2009 began with the world's major economies still reeling from the effects of the worst financial crisis in decades and in the midst of unprecedented action aimed at stemming its impact. It was also a year that saw calls for an eventual move away from the dollar as the world's chief reserve currency.
As we near the end of 2009 the world's biggest economies appear to be gaining steam after a recession and financial authorities are mapping how to unwind their economic support. Where are we in the arc from recession to recovery, and how successful will authorities be at removing their economic "crutches"?
RFE/RL's Kathleen Moore spoke to Jan Svejnar, an economics professor at the University of Michigan who has advised numerous policy makers, institutions and firms. Here's some of what he had to say.
RFE/RL: Where are we in arc from recession to recovery, what risk do you see of a "double-dip" recession?
Jan Svejnar: Our sense is that the most likely scenario is one where we will slowly -- the U.S. Europe and the whole world -- will slowly get out of the recession and we expect moderate rates of growth for next year, more moderate than other forecasters. We do recognize as part of it that there could be a double dip. Yes, it is a possibility, at this point we think it's the lesser of the two scenarios, that it's less likely, but it will still depend on a number of issues and developments: the financial sector problems have not been fully resolved yet, the growth that we see in many areas is conditioned by governments' fiscal support and there has been some significant monetary easing that has helped these economies and that cannot last forever. So there are a number of factors that we take into account where we warn there is a possibility of a double dip, although at this point given the strength and breadth of the recovery we are seeing in a number of areas around the globe, we are thinking that a more likely scenario is a gradual resumption of a boom although not as rapid as others are expecting.
RFE/RL: On the question of that economic support -- how confident are you that authorities will be able to withdraw it successfully without causing more problems?
Svejnar: I think in most of the big countries that have done it, including U.S. the eurozone and Europe in general, it will be very difficult politically to do a second round of fiscal stimuli. So I think there we have a limit that we've reached. On the monetary question, that was a very important step that the Federal Reserve, the Bank of England and the European Central Bank undertook, that they essentially flooded the market with liquidity, it was important for two reasons. One could do it for the same reason that the fiscal stimulus was done, namely to help demand at a time when it was inadequate. And the second was that we had the financial crisis and financial institutions that normally would lend were not lending so the central banks in tandem were essentially substituting for a non-functioning financial system. There we have a big issue in the sense that this extent, this nature of this intervention is unprecedented in modern times, Japan has been doing something like that since the 1990s, so that's the only laboratory where it has been tested.
So on the one hand the argument is -- I think correctly so -- that the central banks have ways of siphoning off this enormous amount of money that is in these economies and can presumably use it successfully. On the other hand it's never been tried before so whether it's a very precise or very dull instrument we will see. A second question that is perhaps even more important is when they should actually start cutting back on the easing. Recently we have heard that the European Central Bank has signaled that it's already beginning to reverse its course, and the Federal Reserve and the Bank of England have hinted that as soon as the conditions are appropriate that they are ready to do so as well. The issue here and the experience from Japan is that if it is done too early, if money is withdrawn very fast, a new boom in the economy can be extinguished and the economy can go back into stagnation. This is what happened a few times in Japan since the 1990s. So the Fed and the Bank of England and the ECB have to be very careful not to stop an early boom by constraining the economy too much. That will be the trick. If they err on the side of excessive constraint we will relapse into stagnation, possibly recession. If they wait too long there could be an inflationary bout.
RFE/RL: One of the many factors blamed for the financial crisis were global imbalances, such as the one between big borrower countries like the United States and countries with large amounts of savings, such as China. The argument is that this needs to be fixed or crises will continue to happen. How can it be addressed?
