A New Round of Financial Crises in Emerging Markets?

Dr Linda Yueh

Good evening. My name is Linda Yueh and it’s my pleasure to Chair this panel with a slightly ominous, but I’m sure it’s going to be a stimulating discussion, as to whether we are facing A New Round of Financial Crises in Emerging Markets. It’s going to be, I’m sure, a lively hour. So, just a couple of housekeeping things before I introduce the speakers. The very first thing to say is, I’d be ever so grateful if you could put your mobile phones on silent. I’m not asking you to turn them off, just on silent and, in fact, I’m going to encourage you to tweet during the session, if you’d like, using the #CHEvents and it is on the record and on top of that, we’re actually being livestreamed. So, hello to all the audience out on the internet as well. So, we are going to hear from each of the speakers and then there will be a discussion on the panel, followed by, of course, questions from all of you. So, that will take us to 7:00pm, at which time we will conclude the panel.

So, let me just properly introduce the panel and the topic a bit, and then I’ll turn to each of the speakers, who will be answering this question, as to whether or not we are facing another financial crisis in emerging markets. Obviously, right now there are growing tensions around emerging markets. The International Monetary Fund has extended precautionary lines of credit. So, a lot of the concerns around what might happen is already, I think, bubbling around in the global economy. And this is a wonderful opportunity to hear from a panel of experts around how we should think about the potential of a financial crisis in emerging markets and generally, about how emerging markets are faring at a time when some of those financial market pressures, associated with a strong dollar, associated with capital movements, are again, issues that they need to think about. And then, of course, what do you – how emerging markets fare are a growing part of the world economy and therefore, how they fare will impact all of us.

So, I’m delighted to have this great panel here to answer these questions for you this evening. To my left is David Lubin. He’s the Head of Emerging Market Economics at Citi. He’s also an Associate Fellow here at Chatham House, in the Global Economy and Finance Department. To his left is Dr Jing Gu. She’s the Director of the Centre for Rising Powers and Global Development at the Institute of Development Studies at the University of Sussex. And then, to her left, is Dr Robert Faulkner. He’s the Research Director of the Grantham Research Institute on Climate Change and the Environment here, as well as Associate Professor of International Relations at the LSE. So, one book plug and then we’ll get to the panellists.

David has written a book called Dance of the Trillions: Developing Countries and Global Finance, published as part of the Chatham House and Brookings Institute Insight book series. I highly recommend taking a look at the book afterwards and, of course, there’ll be a reception after this panel, where you can ask David all about the book and the tremendous work that he’s done on the back of it.

So, I’m just now going to turn to each of the panellists to give a few opening remarks about this issue of whether we are facing a financial crisis in emerging markets and, so, how we should be thinking about this topic. So, David, the floor is yours.

David Lubin

Thank you very much, Linda. Let me start by asking what – you know, why are we asking this question: are emerging markets facing a new round of financial crises? It’s because, since April, there’s been a fairly measurable round of capital outflow from developing countries. This is not a new phenomenon. Outflow episodes, when capital leaves emerging economies, is something that we’ve got used to, over the last 40 years, since Poland defaulted on its debt in 1981, and even before, and we know – well, this episode of capital outflows has already had some quite nasty effects. As Linda mentioned, Argentina, having faced a 35% depreciation of its currency, having tried to defend its currency with 1,000 basis points of rate hikes, couldn’t prevent capital from fleeing further and then had to negotiate a $50 billion standby facility with the IMF. The Turkish Lira has depreciated by 20% and has had to raise interest rates by 500 basis points or so. Central Banks in Mexico, in India, in Indonesia, in Pakistan, in the Philippines, have all had to raise interest rates. The Central Bank of Russia, the Central Bank of Brazil, has had – has – had been prevented from cutting interest rates further, in order to stop capital from flowing out in even greater quantities.

Why this is happening is exactly the same reason as it’s been happening periodically, for 40 years. It’s a tightening of US monetary conditions. US monetary conditions, since the 1970s, are the overwhelming force that shapes the push and pull factors governing capital flows to emerging economies. When US monetary conditions are loose, that tends to push capital towards emerging economies and when they tighten, it tends to suck capital from them. The problem is that saying US monetary conditions is a very broad concept. So, I can say pretty confidently that US monetary conditions determine capital flows to developing countries. The problem is that we never quite know, at any one time, which measure of US monetary conditions counts. Sometimes, it’s the Fed funds rate, you know, it’s what the Federal Reserve does. Sometimes, it’s the ten-year bond yield in the United States.

In 2013, during an episode very famously known as the taper tantrum, the only measure of US monetary conditions that was relevant in shaping the market’s risk appetite towards developing countries, was the US ten-year yield. Sometimes, it’s neither the Fed funds rate, nor the ten-year yield, it’s the dollar exchange rate, and that’s where we’ve been, in the last couple of months. It was an appreciation of the dollar that caused this capital outflow, rather than anything happening to the US yield curve.

This isn’t the first time when the dollar has been the most important, kind of, measure of US monetary conditions, as it governs capital flows. For example, in the run-up to the 1997 Asian financial crisis, barely anything happened to US interest rates. The measure of monetary conditions that was relevant in precipitating the Asian crisis in 1997, was an appreciation of the dollar. Frankly, it’s a mystery, which measure of US monetary conditions is relevant at any one time. I just – I don’t know how to explain that or how to explain why the market changes its view from time-to-time about which measure of monetary conditions is relevant. It just happens. It’s just one of those things.

