Global Economics Weekly

March 5, 2014
Issue No: 14/09
Global Economics Weekly
Economics Research
Small lessons from big crises
Lessons from the “Big Three” crises
Dominic Wilson
Concerns about possible financial crises in the EM world have intensified. So
far, the challenges have not risen to that level. We look back at the ‘Big
Three’ crisis of the past 20 years (the Asian/EM crises of the late 1990s, the
global financial crisis and the Euro area sovereign crisis) to identify the
ingredients that past crises suggest may be needed for risks to escalate
(212) 902-5924 [email protected]
Goldman, Sachs & Co.
Kamakshya Trivedi
+44(20)7051-4005 [email protected]
Goldman Sachs International
Noah Weisberger
(212) 357-6261 [email protected]
Goldman, Sachs & Co.
Four common elements in past episodes
These crises had their origins in a period of easy financial conditions which
fueled leverage and private sector imbalances. Four steps seem to have
been particularly important in intensifying these fault-lines into something
more critical: asset pressure on levered balance sheets; feedback loops that
exacerbated the initial pressure; maturity mismatch in areas that are not
backstopped; and limits to the lenders of last resort. These steps provide
pointers as to the conditions under which stresses in EMs, including China,
might accelerate
Aleksandar Timcenko
(212) 357-7628 [email protected]
Goldman, Sachs & Co.
Jose Ursua
(212) 357-2234 [email protected]
Goldman, Sachs & Co.
George Cole
+44(20)7552-3779 [email protected]
Goldman Sachs International
Julian Richers
(212) 855-0684 [email protected]
Goldman, Sachs & Co.
Four common elements in “Big Three” crisis escalation
1990s
EM/Asian
Crises
US Mortgage
Crisis
Euro Area Debt
Crisis
Levered Asset
Exposure
Feedback
Loops
Maturity
Mismatch
Limits to Lender
of Last Resort
Foreign currency
liabilities
Pressure on banks
and corporates with
FX liabilities
Short-term FX
borrowing in excess of
FX reserves
EM Central Banks lack
enough FX reserves to
satisfy liquity needs
Dependence on
wholesale funding,
SIVs and money
market mutual funds
Shadow banking system
without access to liquidity
support
Short-dated sovereign
borrowing and crossborder bank financing
National central banks
unable to backstop own
sovereign/banks without
ECB approval
Mortgage, housing
"Levered losses" lead
assets (and
to bank balance
structured
sheet shrinkage
mortgage/credit)
Greek/peripheral
sovereign debt
Bank holdings of
sovereign
debt/uncertainty
around sovereign
backstop for banks
Source: Goldman Sachs Global Investment Research.
Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification
and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html.
The Goldman Sachs Group, Inc.
Global Investment Research
March 5, 2014
Global Economics Weekly
Small lessons from big crises
Over the last two decades, the world economy often seems to have been stumbling
through a rolling succession of crises. Hot on the heels of the global financial crisis, the
sovereign crisis in the Euro area arrived. And now, as the tremors in Europe have been
receding, concern about possible financial crises in the EM world, including in China, has
once again intensified. So far, the challenges in the EM world have not risen to that level.
But there is intense focus on the issue of how pressures there could deteriorate into
something more serious or spread to other parts of the global economy. In the process,
comparisons are frequently – but often imprecisely – drawn to prior crises.
We have discussed the nature of the fragilities in EM and the risks of transmission to EM
over the last few months. We attack the issue here from a slightly different angle, looking
back at what we can learn at a high level from the ‘Big Three’ crisis episodes of the past 20
years: the Asian/EM crises of the late 1990s; the global financial crisis of 2007-09; and the
Euro area sovereign crisis that began in 2010. Our goal is to identify the ingredients that
past crises suggest may be needed for risks to escalate. In generalising across very
different episodes, there is a high risk of oversimplification. But there is still value in using
these past experiences to think about how to identify and monitor current vulnerabilities.
Four features appear to have been particularly important in each case (Exhibit 1). First,
there was pressure on an asset that was important to levered balance sheets. Second,
there were clear feedback loops that meant that initial pressure led to further stress. Third,
there was significant maturity mismatch beyond bank deposits that helped fuel liquidity
crises. Fourth, lenders of last resort were unable or unwilling to substitute quickly for that
lost liquidity in ways that might have prevented a self-fulfilling ‘run’. Taken together, these
three crises also highlight the unique role played by banking systems – given their leverage
and maturity mismatch – in amplifying stress.
These features provide some pointers as to the conditions under which stresses in other
areas might accelerate. In particular, a simple checklist would aim to identify:

Any troubling asset exposures on levered balance sheets.

The kinds of feedback loops that may arise if stresses begin.

Maturity mismatches, particularly beyond conventional bank deposits.

The likely responses and constraints on potential lenders of last resort.