Svejnar: I would start with the observation that there isn't anything forced about the imbalance. We have to realize that it arose because people behaved in a particular way and U.S. consumers tended to spend much more than was usual historically and some other countries, China being a good example, were accumulating relatively large foreign exchange reserves. Nobody forced anybody, this was just an outcome. So we have to take it into account. The Chinese behavior, the behavior of some of the developing countries, India being a good example as well, was that after a series of financial crises -- where they realized their currency was attacked because speculators thought the country didn't have sufficient foreign exchange reserves to withstand the attack -- they decided to build up very strong reserves. There were others too but this was one of the main reasons. So we see some of these countries building up relatively large reserves as the U.S. is in fact having a high consumption rate and very low ravings rate.
One way out of it is that U.S. citizens in general should be saving more and we see a little bit of that happening already during the crisis and the reaction to it. And obviously some of these countries are holding reserves that are way too large for normal day-to-day needs. And one can argue that for a long time they were inefficient ways to hold reserves because they were holding reserves in currencies, or short-term debt instruments such as U.S. Treasury bills that are not yielding very high interest rates. That's changing a little bit in the sense that China and other countries have established sovereign funds that are investing in things other than just U.S. Treasuries. So that may be changing. But there's no question about the fact that there's the Chinese currency, the renminbi, that is relatively undervalued. That is one thing that has been held by fiat. In other words most countries nowadays have floating free exchange rates, china has pegged its exchange rate to the dollar so as the dollar has been depreciating so has China's renminbi relative to other currencies such as the euro, which of course very much favors Chinese exporters relative to European exporters.
This is in many respects a voluntary outcome, so it's very hard to change it, Except for the Chinese currency that is held by government rule, none of the rest is forced, The U.S. has not been forcing U.S. individuals to consume or save, so in some sense it is difficult. There are instruments -- the direct one is that China would let the renminbi float or at least appreciate. It did that a little bit over the last 20 years but then stopped, so it would be good if it continued appreciating or allowing it completely to float. Then there are tax or other indirect instruments that could be used to stimulate savings or discourage consumption in the U.S., the government already has certain instruments for instance trying to encourage people to save for retirement, so there is a tax-free accumulation of funds that individuals save in their individual savings account, there could be more of those kinds of instruments used.
But overall unfortunately we live in a world that will see fluctuations of currencies and so long as investors are willing to invest in the U.S. as they have in the past you may see the kind of imbalance where the U.S. is consuming and others are saving and yet the U.S. is a country of investment because a lot of foreign investment is going in there. Here I should mention that the U.S. has a great advantage compared to many other countries in that it borrows in its own currency, it borrows in dollars, so it also repays the loans in dollars, so it doesn't face the same foreign-exchange risk that Thailand or Argentina were facing during their crises, where they were significantly indebted in currencies of other countries, say the dollar, and then when their own currency depreciates, loses value relative to the dollar, they have to pay back debts that are much more expensive to repay because they have to repay in some other currency like the dollar that is now very valuable compared to their holdings in the local currency say Argentinian peso.
RFE/RL: This year there were calls from China and Russia among others for the need to move away eventually from the dollar as the chief international reserve currency. Is it in the world's interest to do so?
Svejnar: We already see some change in the sense that euro has become a significant reserve currency, right now it's the second most significant reserve currency. So what we see already is that most countries, individuals and companies and institutions have been diversifying, which is totally natural, that they will want to hold not just dollars or financial instruments denominated in dollars, but also want to hold euros and yen and maybe Swiss francs, in other words diversification that we would expect in other aspects of financial life we see here as well. That is totally natural and one can in fact mix and match and achieve any kind of portfolio that one wants to have by having different proportions of different currencies or financial instruments denominated in different currencies...
We are already observing that countries are moving from overly simple and significant reliance on the dollar to having a mixture. That may continue more or less depending on things evolve and what people's preferences are, but I think we are already there. I think that the diversification argument is a very strong argument, a good argument in other words to have diversification, and I think we will see perhaps countries diversifying even more from the dollar. None of the large countries, China being a good example, want to cause a panic so they've been doing it relatively slowly, this diversification, and if they continue they will continue to do it slowly. I don't think we will see a complete abandonment of the dollar as a reserve currency , I would predict that it's probably going to remain for a while the [chief reserve] currency, just as the British pound was remaining a major and significant foreign reserve currency long after Britain ceased being the largest economic power in the world.