As we know, you can – well, what’s happened to Argentina, you can quite confidently describe as a financial crisis. And if this was the 1980s or the 1990s, I think it would be possible to predict quite confidently that what just happened to Argentina would be spread broadly across the emerging world, that, you know, crises would multiply, as a result of further tightening of US monetary conditions. But actually, it’s quite tempting to argue that we may be in a, kind of, post-crisis world for emerging economies. And the reason for that is that the vulnerability that characterised developing countries in the 1980s and 1990s, which, you know, gave rise to this two decade long time span of intermittent financial crises, if I generalise, the two central vulnerabilities that existed in the 1980s and 90s, was a) that many developing countries had fixed exchange rates. In other words, their exchange rate was not available to absorb shocks and b) developing countries, during those two decades, had very weak balance sheets. Now, the concept of balance sheets is a very complicated one, but if – you know, maybe the most, sort of, important concept within that is that they lacked foreign exchange reserves. In other words, they lacked dollar resources that they could use to withstand the volatility of capital outflows.

In the 20 years since the Asian crisis, or rather, the 20 years since the Russian crisis in 1998, or the 17 years since the Argentina crisis in 2001, emerging economies have made strenuous efforts, driven, in many ways, by the trauma of what happened to them in the 1980s and 1990s, to eliminate those two vulnerabilities. So, what you see now is a prevalence of floating exchange rates, rather than fixed exchange rates, and a continuous acquisition of foreign exchange reserves. So, the two central vulnerabilities that existed in the 1980s and 90s are rather uncommon these days and it’s because of that that I think it’s, at least, tempting to argue that things have changed.

Now, it sounds like what I’m saying is this time is different and you should be very nervous of an Economist when she says, or he says, “This time is different.” Whether it’s different, I think, depends a lot on what happens in China. China has played a role in reshaping the economic lives of developing countries over the last 20 years, first by delivering a boom in commodity prices, the like of which the world had not seen for 200 years. And secondly, since the global financial crisis in 2008, in using its strong balance sheet to finance stimulus policies, which have supported Chinese growth and therefore, helped to support the growth rates of many – of a number of developing countries. The credit expansion on which China’s stimulus was based may not be survivable for a long time and so, China’s positive benign influence on developing countries may not be sustainable. To put it bluntly, if China itself is going to face a crisis, then a lot of other countries will too.

China’s also become a more important source of influence on the economic lives of developing countries by becoming a, kind of, substitute supplier of funding, particularly, most famously, in the context of the Belt and Road Initiative, which was announced in 2014. But there may be constraints on China’s ability to finance projects in the Belt and Road, something I don’t have time to discuss, but maybe we can come back to it. If China become – if China does – is allowed to, kind of, remain as a, sort of, positive, benign influence on the economic and the financial lives of developing countries, then I think the point that I’m making about emerging economies being somehow post-crisis, may be a valid one. But even if that is the case, if, in other words, China is able to convert the economic influence that it has on the lives of developing countries, intellectual influence, in the same way that Washington was able to convert its economic influence on the lives of developing countries into intellectual influence through the Washington consensus, if that’s the case, then the kind of policy framework, the, sort of, conventional thinking about how developing countries should manage their economies, could change dramatically. Because the central difference between a Washington consensus and a Beijing consensus is, a) that the Washington consensus places primacy on the role of markets, whereas the – whereas China thinks very differently about the correct balance of power between markets and the state. And secondly, that China thinks differently about the relative balance of power between what I call rules and discretion.

What we’ve lived through – 30 seconds, sorry. What we’ve lived through, is – well, one of the characteristics of the Washington consensus that’s governed the economic lives of the developing countries in the last 30 years and which governs the flow of capital to emerging markets, is that it is rule-based. The rule is, you should keep your capital accounts open. You should let capital flow out willy-nilly. China rejects that. China emphasises the role of discretion, the idea that the policymaker should have discretion to decide which kinds of capital flows are good and which kind of capital flows are bad. So, along those two contours, I think we could, actually, in any case, see the economic policy framework, under which developing countries manage themselves, change considerably over time.

Dr Linda Yueh

Thank you very much, David. Okay.

David Lubin

Sorry I’ve been talking so long.

Dr Linda Yueh

I’m just going to make sure we all end up getting out of here in time for drinks…

David Lubin

Yes.

Dr Linda Yueh

…at 7:00, that’s the priority. No, now let me turn over to Dr Jing Gu for your take on the issue today.

Dr Jing Gu

Thank you, Linda. Thank you, David, and thank you. To some extent David has said what I want to say.

David Lubin

Sorry.

Dr Jing Gu

But, yes, I think you raised very important questions in your book about whether China is willing or be able to convert its economic power to the influence around the policy framework in the other developing countries. That’s a very interesting question. My response to this question is actually very positive. I think, you know, will you – because I work on international development co-operation issues, when you look at the global development, in the last 20 years, we witnessed the dramatic change in the global development landscape, especially, in recent ten years, China is becoming increasingly important an actor in global development, which we never imagined, you know, like, 20 years ago.

Taking China and Africa as example, China is – Africa is the largest trading power and China is more than 3,000 companies across 50 African countries and according to some statistics, China has nearly one million, you know, well, basically, one million Chinese working in various African countries. Apparently, you know, but China is not just a financial power in many developing countries, but a power of ideas and knowledge, especially its development paradigm, its development model, become increasingly very attractive for many African leaders and also, the leaders from other, you know, developing countries.

So, I think, you know, my answer is definitely yes, China is playing a very important role, not just in terms of the hard power, but also, the softer power, you know, the ideas and how to do development, how to develop your economy, how to manage your economy that you mentioned, the capital mobility, you know. Apparently, China, well, to some extent, is harmful to have free capital movement or free capital flow in and out of the countries, especially for developing countries. I think, given China’s last 20 years’ experience, the liberalisation of the capital account very limited and also, you know – but we don’t know what the future holds, and especially this – the internationalisation of the currency, the renminbi, and also China’s ambition to become the real power in global development. So, it’s a difficult question, what the future holds.