Exhibit 1: Four common elements in “Big Three” crisis escalation
1990s
EM/Asian
Crises
US Mortgage
Crisis
Euro Area Debt
Crisis
Levered Asset
Exposure
Feedback
Loops
Maturity
Mismatch
Limits to Lender
of Last Resort
Foreign currency
liabilities
Pressure on banks
and corporates with
FX liabilities
Short-term FX
borrowing in excess of
FX reserves
EM Central Banks lack
enough FX reserves to
satisfy liquity needs
Dependence on
wholesale funding,
SIVs and money
market mutual funds
Shadow banking system
without access to liquidity
support
Short-dated sovereign
borrowing and crossborder bank financing
National central banks
unable to backstop own
sovereign/banks without
ECB approval
Mortgage, housing
"Levered losses" lead
assets (and
to bank balance
structured
sheet shrinkage
mortgage/credit)
Greek/peripheral
sovereign debt
Bank holdings of
sovereign
debt/uncertainty
around sovereign
backstop for banks
Source: Goldman Sachs Global Investment Research.
Goldman Sachs Global Investment Research
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Global Economics Weekly
A key difficulty that prior crises also highlight in assembling this checklist is that it is much
harder ex ante to identify the sources of leverage, balance sheet exposure and policy
commitments, than it is ex post.
Common elements in the ‘Big Three’ crises
IMF Managing Director Michel Camdessus famously referred to the 1994-95 Mexico
financial crisis as the “first financial crisis of the 21st century”. In doing so, he drew
attention to the extraordinary shifts in capital flows and balance sheet problems that
resulted. The series of crises that have followed over the last 20 years have continued to
highlight those issues. The Big Three crises – in EM in the late 1990s, the global financial
crisis and the Euro area crisis – stand out in terms of the sharpness of growth collapses in
the affected areas, the scale of the damage to local banking systems and the degree to
which they appeared to threaten the global financial system (Exhibit 2).
When investors now worry about significant crisis risk, one or other of these templates is
usually lying in the background. However, since the global financial crisis in particular,
there has been a tendency to see a crisis behind every tremor. So it is useful to define the
conditions that turn a ‘run of the mill’ economic challenge or financial imbalance into a
much more serious problem for growth or financial markets.
There are huge differences across those three episodes, in terms of their origins, their
impact and the breadth of their transmission. But there are also some important
commonalities. The build-up to these crises shared some common themes. In each case, a
prolonged period of easy financial conditions fuelled a build-up in leverage that eventually
unwound painfully for borrowers. The period of easy financing generally encouraged a
loosening of lending standards and new forms of financing that often sprang up outside
the traditional regulatory net. The build-up in leverage led to real economic imbalances
(Exhibit 3). More than any single macro indicator, current account deficits (and significant
current account deterioration) were key symptoms of the growing cross-border imbalances
in each case and the deterioration in private financial positions. Those elements have
generally already been visible in the run-up to the latest round of problems in the emerging
markets. So the question is more about what happens next.
Exhibit 2: Significant recessions in each of the countries
at the centre of the “Big Three” crises
0
Trough in GDP growth (%, yoy)
-2
-2
-4
2011
2012
Source: Haver Analytics, Goldman Sachs Global Investment Research.
Goldman Sachs Global Investment Research
1996
2006
2008
Current Account Balance
(% of GDP)
Indonesia
Spain
Greece
UK
US
Korea
Russia
Thailand
-16
Indonesia
-18
-14
Greece
-16
2008
Portugal
1998
Spain
-12
-14
Ireland
-10
-12
Italy
-8
-10
UK
-6
-8
US
-6
Thailand
-4
Malaysia
0
Korea
2
Exhibit 3: Current account deficits, amid easy financing
conditions, a pre-cursor in each crisis
Source: Haver Analytics, Goldman Sachs Global Investment Research.
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Global Economics Weekly
Beyond these similarities in the origins of the crises, there were also similarities in the
ways in which those initial pressures intensified. Without attempting to be comprehensive,
we argue that four common elements were particularly important in explaining how the
Big Three crises moved into the critical phase.
1. Asset pressure on levered balance sheets
The first common element was initial pressure on an asset that was widely held on levered
balance sheets. In the Asian financial crisis, it was (in the first instance) local currencies that
came under pressure for devaluation, although subsequent pressure on commodity prices
ultimately saw the problem spread to a much larger range of EM economies. In the run-up
to the global financial prices, US mortgages embedded excessively optimistic expectations
of home prices. In the Euro area, Greek sovereign debt – and then the debt of other
peripheral economies – came under scrutiny on the back of doubts about fiscal
sustainability.
In each case, the asset exposures that were built up were generally perceived as ‘safe’ and
in some cases implicitly guaranteed by governments. Asian borrowers viewed their
government’s commitment to currency pegs as solid. US mortgage default risk, assessed
through the prism of past experience, was regarded as extremely low. And there was a
widespread assumption that peripheral sovereign debt was implicitly backstopped by the
stronger Euro area members (Exhibit 4). These assumptions fuelled the willingness to take
on leverage against these assets and also generally led to low (and sometimes no) capital
provisioning against them.