RFE/RL: Would a move away from the dollar be in the U.S. interests?
Svejnar: I think to the extent that people don't like major fluctuations and the dollar being the central currency that people buy and sell as mood changes -- that would be in the U.S. interests in that it could add a little bit more stability. I don't see as being very valid the argument that it would affect consumer behavior, I think consumers are motivated by other things and other factors than what producers and investors elsewhere in the world are thinking at the moment. Obviously the U.S. as it ceases being the major issuer of currency that others are willing to hold, is losing some advantage called seigniorage, that's the benefit of the government that issues currency that others hold interest-free. If you're holding U.S. dollars as currency, as bills, you're essentially lending money to the U.S. government by having exchanged some other money for the dollar you're holding, so that gives the U.S. government and U.S. taxpayer an advantage called siegnorage, but that's fine, that's being lost gradually anyway as people switch to other currencies and it's not such a significant effect here.
RFE/RL: How to explain the strengthening of the dollar in recent weeks, after it weakened for most of the year?
Svejnar: First of all I'd like to stress that nobody really understands or is willing to say they fully understand the behavior of exchange rates. The exchange rates are affected by so many factors, economic and noneconomic that it's very difficult to attribute a particular movement in the exchange rate to a single factor or even a small group of factors. So we should bear that in mind when we interpret things. But everything [being] constant, I think it's true that the feeling is that the U.S. has gone through a shallower and shorter recession than most people expected, most of us expected the U.S. would go through a deeper recession than Europe would, What now is looking like the likely scenario is that the U.S. is pulling out of a recession that turned out not to be so deep, and that Europe is also getting [up] perhaps but more slowly and a number of countries in Europe have significant problems that the recession accentuated -- not caused completely but accentuated. And that Europe as a whole, and some countries like Greece and possibly Italy have more problems than was evident at first sight.
As we near the end of 2009 the world's biggest economies appear to be gaining steam after a recession and financial authorities are mapping how to unwind their economic support. Where are we in the arc from recession to recovery, and how successful will authorities be at removing their economic "crutches"?
RFE/RL's Kathleen Moore spoke to Jan Svejnar, an economics professor at the University of Michigan who has advised numerous policy makers, institutions and firms. Here's some of what he had to say.
RFE/RL: Where are we in arc from recession to recovery, what risk do you see of a "double-dip" recession?
Jan Svejnar: Our sense is that the most likely scenario is one where we will slowly -- the U.S. Europe and the whole world -- will slowly get out of the recession and we expect moderate rates of growth for next year, more moderate than other forecasters. We do recognize as part of it that there could be a double dip. Yes, it is a possibility, at this point we think it's the lesser of the two scenarios, that it's less likely, but it will still depend on a number of issues and developments: the financial sector problems have not been fully resolved yet, the growth that we see in many areas is conditioned by governments' fiscal support and there has been some significant monetary easing that has helped these economies and that cannot last forever. So there are a number of factors that we take into account where we warn there is a possibility of a double dip, although at this point given the strength and breadth of the recovery we are seeing in a number of areas around the globe, we are thinking that a more likely scenario is a gradual resumption of a boom although not as rapid as others are expecting.
RFE/RL: On the question of that economic support -- how confident are you that authorities will be able to withdraw it successfully without causing more problems?
Svejnar: I think in most of the big countries that have done it, including U.S. the eurozone and Europe in general, it will be very difficult politically to do a second round of fiscal stimuli. So I think there we have a limit that we've reached. On the monetary question, that was a very important step that the Federal Reserve, the Bank of England and the European Central Bank undertook, that they essentially flooded the market with liquidity, it was important for two reasons. One could do it for the same reason that the fiscal stimulus was done, namely to help demand at a time when it was inadequate. And the second was that we had the financial crisis and financial institutions that normally would lend were not lending so the central banks in tandem were essentially substituting for a non-functioning financial system. There we have a big issue in the sense that this extent, this nature of this intervention is unprecedented in modern times, Japan has been doing something like that since the 1990s, so that's the only laboratory where it has been tested.
