Emerging Trends in Global Savings and Its Allocation: New Challenges for Financial Markets

1. Emerging Trends in Global Savings and Its Allocation: New Challenges for Financial Markets Joseph E. Stiglitz Analysis Economic/Financial Conference Milan June 18th, 2002

2. Major Challenges • The demographic challenge in the advanced industrial countries • The challenge of providing funds for the emerging markets • The challenge of funding the U.S. Trade Deficit

3. Curious world • U.S., richest country in the world, largest borrower—to finance consumption • Limited flow of funds to less developed countries—and often the flow goes the wrong way • U.S., facing challenge of baby-boom retirement, should be saving heavily; yet savings rates close to zero

4. Problems related to instability of global financial system • Crises in developing countries have become more frequent and deeper • Argentina last of a long line • Scaring off investors • But also likely to begin to scare off borrowers • As they recognize risk of borrowing • Typical pattern of lending requires exchange rate risk and interest rate risk to be borne by developing country (in contrast to what would be the case with well functioning markets) • Even limited indebtedness can be unaffordable • And with devaluation, debt/GDP ratio can increase overnight • Borrowing also leads to Dutch disease problems • And thus can adversely impact employment • Downside risks from crises more than offset benefits

5. Instability related to global reserve system • Sum of surpluses equal sum of deficits • If China and Japan insist on having surpluses, rest of world must be in deficit • A decrease in deficit by one country leads to an increase by someone else • A form of Global Hot Potato

6. Situation where U.S. is “deficit of last resort” also related to global reserve system • Demand for dollars for reserves • In equilibrium, U.S. must export “dollars” • Implies that U.S. must have deficit

7. Low savings rate also related to global reserve system • U.S. should be saving for retirement of baby boomers • In all countries retirement of baby-boomers may put strain on asset markets • As baby boomers try to simultaneously cash out at same time • Good news: dis-saving not as strong as life cycle theory predicts • Real problem: U.S. must have a trade deficit • Implies U.S. must be borrowing abroad • Implies savings less than investment • In 90s high level of investment • In 80s low level of savings • Post tech bubble—returning to earlier situation • Surprising, given traditional explanation of low savings: • Large increases in stock market values

8. Issues can be looked at from macro and micro perspective From micro-perspective • How to allocate huge flows of funds into pension funds in coming years • Avoiding mistakes of “bubbles” • Including herd behavior • Problems exacerbated by conflict of interest issues in U.S. banking/investment/auditing • Importance of good regulatory framework

9. But deficit represents a threat to long term global stability • As U.S. has already moved from being largest creditor to largest debtor country • Foreign holdings of US securities had raised from 49% of all portfolio liabilities in 1989 to 65% in 2000 • Account for 42.8% of holdings of U.S. treasury securities • Own 11.2% of US equities • 21.4% of corporate bonds • And lack of confidence could lead to a shift away from U.S. securities • Leading to a weakening US dollar • Reinforcing shift away • Exacerbated by large amounts of short term funds

10. Instability helps account for some of peculiar patterns • China has large trade surplus • Wants to avoid disaster caused by trade deficits • Likely to be exacerbated by China’s entry into WTO • Strong comparative advantage in industrial goods • Low wages • Strong technology • Access to markets • Likely to contribute to problems in both developing and developed countries • Risk: new era of protectionism • Signs already apparent in U.S.

11. System also leads to a systemic global aggregate demand problem, which is likely to get worse as country deficits are tames and monetary policies restrained • Huge additions to reserves every year • Additions to reserves are a subtraction from global aggregate demand • In this view, U.S. had to get rid of its huge fiscal surplus • True numbers far worse than official numbers • “Enron” level accounting problems • Though it poses problems for U.S. long term growth • Contributing to risk of global instability

12. System is also inequitable • Cost of reserves is enormous for developing countries • U.S. reaps benefit

13. SDRs / Global Greenbacks (I) • Regular issue of SDRs or Global Greenbacks could be used to finance global public goods, including development, break the instability nexus, promote equity and development • Would not be inflationary • Represents a mutual help arrangement (CLUB or COOP) • With reserves representing amount of goods a country could acquire from others in time of crisis.

14. SDRs / Global Greenbacks (II) • Could be done in way to induce all to participate • Members of “CLUB” would only hold reserves in other members

15. Summary (I) • From Mexico to Thailand • From Thailand to Indonesia and Korea • From Korea to Russia • From Russia to Brazil • From Brazil to Argentina…and Turkey? • Who is next?

16. Summary (II) • Great deal of talk about reform of global financial architecture • Little action • Argentina: Recognition that Big bailouts don’t work • Looking for alternatives: bankruptcy/workouts/standstills • But U.S. looks askance at any judicial approach • Just reform of contracts • But contractual approach has not worked within countries • Won’t work for debts that move cross borders • Failure to recognize systemic nature of problem • Requires systemic reform