As these assets were important for levered institutions, even small shifts in their prices
quickly led to balance sheet pressure. In the EM crises, banks and corporates had taken on
significant foreign currency exposure through offshore funding. Alongside high financial
and corporate leverage, small shifts in currencies led to sharply increased liabilities. In the
global financial crisis, many households had increased leverage in ways that left them
unusually vulnerable to house price declines. Banks had increased leverage while
accumulating assets that were heavily influenced by home price values, some of which –
through structuring – often embedded further leverage. And conventional banking system
leverage was itself unusually high. In the Euro area crisis, alongside high bank leverage,
peripheral sovereign bonds were also a major asset held on bank balance sheets, so small
shifts in their value had large effects on perceived capital positions.
Exhibit 4: Crises involved pressures on assets important
to levered balance sheets
Exhibit 5: Without leverage, equity value collapse after
the dot-com bubble was much less damaging
12
-80
8
ppt
USD trn
Real
Estate
-70
10
-60
Dot-com
Mortgage crisis
ppt
Equities
7
6
8
6
2007
2010
4
2
-50
5
-40
4
-30
3
-20
2
-10
1
0
EA Periphery Net Gov't Debt
US Mortgage Debt
0
0
Max Drop in asset value
(as share of GDP)
Source: Haver Analytics, Goldman Sachs Global Investment Research.
Goldman Sachs Global Investment Research
Max Change in unemployment
rate
Source: Haver Analytics, Goldman Sachs Global Investment Research.
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Global Economics Weekly
While banks were the most obvious form of levered actor, these exposures were not
always held directly on bank balance sheets. In the Asian crises, exposure to foreign
currency weakness was sometimes in highly leveraged corporates and in non-bank
intermediaries. The main systemic threat to the developed markets in the fall of 1998 came
not through bank leverage but through the leverage built up in LTCM, a hedge fund. And in
the US mortgage crisis, leverage in funds and financing vehicles that were off bank balance
sheets played an important role. The distribution of leverage was also important.
The case of large conglomerates in Korea, or LTCM in 1998, illustrated that the presence of
concentrated leverage in a smaller portion of the economy or financial sector could lead to
problems even if aggregate measures were more benign. But ultimately, these exposures
ended up – directly or indirectly – causing stress for bank balance sheets.
A counter-example underscores the critical role by leverage in determining the degree of
economic stress from asset price declines. In the tech bubble, a large hit to asset values
(close to 60% of GDP in the US) had much smaller economic consequences because
financing took the form of equity rather than debt (Exhibit 5). The IMF has shown that
equity busts tend to be less damaging than housing busts historically, partly for this reason
(see Chapter II “When Bubbles Burst”, IMF, 2003, World Economic Outlook). With leverage,
shifts in asset prices in the Big Three crises quickly impaired capital positions and put
pressure on local banks and the broader system of credit provision.
2. Feedback loops that exacerbate the initial pressures
The second common feature was that significant feedback loops exacerbated the initial
movements in asset prices. In the case of the Asian/EM crises, this was largely because the
balance sheet stress on financials and corporates that had borrowed in foreign currency
made their creditors keener to retrench. In the US mortgage crisis, the story of ‘levered
losses’ (by which banks sought to shrink their balance sheets further as capital positions
were threatened) precipitated further selling pressures (Exhibit 6). And in the Euro area
crisis, concerns about sovereigns led to pressure on banks, whose balance sheet
constraints then led to further pressure on sovereigns (Exhibit 7). The presence of
significant private sector and current account imbalances meant that these pressures on
debtors had larger than usual consequences for demand.
Exhibit 6: In US mortgage crisis, capital pressures led to
credit restraint and asset sales
No Refis
Available
Distressed
Housing
Supply
Negative
Equity
Less
Homebuilding
Deeper
Recession
Source: Goldman Sachs Global Investment Research.
Goldman Sachs Global Investment Research
Bank
Solvency
Concerns
Lower Tax
Receipts
Expected
Bailout
Costs
Weaker
Housing
Market
Negative
Wealth
Effect
Credit
Losses
Reduced
Loan
Supply
Fiscal
Crisis
More
Mortgage
Defaults
Bank
Solvency
Concerns
More
Banking/
Financial
Strains
Exhibit 7: In Euro area crisis, sovereign stress hurt banks,
which added pressure back on sovereigns
Fiscal
Auster
ity
Loan Losses
Banking
Crisis
Higher
Unemployment
Economic
Crisis
Reduced
Loan
Supply
Source: Goldman Sachs Global Investment Research.
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Global Economics Weekly
The main feedback loops again highlight the special role played by banks and balance
sheet channels. The work of former Fed Chair Ben Bernanke – among others – has
highlighted the special role played by banks in screening and monitoring borrowers, and
the ways in which pressure on balance sheets and collateral makes it harder for borrowers
to access credit. Both can act as accelerators for initial asset market stresses and lead to
sharper pressures to shrink spending. At the same time, monetary policy tends to be less
effective in stimulating spending in downturns where those credit channels are clogged.
Put simply, once economic problems become banking sector problems, the risks to activity
tend to rise.
Uncertainty about exposures and how they would be treated also played a central role in
exacerbating initial problems. The difficulty of gauging ‘true’ balance sheet exposures and
liquidity conditions amplified uncertainty about banking sector risk. In the EM crises,
information on the foreign currency exposures of corporates and banks was not easily
available; in the US, the complexity of the underlying structured products made it harder to
value mortgage and credit exposures; and in the Euro area the circular nexus between
banks and the sovereigns that guaranteed them led to uncertainty about how to treat
capital positions.
