BoE's Haldane: Global imbalances likely to rise, not fall (great speech)

The Bank of England's Andy Haldane has delivered a terrific speech on the historical growth in 'global imbalances', and his outlook for the future. The first interesting point he makes is that "[o]ther than in wartime, global imbalances are at their highest in well over a century. They have surpassed levels which prevailed during the classical Gold Standard and are more than twice levels during the Bretton Woods period".

His next insight is that the direction of the flows are the opposite of what one would expect: "It is not just the size of these global flows that is unusual. So too is their direction. Contrary to theory, capital is flowing from developing countries with a low capital stock, towards developed countries with a high capital stock (Lucas (1990)). In other words, capital is flowing “uphill”, away from countries where the marginal product of capital should be high and towards countries where it should be low. This makes the pattern of global capital flows doubly perplexing."

Haldane then explains that the growth in imbalances has reflected changes in the balance-sheet positions of the key countries:

"In 1985, the US was a net external creditor. By 2009, it had become a net external debtor to the tune of around 20% of GDP. In 1999, China was a net external debtor. By 2008, it had become a net external creditor of around one third of GDP...

In 1980, the US contributed around a quarter of global saving. Today, it contributes around a tenth. China has been the mirror image. Having contributed less than 5% in 1980, today China is the single largest source of global saving, contributing around one fifth."

Haldane points out that the rise in Chinese savings has not been driven by households, but by their companies (and really thus the State), who are retaining earnings rather than distributing them:

"Around two-thirds of the rise in Chinese savings since the early 1990s derives from the corporate sector. This reflects two things. First, rapidly rising corporate profitability, against a backdrop of strong growth and rising productivity (Ma and Yi (2010))...

Second, more significantly still, most of these profits have been retained within Chinese companies rather than distributed to shareholders (Qiao and Song (2009)). These differences in US/Chinese corporate savings behaviour show up dramatically in dividend payouts. The average dividend payout ratio among US corporations in 2009 was 40%, with less than a quarter of companies failing to pay a dividend. The average dividend payout ratio among listed Chinese corporations in 2009 was around 18%."

Haldane finishes off with some simulations of future global imbalances. Making simplifying assumptions, he finds:

"Among the BRICs, external balance sheets as a fraction of GDP exceed G7 levels by around 2035. By 2050, they are around 2.5 times nominal GDP. These patterns are even more striking when expressed as a share of global external assets. By 2050, over half of all G20 external assets are associated with the BRICs, up from around 9% currently...

Within this, some countries’ share of global assets sky-rocket. China’s share of global finance rises to around 30% by 2050, roughly that of the entire G7. India rises to almost 20%, from less than 0.5% currently (Chart 19). The US share falls from 28% to around 12%.

The flow counterpart to these external stock positions is no less dramatic (Chart 20). By 2020, gross capital flows of the non-G7 countries are projected to exceed those of the G7 economies. By 2030, non-G7 flows are more than three times G7 flows. And by 2040, they are almost four times G7 flows.

Even if these calibrations represent an extreme case, they are indicative of a striking power shift in the pattern of global financial flows. If this path were to be even broadly followed, it would have implications for the scale of global imbalances, which will tend to rise as gross capital flows outpace GDP growth. It would have implications for financial stability, as the scale of gross capital surges (fuelling bubbles) and reversals (fuelling crises) increases. And it may also have implications for the dollar’s reserve currency status...

So where does this leave us? With a potentially dramatic change in the future international financial landscape. With a potentially decisive shift in the pattern of global capital flows. With potential pressures for a further widening in global imbalances. And, if so, with a likely intensification of pressures on international monetary, financial and trading systems. The impetus to reform these global systems is strong today. It may be stronger still tomorrow."