Kopi Time E077 - Barry Eichengreen on War, Inflation, Crypto, Debt

Welcome to Coffee Time,

a

podcast series on markets and economies from DBS group research Team will break Chief Economist welcoming you to our

77th episode, I'm excited about this one. There are macro economists and economic historians and then there is Barry Eichengreen. He's George C pardee and Helen and party professor

of Economics and political

science at the University

of California at

Berkeley. His contribution

to economics

and international finance stretches over four decades.

Consider his

seminal book, Golden Federer is the Gold Standard and the Great

Depression, published in

1992, or

the co authored volume

in defense of public debt. Published just last year in between, Professor

Eichengreen has delved

deeply into exchange regimes, trade

and monetary unions,

financial market, contagion, banking crisis, global, international financial architecture and all of these in the context of now or a century ago and across

events in the

US eurozone, china latin America and so on. So truly

an honor to have him

on board today. Professor Barry Eichengreen, welcome to Covid Time. Thank you tom you're you're making me feel long in the tooth, but

so relevant

then and now, um professor, I have just read a long list of your expertise but I didn't

mention post

conflict reconstruction. Neither did I talk about sanctions, but you've been writing

on these issues lately,

given the war in Ukraine.

So let's begin

there in a recently published article in project syndicate. You wrote that, talking about marshall plan for Ukraine is a popular

sport nowadays. But

Ukraine's reconstruction

must be done

with full appreciation of the

most relevant features

of the plan that

was put in motion close

World War Two europe. So, if you may walk us through those features from your historical study, I I should probably start by mentioning the context for that historical study. I did my work on Uh the history of the Marshall plan some together with my colleague Brad Delong some together with a former student, now colleague mark at the beginning of the 1990s, because everybody was thinking about a Marshall plan for Eastern Europe and the former Soviet Union. So the context was different. Obviously,

there was no war

raging in that part of

the world

at the time. Um so the situation in Ukraine is somewhat different now, although I think marshall plan history is relevant once again. So I would I would make a couple of points building on that. Um post

World War Two

uh experience. First of all, um Marshall plan funds began to be dispersed even before the conflict in europe was entirely over. So the war with Nazi Germany was certainly over. But

there was still a

civil war raging in Greece Through 1949, uh into 1950. and Marshall Plan funds began to flow from the United

States to

The recognized government of Greece already in 1948. So one

here sometimes

today that we should wait until the conflict in in Ukraine is over, until the Russians withdraw or whatever before we begin to provide aid for reconstruction

as opposed

to military

aid. Think

marshall plan experience shows that uh thoughtfully administered and dispersed, we can begin to provide aid for reconstruction

once the west of the country

is secure, for

example, uh already today.

Um

secondly, uh

there has been talk

about whether we the West should be providing mainly grants or loan guarantees and it's worth recalling that

uh european

countries came out of World War Two heavily indebted

and we

provided grants rather than uh more

debt if you

will. And I think that's relevant to Ukraine today as well. They looking forward are are going to face uh

difficult

problem of debt renegotiation. They're going to have

to restructure the debts

that they inherited from the pre

war period.

Their economy will

have shrunk.

Uh those negotiations will take time. So I don't think we should add pile more

debt on top

of the existing

debt if

you will. And finally

there's the question

of how a marshall plan

for

Ukraine should be structured and

administered.

I don't think it should be administered by the Bretton woods institutions, for example, by the I. M. F. And the World Bank Russia

being a

member of the I. M. F. And the World Bank uh and uh in

a position therefore

to throw a wrench in the works if you will. The um uh brilliance of the marshall plan was that the US government set up autonomous self standing agency that could

cut through red tape

and wasn't uh

answerable

directly answerable to the bureaucracies of the U. S. State Department and the U. S. Treasury Department. And I think a self standing international agency maybe under the umbrella of the United

Nations,

uh maybe under the umbrella of the O. E. C. D. Would be the right way to go for Ukraine as well. Would you consider a BRD or the european union along the same lines? Well, I would I I would be prepared to consider

E. B. R.

D. Um E. B. R. D. Did not exactly distinguished itself in its early

days.