3. Maturity mismatch in areas outside bank deposits
The third common element came from significant maturity mismatch. The liquidity risk
inherent in rolling over short-term financing played a key – and perhaps the key – role in all
of the Big Three crises. Even where worries about solvency and capital exposure may have
been overstated, concerns about maturity mismatch represented a genuine source of
fragility.
Maturity mismatch, and the vulnerabilities it generates, is at the heart of modern banking
given the use of short-term deposits to fund longer-dated loans. The problem with shortterm financing is that it involves a coordination problem. Since those providing short-term
financing may not be paid back easily if they all demand repayment together, any sense
that other creditors may refuse to roll over financing may provide an incentive to do the
same. Even without an underlying solvency problem, a liquidity crisis can then in principle
ensue. Deposit insurance and the central banks’ role of lender of last resort were designed
precisely to mitigate the risk of self-fulfilling liquidity crises and explain why classic ‘bank
runs’ are much rarer than they were a century or more ago. Given those schemes and the
stickiness of depositors, other forms of short-term funding proved to be the critical source
of vulnerability in the Big Three crises. Precisely because the liquidity problems lay in areas
that were outside the conventional insurance and lender of last resort system, existing
mechanisms were not sufficient to prevent them.
In the Asian crisis, reliance on short-term foreign currency borrowing (in excess of
available reserves) was the principle vulnerability and the difficulty of rolling that over once
currency pegs broke was a major trigger for the acceleration of the crisis (Exhibit 8). Nonbank intermediaries – Thai finance companies and Korean merchant banks – were often on
the front line of problems, highlighting the role played by financial innovation and
disintermediation of traditional banks. In the global financial crisis, central roles were
played by the dependence on wholesale funding (Exhibit 9), the maturity mismatches in
SIVs and eventually the ‘run’ on money market mutual funds, which in turn supported the
US commercial paper market – all of which lay outside the conventional remit of
government or central bank guarantees. In the Euro area crisis, dependence on short-term
cross-border bank financing – and reliance of peripheral sovereigns on short-dated
Goldman Sachs Global Investment Research
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Global Economics Weekly
Exhibit 8: Short-term foreign currency debt exceeded
reserves in the 1990s crises, though less so now
Exhibit 9: US reliance on non-deposit funding increased
vulnerability to “rollover” risk in 2008-09
12
80
Reserves / Short-term external debt
Deposits (% of total Liabilities)
78
10
76
8
74
6
72
70
4
68
66
2
64
BRL
CNY
RUB
COP
THB
INR
MYR
KRW
MYR '96
IDR
CLP
MXN
HUF
ILS
ZAR
CZK
BRL '98
PLN
TRY
THB '96
UAH
IDR '96
KRW '96
MXN '94
0
Source: Haver Analytics, Goldman Sachs Global Investment Research.
US Banks
62
60
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12
Source: Haver Analytics, Goldman Sachs Global Investment Research.
borrowing – acted as amplifiers for initial stress. Interbank markets also proved to be
particularly vulnerable to doubts about capital positions. Just as the distribution of
solvency risk mattered, the distribution of liquidity risks also mattered. At times of stress,
some banks had excess liquidity even as others had funding needs. But when capital
positions came into question, the willingness to supply that liquidity evaporated.
4. Limits to the lender of last resort
The fourth common element was that as these liquidity risks rose and rollover risks
increased, lenders of last resort were unable or unwilling to replace the lost liquidity
quickly or to provide guarantees that might have halted withdrawals. In some cases, the
conventional lenders of last resort (central banks) were simply unable to perform that
function. In the EM crises of the late 1990s, foreign currency liquidity was what was needed.
With limited reserves, local central banks were unable to fill that need. And without
confidence in the nominal exchange rate, attempts to provide local currency liquidity to the
banking system, in Indonesia for instance, sometimes simply provided the financing for
depositors to withdraw funds and convert them into Dollars. The same problem was true to
a degree in the Euro area crisis, where devolution of authority to the ECB left national
central banks unable to act independently as lenders of last resort to their own sovereigns
and banks. Euro area sovereigns struggled to provide credible guarantees to their banking
system when they themselves were under pressure.
In other cases, the issues stemmed less from a capacity to act but more from an
unwillingness to accept the political and economic consequences. Because of concerns
about moral hazard, the risks of lending to potentially insolvent borrowers, the possible
impact on public-sector balance sheets, a reluctance among financial institutions to signal
a need for support and (in the Euro area particularly) the distributional consequences of
assistance, liquidity provision was generally not extended rapidly enough to offset the
collapse in private provision, and often it was only extended under duress. These concerns
are fundamental to the challenges of policy-making in crises. Ex post, it is easy to argue
that it would have been better to provide support earlier or more forcefully. But ex ante, the
question of when support for troubled institutions is a wasteful bailout and when it is an
essential defence against systemic risk is rarely completely clear. And because – in the end
– the resolution of these issues is usually about who should bear the losses that have
accumulated, these decisions are inherently politically complicated.