But I also want to raise the point about the reform of the global financial governance. In my view, you know, at the macro-level, the global financial governance is in crisis. We do not have a valid – well, legitimate or institutes, you know, who can design the macro-level international monetary policy and also the trade policy, etc. The global financial system, basically, has grown in an unplanned way and the institutions are ad-hoc, patchy, often reflecting national, rather than global interests and also, can – only influences those in trouble.

So, the global financial institutions certainly needs reform, but this should be whose initiative? It’s a question mark. The initiative very much naturally should come from the emerging markets. But the emerging markets, we have to differentiate the emerging markets. You know, China is very different from Argentina, from Turkey, you know, etc., they have different national interests. So, the future of the reform of the global financial institutions will be very interesting and we have to say, you know, what’s the planned from the emerging markets.

And my last point is actually, on this important Chinese initiative, global and the regional initiative you mentioned, you know, like the Belt and Road Initiative and also, the AIIB Bank, Asian Infrastructure Investment Bank. So, up to now, you know, 70 – more than 70 country joined the AIIB and most of its capital is provided by emerging and the developing Governments. It will reflect this development experience of these Governments and also, you know, it has incorporated many developing economies into its membership.

The authorised initial capital stock of the AIIB Bank is about $100 billion, about one third of the World Bank. So, the Board of the Directors will function on a non-resident basis. In 2016, IDS Research Team had a meeting with President Jin of the AIIB Bank and he mentioned that the AIIB expected to lend between ten to 25 billion dollars during the first five to six years. And also, my colleague, Stephany Griffith-Jones’s, calculation is that in 2025, the total level of accumulated loans by AIIB could reach $120 billion. And the total stock of in the infrastructure lending of the AIIB in 2025, could be significantly higher than the World Bank stock of infrastructure lending. If it co-finances with the private funders, World Bank and also, Asian Development Bank, the AIIB could reach well over $120 billion, up to $240 billion.

So – but my point is not about the financial power of the AIIB. To me, and very interestingly, we need to watch the AI – the development of AIIB in the next 20 years. It’s – AIIB is not just about finance, it’s not just about money, but about knowledge, how to do development. So, my confidence with the AIIB is actually, last year, it’s perhaps another identity as a knowledge bank. So, I will end up, okay, here.

Dr Linda Yueh

Thank you very much.

Dr Jing Gu

Okay, thanks.

Dr Linda Yueh

Robert, over to you on your take on this issue about a new round of financial crises and emerging markets.

Dr Robert Faulkner

Thank you, Linda. Thanks for having me here. May I take the opportunity to start with a comment on the book, since it was introduced at the beginning and we didn’t really touch on it too much? I read it. I enjoyed it hugely. It’s not just deeply researched, sharp in its analysis, and quite provocative in its conclusions, it’s beautifully written, and how many monetary policy books do you know that are in that sort of category, right? So, my only disappointment is, there are not enough copies here to buy the book today. So, that’s my main complaint. But, apart from that, all I can say is, don’t miss out on that opportunity.

It actually reminds me, the book, of a senior scholar, who no longer is with us, who worked in a similar field and also, spanned the two institutions where I have hats to wear: Chatham House and LSE, that’s Susan Strange. Some of you, in the audience, might remember her work. She wrote similarly, perceptive books about the inherent instability of global financial markets. She wrote them at the LSE. Her famous book: Casino Capitalism, in many ways, predicted the financial crisis. But she started out writing on global finance here at Chatham House and so, your book is in that venerable tradition and I hope it’ll carry on in that way. So, so much for the plug. Okay, I’ll stop there.

Now, what about the looming financial crisis? I don’t want to add too much to what David said, because you’ve laid it out. It all starts in the US, rising interest rates, the rising dollar, the withdrawal of liquidity in the US, is all going to have ripple effects around the world and particularly, in emerging markets. That’s the formula that we’re familiar with. But I want to mention just a broader context to this, and it’s not just contemporary issues in US monetary policy, or even Trump’s trade war, which we probably need to touch on here, but it goes back further. It goes back at least ten years and that’s the post-financial crisis monetary situation that we found ourselves in.

Thanks to the financial crisis, we’ve enjoyed, if that’s the right word, a good decade of relatively abundant and cheap money. Quantitative easing has pushed money out into the emerging markets, in search for higher yield, but also, higher risk investments and that, of course, is now looking a bit shaky, as quantitative easing is being wound up and as the liquidity flows are draining – are drying up. So, in a way, the emerging markets, I think, have had an easy run for the last ten years. They’ve been blessed by the fallout of the financial crisis. So, some of the volatility that’s returning to these markets is, not least, due to the, sort of, post-crisis unwinding that we are starting to work on now. So, I think there’s nothing unusual about the rising volatility that we’re expecting.

Now, what about those four words that you used? I think you, in the book you described them as, “The four most expensive words in world history: this time is different,” right? So, if you ever hear that word, run for the exit immediately. So – but what is different? So, you mentioned currency fluctuation, so within a more flexible currency exchange system it should be easier to adapt. You mentioned the hoarding of foreign currencies as a buffer. That is all good news. The problem is, we haven’t really tested it and we’re not quite sure which of those countries are likely to rely on that successfully and which aren’t. So, that’s – there’s some uncertainty around that.

Capital controls, again, there’s now a much more liberal – sorry, liberal as in free approach to using capital controls. It’s almost the opposite of the Washington consensus that had existed so far and again, we haven’t put them to the test. China has demonstrated how you can shield yourself against financial instability, but of course, China is a very different player in that field and has its own unique characteristics that many other emerging markets can’t replicate. So, I’m not convinced yet that this time is different, indeed, because I’m not sure we’ve put these new mechanisms to the full test. And so, we are probably going to run a good social science experiment and as in – as so often in social science research, others will pay the price for it.

