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The Sunday Paper – The Curious Case of the Missing Defaults

The author of the paper highlighted today, Carmen Reinhart of the Harvard Kennedy School, notes how curious the world we’ve lived in recently has been. Viz; “It is rare …to have a triple boom, or robust capital flows, low interest rates, and high commodity prices, as was the case from 2000 to 2007.” Rare indeed; and, in her nearly 200-years of observations, nothing like the aftermath of this has been seen before.

Usually when commodities stop booming or capital flows are curtailed emerging and developing market defaults are not far behind. Given this has just happened where then are the defaults (she notes Venezuela but ignores it for now)?

Did macroeconomic policies in vulnerable economies somehow improve preventing history from repeating itself? Was the commodity price boom managed somehow ‘better’ than in previous cycles? Were monetary and fiscal policies managed less pro-cyclically than in past booms? Or, has dumb luck just played a hand?

As she goes on to note ” The global financial system has yet to see a normal reversal in policy interest rates as in previous cycles. Thus far, the increase in US interest rates has been mild, gradual, and foreshadowed. It remains an open question if good policies are sufficient to keep the system resilient were international interest rates to rise more sharply.” Are we, in fact, not yet out of the woods then?

It seems likely that somehow ‘old’ relationships have broken down and the paper suggests China is the most likely missing component in this Solve-for-Y puzzle. We all know how important China has become in the last 15-years in terms of global trade but their impact on capital flows, because many of them are (sort of) secret, has been harder to track.

The question now is have problems been deferred or defused? The paper avoids a firm conclusion ending wisely with the following observation “..
we all should be humbled by having declared the great moderation shortly before the largest global financial crisis since the 1930s.”

My own two pennyworth would be that if, as seems most likely, China’s emergence as an economic superpower has had a stabilizing effect on a post-GFC economic world we should pay especial attention to recent progress there. If what has been a tremendous force for good is less able to hold up it’s end as surely as in recent years a grey-rhino may be on the loose.

The paper is a short and easy read available via the following link The Curious Case of the Missing Defaults.

Happy Sunday.

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