Goldman Sachs Global Investment Research
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Exhibit 10: Fed and ECB ultimately used balance sheets
aggressively to substitute for liquidity squeeze
Exhibit 11: Current EM feedback risks centered on the
impact of higher rates, slower growth on credit quality
1.8
Change in balance sheet from 2007 ($ trn)
1.6
1.4
Higher
Interest
Rate
Federal Reserve
(emergency credit only)
1.2
Government/CB
Banks
Recap
Costs
ECB
1.0
Banks
0.8
0.6
Fewer
Loans
0.2
0.0
07
08
09
10
11
12
13
Source: Haver Analytics, Goldman Sachs Global Investment Research.
Worsening
Fiscal/Capital
outflows
Lower Tax Receipts
Loan
Losses
0.4
Weak capital inflows/FX Depreciation
External Sector
FX
Depreciation/
Reduced
Funding
Weaker Growth
Corporates
Weaker
Growth/Lower
Debt Service
Source: Haver Analytics, Goldman Sachs Global Investment Research.
Ultimately, each of the Big Three crises settled only when liquidity provision and/or
government guarantees were dramatically extended to replace the freeze in short-term
financing in the private sector. In the EM crises, external financing through the IMF played
the largest role. During the global financial crisis, the Fed ultimately expanded emergency
liquidity facilities to all the main financial players against increasingly lenient collateral
standards, took on direct responsibility for rolling over the US commercial paper market
and provided extensive Dollar swap lines to other central banks (Exhibit 10). By 2012, the
ECB had extended unlimited term funding to the Euro area banking sector through a 3-year
LTRO, had largely replaced the interbank markets in funding peripheral banking systems
and through the OMT had provided a conditional lending facility to backstop troubled
sovereigns. In the US and Europe, deposit guarantees were also significantly expanded
during their financial crises. Central banks were not the only lenders of last resort brought
into action to provide emergency liquidity in these crises. In Korea in late 1997, for instance,
and in LTCM consortia of banks were brought together to coordinate liquidity supply as
part of the rescue packages. But even in these cases, official intervention was needed to
solve the coordination problem and to reassure banks that they would be supported.
Beyond constraints on the ability to act as a lender of last resort, other constraints limited
the effectiveness of crisis response in some places. In particular, in the global financial and
Euro area crises, concerns about public sector balance sheets limited counter-cyclical fiscal
responses, while the constraints from the “zero lower bound” to policy rates made an
effective monetary policy response more difficult.
Lessons for the future
In thinking about the risk of more serious problems in other circumstances – including in
China and in the other fragile EM economies – it is helpful to consider what kind of
exposures or policy choices could pose similar risks in each case. We do that briefly here.
In terms of asset exposures on levered balance sheets, we have highlighted already that
foreign currency mismatch for EM banks and corporates is generally lower than in the past
in many EM economies (Exhibit 11). But clearly there are still some economies where those
exposures are meaningful and it is difficult to be completely certain about unhedged
currency exposures, particularly in the corporate sector. Instead, the main vulnerability
seems more likely to come in most places through deterioration in domestic credit quality.
Goldman Sachs Global Investment Research
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Global Economics Weekly
That is the most significant asset on bank balance sheets. And the risks posed by a period
of loose monetary policy and increased leverage are most visible here. In China, we have
argued that corporate credit exposures are the area to watch.
In terms of feedback loops, the lower risk from foreign currency mismatch means that
domestic credit channels are again a more important focus for many of the more fragile
EM economies. In particular, where local inflation is already high, currency weakness may
add to that pressure. Policymakers are already seeing pressure to tighten monetary policy
in response to the deteriorating inflation outlook to avoid greater pressure on bond and FX
markets. The risk is that the combination of higher interest rates and slower growth now
begins to expose corporate or banking sector vulnerabilities, which discourage credit
extension and add to asset market pressure. The role that uncertainty over balance sheet
exposures may play in amplifying risks is also central here. In China, for instance, the
complexity and perceived lack of transparency about the precise nature of exposures is a
major source of anxiety for investors and policymakers alike.
In terms of maturity mismatch, loan-to-deposit ratios generally show relatively limited
reliance on non-deposit financing in many EM banking systems, including China where the
large banks’ wholesale financing needs are relatively low. Even then, interbank markets –
including in China – need to be watched for signs of stress. As we have seen elsewhere, if
those banks with excess liquidity become reluctant to lend to those with funding needs –
and if the distribution of liquidity becomes more uneven – those stresses have the potential
to disrupt credit provision even in a system that is not on aggregate short of funding. The
experience in the Big Three crises shows the importance of looking beyond conventional
deposit finance where the structure of liquidity support is usually most immediate.
Corporate deposits – which are often not separately identified – represent one potential
source of vulnerability across markets, but their magnitude is hard to determine. In China,
the focus is rightly on the financing of the shadow banking system where maturity
mismatch is inherent to some of the trust fund financing vehicles. Our China team has
argued, however, that the proportion of overall credit financed through this source is still
relatively small and that most of the funding is not callable on demand.