The last point, and I’m aware I need to come to the final point, brings me to China and China’s role, and in the book, David, you talk about how the Washington consensus is receding, and I would go further, it’s dead in the water. And you then talk about the Beijing consensus emerging as a potential alternative, as a, perhaps, new intellectual framework, with China providing solutions to the world. I’m just not sure there is such a thing as a Beijing consensus. I mean, consensus means lots of people agreeing on something.

There’s probably more of a Beijing model and it’s not clear yet whether many world financial players will agree on that model, and I’m not even sure if there’s a Beijing model either. What is it usually assumed to be? It’s a mixture of heavy handed, but clever role of the state in directing investment and managing economic growth, and that’s then coupled with the idea of shielding that state-run capitalist system with, from external shocks, through, for example, the use of capital controls, your discretionary methods. Fascinating model, but I can’t quite see how you will solve emerging markets’ problems by telling other countries do the same and do more of the same. It takes a lot. It takes a very capable state. It takes a very focused state and not the kind of state that we’re usually observing in lots of emerging markets and so, I’m not quite sure that that is going to be the, sort of, the recipe that will unlock these political dilemmas that these countries face. So, I think there’s – there are other measures needed.

And finally, just on China’s role, if I may, Chair, and one last comment, yeah, China is playing that huge role now. Its lending is almost on a par, and in some cases, exceeding the lending that the World Bank and other Western multilateral banks are dishing out around the world. But again, China has had an easy run so far. It’s been lending huge amounts of capital in environments that are not rocked by financial instability. China has not had to deal with countries that default, that do not play by the rulebook and so, China has yet to experience what it means to be the world’s largest lender and then have to enforce the rules and then have to deal with those countries that behave in rather awkward ways. So, in a way, it’s interesting to note that China’s lending institutions, the Exim Bank and so on, are starting to try and draw other multilateral banks into their own activities, not least, both to spread the risk, but also, learn from them how you manage those potentially defaulting countries. So, I’m not convinced that China is going to be the next big thing after the failure of the West, and I’ll leave it at that. Thank you.

Dr Linda Yueh

Thank you very much, Robert. I’m just going to follow-up with a set of questions to the audience and let you guys get ready for your own questions. I think to David, given that you operate in financial markets, what are some indicators to look for if one was worried about a looming financial crisis in an emerging market? So, in other words, you discussed it’s very difficult to work out which monetary conditions matter the most, but we have some guidance through history, the early 80s, the first generation currency crisis in Latin America. The big triggers there were fiscal deficits in Latin American countries, indicators of external indebtedness. The second generation of currency crisis was actually in Europe, in the ERM, and that had to do with unsustainable pegs and George Soros selling sterling. I think we all know the story. The third generation crisis was a – which was a currency and financial crisis in the late 80s, the Asian financial crisis, was a financial crisis based, first and foremost, on cronyism and some inner – you know, too much money being lent, which then triggered a currency crisis. So, what I’m getting at is, each of these crises have to do with monetary tightening, but they all have certain indicators attached to them, whether it’s deficits or too much how many in-flow. I know this time it’s probably not different, but what should we be looking out for in this next potential fourth generation financial crisis?

David Lubin

I think the analysis of vulnerability to capital outflows has something to do with what Economists call stocks and something to do with what Economists call flows. The most important flow indicator is how many dollars you need from the rest of the world. In other words, the more dollars you need from the rest of the world, at the point at which those dollars become unavailable, because US monetary tightening is sucking them away, then you are vulnerable. That indicator is usually conventionally measured by the size of a country’s current account deficit, which is the broadest measure of a trade deficit.

Dr Linda Yueh

How much of it is covered by their own reserves?

David Lubin

Yes and, you know, what obligation each country has to repay debt over the next 12 months, let’s say. So, that’s a, kind of, you know, a way of thinking about a, kind of, flow indicator that gives rise to vulnerab – that helps to understand vulnerability. But stocks are important too. What I mean by stocks is just how much debt you have in the first place. So, you know, just making up an example, you know, a country that has a large current account deficit, in other words, a large financing need, but very little debt in – on its balance sheet, will be safer than a country that has a lar – same large current account deficit, but has a lot of debt. So, it’s that, kind of, it’s a, sort of, balance between an analysis of stocks and analysis of flows.

Dr Linda Yueh

No quick rules of thumb, 50% external debt denominated in dollars or anything?

David Lubin

I wish. There was a – one of – you know, many of the people who, kind of, failed to see the Argentina crisis coming in 2001 drew a lot of confidence from the fact that Argentina’s public debt burden was less than…

Dr Linda Yueh

Was very…

David Lubin

…60%…

Dr Linda Yueh

…measured.

David Lubin

…which was the Maastricht criterion for public debt. So, as soon as you think you’ve identified a rule of thumb, something’s going to come and make it wrong.

Dr Linda Yueh

That’s a very good tip, actually. Jing Gu, I wanted to get you to elaborate a bit on – you talked a lot about China’s growing role. If there was an emerging market financial crisis, given how vested China is in emerging markets at the moment, literally invested in the case of African countries, would China come to the rescue of an emerging market that needed a bailout itself? So, rather than go to the IMF, would China play that actual rescue role, given it’s already set up, essentially, a counterpart to the World Bank in the AIIB? But could it play the role the IMF currently plays, but perhaps with different conditionality attached?