Um

in

The early 1990s it became famous more for for building lavish headquarters with with a lot of

marble than

it didn't dispersing funds. But it is presumably leaner and meaner now. And I I would um uh consider that uh I I don't think um Reconstruction of Ukraine is going to be an exclusively Eu endeavor. We're going to want to uh in in in enlist the support of the United States and Japan

and others.

So uh the european union, the european commission is clearly going to have to play a leading role. Whether it should house this autonomous agency though is another

matter

if I may ask you one more follow up

question, what's your

view on the refugees?

So Ukraine is

blessed with many skilled workers. Some of them presumably will fill the labor market gap. The skills mismatch that Poland had before this conflict. And of course, you know, the U. S. Is granting large number of green cards to Ukrainians and so on for the post conflict rebuilding. Would you want the refugees to go

back as soon as

possible? Is that what we saw in the case of europe

post World War Two?

Or it was the case that you know, many left regardless and many stayed on and that was sufficient? Well, in the case of of

Ukraine, I think it is

critically important to reverse the brain brain. Uh, among other things,

Ukraine

had relatively small but vibrant high tech sector. Uh people can work remote so maybe they can work from Poland

for

the Ukrainian

startup.

But I think more generally it will be important to attract back the skilled workers. There was a lot of labor displacement after World War Two, a lot of voluntary

and

some involuntary movement

of labor

from from the east to uh to the west. The

big problem after

World War Two was rebuilding the housing stock

and

uh thereby allowing

people to move

back to the

urban centers

and the industrial centers where their labor was needed where they were most productive. And this is going

to be a big problem for

Ukraine as well.

They want to attract

back the refugees skilled workers,

but they're going to have

to be able to house them and

it will take

years to rebuild the housing stock. So I think um modern

technology can be

part of the solution. They're modular housing and so forth. But where you

can rebuild a

bridge or a railway virtually overnight, pontoon

bridges

and uh, and and so forth, rebuilding the housing stock takes longer. And that will be a constraint on repatriation. Uh, Professor, I can I just want to press you a little more on the IMF's World Bank

question. I just want to go back there for

a second. Both institutions have already offered, you know, substantial assistance to the Ukrainian

government. And of

course, Ukraine has had multiple

programs with the I. M.

F. In the past by myself. And as an ep, actually worked on a Ukraine program 20 years ago. Um, you wouldn't want those interactions to be suspended even under your envisioned framework.

No,

I think,

um, that

the agency in in in charge of dispersing uh, bilateral aid

from the United

States to Ukraine, from the european union to Ukraine can also work with the

I. M. F. And and

and and the World Bank. But it's a matter of who's going to be in charge if you will. And what the um, where, where the organizing center will

uh,

be housed. And I think it should be housed outside the bank and outside the fund. I don't think your friends in Washington are going to be very happy to hear this. I'm gonna move on to one more subject on the conflict. So, this is the first line of an article you recently wrote for the East AsIA forum, what will be the demonstration effect of Western sanctions on

Russia?

Mm hmm. So it's widely argued that with

uh,

western sanctions and in particular with the virtually unprecedented step

of freezing

the

foreign exchange

reserves of Russia's

central bank,

there will be movement

away from the

dollar

in particular

movement away from reliance on Western financial institutions, both swift as a messaging system, the new york clearinghouse, US banks, etcetera. Uh, it's

important though,

to observe that you asked not about US sanctions, but about Western sentence where the West in this

context means

not only the United States and Canada and Western europe, but also Japan and South Korea and others. So in this context, the West is a set of economic and political

values,

if you will, meaning that there are relatively few places to

go. So,

the demonstration effect will be

to make countries contemplating the possibility that one day

they might be in the

position that Russia is

currently in um, China, uh,

wonders

whether there could be a more direct conflict with the United States

over

Taiwan. Most obviously,

uh, such

countries will want to hedge their bets, that will be the

demonstration effect,

but I think they will quickly come to

learn that

hedging their bets is

not really

possible in the short

run because there's

nowhere to turn uh, and, and building an alternative

set of

institutions that does

create a

viable alternative is a time consuming process. So I think the best case in point

is china

has been attempting to build an alternative to chips the new york based dollar based interbank clearing house china's alternative is called uh sips the cross

border

interbank

payments

system. China

has been trying

To build it for seven years now and it hasn't gotten

too far, yep,

I think

china's alternative is viable

and it will continue to grow, but it won't provide uh an alternative. In the

short one.

