Financial Crises: Past and Future

Carmen M Reinhart Harvard University Reunión Anual de la Asociación Argentina de Economía Política Universidad Nacional de La Plata, Argentina, November 16 2018 Roadmap

Global risks: EMs The post-crisis Global risks: and developing Long-term risks decade Advanced economies economies • Crisis severity and • US trade war • The curious case of duration • Underpriced the missing defaults • The US stock/flow • Delayed European corporate risk? and China’s problem recovery? • Europe’s overseas lending • The US dollar and unresolved debt • External factors and the modern Triffin crises classic EM crises Dilemma • Argentina

Reinhart 2 The advanced economies: The last crisis is not Protracted post-crisis recoveries yet over in Greece and Italy… Real GDP per capita General By 2023, the IMF % change government projects that their per Crisis peak to peak to Severity Breakeven gross debt capita GDP will Year Country trough recovery index year crisis year remain below its 2008 France -3.8 8 11.8 2015 68.7 2007 level. 2008 Germany -5.2 3 8.2 2011 65.1 2008 Greece -26.3 16 42.3 beyond 2023 109.4 2007 Iceland -9.2 9 18.2 2016 27.3 2007 Ireland -9.3 7 16.3 2014 23.9 2008 Italy -11.9 16 27.9 beyond 2023 102.4 2008 Netherlands -4.1 9 13.1 2017 54.5 2008 Portugal -7.0 13 20.0 2017 71.7 2008 Spain -10.6 11 21.6 2017 39.4 The track record is 2007 UK -6.1 8 14.1 2015 41.9 worse 2007 US -4.8 6 10.8 2013 64.6 than historic norms, Summary Mean -8.9 9.6 18.5 where Median -7.0 9 16.0 the mean for advanced 63 crises: Avanced economies from 100 in Reinhart and Rogoff (2014) Mean -9.5 7.3 16.8 economies is about 7 Median -7.0 6 13.0 years Note: The italics denote IMF estimates for 2018-2023 are used. 3 • In the US is particular, monetary policy responded and rapidly and aggressively to the crisis. ECB and BoJ also became more accommodative. Why the • Fiscal policy in the advanced economies and some EMs provided delayed and concerted stimulus, while China anemic engaged in a fiscal/domestic credit package of unprecedented magnitudes recovery and scope. despite policy • Dozens of countries almost simultaneously significantly expanded stimulus? their safety nets to depositors to foster confidence. • The IMF made loans of an unprecedented scale. The size of the IMF response to the troubles in Greece, Iceland, Ireland, and Portugal set all time records…

IMF Program Size 18% (median, as % of country GDP, at approval)

16%

14% Advanced Economies - Median Program Size as 12% % of Country GDP (bars)

10% Emerging Economies - Median Program Size as % of Country GDP (line) 8%

Source: Reinhart and Trebesch (2016). Reinhart 5 The synchronicity of the crises in the advanced economies is likely to have contributed to deepening and extending the slump. But, there is much to be said about the role played by the policy response to the crisis…

Reinhart 6 Eurozone periphery: Chronic currency overvaluation

Percent Kaminsky and Reinhart (1999) present evidence that real exchange rate overvaluation (lower denotes appreciated) is a key feature of the boom phase in the runup to a banking crisis. Overvaluation and loss of competitiveness were an issue While the pre- and post-crises patterns look for much of periphery Europe and Iceland, similar in both figures, the scales reflect where current account deficits swelled into the major difference in that periphery double digits. Europe’s very modest real depreciation has 2,0 Bilateral Real Exchange with Germany; been effected through a recessionary Average for Greece, Ireland, Italy, Portugal, 1,0 and Spain (annual % change) deflation. 0,0 -1,0 Note: The values of the variables relative to -2,0 "tranquil" times are reported on the vertical axes. -3,0 -8 -6 -4 -2 crisis 2 4 6 8 10 The horizontal axes show the number of months before (negative sign) and after a crisis. The solid Sources: Kaminsky and Reinhart (1999); lines show the behavior during twin-crises episodes, Reinhart (2018) and IMF WEO (2018) for periphery and the dotted lines show the behavior during EZ. "single“ currency crises. Reinhart Reinhart, Harvard Lack of significant and timely debt write- offs (especially Eurozone) • The aggressive and rapid repair of bank balance sheets that characterized the Nordic banking crises and later emerging market crises did not materialize in Eurozone. • The sharp reversal in external debt that was a feature of the post-Asian crisis landscape has been absent except for Iceland and Ireland. Large and mostly chronically growing Target2 balances for Greece, Italy, Portugal and Spain show up as significant external liabilities of the national central banks. • The prevalence of evergreening by banks in much of Europe (much less so in the US) coupled with the placement of government debt in bank balance sheets severely limited the scope for new credit, impairing the transmission channel of monetary policy.