Dr Jing Gu

I think this is really an interesting question about, you know, how will China protect its overseas investment? How should Chinese define its overseas interests? I think at the moment, in terms of the relationship between China and other developing countries, especially the least developing countries, it’s very much a kind of, I should put it this way, China is still in a steep learning curve. So, it’s not – you know, the answer is yes or no. Yes, is China is actively pursue a policy of trying to, you know – well, it’s to help the developing countries develop its economy, but also, to treat them as business partners, rather than the relationship between donor and the recipient. We’ve written is the, you know, in the last 50 years, between the North and the South it’s always the relationship between donor and the recipients. But China regards its relationship with many developing countries as very much a partnership, strategic partnership. In other words, you know, if you are business partners, you need to behave like business partners.

So, I think China will to try its best to, you know, help the other emerging markets or the other developing countries, but there’s so much China can do itself, because it’s facing a severe domestic challenge, in terms of how to manage its own financial risk. Linda, perhaps you know very well on this, in recent two days, there’s a hot debate between the Chinese Minister of Finance and also Chinese Central Bank on the how to manage financial risks and also, can China have a valid fiscal policy? And what’s the difference between Chinese fiscal policy and Chinese monetary policy? All these debates are going out right now. So, I think, you know, it’s difficult to answer, but I think, from China’s national interest point of view, China will do its best to help the other developing countries.

Dr Linda Yueh

Thank you. Yes, no, I think China has a lot of discussions around macro credential regulation, how you manage financial stability on top of all the other risks that it currently manages with exchange rates. And that, now that actually leads me nicely, actually, to Robert, for the final question, in terms of you’ve expressed, I think, some scepticism around the current economic order, as it stands. I suppose the question I would ask you is, if you looked across the emerging economies, and we’ve talked a lot about the financial side, are there other triggers that could cause a crisis? ‘Cause, as we know, crises can be a crises of confidence.

Dr Robert Faulkner

Exactly and there are a lot of economic factors, but also, geopolitical factors, that play…

Dr Linda Yueh

Yeah.

Dr Robert Faulkner

…into that. At the moment everyone’s looking very carefully at the evolving trade relationship, or is it already a trade war, between the US and China and the US and the EU.

Dr Linda Yueh

Well, talks have just broken down today, so we’re getting closer to a trade war.

Dr Robert Faulkner

It’s hard to keep up with developments here. But I think this has huge implications for emerging markets. They may think, who knows, that they are not at the moment in the, sort of, the – they’re not the target of Trump’s various trade policy measures, but of course, may – for many emerging markets, the last ten/15 years were all about embedding their own companies in the global supply chains that American, European, and increasingly Chinese, companies have run around the world. So, there’s a famous Economist, Richard Baldwin, who, in his book about the history of globalisation rights, that this was the main growth strategy, “to find your niche in global supply chains.” But that means this strategy of export-led growth only works if those trading relationships will continue to work in that way. And what Trump is currently doing is he’s disconnecting, disrupting many of these supply chains, forcing back American capital and American employment, back to the US, a reassuring effort, which is enforced. And this will leave a lot of emerging markets high and dry, in terms of their ability to insert themselves and stay engaged in this chain. So, that could certainly drive down investor confidence very rapidly. So, I think this is actually an unusual situation that we’ve not had before.

Some observers point out that growth in the global economy is still looking good. China’s growth rate has just been revised down again to another six point something rate. Wouldn’t we all…?

Dr Linda Yueh

6.7. Still about…

Dr Robert Faulkner

6.7.

Dr Linda Yueh

…six and a half.

Dr Robert Faulkner

What looks terrible, from a Chinese perspective, is admirable from everywhere else. So, there’s still robust growth around the world and, of course, China’s investment programme in infrastructure will sure up some of that growth. But that can turn sour very quickly indeed and that’s where I’m rather worried that we will pile crisis onto crisis.

Dr Linda Yueh

No, it’s very good and indeed, I think that is probably one of the other big risks, which is if this trade war, if it is a trade war, starts to target investment across countries by putting up barriers, then I think that could cause some developing countries to find it very difficult to continue to grow. And that’s the issue with debt, if you’re growing, then the debt to GDP ratio always looks slightly better than if growth gets really hit. You knew we’d get to Trump.

Now, the floor is open. There are microphones, which are coming around. If you could please introduce yourself, your name, who you’re with, and who you’d like to answer your question. But I’d be so grateful if you’d keep the question concise, so we can get in as many questionnaires as possible. So, the gentleman there in the white shirt, and then I see a hand up over there, the gentleman in the back row, after that.

Nick Harriss

Good afternoon. Nick Harriss from Allenby Capital. To be honest, I’m not sure who would be the best person to answer. But question on China and its, sort of, stock of foreign assets, what is the proportion between maybe more conventional debt holdings and direct stakes, whether they are equity or quasi-equity?

Dr Linda Yueh

Good question, thank you. Okay, there was a question there?

Andrew

Andrew, Member and Freelance Marketing Consultant. My question is, can the future economic crisis prevent it by applying behavioural economics?

Dr Linda Yueh

Great question, thank you. Okay and we’ve got two questions. We’ll take both of you, yeah.

James King

Thank you. I’m James King from the Financial Times. First of all, I’d just like to say, David, I read the book and I thought it was absolutely terrific and really taught me a lot.

Dr Linda Yueh

That goes undercover, David, that’s James.

James King

The – my question is, either to Jing Gu or to David, do you feel that the Chinese authorities think that they’re, kind of, running short of money to fund the Belt and Road Initiative?

Dr Linda Yueh

Thank you.

James King

It’s just as simple as that.

Dr Linda Yueh

Okay, we’ll come to the next round in a moment. So, foreign assets of China, debt versus equity stakes, David, do you want to take that?

