Role Reversal in Global Finance

Back from vaccation (where I read little), I managed to go through some papers that academics had been invited to present at the annual Jackson Hole Symposium organised by the Kansas City Federal Reserve Bank's late August. While I must confess that I found most papers were underwhelming given the claim that they provide fresh thinking for the grandees of international finance, Eswar E. Prasad (Brookings/Cornell) gave a presentation of core interest to readers of this blog: Role Reversal in Global Finance.

Prasad's table, showing the cross-sectional median values for each year for the respective group of emerging countries, documents the dramatic shift in the international balance sheets of emerging countries. Foreign direct and portfolio equity liabilities now exceed foreign debt liabilities, while foreign exchange reserves constitute the overwhelming part of emerging countries'net foreign assets.

Their liabilities side is good news for emerging countries, beyond reducing the risks inherent in foreign debt stocks, as foreign equity inflows can predict future growth. Marcelo Soto (now at Barcelona Graduate School of Economics) and I had found in a paper published 2001 in International Finance (Which Types of Capital Inflows Foster Developing-Country Growth) that developing countries should not only rely on national savings but encourage foreign direct and portfolio equity inflows as these broad flows add to growth after correcting for other standard growth determinants. This finding holds also for Asian countries that save enough to finance investment at home but who would not gain the external benefits of equity flows under financial autarchy.

The asset side, by contrast, is what must worry the emerging countries these days. Emerging countries, not just China but China above all, hold debt claims against OECD countries that find themselves on unsustainable fiscal trajectories as a result of very, very unpleasant debt dynamics - depressed growth and rising sovereign risk premia. Prasad suggests, implicitely assuming that the rise of emerging-country foreign reserves is due to self-protection against negative shocks rather than to exchange-rate protection,  a global insurance scheme that might absolve emerging countries from the need to run large surplusses on their balance of payments.

To be sure, neither the IMF nor the US Treasury are going to like such insurance schemes as it undermines the Fund's core business (to help countries in trouble) and the US Treasury's core demand for its low-coupon bills.