Reinhart 8 The aftermath of crises with and without external deleveraging

External Debt (public + private) as a percent of GDP: Asian and Eurozone Global Financial Crisis 1.40 (crisis year = 1) 1.20 Eurozone crises (ex Ireland), 1.00 2008=1: France, Germany, 0.80 Greece, Italy, Netherlands, Portugal, Spain (solid line) 0.60

0.40 Asian 5, 1998=1: Indonesia, Korea, Malaysia, Philippines, and 0.20 Thailand (dashed line) 0.00 t-5 t-4 t-3 t-2 t-1 T t+1 t+2 t+3 t+4 t+5 t+6 t+7 t+8 t+9

Sources: IMF, World Bank, and author’s calculations. Note: T indicates crisis year and -/+s indicate years prior and after the crisis. Reinhart 9 Near-term global risks: The advanced economies

US trade war Underpriced risk in US corporate sector? Europe’s unresolved debt crises

Reinhart 10 If tariffs increases are a 1970s-style supply shock, remember that the 1970s were not easy to live through.

Risks are not just to output. Spikes in the CPI?

Source: Vincent Reinhart , 2018, “President Trump and Trade” Reinhart 11 Selected yield spreads percentage points

20 1000

18 900

16 <-High-yield 800 option adjusted spread (%) 14 700 12 600 10 JPM EMBI+ 500 (bps) - > 8 400 6 300 4

2 200

0 100 1/11/2008 7/11/2009 1/11/2011 7/11/2012 1/11/2014 7/11/2015 1/11/2017 7/11/2018

2018 EM-High yield divergence: Are these corporate risks underestimated?

Source: Bloomberg. Reinhart 12 Italy: General Government Debt and Target2 Balances (% of GDP), 1861-2018 Greece, Ireland and Portugal account for 6% of EZ GDP and Global 8% of the government debt—Italy alone accounts for 15% of spillovers: GDP and 24% of the debt (these figures almost double when Bad news Spain is included) from Europe 170 WWII default (shaded) Target2 balances (dark (in general) shading) are about 150 and earlier in 28% of GDP 2018, Italy (in as of June 2018 130 particular) 110 trigger a predictable 90 flight to US dollar 70 assets. 50 Dollar appreciation, 30 in turn, raises 10 risks for 1861 1871 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011 emerging Sources: Bank of Italy, ECB. International Monetary Fund markets and Reinhart (2010 and 2018). https://www.project- with syndicate.org/commentary/italy-sovereign-debt-restructuring-by-carmen- Reinhart dollar debts. reinhart-2018-05 13 Cycles of past and one ongoing (updated through 2018:Q1) real house prices and banking crises: peak-to-trough price declines (left panel) and years duration of downturn (right panel) House prices (real

Spain, 2008 23 estate) usually begin Subset of the 22 Systemic 11 Italy, 2008 their steep decline Portugal, 2008 21 US,1929 20 before the onset of the UK, 2007 19 banking crises. Unlike As of 2017:Q4, house prices 18 Iceland, 2007 equity prices, which are In Italy are still declining, Malaysia, 1997 17 th Thailand, 1997 16 more “spike-prone” and marking the 10 year of a 15 Korea, 1997 can quickly reverse, downturn. Ireland, 2007 14 Norway, 1899 13 housing prices exhibit Argentina, 2001 12 longer cycles. US, 2007 11