David Lubin

Yeah. China accumulated a stock of foreign exchange reserves, which reached 2000 – which reached $4 trillion in 2014. Because of capital outflows, in 2015/2016, that stock is now around just above $3 trillion. At one stage, when reserves were high, and in the context of the announcement of the Belt and Road Initiative, SAFE, which manages the Central Bank’s reserves, the State Administration for Foreign Exchange, used some reserves to capitalise a number of investment companies. The Silk Road Fund, CIC Capital, the Chinese National Investment Corporation, the China-Latin America Fund, you know, there are a number of different investment vehicles. Actually, there is not much transparency about the exact amount of funds that were used to capitalise these investment vehicles, what their exposure is, or what they do. There’s just not much transparency.

And I’ll, to save time, I’ll quickly use that as a, kind of, segue to answer James’s question, which is that if the renminbi were a properly functioning global currency, then China could just print the stuff and lend it to other developing countries. The fact is that Chin – that the renminbi is not a fully functioning devel – global currency. We thought that it was making progress towards that in the years running up until 2015, when it really seemed like there was a big increase in the amount of China’s trade that was settled in renminbi. There was a big increase in the volume of renminbi denominated bond issuance that was sold to foreign investors. It was all looking great until 2015, and that – just at that point when China’s foreign exchange reserves started to fall again and against the background where China’s economy was slowing and people didn’t know what its capital account policies were, the – those measures of the renminbi’s internationalisation collapsed.

So, the fact is that China has a kind of dollar constraint. In other words, its ability to fund these projects, its ability to expand its economic influence across, you know, across borders, relies, to a large extent, at the moment, on its possession of dollars. Now, as I said, a) those dollar resources have fallen in the last couple of years, b) China itself is possibly a victim of the consequences of US monetary tightening. China is another developing country and so, just as we’re discussing that, you know, when US monetary conditions such capital from most developing countries, it will also tend to suck capital from China.

Now, China has a way of preventing that becoming a big problem, which is that in 2016 and 2017, China put into place a bunch of controls on capital outflows. So, that helps to, kind of, sever the link between your domestic economy, or your dollar resources, and what’s happening at the US fed, or what’s happening in US monetary conditions. But we don’t know that that – that those capital controls will stay as effective as they seem to be at the moment. You know, the history of capital controls, frankly, is that when money has an incentive to leave a country, it’s going to leave the country. Maybe China has a better chance of making its capital controls effective than other countries have in the past, but it’s still a question. And there’s a c), there’s a third point as well, which is that China has been running a current account surplus for as long as it’s been plugged into the global economy. The only China that financial markets have had to think about is a China with a current account surplus and yet, it looks very likely that that current account surplus is going to perhaps disappear quite soon.

Dr Linda Yueh

The first quarter was a deficit.

David Lubin

For the first time in 20 years.

Dr Linda Yueh

Yes.

David Lubin

If China starts to run persistent current account deficits, in other words, it will need the rest of the world’s dollars to finance itself. If it needs dollars to finance itself, that, kind of, means that there might be fewer dollars to go around for China to lend to other countries. So, I think that there are a number of constraints on fulfilling China’s objectives in the Belt and Road Initiative.

Dr Linda Yueh

Thank you. Jing Gu, let me bring you in. Obviously, China’s committed to spending $800 billion on the Belt and Road Initiative over the next five years. There’s another 200 billion, which has been pledged as part of the new Silk Road Fund. Is it – are they going to run out of money before they could fund it?

Dr Jing Gu

I actually – I agree, there are lots of constraints to China’s investment in this Belt and the Road Initiative. But, on the other hand, you know, the Belt and the Road Initiative at the moment, we’re very much a focus on the power of the Government, of the state, of the public sector. China hasn’t fully utilised the private investment and private capital. There are lots of potentials with the private – Chinese private investors. But because, as you said, you know, lots of issues are not transparent, so we don’t really know what’s the potential China holds on the Belt and the Road Initiative, so, I think we need more evidence and more data, in order to draw a useful conclusion. Thank you.

Dr Linda Yueh

Thank you. Okay, so, Robert, I’m going to get you to ask – answer the really hard question that was posed, is…

Dr Robert Faulkner

Thanks, that’s…

Dr Linda Yueh

…can we prevent a…

Dr Robert Faulkner

…very good of you.

Dr Linda Yueh

…financial crisis, behavioural economics, or any other way?

Dr Robert Faulkner

Well, there’s a short answer to that, which is, I’m not a Behavioural Economist, so I had better be polite about my colleagues at the LSE and what they’re doing. I think behavioural economics is a terribly exciting development within the economics, should remind all trained Economists that there are other disciplines out there that can contribute to the discourse. I trained as an Economist myself, but I’m now an International Relations Scholar, so I carry humility on both sides of that divide. But I think it has its uses, but I think it’s also, quite limited in what it can do. So, it’s good about understanding how personal beliefs, psychological traits, but also, incentive structures, affect behaviour. And, you know, at LSE, they’re doing work, quite – some esoteric work into, for example, trading behaviour in the city and what factors influence that, and the latest research shows air pollution levels in London affect trading in the city. And there are lots of way you can, therefore, sort of, tweak or nudge people in the right direction.

But if we’re talking here of a highly complex global system, an interconnected system where, you know, lots and lots of actors respond to each other’s movements, and would be difficult to design a behavioural economic sort of approach to fixing the systemic faults in the system. That’s why I think there will be a small contribution, but not too big a one.

Dr Linda Yueh

Thank you. There were three more hands, one here, the lady in front, and the hand there, and if we keep these questions brief, we might be able to get in a final round, so, please.

Simon Kitchen

Thank you. Simon Kitchen from EFG Hermes. David, you mentioned that having a flexible currency, having a lot of reserves, was a, sort of, a good policy in the face of dollar – well, US monetary policy, that was the best preparation. So, what’s the best preparation, and this is for everyone on the panel, what’s the best preparation and which countries are the best prepared for an era of rising trade barriers, and disputes over trade and over financial policy?

Dr Linda Yueh

Thank you very much and a question here?

