Doug Criscitello, Executive Director of MIT’s Center for Finance and Policy
High rates of debt growth by local governments are a cause for concern in any country. In China, where recent turmoil in the equity and foreign-exchange markets has put a spotlight on that country’s economy and growth prospects, increasing levels of borrowing by provincial and other lower levels of government has resulted in local indebtedness rising nearly four-fold since 2008, reaching about 40% of GDP.
Debt growth of that magnitude raises concerns about fiscal sustainability, debt affordability, transparency and accountability. Cautionary tales abound. From New York City in the ‘70s, emerging market countries in the ‘80s, Russia in the ‘90s, and Detroit, Greece and Puerto Rico more recently, there is a long list of governments that have experienced the painful economic repercussions of taking on debt they could not afford.
While the massive debt buildup in China presents challenges, the situation is not as dire as a full-blown debt crisis, a new policy brief from the MIT Center for Finance and Policy by Xun Wu, a visiting scholar, suggests.
Whether Greece stays in the Eurozone and accepts its bitter medicine or is one day forced to exit the single currency, the country’s future is usually regarded as bleak. Either course seems to promise years of hardship and privation for the Greek people.
From another perspective, though, one could see opportunity for Greece. “Never let a crisis go to waste,” is a quote attributed to Winston Churchill, who knew something about crises. Greece today has a chance to turn adversity into advantage. With change in the air, it will be easier for the country’s institutions, government leaders, and people to abandon some of the failed approaches of the past and to embark in new directions.
Trying to predict currency movements is — as they say here in the U.K. — a mug’s game. Any economist, myself included, will tell you it’s virtually impossible to do.
And yet, movements in exchange rates are incredibly important. They affect a country’s competitiveness — influencing everything from export competitiveness to GDP growth. They affect the prices of items coming from abroad, from oil to oranges to iPhones. They make it harder, or easier, to repay foreign debt and they affect earnings on foreign investments.
Currency movements also have big implications for the outlook for inflation. This relationship is known as “pass-through,” because it captures how changes in the exchange rate “pass-through” to import prices and then inflation.
So even if we can’t predict exchange rate movements, we need to understand how exchange rates will affect the economy. And for those of us tasked with setting monetary policy, understanding how currency movements pass-through into inflation is critical to our decision on when to adjust interest rates.
The problem is, much of what we thought we knew about pass-through has not been holding up well.
A major shift in American politics has taken place. All three of the remaining mainstream Democratic presidential candidates now agree that the existing state of the financial sector is not satisfactory and that more change is needed. President Barack Obama has long regarded the 2010 Dodd-Frank financial-reform legislation as bringing about sufficient change. Former Secretary of State Hillary Clinton, Senator Bernie Sanders, and former Governor Martin O’Malley want to do even more.
The three leading Democratic candidates disagree, however, on whether there should be legislation to re-erect a wall between the rather dull business of ordinary commercial banking and other kinds of finance (such as issuing and trading securities, commonly known as investment banking).
The ability of the Chinese government to control is undisputed and unparalleled compared with governments in other countries and, indeed, compared with the Chinese state during imperial times. If the stock market does not go up, then prevent it from going down by shutting it down. If too many investors want to cash out their positions at the same time, just charge them with “malicious intent to sell” and arrest them as proverbial chickens to scare off the monkeys.
The problem is that a government so focused on and obsessed with controls is not one that cares about or is particularly good at establishing credibility. A government needs credibility when it tries to convince others to do its bidding without the ability to dictate actions directly.
In his book, The Courage to Act, Ben Bernanke wrote about how US Federal Reserve officials debated and deliberated long and hard about particular words and phrases, and even about the usage of different punctuation marks, in their communiqués with the public.
The reason is that the effectiveness of the Fed does not depend on its ability to arrest people at will but on how it is perceived by market participants – whether it is perceived as being capable, deliberative and above all credible. If the Fed lost the confidence of the market, much of its influence and leverage would evaporate.