Hindsight is 20-20
Finally, these stresses highlight the importance of how lenders of last resort act in
substituting for liquidity stresses and how quick they are to act to supply emergency
liquidity to financial intermediaries if needed. Unlike the 1990s, the build-up of foreign
reserves means that many EM central banks have capacity to provide emergency foreign
currency liquidity to local banks and corporates, as some did in 2008-09. Because the major
vulnerabilities are more likely to be associated with local credit in local currency, the
capacity of central banks to act as lenders of last resort is – in principle – relatively high.
But the Big Three crises highlight two risks on that front. The first is that if inflationary
credibility is lost, central bank liquidity provision may simply finance deposit flight. So
maintaining anchored inflation expectations will be important in allowing some of the
more vulnerable EM economies to act decisively to alleviate any banking sector stress. The
second is that successfully dealing with credit excesses – particularly in China – involves a
tricky balancing act for policymakers between restraining riskier lending channels without
prompting a sharper withdrawal of credit. In a sense, policymakers are deliberately
introducing more uncertainty about the extent of their support to limit some of the risks
built up during earlier period. Spikes in interbank rates last summer can be seen through
that lens and China’s first corporate default was reported today. So far, risks of trust fund
defaults have been quickly dealt with through pressure on banks and local governments to
provide ongoing support. But even with significant flexibility and tools at their disposal,
there is a risk that policy is insufficiently responsive to emerging stresses.
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In thinking about these risks, the difficulty of identifying exposures and in gauging how to
respond to them again deserves special mention. It is easy to know these answers after a
crisis is over, but much harder to identify them in advance. Some of the key challenges in
China and other EM economies lie firmly in that domain. In principle, policymakers may
have advantages relative to the past in their capacity to backstop crises. Most versions of
the more sanguine view of China’s credit issues, for instance, stem from the notion that the
government and central bank have significant leeway to provide lender of last resort
facilities and to absorb or distribute losses. That assessment is a reasonable one. But the
risk of policy missteps cannot be ignored.
Dominic Wilson
Goldman Sachs Global Investment Research
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Global Economics Weekly
Global economic forecasts
Real GDP, %ch yoy
Consumer Prices, %ch yoy
2014
G3
USA
Euro area
Japan
Advanced Economies
Australia
Canada
France
Germany
Italy
New Zealand
Norway
Spain
Sweden
Switzerland
UK
Asia
China
Hong Kong
India
Indonesia
Malaysia
Philippines
Singapore
South Korea
Taiwan
Thailand
CEEMEA
Czech Republic
Hungary
Poland
Russia
South Africa
Turkey
Latin America
Argentina
Brazil
Chile
Mexico
Venezuela
Regional Aggregates
BRICS
G7
EU27
G20
Asia ex Japan
Central and Eastern Europe
Latin America
Emerging Markets
Advanced Economies
World
2015
2016
2017
2.9
1.2
1.0
3.2
1.5
1.2
3.0
1.7
1.5
3.0
1.6
1.4
2.0
2.6
0.9
2.0
0.6
3.1
1.8
0.9
3.6
1.9
2.9
2.6
2.7
1.1
2.1
1.0
2.1
2.0
1.2
3.4
2.1
2.7
3.6
2.0
1.4
2.2
1.2
2.4
1.7
1.7
2.8
1.9
3.0
3.9
1.9
1.8
1.6
1.3
2.3
1.7
1.7
2.7
1.7
3.0
7.6
3.7
5.0
5.5
4.5
6.3
3.7
3.7
3.8
3.0
7.8
4.4
6.2
6.0
5.2
6.5
4.2
3.8
3.9
4.7
7.6
3.7
6.6
6.0
5.0
6.3
4.0
4.0
3.8
5.0
7.4
4.0
6.9
6.0
5.0
6.3
4.0
3.8
3.8
5.0
1.7
1.8
2.9
3.0
2.4
2.0
2.4
1.9
3.2
3.6
2.9
1.8
2.6
2.2
3.4
3.6
3.6
5.8
2.4
1.9
3.2
3.7
3.5
5.0
1.7
2.1
3.5
3.3
-1.3
1.3
2.9
4.5
3.8
0.5
3.4
3.3
4.5
3.6
1.8
5.3
3.6
4.5
3.6
2.7
6.0
2.3
1.6
3.6
6.2
2.5
2.5
5.2
2.3
3.6
6.5
2.5
1.8
4.0
