Must-Read: Izabella Kaminska: Why the World Needs Investment

Must-Read: Nick Bunker sends us to:

Izabella Kaminska: Why the World Needs Investment: “The liquidity trap, when monetary policy becomes ineffective at very low or zero interest rates…

…may be old news but the global dimension of the problem is a new and worrying phenomenon…. So engrained is the notion saving is always thrifty and good that it’s become extremely hard to articulate why this state of affairs is so disastrous for the global economy.On Monday, however, Citi’s rates team does an excellent job of summing up the problem…. In their opinion liquidity traps–symptomatic of the secular stagnation phenomenon more broadly–are exported abroad by way of four different channels:

1. Capital markets transmit secular stagnation and can transmit recessions in a world with low interest rates.
2. Policies that trigger current account surpluses are beggar-thy-neighbor.
3. Reserve currencies bear a disproportionate share of the global liquidity trap, because of a shortage of safe assets. This works by leaving real rates too low in the face of a negative shock (e.g. Brexit) to give confidence in the ability to stimulate demand.
4. Large fiscal expansions can eliminate secular stagnation (= bearish bonds).

In that regard, it’s worth paying attention to the growing euroglut phenomenon. As the analysts note, the Euro area in 2015 contributed to the glut phenomenon with a large surplus of 3.2% of GDP, adding to the more traditional surpluses from Japan (3.3%) and China (3%). This, in short, isn’t funny anymore. If countries want to carry international surpluses indefinitely the suggestion here is they need also to reinvest those ‘savings’ into capacity expanding investments abroad. If not, those savings will eventually end up constraining global growth by turning everything into a simple zero sum game. We’ve not seen it spelled out that simply before. But it’s an elegant and logical explanation.

Cf.: Ricardo J. Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas (2015): Global Imbalances and Currency Wars at the ZLB: “The consequences of extremely low equilibrium real interest rates in a world with integrated but heterogenous capital markets and nominal rigidities…

…(i) Economies experiencing liquidity traps pull others into a similar situation by running current account surpluses; (ii) Reserve currencies have a tendency to bear a disproportionate share of the global liquidity trap|a phenomenon we dub the ‘reserve currency paradox’; (iii) While more price and wage flexibility exacerbates the risk of a deflationary global liquidity trap, it is the more rigid economies that bear the brunt of the recession; (iv) Beggar-thy-neighbor exchange rate devaluations provide stimulus to the undertaking country at the expense of other countries (zero-sum); and (v) Safe public debt issuances, helicopter drops of money, and increases in government spending in any country are expansionary for all countries (positive-sum). We use these results to shed light on the evolution of global imbalances, interest rates, and exchange rates since the beginning of the global financial crisis.