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On Decoupling and the China Connection *

On Decoupling and the China Connection *. Jorge Carrera Head of Economic Research Central Bank of Argentina IDB, Washington DC May 2008. *The views expressed here are my own and do not necessarily reflect the official position of the Central Bank of Argentina. Agenda.

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On Decoupling and the China Connection *

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  1. On Decoupling and the China Connection* Jorge Carrera Head of Economic Research Central Bank of Argentina IDB, Washington DC May 2008 *The views expressed here are my own and do not necessarily reflect the official position of the Central Bank of Argentina.

  2. Agenda • Decoupling Game - Possible Outcomes • Key players • US • China • What's the role for Europe? • Fields for playing the game • Commodities prices • Reserves accumulation • Summing up: Results of the decoupling game • Decoupling in Argentina

  3. Real GDP Growth (demeaned)

  4. Key Players 2.1 US • US financial sub prime crisis

  5. Key Players 2.1 US US – Policy Reaction I

  6. Key Players 2.1 US US – Policy Reaction II

  7. Key Players 2.1 US • US Spillovers - trade channel

  8. Key Players 2.1 US US Spillovers - financial channel decreasing real interest rates, flight to quality (to treasury bonds in dollars

  9. Key Players 2.2 China How much China depends on US? How much EMEs depends on China and US?

  10. Key Players 2.2 China Could China grow inwards?

  11. Key Players 2.3 What's the role for Europe? New leader for OECD growth? New buyer of last resort?

  12. Key Players 2.3 What's the role for Europe? New leader for reserve currency?

  13. Fields for playing 3.1 Commodity boom Commodity Price Index in Real Terms, 1970-2007

  14. Fields for playing 3.1 Commodity boom Long Run Determinants of Commodity Prices, 1973-2007 Note: Standards Errors in brackets

  15. Fields for playing 3.1 Commodity boom Commodity Price Missalignment, 1973-2007

  16. Fields for playing 3.2 Reserves accumulation • Reserves accumulation (and BW II) • Precautionary view: emerging countries have been preparing for this type of crisis • Exchange rate view: Are BWII at risk? Implicit coordination rules of the game requires dollar stability and US deficits (buyer of last resort). Passive attitude in the exchange rate markets

  17. Fields for playing 3.2 Reserves accumulation SWF: 3 trillons? SWF: 2 trillons? Reserves and Sovereign Wealth Funds (millions of dollars)

  18. Fields for playing 3.2 Reserves accumulation 50% 50% 2 40% 40% 30% 30% China 1997 China 1997 Change in Monetary Base Change in Monetary Base A A lgeria lgeria 2004 2004 China 2004 China 2004 20% 20% Ukraine Ukraine 2005 2005 10% 10% Singapore Singapore 1995 1995 Mala Mala y y s s ia ia 1993 1993 China 1995 China 1995 0% 0% 0% 0% 10% 10% 20% 20% 30% 30% 40% 40% 50% 50% Change in International Reserves Change in International Reserves Sterilization policy of systematic accumulators

  19. 4. Summing up Coordination is a key determinant for a successful decoupling A successful decoupling is the more probable scenario the more effective the Fed will be in shortening the crisis in the US

  20. 4. Summing up Crisis duration A long crisis in US (Japanese style?) implies weak dollar and strong American exports? Real GDP Growth (demeaned)

  21. 4. Summing up Crisis duration • Who will absorb additional US exports? • Who will absorb the excess EMEs exports to US? • Are China, Japan, Europe and Middle East prepared to do that? Another unpleasant arithmetic. • We need a new buyer of last resort that take suddenly the role of US has had in the last decades. • The risks are massive competitive devaluation (or reluctance to appreciate) and trade restrictions

  22. 4. Summing up

  23. 4. Summing up • Decoupling is not at alla result of passive policy. • Leader Countries should be active and coordinate among them • Central Banks have revealed that they have more than one objectives with variables weights: • Price Stability • Output Stability • Financial Stability

  24. 4. Summing up • Decoupling and after • If US recession is small, it will be the best scenario… • …but if inflation increases we will see: • an abrupt increases in US policy interest rate (Mishkin) • dollar RER appreciation • contraction in liquidity • All these imply lower real commodity prices

  25. 4. Summing up • Decoupling and after • If US recession is Xlarge we will see: • negative real interest rates for a long time • higher fiscal deficits • dollar RER depreciation • expansion in liquidity • high pressures in US financial market as financial center

  26. 5. Decoupling in Argentina Argentina has a high diversified trade by destination

  27. 5. Decoupling in Argentina Argentina has a high diversified trade by sector

  28. 5. Decoupling in Argentina A simple estimation on the impact on the Argentine economyof a decrease in exports to China and US

  29. 5. Decoupling in Argentina

  30. 5. Decoupling in Argentina

  31. Thanks!

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