So on the one hand the argument is -- I think correctly so -- that the central banks have ways of siphoning off this enormous amount of money that is in these economies and can presumably use it successfully. On the other hand it's never been tried before so whether it's a very precise or very dull instrument we will see. A second question that is perhaps even more important is when they should actually start cutting back on the easing. Recently we have heard that the European Central Bank has signaled that it's already beginning to reverse its course, and the Federal Reserve and the Bank of England have hinted that as soon as the conditions are appropriate that they are ready to do so as well. The issue here and the experience from Japan is that if it is done too early, if money is withdrawn very fast, a new boom in the economy can be extinguished and the economy can go back into stagnation. This is what happened a few times in Japan since the 1990s. So the Fed and the Bank of England and the ECB have to be very careful not to stop an early boom by constraining the economy too much. That will be the trick. If they err on the side of excessive constraint we will relapse into stagnation, possibly recession. If they wait too long there could be an inflationary bout.
RFE/RL: One of the many factors blamed for the financial crisis were global imbalances, such as the one between big borrower countries like the United States and countries with large amounts of savings, such as China. The argument is that this needs to be fixed or crises will continue to happen. How can it be addressed?
Svejnar: I would start with the observation that there isn't anything forced about the imbalance. We have to realize that it arose because people behaved in a particular way and U.S. consumers tended to spend much more than was usual historically and some other countries, China being a good example, were accumulating relatively large foreign exchange reserves. Nobody forced anybody, this was just an outcome. So we have to take it into account. The Chinese behavior, the behavior of some of the developing countries, India being a good example as well, was that after a series of financial crises -- where they realized their currency was attacked because speculators thought the country didn't have sufficient foreign exchange reserves to withstand the attack -- they decided to build up very strong reserves. There were others too but this was one of the main reasons. So we see some of these countries building up relatively large reserves as the U.S. is in fact having a high consumption rate and very low ravings rate.
One way out of it is that U.S. citizens in general should be saving more and we see a little bit of that happening already during the crisis and the reaction to it. And obviously some of these countries are holding reserves that are way too large for normal day-to-day needs. And one can argue that for a long time they were inefficient ways to hold reserves because they were holding reserves in currencies, or short-term debt instruments such as U.S. Treasury bills that are not yielding very high interest rates. That's changing a little bit in the sense that China and other countries have established sovereign funds that are investing in things other than just U.S. Treasuries. So that may be changing. But there's no question about the fact that there's the Chinese currency, the renminbi, that is relatively undervalued. That is one thing that has been held by fiat. In other words most countries nowadays have floating free exchange rates, china has pegged its exchange rate to the dollar so as the dollar has been depreciating so has China's renminbi relative to other currencies such as the euro, which of course very much favors Chinese exporters relative to European exporters.
This is in many respects a voluntary outcome, so it's very hard to change it, Except for the Chinese currency that is held by government rule, none of the rest is forced, The U.S. has not been forcing U.S. individuals to consume or save, so in some sense it is difficult. There are instruments -- the direct one is that China would let the renminbi float or at least appreciate. It did that a little bit over the last 20 years but then stopped, so it would be good if it continued appreciating or allowing it completely to float. Then there are tax or other indirect instruments that could be used to stimulate savings or discourage consumption in the U.S., the government already has certain instruments for instance trying to encourage people to save for retirement, so there is a tax-free accumulation of funds that individuals save in their individual savings account, there could be more of those kinds of instruments used.