6.7
2.8
3.2
5.8
2.5
4.0
6.6
2.5
2.1
4.2
6.7
3.0
3.6
6.0
2.5
4.1
6.6
2.4
1.9
4.2
6.7
2.8
3.9
6.1
2.5
4.1
G3
USA
Euro area
Japan
Advanced Economies
Australia
Canada
France
Germany
Italy
New Zealand
Norway
Spain
Sweden
Switzerland
UK
Asia
China
Hong Kong
India
Indonesia
Malaysia
Philippines
Singapore
South Korea
Taiwan
Thailand
CEEMEA
Czech Republic
Hungary
Poland
Russia
South Africa
Turkey
Latin America
Argentina
Brazil
Chile
Mexico
Venezuela
Regional Aggregates
BRICS
G7
EU27
G20
Asia ex Japan
Central and Eastern Europe
Latin America
Emerging Markets
Advanced Economies
World
2014
2015
2016
2017
1.6
0.9
2.6
1.9
1.5
1.7
2.1
1.8
2.1
2.2
1.9
1.0
3.2
1.5
1.0
1.4
0.9
2.0
1.7
0.3
0.6
0.5
1.7
2.6
1.8
1.3
2.5
1.3
2.2
1.5
0.6
1.5
1.3
1.7
2.8
2.0
1.6
2.9
1.4
2.2
1.8
0.8
2.3
1.6
1.8
2.4
2.0
1.6
2.9
1.5
1.9
2.0
1.0
2.5
1.9
1.9
3.0
3.3
6.5
6.8
3.0
3.8
3.3
2.2
1.4
2.6
3.0
3.3
6.1
5.5
2.6
3.5
3.5
2.6
1.8
2.9
3.0
3.1
5.8
5.5
2.5
3.5
3.2
2.7
1.8
3.0
3.0
3.1
5.2
5.5
2.5
3.5
2.8
2.2
1.7
2.8
0.6
1.3
1.5
5.5
5.9
7.7
1.9
2.9
1.8
5.1
5.8
6.8
2.0
3.0
2.3
4.7
5.6
6.1
2.0
3.3
2.4
4.4
5.7
6.5
14.8
5.8
3.3
4.2
61.4
17.7
5.9
2.9
3.5
50.9
16.8
5.5
3.0
3.1
28.3
13.7
5.1
3.0
3.0
20.8
4.3
1.7
1.0
2.9
3.8
1.2
10.7
5.7
1.6
3.3
4.2
1.8
1.6
3.0
3.7
2.0
8.7
5.1
1.8
3.3
4.0
2.1
1.9
3.1
3.6
2.3
6.6
4.5
2.1
3.2
3.8
2.0
2.0
2.9
3.5
2.5
5.6
4.2
2.0
3.0
Source: Goldman Sachs Global Investment Research
For India we use WPI not CPI. For a list of the members within groups, please refer to ERWIN.
For our latest Bond, Currency and GSDEER forecasts, please refer to the Goldman Sachs 360 website: (https://360.gs.com/gs/portal/research/econ/econmarkets/).
Goldman Sachs Global Investment Research
11
March 5, 2014
Global Economics Weekly
Global macro and markets charts
PMI-implied global growth
8
6
GLI momentum vs. global industrial production*
2
% qoq
annl
%mom
1
4
0
2
-1
0
-2
Global PMI ModelImplied Growth
-2
-4
Global Actual
Sequential Growth
-3
-6
-8
GLI Momentum
Global Industrial Production*, 3mma
GS Forecast
-4
03
04
05
06
07
08
09
10
11
12
13
14
15
00
01
02
03
04
05
06
07
08
09
10
11
13
See Global Economics Weekly 12/18 for methodology
Source: OECD, Goldman Sachs Global Investment Research
* Includes OECD countries plus BRICs, Indonesia and South Africa
See Global Economics Paper 199 for methodology
Source: OECD, Goldman Sachs Global Investment Research
GLI ‘Swirlogram’
China, Europe and US risk factors
0.06%
Recovery
0.04%
Current
Last Month
Jul-13
0.02%
GLI Acceleration
Expansion
May-13
Apr-13
Jun-13
Aug-13
0.00%
110
Index
105
100
Europe Risk
Feb-14
Mar-13
-0.02%
Jan-14
-0.04%
Sep-13
95
China Risk
US Risks
90
Oct-13
Dec-13
-0.06%
Nov-13
Contraction
-0.08%
-0.2% -0.1%
0.0%
0.1%
0.2%
0.3%
Slowdown
0.4%
0.5%
GLI Momentum
85
80
Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14
See Global Economics Paper 214 for methodology
Source: OECD, Goldman Sachs Global Investment Research
See Global Economics Weekly 12/15 for methodology
Source: Goldman Sachs Global Investment Research
US equity risk premium
US equity credit premium
6.5
5
%
6.1
14
%
4
5.7
US ERP, calculated daily
5.3
US ERP, 200 Day Moving Average
3
4.9
4.5
2
4.1
1
3.7
1985-1998
average
Credit
relatively
expensive
0
3.3
2.9
-1
2.5
-2
2.1
1.7
04
05
06
07
08
09
10
11
12
See Global Economics Weekly 02/35 for methodology
Source: Goldman Sachs Global Investment Research
Goldman Sachs Global Investment Research
13
14
-3
2 standard deviations
band
82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14
See Global Economics Weekly 03/25 for methodology
Source: Goldman Sachs Global Investment Research
12
March 5, 2014
Global Economics Weekly
The world in a nutshell
THE GLOBAL ECONOMY
OUTLOOK
KEY ISSUES
UNITED STATES
We expect annual growth to accelerate to 2.9% in 2014
after 1.9% in 2013. Growth should then remain above
trend in 2015 and 2016. On an annualised sequential basis,
we expect growth of 1.8% in the first quarter of 2014 and
3.0%-3.5% for the rest of the year.
