A decade ago, crises in east Asia, Russia and Latin America hurt the case for cross-border capital flows. The US Treasury and the International Monetary Fund were derided for championing capital account liberalisation, and free traders explained why the case for mobility of goods and people should not be extended to mobility of capital. But the world ignored the intellectuals. Far from reining in cross-border capital flows, policymakers let them accelerate. In the wake of the 2007-09 crisis, the question is whether financial globalisation will be tamed this time.
It certainly looks as though it might be. The finance ministers at the IMF's weekend gathering were in no mood to celebrate capital flows, and the Fund's own economists have softened their former opposition to border restrictions. Emerging economies that have resisted opening up their capital markets – notably China and, to a lesser extent, India – are smugly pleased about their caution; those that liberalised more hastily – including Brazil, Taiwan, Indonesia, South Korea and Russia – have reimposed various restrictions. In the sclerotic ageing democracies – the Sads, one might call them – there is talk of erecting barriers to Chinese capital inflows.
This mood is hardly surprising, since the case against financial globalisation is stronger now than it was after the crisis of the 1990s. Then, policymakers in emerging economies bet that they could ignore the intellectuals if they took out appropriate insurance: they would protect themselves against sudden outflows of hot money by accumulating vast foreign exchange reserves. But this bet proved doubly disastrous. Determined reserve accumulation implied huge capital exports to the issuer of the reserve currency, with the result that the US experienced the mother of all bubbles. When the bubble burst, hot money whooshed out of emerging markets so rapidly that even prodigious reserve accumulators such as South Korea needed emergency dollar lifelines from the Federal Reserve.
If the 2007-09 crisis bolsters the case against financial globalisation, today's post-crisis conditions reinforce the argument, for two distinct reasons. First, continued reserve accumulation by China and its east Asian imitators, coupled with quantitative easing in the Sad economies, is driving capital into other emerging markets, threatening new bubbles. The emerging market stock index is up 17 per cent in the past three months, roughly twice as much as the S&P 500 index. Colombia, Indonesia and Thailand are up almost 50 per cent this year in dollar terms.
Second, capital flows are increasingly entangled with international tensions over China's exchange rate peg. The peg drives China to export savings and run a big current account surplus. Yet China is the world's most dynamic large economy, and therefore an obvious supplier of demand growth in a world that can no longer rely on battered American consumers or over-extended governments. Perversely, the current account surplus makes China a net subtractor of demand from the world economy. It is hardly surprising that western policymakers, facing slow growth and furious electorates, have lost patience with the peg.
Hence the brewing consensus in favour of restraining cross-border flows of capital. To combat inflows of hot money, Brazil has imposed taxes on foreign purchases of bonds (taxed at 4 per cent) and equities (2 per cent), and its logic is impeccable. It has nothing to gain from an asset bubble and no desire to allow capital inflows to choke off its competitiveness by driving its exchange rate through the roof. Brazil's barriers also make sense from the perspective of the rich democracies. The Sads are engaged in quantitative easing because they are desperate to pump up their economies with cheap capital. They can hardly object if capital-flow restrictions prevent the money they are printing from fleeing to the emerging world.
Equally, proposals to prevent Chinese capital from flowing into the western economies have a clear appeal. China's peg, and the associated capital exports, distort the world economy; and years of patient diplomacy have failed to resolve the problem. Retaliating against China via trade sanctions would be reckless, since doing so would spread the existing currency war into the trade realm. So why not apply a more proportionate sanction? China already prevents foreigners from buying its bonds, so what is wrong with preventing China from buying US Treasuries?
And yet the truth is that, however cogent the case for reining in financial globalisation, sheer momentum will carry it forward. Brazil's capital inflow barriers will be constructive at the margin, but they are simply not high enough to deter yield-hungry investors. Raising them further would increase the incentive to circumvent them: foreigners could sneak money into Brazil disguised as foreign direct investment or trade payments, then use it to buy securities; or they could buy Brazilian securities, or derivatives on those securities, that are traded offshore. The bottom line is that, once a country has a sophisticated capital market, it is tough to keep foreigners out.
It is even tougher to exclude a particular class of foreigner, which is why the understandable urge to impose portfolio sanctions on China will prove impractical. The US has sold around $3,000bn worth of Treasury bonds to foreigners, and perhaps only a third of those are held by China – if Beijing wants to bulk up its holdings tomorrow, it can buy plenty from Middle Eastern sovereign funds. Once finance is globalised, it just is not possible to deglobalise it cleanly. The genie is out of the bottle. We must find ways to live with it safely.
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