Ann

Hi, Ann from Cedar Group Corporate Banking. I have a question for David and Dr Jing Gu on China’s influence. So, I’ve come across some comments saying that the Belt and Road Initiative is a debt trap for emerging market economies, with the loaned to own approach of China, and they quote the recent example of Sri Lanka having to give up their port because they couldn’t service the Chinese debt. What is your take on this?

Dr Linda Yueh

Thank you very much and the question there, the gentleman there?

John Galani

Hello, I’m John Galani. I am the European-Middle Eastern Operations of an Asian-based commodity trader. I view of the dollar system a bit as the gold standard, whereby the dollar is actually not a moving target, everything else around it is. If the dollar shifts, then everything else has to shift around it. If and when we do go into the next crisis, we need to work around the dollar, as is today the case and so, with the splintering of the politi – the geopolitical structures, do you believe that any crisis would be exacerbated by the current tensions, or is there still a consensus, whereby we can get together and help each other, in a way?

Dr Linda Yueh

Great question, thank you very much. So, let’s start with the best prepared EMs, David? I want to get another round, so if I may just ask each of you…

David Lubin

Yes, well, I mean…

Dr Linda Yueh

…to answer one of the questions.

David Lubin

…just on the – Simon’s question about trade barriers, it’s critically important. Emerging markets is a, kind of, organising concept in international capital markets. It’s, you know, for anyone who’s involved in finance, it’s an asset class. In other words, it attracts capital, because there are Bankers and people who sell the idea of investing in emerging markets. Emerging markets would not exist as an asset class. It would not exist as an organising principle in international financial markets, were it not for globalisation. And the rise of protectionism, which is not something that was born on January the 20th 2017 when Donald Trump was inaugurated, it’s something that we’ve seen grow, you know, for the last several years, rising protectionism is a critical threat to globalisation. I’m not trying to make any prognosis or anything. I’m just trying to identify the threat. Because what globalisation has been, the reason why emerging markets exist as an organising concept, is because there’s an economic globalisation process underneath the financial globalisation stuff. That economic globalisation process existed because developing countries 30/40 years ago, began to realise that they had an incentive to open themselves up to trade. If those incentives start to get closed down because of a rise in protectionism, that is, I mean, well, it’s bad news for capital mark – you know, for capital markets, actually, but it’s – but more importantly, it’s bad news for growth. And to answer the question, I don’t think anybody’s really protected against that.

Dr Linda Yueh

Sorry, I was going to get you an answer.

David Lubin

Well, I think…

Dr Linda Yueh

But it is…

David Lubin

Yeah, yeah.

Dr Linda Yueh

…an answer, it’s an honest answer, thank you. Well, if we try to keep these brief to get another round in. Jing Gu, is the Belt and Road Initiative just a debt trap, Sri Lanka having to give up control of its ports because it couldn’t repay the funding from China?

Dr Jing Gu

I think it’s too simple to say the Belt and the Road Initiative is just a debt trap, because it’s not just about an infrastructure investment, but about, you know, the connectivities between the different region, different continent, and also, it’s about China’s ambition in global development. So, China, as you know, China is desperate for the Belt and Road Initiative to be agreed to success. So, in other words, you know, the Government and also the companies and also, the think tanks, are trying very hard to make it a success. This – that issue definitely is on the top agenda of the Government and the think tanks and the companies, so how to deal with this debt issue. And also, the Belt and the Road Initiative at the moment, it just started in 2015, so it’s too early to say, oh, it’s just a debt trap, or it’s just a blueprint for the global development. It’s too early to say. We need evidence. We need, you know, a solid, clear study to prove, you know, the benefit and the pros and the cons of this global initiative of China. So, definitely more research, more in-depth research, needed.

Dr Linda Yueh

Like at your centre. Robert, just quickly on the, when we had the 2008 financial crisis, obviously, all the countries came together and swap lines were…

Dr Robert Faulkner

G20, yeah.

Dr Linda Yueh

…agreed between Central Banks and you saw, really, the G20 acting together to promise things, like not do protectionist measures and all of that. Are we in an era in which if we had another financial crisis, you could get the same level of consensual working together collaboration?

Dr Robert Faulkner

Do you want me to keep it short?

Dr Linda Yueh

Yes.

Dr Robert Faulkner

And the answer is no. I think…

Dr Linda Yueh

Okay, you’re going…

Dr Robert Faulkner

…well, that’s…

Dr Linda Yueh

…to have to say a bit more.

Dr Robert Faulkner

Okay, that’s – okay, there’s a bit more to that. I think we’re only beginning to see the Trump effect playing itself out in a lot of different forums and even if you think that this is a four-year problem or an eight-year problem and then we’ll revert back to normality, I don’t think that’s a realistic scenario. I think the world, since the end of the Cold War, has been drifting into a much more regionalised system, but certainly in security terms, also, in political terms. China, as a rising power, is unlikely ever to become a global power, is more likely to become a regional power. It already is, but I don’t think it has either the aspiration or the capacity to be a global power, the way the US was. So, I think the long-term consequences of Trump’s policies will be to reinforce tendencies in other regions in Europe, in Asia, to go your own way, to find your own solutions, and not wait for the US to be the benign hegemon, as we used to think.

Dr Linda Yueh

We are going to squeeze in one more round, ‘cause there are so many hands. There are way too many hands, we’re not going to be able to do this. So, I’m just going to take these two questions and then, the lady in the final row, and I’m go – there’ll be drinks at 7 o’clock, get the answers then from these guys. But if you could please introduce yourselves and keep your questions really short, I’d be so grateful.

