Financial Crises: Past and Future Carmen M Reinhart Harvard University Adam Smith Lecture NABE 60 th Annual Meeting, Boston, September 30, 2018
Roadmap The post-crisis decade Global risks: Advanced economies Global risks: EMs and developing economies The long horizon Crisis severity and duration Delayed European recovery? US trade war Underpriced corporate risk? Europe s unresolved debt crises The curious case of the missing defaults External factors and classic EM crises China s lending to low income countries The US stock/flow problem The US dollar and the modern Triffin Dilemma Reinhart 2
The advanced economies: Protracted post-crisis recoveries Real GDP per capita General % change government Crisis peak to peak to Severity Breakeven gross debt Year Country trough recovery index year crisis year 2008 France -3.8 8 11.8 2015 68.7 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 2007 UK -6.1 8 14.1 2015 41.9 2007 US -4.8 6 10.8 2013 64.6 Summary Mean -8.9 9.6 18.5 Median -7.0 9 16.0 63 crises: Avanced economies from 100 in Reinhart and Rogoff (2014) Mean -9.5 7.3 16.8 Median -7.0 6 13.0 Note: The italics denote IMF estimates for 2018-2023 are used. The last crisis is not yet over in Greece and Italy By 2023, the IMF projects that their per capita GDP will remain below its 2007 level. The track record is worse than historic norms, where the mean for advanced economies is about 7 years 3
Why the delayed and anemic recovery despite policy stimulus? In the US is particular, monetary policy responded and rapidly and aggressively to the crisis. ECB and BoJ also became more accommodative. Fiscal policy in the advanced economies and some EMs provided concerted stimulus, while China engaged in a fiscal/domestic credit package of unprecedented magnitudes and scope. Dozens of countries almost simultaneously significantly expanded 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 18% IMF Program Size (median, as % of country GDP, at approval) 16% 14% 12% 10% 8% Advanced Economies - Median Program Size as % of Country GDP (bars) Emerging Economies - Median Program Size as % of Country GDP (line) 6% 4% 2% 0% 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 While the pre- and post-crises patterns look similar in both figures, the scales reflect the major difference in that periphery Europe s very modest real depreciation has been effected through a recessionary deflation. Note: The values of the variables relative to "tranquil" times are reported on the vertical axes. The horizontal axes show the number of months before (negative sign) and after a crisis. The solid lines show the behavior during twin-crises episodes, and the dotted lines show the behavior during "single currency crises. 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 for much of periphery Europe and Iceland, where current account deficits swelled into Reinhart double digits. 2.0 1.0 0.0-1.0-2.0-3.0 Bilateral Real Exchange with Germany; Average for Greece, Ireland, Italy, Portugal, and Spain (annual % change) -8-6 -4-2 crisis 2 4 6 8 10 Sources: Kaminsky and Reinhart (1999); Reinhart (2018) and IMF WEO (2018) for periphery EZ. Reinhart, Harvard
Lack of significant and timely debt writeoffs (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 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 External Debt (public + private) as a percent of GDP: Asian and Eurozone Global Financial Crisis (crisis year = 1) Asian 5, 1998=1: Indonesia, Korea, Malaysia, Philippines, and Thailand (dashed line) Eurozone crises (ex Ireland), 2008=1: France, Germany, Greece, Italy, Netherlands, Portugal, Spain (solid line) 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
Near-term considerations about the odds of recession There is little evidence of duration dependence, in that the longevity of this recovery does not imply that it is about to end soon. The recovery has been atypical, but so was the recession. I documented in work with Rogoff (2008 and 2009) and Reinhart (2010) that post-crisis recessions are more severe and halting. The usual excesses in residential housing and business fixed investment often manifest at this stage of the recovery are not evident. The normalization of monetary policy presents a challenge. The Fed anticipates that it will have to raise the funds rate above its neutral level in 2019 and 2020. However, policy makers do not know the level of the neutral rate, introducing the risk of a mistake. Fiscal stimulus of 2019 was an impetus to the level of GDP. When this rolls off, growth will slow just as the Fed induces monetary policy restraint. Trade disruptions, both for what it may do to the US and to important global players, elevate risks. Reinhart 11
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 12
Selected yield spreads percentage points 20 18 16 14 12 10 8 6 4 2 1000 900 800 700 600 500 400 300 200 <-High-yield option adjusted spread (%) JPM EMBI+ (bps) - > 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 13
Global spillovers: Bad news from Europe (in general) and earlier in 2018, Italy (in particular) trigger a predictable flight to US dollar assets. Dollar appreciation, in turn, raises risks for emerging markets with dollar debts. Italy: General Government Debt and Target2 Balances (% of GDP), 1861-2018 Greece, Ireland and Portugal account for 6% of EZ GDP and 8% of the government debt Italy alone accounts for 15% of GDP and 24% of the debt (these figures almost double when Spain is included) WWII default (shaded) Target2 balances (dark shading) are about 28% of GDP as of June 2018 1861 1871 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011 Sources: Bank of Italy, ECB. International Monetary Fund and Reinhart (2010 and 2018). https://www.projectsyndicate.org/commentary/italy-sovereign-debt-restructuring-by-carmenreinhart-2018-05 Reinhart 170 150 130 110 90 70 50 30 10 14