But overall unfortunately we live in a world that will see fluctuations of currencies and so long as investors are willing to invest in the U.S. as they have in the past you may see the kind of imbalance where the U.S. is consuming and others are saving and yet the U.S. is a country of investment because a lot of foreign investment is going in there. Here I should mention that the U.S. has a great advantage compared to many other countries in that it borrows in its own currency, it borrows in dollars, so it also repays the loans in dollars, so it doesn't face the same foreign-exchange risk that Thailand or Argentina were facing during their crises, where they were significantly indebted in currencies of other countries, say the dollar, and then when their own currency depreciates, loses value relative to the dollar, they have to pay back debts that are much more expensive to repay because they have to repay in some other currency like the dollar that is now very valuable compared to their holdings in the local currency say Argentinian peso.
RFE/RL: This year there were calls from China and Russia among others for the need to move away eventually from the dollar as the chief international reserve currency. Is it in the world's interest to do so?
Svejnar: We already see some change in the sense that euro has become a significant reserve currency, right now it's the second most significant reserve currency. So what we see already is that most countries, individuals and companies and institutions have been diversifying, which is totally natural, that they will want to hold not just dollars or financial instruments denominated in dollars, but also want to hold euros and yen and maybe Swiss francs, in other words diversification that we would expect in other aspects of financial life we see here as well. That is totally natural and one can in fact mix and match and achieve any kind of portfolio that one wants to have by having different proportions of different currencies or financial instruments denominated in different currencies...
We are already observing that countries are moving from overly simple and significant reliance on the dollar to having a mixture. That may continue more or less depending on things evolve and what people's preferences are, but I think we are already there. I think that the diversification argument is a very strong argument, a good argument in other words to have diversification, and I think we will see perhaps countries diversifying even more from the dollar. None of the large countries, China being a good example, want to cause a panic so they've been doing it relatively slowly, this diversification, and if they continue they will continue to do it slowly. I don't think we will see a complete abandonment of the dollar as a reserve currency , I would predict that it's probably going to remain for a while the [chief reserve] currency, just as the British pound was remaining a major and significant foreign reserve currency long after Britain ceased being the largest economic power in the world.
RFE/RL: Would a move away from the dollar be in the U.S. interests?
Svejnar: I think to the extent that people don't like major fluctuations and the dollar being the central currency that people buy and sell as mood changes -- that would be in the U.S. interests in that it could add a little bit more stability. I don't see as being very valid the argument that it would affect consumer behavior, I think consumers are motivated by other things and other factors than what producers and investors elsewhere in the world are thinking at the moment. Obviously the U.S. as it ceases being the major issuer of currency that others are willing to hold, is losing some advantage called seigniorage, that's the benefit of the government that issues currency that others hold interest-free. If you're holding U.S. dollars as currency, as bills, you're essentially lending money to the U.S. government by having exchanged some other money for the dollar you're holding, so that gives the U.S. government and U.S. taxpayer an advantage called siegnorage, but that's fine, that's being lost gradually anyway as people switch to other currencies and it's not such a significant effect here.
RFE/RL: How to explain the strengthening of the dollar in recent weeks, after it weakened for most of the year?
Svejnar: First of all I'd like to stress that nobody really understands or is willing to say they fully understand the behavior of exchange rates. The exchange rates are affected by so many factors, economic and noneconomic that it's very difficult to attribute a particular movement in the exchange rate to a single factor or even a small group of factors. So we should bear that in mind when we interpret things. But everything [being] constant, I think it's true that the feeling is that the U.S. has gone through a shallower and shorter recession than most people expected, most of us expected the U.S. would go through a deeper recession than Europe would, What now is looking like the likely scenario is that the U.S. is pulling out of a recession that turned out not to be so deep, and that Europe is also getting [up] perhaps but more slowly and a number of countries in Europe have significant problems that the recession accentuated -- not caused completely but accentuated. And that Europe as a whole, and some countries like Greece and possibly Italy have more problems than was evident at first sight.
World Economic Crisis
World Economic Crisis
Multimedia coverage on the impact of the global financial crisis on markets and individuals across RFE/RL's broadcast region. More
