Tooze Crashed: How a Decade of Financial Crises Changed the World
2019 Branko Milanovic Capitalism, Alone
2020 Tim Lee, Jamie Lee The Rise of Carry
and Kevin Coldiron
2021 Anthony Elson The Global Currency Power of the Dollar
Jeff Garten Three Days at Camp David
The restrictions by the Biden administration on the sale of semiconductor chips and the equipment to manufacture them represent a new stage in the division between China and the U.S. The belief that increased trade would lead to a convergence of Chinese and U.S. interests faded years ago. The history of globalization shows clearly that the chances of Chinese as well as Russian acceptance of a liberal order overseen by the U.S. were unlikely, and a struggle for control inevitable.
The study of hegemonic power can be used to illustrate how discord can arise over the distribution of the global benefits of economic growth. MIT economic historian Charles Kindleberger made the case in The World in Depression, 1929-1939 that international economic prosperity needs a nation to provide leadership. The duties of the hegemonic power include maintaining an open market for imports from countries in distress, providing long-term capital and acting as a lender of last resort. More generally, the hegemonic country provides the public good of rules that govern international transactions and ensures compliance to them by other nations.
Great Britain was the hegemonic power of the 19th century and its dominance lasted until the first World War. This was a period of rapid growth for the European countries and Britain’s “offshoots,” i.e., Canada, the U.S., Australia and New Zealand. The shared economic prosperity made the outbreak of a war among the industrial powers seem unlikely. Norman Angell made the case in The Great Illusion, first published in 1909, that the costs of a war among the industrial powers were so great that they would deter their governments from engaging in conflict.
But the predominance of Britain during this period was being questioned by the U.S. and Germany. Each country had leaders—President Theodore Roosevelt in the U.S. and Kaiser Wilhelm II in Germany—who made clear that they would not accept subordinate positions. The Germans were particularly resentful of their inability to match the size of Britain’s colonial empire, as the colonies had largely been claimed before Germany’s emergence as a nation in 1871after its defeat of France in the Franco-Prussian War.
Graham Allison of Harvard’s Kennedy School wrote about these tensions, and the British response, in his Destined for War: Can America and China Escape Thucydides’s Trap? The “trap” that Allison draws from the work of the Greek historian Thucydides is the confrontation that arise when a rising power threatens a ruling one. Thucydides wrote about the Peloponnesian War between Athens and Sparta, which occurred when Sparta responded to what it saw as a threat to its dominance of the Greek states by the growing Athenian empire.
In the 19th century, Britain was the dominant power facing challenges from other nations. British statesmen decided that Germany posed a more immediate security threat, and accommodated U.S. demands in the Western Hemisphere without surrendering their own interests. But Britain also built up its already powerful battle fleet and created an alignment with France and Russia, the Triple Entente, to counter a German threat.
This deterrence was not enough to avoid the breakout of World War I. The costs of the war hindered Britain’s ability to resume its hegemonic role, and the U.S. was not willing to take its place. As a result, Kindlerberger claimed, the economic crisis of the 1930s was deeper and more extended than it would have been if an international hegemon had been present. The response of the U.S. in creating the United Nations, the International Monetary Fund, and other multilateral organizations after World War II showed that by that time it had learned the lesson of the need for international institutions.
Allison presents other examples of challenges to hegemonic powers by rising powers. In the 17th century, the Dutch Republic was the leading maritime power. It possessed trading posts and colonies in Asia, Africa, and the Americas, and a formidable fleet of warships to defend them. England resented this control and engaged in three maritime wars with the Dutch. The hostilities between the two countries only ended when William of Orange became King William III of England, and the Dutch and English waged war together on the predominant European land power, France.
Allison makes clear that the rivalry between China and the U.S. need not result in war. Besides the British accommodation of U.S. interests in the late 19th century, he points to the “Cold War” between the Soviet Union and the U.S. as an example of a struggle that did not lead to direct conflict. One of the reasons for the avoidance of the escalation of hostilities to total war was the existence of nuclear weapons,, which dramatically raised the cost of using the full range of weapons. But the Cuban missile crisis showed that it was possible to come perilously close to moving into a full-blown conflict. The expansion of trade and finance to new markets creates opportunities for rivalries and competition that can trigger responses that lead to unforeseen consequences.