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) Subset of the Systemic 11 As of 2017:Q4, house prices In Italy are still declining, marking the 10 th year of a downturn. -35.3 percent -70.0-60.0-50.0-40.0-30.0-20.0-10.0 0.0 Percent decline Spain, 2008 Italy, 2008 Portugal, 2008 US,1929 UK, 2007 Iceland, 2007 Malaysia, 1997 Thailand, 1997 Korea, 1997 Ireland, 2007 Norway, 1899 Argentina, 2001 US, 2007 Sweden, 1991 Spain, 1977 Historical Average Japan, 1992 Colombia, 1998 Norway, 1987 Indonesia, 1997 Finland, 1991 Philippines, 1997 Hong Kong, 1997 Sources: Reinhart (2018) update of Reinhart and Rogoff (2009); Bank of International Settlements. Reinhart, Harvard 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 6 years 0 5 10 15 20 Duration in years House prices (real estate) usually begin their steep decline before the onset of the banking crises. Unlike equity prices, which are more spike-prone and can quickly reverse, housing prices exhibit longer cycles. For a historical perspective, see Jorda, Schularick and Taylor (2015). 36 Reinhart 15
Near-term global risks: The EMs and developing economies The curious case of the missing defaults External factors and classic EM crises China s lending to low income countries Reinhart 16
Percent of countries entering a new default The curious case of the missing defaults: commodity and capital flow double busts and sovereign defaults 50 1 45 Double Busts 0.9 40 35 30 25 joint declines in capital flows and commodity prices (>1 year) red shading Share of sovereigns entering a new default 3-year sum solid line 0.8 0.7 0.6 0.5 20 0.4 15 0.3 10 0.2 5 0.1 0 1815 1830 1845 1860 1875 1890 1905 1920 1935 1950 1965 1980 1995 2010 0 Source: Reinhart, Reinhart, and Trebesch (2017) Reinhart 17
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) Lower rates in US and other financial centers? Better macroeconomic management? Mismeasurement? China s emergence as a push factor (both real and in finance)? Reinhart 18
Some not mutually exclusive hypotheses for the missing defaults Better macroeconomic management, including macroprudential and more hedging. Better luck, external factors have remained more favorable than in past cycles low interest rates in US and other advanced economies high growth in China (the newest push factor)? Mis-measured (under-reported) defaults, arrears on official creditors. Arrears on Chinese lending to low income commodity producers?
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 20
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Percent EM turbulence contributes to a flight to US dollar assets A brewing debt crisis? 110 100 Developing and emerging markets: External (public + private) debt as a percent of GDP, 1970-2017 90 80 70 60 50 40 30 Debt crisis, 1982-1991 At 47% end 2016), it is about the same level as in 1981 20 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 21
Holdings by the official sector (bilateral and multilateral development agencies, etc.) have fallen, debt held by nonbank 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. EMs: Debt held by non-residents, 2004-2017 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-economistsand-practitioners Reinhart 22
1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Percent Vulnerability to changes in international interest rates, which are expected to continue to rise Share of variable rate external debt, 1970-2016 55 50 45 Share of variable rate external debt developing countries and EMs 40 35 30 25 20 Source: World Bank (2018). Reinhart 23
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 Loans > 1% and swap lines. Red: Chinese loans > 1% of recipient country GDP Source: Reinhart, Reinhart, and Trebesch (2017) and Horn, Reinhart, and Trebesch (2018). Reinhart 24
The long horizon The US stock/flow problem The US dollar and the modern day Triffin Dilemma Reinhart 25
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 balances: general government budget and current accounts Relative to nominal GDP, average from 2018-20, percent Current account/gdp 0 percent -6-4 -2 0 2 4 6 Twin deficits quadrant United States Source: IMF, WEO April 2018. 12 8 4-4 -8-12 General government budget balance/gdp (percent) Twin surplus quadrant Gross government debt relative to GDP, percent Japan Greece Italy Portugal United States Belgium France Spain Cyprus United Kingdom Canada Austria Slovenia Ireland Israel Finland Germany Netherlands Slovak Republic Malta Switzerland Australia Korea Norway Iceland Denmark Sweden Latvia Lithuania Czech Republic New Zealand Luxembourg Estonia Hong Kong SAR Twin deficit countries red bars 0 50 100 150 200 250 Reinhart 26
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 10 8 6 4 The Triffin dilemma is the conflict of economic interests that arises 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 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 its currency to fulfill world demand for these foreign exchange reserves, thus leading to a chronic trade deficit. The Triffin dilemma 2 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 27
Role of the Dollar and US Economy 1950-2016 Share of countries 70 60 50 40 30 20 US GDP as a share of world GDP (percent, right scale) Share of countries where the US dollar is the principal anchor currency (percent, left scale) 30 28 26 24 22 20 18 16 14 12 10 1950M1 1960M1 1970M1 1980M1 1990M1 2000M1 2010M1 10 Source: Ilzetzki, Reinhart, and Rogoff (2017). Reinhart 28