I remember talking to a senior official at

Beijing a few years

ago and he argued that we coming from our Western persuasion think that without capital account convertibility, a country cannot have a fully international currency. And his argument was, you don't have to have corner solutions, you can have mid points. Um I sort of understand the wisdom behind that, but I fail to see it catching traction. I mean there are many countries

which large

run large and persistent trade deficits, vis a, vis china, so they can all have some sort of a glorified barter system.

You know, you give me stuff, I pay you with R and B

and then I buy stuff from you

and you take the R and B back,

but it

hasn't really caught on, I mean in the last couple of months we're

hearing petrol

RMB and rubble RMB swap. Um so you, you remain unpersuaded that

anytime soon. We're going to

see any seismic movement. Yeah. You know, um it we we can monitor cross border use of the Renminbi in large part through swift because the ironic fact is even though china is building this cross border interbank payments system, it still sends instructions between

domestic for

transfers between domestic banks and foreign banks through

Swift. It

still depends on that Messaging system. If you look there, the renminbi accounts for 2% by value Of cross border payments, where the dollar accounts for 40% and the euro is not too far behind the dollar along that dimension. So

the

Renminbi is growing in

importance over the last few years, its share by value of

transactions through swift has risen

From like 1.9% to 2.4% or some number

in that

neighborhood. But it's

still very far

from being a full fledged rival to the dollar. Absolutely.

Um

What about on the issue of weaponization of the dollar? This aspect that the US has pursued twice in the last one year. First it froze the Central Bank of Afghanistan's US based reserves. And now a large part of Russian Central bank's reserves are unusable because the same. I mean, that ought to give certain antagonist of the US pause in terms of holding US dollar assets. So it does give them pause. But the point is they don't have a lot of other places to go. They can't move into euros.

I

recently published a paper together with a

couple of colleagues

both at the I. M. F

observing that

over the last couple of decades there has been gradual migration away from dollar reserves

in a small

part toward the Renminbi, but principally toward

nontraditional

reserve currencies like the Canadian dollar and the Australian dollar and the korean

won. Those

countries are all participating in in in in the sanctions. So they do not provide safe havens

for

countries contemplating moving away from the dollar. Really,

the only place

to go is toward the

Renminbi

and how freely you will be able to use your Renminbi reserves

is

uncertain both because of those regulatory restrictions that you mentioned before and because chinese banks

are

reluctant to

flaunt

Western sanctions to

openly for

fear of secondary sanctions.

There, china

is still heavily interdependent with the West. Chinese banks value their ability to do business with the West. That

business is a whole

lot more valuable to them than business with

Russia.

I suppose the wisdom in the post-1990-91 episode when Soviet Union broke up was that if we move towards economic integration and more liberalization countries like breakaway Russia or china post W. T. O. Would as you just pointed out that have certain interests in place, which would make them shy to embrace conflict. Um I think you still are holding on to the belief that conflict risk can be mitigated if there's deeper integration. Yeah.

So,

well we learned that there is no end to history. We learned that um uh economic fostering economic interdependence won't lead to

changes

in countries, fundamental changes in the country's political regimes. But if they have an economic stake in their relations

with

rivals, they will think

twice about

jeopardizing that

through

kio

political action.

So um

Russia is kind of proof by counter example.

Mr

Putin for whatever reason, I hesitate to say in his wisdom for whatever reason,

decided to go to

war. And I

think uh we

have seen that the economic

consequences

are for for Russia are are very serious, quite profound and are not going

to be reversed

anytime in the foreseeable future, right? That's the

demonstration effect.

Um Alright

enough

about Russia and the war.

Let's talk about something

that commands the headlines every single

day, the

Great inflation of 20

22

uh here, your

take on it

here. So

I think this uh inflation will be with us for some

time.