Awei Shale

Sure, my name’s Awei Shale, I’m working on a project in emerging markets using tech and cryptocurrency. I was just wondering what role you think cryptocurrency can play in emerging markets? You know, when you look at fiat currencies, the average life expectancy is 27 years, countries like South Sudan have inflation rates of 295%, and I’m interested to know what you think of the role of cryptocurrency?

Dr Linda Yueh

Thank you very much, and the gentleman behind you?

John Bishop

Yes, John Bishop, a Chatham House Member. The Beijing model has been pretty successful, in spite of some reservations over getting on for four decades. Is it still going to operate in the same way, under President Xi, who seems to have a much more moralistic attitude, in some ways, than his predecessors, as incidenced by his anti-corruption drive? Does this also extend to things like use of low quality credit from secondary financial institutions and Local Government?

Dr Linda Yueh

Thank you very much, and the final question?

Wai Yai

Hi, Wai Yai from KPMG, Macroeconomics and my question is actually, how will the emerging markets crisis actually affect us in the developed world? Like, to give some examples, I was looking at the first stress testing scenario and all it assumes is under severe stress, we’ve got 1% CPI and 0.1% interest rate. Is that going to be possible if we have, like, protectionism from the developed world and, as a result, emerging markets financial crisis? And also, another example, emerging markets building up foreign reserves, as you mentioned, and this has been an important factor in driving down interest rates. Would we still have the same level of interest rate protection, if we have emerging markets reducing their foreign reserves?

Dr Linda Yueh

Thank you very much. Okay, so I think if we could just briefly – David, can I get you to address Wai’s question?

David Lubin

Yes.

Dr Linda Yueh

And then, I think, if I get the others just to pick up quickly on the others.

David Lubin

It’s very interesting. I mean, and the debt crisis, the Latin American debt crisis of the 1980s almost took down the US banking system. The exposure that US banks had in 1982 to Latin America was equal to around 250% of their capital and the whole management of that crisis was effectively, and certainly in the early years, designed to support the US banking system, because the consequences of losing the US banking system, because of defaults in Latin America, was just unthinkable for the world. It’s not like that these days. The world’s exposure to developing countries is much smaller in comparison to, you know, any measure of global finance. It’s a much, sort of, smaller corner of the global asset allocation. So, I wouldn’t worry about crises in developing countries becoming some systemic problem for the financial system.

But just one sec, on the – this very interesting point, sorry, very interesting point about the effect of reserves holdings on interest rates, I think that’s a very interesting question. In other words, the picture you’re setting out is that if reserve’s fallen, countries are selling their foreign exchange reserves, that puts upward pressure on interest rates and creates a, kind of, negative feedback loop, very interesting, a very interesting point.

Dr Linda Yueh

Thank you. Jing Gu, the Beijing model under President Xi Jinping, is that going to change?

Dr Jing Gu

I actually – I don’t think there is a Beijing model.

Dr Linda Yueh

Well, in that case, it will change.

David Lubin

No, no.

Dr Jing Gu

I think, you know, the most valuable lessons, from China’s development experience over the last 40 years, is very much the ability to learn and adapt and not just simply copy things. So, that’s the most valuable lessons from Chinese development experience. So, there’s no mod – no Beijing model, actually.

Dr Linda Yueh

Okay.

Dr Jing Gu

Thank you.

Dr Linda Yueh

I’m not going to ask Robert to answer the cryptocurrency question, unless he wants to.

Dr Robert Faulkner

Happy to.

Dr Linda Yueh

Are you?

Dr Robert Faulkner

Yeah. Okay, then.

Dr Linda Yueh

All yours, okay.

Dr Robert Faulkner

No, no, just one footnote, with regard to the future of the Beijing model. What we didn’t get a chance to talk about is, of course, the viability of China’s domestic financial system. The IMF sent out a note in December warning that addiction to debt and levels of debt had risen to such a level that comparisons with 2008 are now appropriate. That may be overblown, but there are questions about the long-term viability of a debt-driven infrastructure investment growth strategy, as China has been playing it out, so that’s that.

Cryptocurrencies, I know next to nothing about cryptocurrencies, but I can tell you, LSE has launched an online course on cryptocurrencies, so here’s my answer.

Dr Linda Yueh

With that we are literally out of time, but I’m going to – I am, on your behalf, going to insist that the panel answer the question, which was posed when you came this evening: is there a new round of financial crises in emerging markets, yes or no? David?

David Lubin

I think…

Dr Linda Yueh

Literally, yes or no, ‘cause we’re cutting into drinks now.

David Lubin

Okay, there’s a difference between a sell-off and a crisis. In other words…

Dr Linda Yueh

‘Cause a sell-off…

David Lubin

…currencies can fall in value, investors can lose money, countries go into recession, those are all bad things that happen. But financial crisis is a very specific term and I think a systemic financial crisis in emerging markets, at the moment, I think is unlikely.

Dr Linda Yueh

Thank you. Jing Gu?

Dr Jing Gu

I think we have to differentiate the emerging markets, you know. They are very different, so we can notice the…

Dr Linda Yueh

Okay, so China, will China have a financial crisis?

Dr Jing Gu

I don’t think China will have a financial crisis.

Dr Linda Yueh

Thank you. Robert?

Dr Robert Faulkner

It’s not here yet, but there’s bound to be the next financial crisis and I would bet my house on that, so…

Dr Linda Yueh

Do you know, somebody told me that when you make a prediction, you should either make the prediction or give a timing. You notice he didn’t give a timing, so Robert’s going to be right at some point.

Dr Robert Faulkner

Yes.

Dr Linda Yueh

And so will David and so will Jing Gu. Please join me in thanking this fantastic panel for a wonderful discussion this evening [applause]. Please go and take a look at David’s book, I think it’s absolutely fantastic and it’s a good, sharp read. See you for drinks.

David Lubin

Thank you very much.

Dr Linda Yueh

Thank you.