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Lecture 5

ECON 203 Lecture Notes - Lecture 5: Tantrum, European Central Bank, Quantitative EasingPremium

11 pages79 viewsFall 2016

Department
Economics
Course Code
ECON 203
Professor
Strow
Lecture
5

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The world economy
Pulled back in
The world is entering a third stage of a rolling debt crisis, this time centred on emerging markets
Nov 14th 2015 | From the print edition
BY THE time the third film in a franchise comes around, it is not just audiences that may be getting
restive; the characters themselves have been known to complain. It is his inability to put the sins of
screenplays past behind him that gives Al Pacino’s Michael Corleone the most memorable line in
“The Godfather: Part III”: “Just when I thought I was out, they pull me back in!
As with anti-heroes in sequels, so with the world’s debt crisis; seeming conclusions serve only to set
the narrative off in new directions. Householders in America have struggled for years to work off the
excess borrowing taken on during a global housing boom in the 2000s. The economy has suffered
from a shortfall of spending as a consequence. The world economy was dealt a second blow, after
2010, when the delayed effects of that earlier boom were played out in a debt crisis at the fringes of
the euro area, one that at several points threatened to break up the currency union.
Related topics
Economic development
Federal Reserve (United States)
Brazil
International Monetary Fund (IMF)
India
America has put that crisis behind it. Consumer spending is rising at a healthy 3% or so. Nominal
wages are beginning to edge up in response to a tighter labour market, leaving the Federal Reserve
poised to increase interest rates for the first time since 2006 (see article). And household debt looks
as if it is bottoming out. Much the same is happening in Britain, which suffered a boom and hangover
quite like America’s (see chart 1).
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Europe was slower in dealing with its debt and always tends to lag behind America and Britain in its
economic cycle. Nevertheless it is having its best year of growth since 2011. It is for these reasons,
among others, that the IMF is predicting that world GDP will pick up to 3.6% next year; not the sort of
growth seen in the early 2000s, or when emerging markets were booming after the financial crisis,
but not too shabby, considering the slowdown in the developing world that started a few years ago.
Yet just as the rich world seems to be getting shot of its dodgy legacy of indebtedness, it risks being
dragged back into the mire by a third leg of the debt crisis. The debt that built up in emerging
markets after the American bust is still there. It has continued to grow even as the economies have
slowed, and now overhangs them ominously. In the past, the rich world had the muscle to shake off
such problems elsewhere. But emerging markets now make up most of the world economy (around
58% if exchange rates are measured at purchasing-power parity). They are quite capable of
weighing down rich-world recoveriesespecially if, as in Europe, they are already fragile ones.
Taking full account of the effects of emerging-market debt makes the world economy look far less
secure.
The burdens of past opportunities
The build-up of emerging-market credit began just as the rich world’s financial system started to
creak in 2007. According to figures collated by J.P. Morgan, a bank, private-sector debt in emerging
markets rose from 73% of GDP at the end of 2007 to 107% of GDP by the end of last year. These
figures include loans made by banks and bonds issued by companies. Including the credit extended
by non-bank financial institutions (so-called “shadow banks”) for the handful of emerging markets
where such estimates are available gives a steeper rise and a higher total burden: 127% of GDP.
The credit boom in emerging markets was in large part a response to the credit bust in the rich
world. Fearing a depression in its richest export markets, the authorities in China brought about a
massive increase in credit in 2009. Meanwhile a flood of capital escaping the paltry yields on offer in
developed economies pushed interest rates lower in developing ones. This search for yield by rich-
world investors took them to ever more exotic places. A dollar-denominated government bond
issued in 2012 by Zambia, a copper-rich country with an average GDP per person of $1,700 a year,
offered just 5.4% interest; even so, it was 24 times oversubscribed as rich-world investors clamoured
to buy. The following year a state-backed tuna-fishing venture in Mozambique, a country even
poorer than Zambia, was able to raise $850m at an interest rate of 8.5%.
In contrast to the credit booms in America and Europe, where households were the main borrowers,
three-quarters of the private debt burden in emerging markets is shouldered by businesses:
corporate debt has ballooned from less than 50% of GDP in 2008 to almost 75% by 2014. Much of
the lending was done in Asia, notably in China. But Turkey, Brazil and Chile also saw substantial
increases in the ratio of company debt to GDP (see chart 2). Construction firms (notably in China
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