Chastened prophets of doom

In a recent talk at the Council on Foreign Relations, former US Treasury Secretary Larry Summers described himself as a “chastened prophet”– a description that former Chairman of the Fed Paul Volcker also embraced.  Both warned about the risks associated with large US current account deficits several years ago.

I lack the stature of Summers and Volcker, but I too often feel like a “chastened prophet of doom.”   Along with Dr. Roubini, I publicly worried in 2004 that a $600b US current account deficit financed in large part by demand for US debt from the world’s central bank carried grave risks.     It is hard to be less worried by a $800-900b current account deficit if anything now financed in even larger measure by demand for US debt from the world’s central banks.    

Especially a deficit that doesn’t seem to be falling when global conditions are about as good – setting aside the dollar’s inability to fall v. many in Asia and high oil prices – for a benign adjustment as is likely to be case for some time.   

Yet, as Summers noted in his talk, the “balance of terror” generated a relatively stable state system during the cold war, as – at least-- so far, has the “balance of financial terror”.

Dooley, Garber and Folkerts-Landau’s core argument back in 2003 – that reserve accumulation in the emerging world finance large current account deficits in the center at low cost – has stood the test of time. 

The best their critics can claim is that some of the contradictions in the Bretton Woods system are still playing themselves out, just at a slower pace than their critics – myself included – initially expected.  Protectionism in the center and inflation in the periphery are more visible now than they have been previously. 

Still, I never imagined that China would add over $40b to its reserves a month in a quarter – and might sustain that pace (close to $500b annualized) for an entire year.    That is an extraordinary number.   I never imagined that the Gulf countries – given all that has happened in the Middle East – would be as willing as they seem to have been to lend a large share of the oil windfall to the US (60%?).  If the most Kuwait is willing to do is to reduce the dollar’s share in its basket to 80%, I am not sure that changes much.    

I never imagined that Russia might be on track to add $30b (if not more) to its reserves in a single month.   I certainly never imagined that Brazil would stop releasing high-frequency data about its reserves because of worries that its reserves are growing too quickly, not because of worries that it was close to running out of foreign exchange.    Behind the wall of secrecy, Brazil probably is on track to add $20b to its reserves this month – though some of the accumulation may be “off balance sheet.”

Those are phenomenal numbers.   In the first quarter, Christian Menegatti and I estimate that central bank reserve accumulation reached $100b a month.    That is more than enough to finance the US current account deficit.    And if anything, the global pace of reserve growth looks to have picked up in April and May.  While India's central bank stepped back and let the rupee appreciate, other central banks did not.

It is hard to argue that Bretton Woods 2 (the financial coalition of the willing?) isn't still going strong.  Maybe a bit too strong.