We expect the US to lead the reacceleration in global
growth in 2014. The rationale is a sharp reduction in fiscal
drag, which should allow the continued recovery in
underlying private-sector spending to translate into a
stronger growth picture. In particular, we expect positive
impulses from personal consumption and business fixed
investment to add significantly to growth in 2014.
JAPAN
We expect real GDP growth of 1.0% in 2014 and 1.2% in
2015. On a sequential basis, we expect volatile growth
over the coming quarters as forthcoming consumption tax
hikes in 2014 and 2015 will affect personal consumption
expenditures. We expect positive private demand
dynamics to continue but worry about increased fiscal
drag.
Structurally, Japan is poised to reach above-trend growth
rates in step with an improvement in the global economy.
The new leadership at the BoJ has led to a regime shift in
Japanese monetary policy, with much more aggressive,
Fed-style easing capabilities. While this potentially offers
a way out of more than a decade of deflation, reaching
the 2% inflation target remains a tall order.
EUROPE
For the Euro area as a whole, we expect a return to
positive growth of 1.2% in 2014, followed by 1.5% in 2015.
The growth outlook at the country level looks friendlier
than in 2013 but it still shows a divergent trajectory, with
growth in Italy, Spain and France around or less than 1%
and in Germany at 2%. At the same time, private-sector
headwinds remain as banking lending standards have
continued to tighten.
We expect the Euro area to continue pulling out of
recession, driven by modest improvements across all
major components of domestic demand. Still, the list of
necessary adjustments in the periphery remains long,
ranging from cleaning up the banking system and labour
market reform to increasing competitiveness.
NON-JAPAN ASIA
For Asia ex-Japan, we expect growth of 6.2% and 6.7% in
2014 and 2015, respectively. We expect the economies in
the region to benefit from the stronger DM recovery in
2014, but with significant differentiation across countries.
In China, we expect real GDP growth of 7.6% in 2014, and
7.8% in 2015. Although growth is slightly below trend, the
recent tightening in financial conditions sends the signal
that policymakers are willing to tolerate somewhat lower
growth in order to tackle structural problems and foster
more sustainable medium-term growth.
LATIN AMERICA
We forecast that real GDP growth in Latin America will be
2.5% in 2014 and 3.2% in 2015. Against a more favourable
global backdrop, the divergence between those economies
with more challenging (Brazil) and more stable (Mexico)
policy outlooks is likely to increase.
In Brazil, we expect real GDP growth of 2.1% in 2014, and
2.9% in 2015. Despite two consecutive years of sub-par
growth, inflation has been sticky above the inflation target
of 4.5%. BRL weakness will likely force the Copom to
continue to hike policy rates.
CENTRAL &
EASTERN EUROPE,
MIDDLE EAST AND
AFRICA
With growth across the region forecast at 2.9% in 2014 and
3.2% in 2015, we expect CEEMEA to continue to recover.
Helped by improvements in external demand conditions,
large output gaps provide fertile ground for recovery from
the 2012 soft patch, although current account deficit
countries in particular will continue to face stiff challenges.
The EM differentiation theme is again visible across the
region. While we forecast strong and steady growth in
Israel and Russia, we see a similar recovery in Turkey as
less sustainable. Growth in South Africa and Ukraine will
likely be dragged down by idiosyncratic political and
economic risks.
CENTRAL BANK WATCH
CURRENT SITUATION
NEXT
MEETINGS
EXPECTATION
UNITED STATES:
FOMC
The Fed funds rate is at 0%-0.25%. The Fed
initiated a new round of asset purchases and
extended its rate guidance on September 13, 2012.
Mar. 19
Apr. 30
We expect the Fed to keep the funds rate near 0%
through 2015, and to continue asset purchases until
3Q2014, albeit at a reduced pace.
JAPAN: BoJ
Monetary Policy
Board
The overnight call rate is at 0%-0.1%. The BoJ
significantly extended asset purchases, as well as
the related maturity horizon, on April 4, 2013.
Mar. 11
Apr. 8
We expect the BoJ to keep the policy rate near 0%
and to expand its monetary easing efforts through
ongoing asset purchases.
EURO AREA: ECB
Governing Council
The refi/deposit rates are at 0.25%/0.00%. The ECB
announced the OMT programme for conditional
purchases of Euro area sovereign bonds in Sept.
2012 and cut the refi rate by 25bp on Nov. 7, 2013.
The BoE policy rate is currently at 0.5%. The BoE
announced threshold-based forward guidance for
the path of the policy rate on August 7, 2013.
Mar. 6
Apr. 3
We expect the ECB to cut the MRO and deposit rate
by 15bp at its April meeting.
Mar. 6
Apr. 12
We expect the BoE to keep the policy rate unchanged
until mid- 2015.
UK: BoE Monetary
Policy Committee
Goldman Sachs Global Investment Research
13
March 5, 2014
Global Economics Weekly
Disclosure Appendix
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We, Dominic Wilson, Kamakshya Trivedi, Noah Weisberger, Aleksandar Timcenko, Jose Ursua, George Cole and Julian Richers, hereby certify that all
of the views expressed in this report accurately reflect our personal views, which have not been influenced by considerations of the firm's business
or client relationships.
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Goldman Sachs Global Investment Research
14