Sweden, 1991 10 For a historical

Spain, 1977 9 -35.3 percent Historical Average perspective, see 8 6 years Japan, 1992 7 Jorda, Schularick and Colombia, 1998 6 Norway, 1987 Taylor (2015). 5 Indonesia, 1997 4 Finland, 1991 3 Philippines, 1997 2 Hong Kong, 1997 1 -70.0 -60.0 -50.0 -40.0 -30.0 -20.0 -10.0 0.0 0 5 10 15 20 Percent decline Duration in years Sources: Reinhart (2018) update of Reinhart and Rogoff (2009); Bank of International Settlements. Reinhart, Harvard 36

Reinhart 14 Near-term global risks: The EMs and developing economies

The curious case of the missing defaults and China’s lending to low income countries External factors and classic EM crises Argentina’s dilemma

ReinhartReinhart 1515 The curious case of the missing defaults: commodity and capital flow “double busts” and sovereign defaults

50 1

45 “Double Busts” 0.9

40 0.8 joint declines in Share of 35 capital flows and sovereigns 0.7 commodity prices entering a 30 (>1 year) new default 0.6 red shading 3-year sum 25 0.5 solid line 20 0.4

15 0.3

10 0.2 Percent of countries entering Percentcountries of newdefault entering a

5 0.1

0 0 1815 1830 1845 1860 1875 1890 1905 1920 1935 1950 1965 1980 1995 2010

Source: Reinhart, Reinhart, and Trebesch (2017) Reinhart 16 Double and Triple Busts and the “missing” defaults since 2011

Double bust Capital flow Commodity Interest Rate Share of Countries episodes Bust Bust Spike (real)? in Default (in peak year) 1824 - 1828 yes yes yes 43.75 1890 - 1894 yes yes no 18.60 1914 - 1918 yes yes yes 17.65 1929 - 1933 yes yes yes 46.43 1981 - 1986 yes yes yes 42.74 1991 - 1999 yes yes yes 46.34 2011 - 2016 yes yes no 13.82 About 15-20 new defaults “missing” since 2011 (in historical comparison)

Reinhart 17 • Better macroeconomic management, Some not including macroprudential and more mutually hedging. • Mis-measured (under-reported), arrears exclusive on official creditors. defaults • Arrears on Chinese lending to low hypotheses income commodity producers? • Better luck, external factors have for the remained more favorable than in past missing cycles • low interest rates in US and other defaults advanced economies China’s expanding global financial links: 2000-2017 Through 2016 there have been 16 debt restructurings

Green: PBoC or SAFE swap lines. PBoC is also s large holder of middle income EM debt. Note: Red is applied to countries with both Red: Chinese loans > 1% Loans > 1% and of recipient country GDP swap lines. Source: Reinhart, Reinhart, and Trebesch (2017) and Horn, Reinhart, and Trebesch (2018). Reinhart 19 EM turbulence contributes to Developing and emerging a flight to US dollar assets… markets: External (public + A brewing debt crisis? private) debt as a percent of GDP, 110 1970-2017 100

80 At 47% end 70 2016), it is about the 60 Percent same level 50 as in 1981

40 Debt crisis, 1982-1991 30

1970 1974 1980 1984 1990 1994 1996 2000 2004 2006 2010 2016 1972 1976 1978 1982 1986 1988 1992 1998 2002 2008 2012 2014 External debts to China, not well measured and not included in WB data, are estimated to add another 15% or so to this ratio in 2016-2017. Sources: Reinhart, Reinhart, and Trebesch (2017) and sources cited therein and World Bank

Reinhart 20 Vulnerability to changes in international interest rates, which are expected to continue to rise… Share of variable rate external debt, 1970-2016

55 Share of variable rate 50 external debt developing 45 countries and EMs

Percent 35

1980 1997 2014 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2015 2016

Source: World Bank (2018). Reinhart 21 EMs: General government debt, 1880-2023 (percent of GDP) These countries have been historically debt intolerant

Source: Hugh Bredenkamp, Ricardo Hausmann, Alex Pienkowski and Carmen Reinhart (2018) https://www.imf.org/en/News/Seminars/Conferences/2018/ 05/24/sovereign-debt-a-guide-for-economists-and-practitioners

Reinhart 22 EMs: Debt held by non-residents, 2004-2017 Holdings by the official sector (bilateral and multilateral development agencies, etc.) have fallen, debt held by non- bank investors, such as pension and hedge funds, has increased dramatically. The rise in foreign ownership has been particularly acute for domestic-currency debt. And there are reasons to think that this creditor base may be particularly volatile. Sources: Arsnalalp and Tsuda (2014 and 2018 update) Hugh Bredenkamp, Ricardo Hausmann, Alex Pienkowski and Carmen Reinhart (2018) https://www.imf.org/en/News/Seminars/Conferences/ 2018/05/24/sovereign-debt-a-guide-for-economists- and-practitioners

Reinhart 23 • Flows: Need to close the current account Argentina: deficit (benefits from a weaker peso) Navigating a • The acceleration in inflation together with the more recent stabilization of the peso will narrow path, swiftly erode the competitiveness gained in the stock-flow the earlier part of 2018 • Stocks: Need to stabilize external debt-- problem stocks have risen rapidly relative to There are no GDP(benefits from a stronger peso viz the US dollar) silver • Stabilizing the peso via high rates and tight money adds to the ongoing credit crunch— bullets… impacting economic activity Widening current account deficits have usually ended badly

Argentina: Current account balance, 1880 - 2018 (as a % of GDP)

10 Share of years with a current account deficit: 0.625 Surplus 5

` Percent -5

-10 External defaults (shaded)

-15 1880 1886 1892 1898 1904 1910 1916 1922 1928 1934 1940 1946 1952 1958 1964 1970 1976 1982 1988 1994 2000 2006 2012 2018

Sources: Reinhart, Reinhart, and Trebesch (2018), and October 2018 World Economic Outlook. Reinhart 25 Apart from new borrowing, valuation effects have led to rising external debt/GDP ratio (≈ 55% end of 2018:Q2)

Argentina: Total (public + private) external debt, 1970 - 2018 (as a % of GDP) 180

160

External defaults (shaded) 140

120

100 `

80 Percent

0 1970 1980 1990 2000 2010 Sources: Reinhart (2018), IMF: SDDS and October 2018 World Economic Outlook. Reinhart 26 Note: this does not include Lebacs. The long horizon The US stock/flow problem

The US dollar and the modern day Triffin Dilemma

Reinhart 27 An old problem which is getting worse: It used to be about flows (twin deficits=current account + fiscal deficit)—now it is stocks (debt) and flows 2018-2020. What does it imply long-term for the US dollar? Twin deficit

Twin balances: general government budget and Gross government debt countries current accounts relative to GDP, percent red bars Relative to nominal GDP, average from 2018-20, percent

Japan 12 Greece Twin surplus Italy Portugal quadrant United States Belgium 8 France Spain Cyprus United Kingdom Canada 4 Austria Slovenia Ireland Israel Current Finland account/GDP 0 Germany percent -6 -4 -2 0 2 4 6 Netherlands Slovak Republic Malta Switzerland -4 Australia Twin deficits Korea Norway Iceland quadrant Denmark -8 Sweden Latvia Lithuania United States Czech Republic New Zealand -12 Luxembourg General government budget balance/GDP (percent) Estonia Hong Kong SAR 0 50 100 150 200 250 Source: IMF, WEO April 2018. Reinhart 28 The original Triffin Dilemma: Ratio of total reserves minus gold (US dollars) to gold reserves (US dollars), World since1948 Ratio of non-gold to gold reserves 12 The Triffin dilemma is the conflict of economic interests that arises 10 between domestic and international objectives for countries whose currencies serve as global reserve currencies. This dilemma was first identified in the 1960s by Robert Triffin, who pointed out 8 that the country whose currency (debt really), being the reserve currency, foreign nations wish to hold, must be willing to supply the world with an extra supply of 6 its currency to fulfill world demand for these foreign exchange reserves, thus leading to 4 a chronic trade deficit. The Triffin dilemma

0 1948 1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 Source: Ilzetzki, Reinhart, and Rogoff (2017).Reinhart 29 Role of the Dollar and US Economy 1950-2016 Share of countries

70 30 US GDP as a share of world GDP (percent, right scale) 28 60 26 24 50 22 40 20 18 30 16 Share of countries where the US dollar 14 20 is the principal anchor currency (percent, left scale) 12 10 10 1950M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1

Source: Ilzetzki, Reinhart, and Rogoff (2017).Reinhart 30