We're still going to be battling with this problem in 2023 absent a recession. So that's a big caveat right uh unconditional forecasts of how inflation is going to play out

our

treacherous and they don't make a lot of sense because there's one scenario in which the U. S. And the world economy continued to expand

and in that

scenario I think in in inflation above 4%

is

going to persist in the United States in europe and Britain more generally.

And there is another

scenario in which we do tip into recession later this year or next year,

in

which case

that bed is

off, if you will, the pressure of demand will be less. The pressure on on inflation

will come down

faster of its own volition and the pressure on central banks to continue to raise rates will be less. So the way I

think about the the the the problem in the no

recession case

is that the best case scenario

in the US and

europe is that uh in in in inflation comes

down next

year towards four

percent.

If the neutral real

interest rates,

Natural rate of real rate of interest is one half of 1%. The Fed has to jack up

its policy rates to 4.5

percent just to keep

inflation

steady at four.

And if the Fed is

uncomfortable with four,

which it will be, it's going to

have to raise rates above 4.5

percent. So I think, you know, as we speak today, the markets are are displaying more volatility and signs of more worries. So they're finally catching up with this scenario, which is the you ain't seen nothing yet scenario in terms of central bank

reactions. So,

uh if economies continue to expand, I think that's what we will see continued financial volatility movement away

from risk

assets. Um and More than 2 50 basis point hikes by the Fed which is what's in the market, all that's in the market

at the

moment. I haven't quite gotten my head around how the recessionary scenario will play out. We're all collectively only beginning to think about that possibility. I was about to ask you for a probability distribution around the two scenarios. But I think with your last sentence, I think your caveat is well taken. Um I want to ask you one follow up question on the US dollar and one question on inflation later on the U. S. Dollar.

uh risky

business. And and I can put on my

academic cap

and

uh

say I don't have skin in that game, if you will uh you know, efficient markets theory tells us that the markets have priced all this in, they know that the U. S. Economy is stronger than many other economies and that will be dollar positive because the Fed is going to be moving faster than other central banks. In response. They know the dollar is a traditional safe haven and and that um there will be more volatility favoring safe haven currencies going forward,

that uh in

principle all ought to be in in in the markets already. But 21st century economists, even academics

are skeptical

about efficient markets theories.

So,

you know, the markets were slow to cotton on to these ideas, maybe

they haven't fully

incorporated them yet. And we'll see a bit of additional dollar strength indeed,

is a strong

dollar not a problem for the US and basically a problem for the rest of the world, I think um That's what

john Connolly

would have said,

right, it's our currency,

It's your problem, Treasury Secretary in the 1970s for for the youngsters among among us. Um I don't think it's a problem for the US economy at the moment.

If you look back at

The at the mid 1980s when the dollar was so strong and it and that was

associated with

uh gaping trade deficits for the United States and the rust belt problem, the industrialization of the Heartland, that's not a problem at the moment. The U. S. Economy seems to be firing on all cylinders and uh ah uh certainly uh there's excess demand for

a lot

of things that are in supply chain

shortage

at the moment. But it's a big problem for the rest of the world because it

feeds inflation,

weak currencies feed inflation and the rest of the world and they create serious debt sustainability problems for countries with dollar denominated debts. So we're gonna see more problems developed along both of those lines. So professor in one area where the market's interviews very forward looking is the supply of the U. S. Dollar. So when we look at aggregate indicators of liquidity, it doesn't seem like there's major tightening taking place anywhere in the world.

But in the

uh dollar desks around the world there is you know already you can see this sort of panic around not there not being enough dollar and so on. Um So that that I find interesting that quantitative tightening hasn't come yet but people are charging a premium in their local currencies for dollar supply

for structural

reasons aging

contrary to

what we thought in the context of Japan is actually going to be inflationary um de globalization is going to be a fact of life that's inflationary as well and

china, you know, both suffering

from the globalization

and aging would also contribute toward inflation.

So what's

your view on this

structural inflation

story? I have immense respect for my uh colleague

Charles good

Heart. I tend to uh disagree with him on this one. I looked back at the 1970s and there were central

bankers like

uh Fed Chairman Arthur Burns who cited structural

explanations

for the high inflation of that decade. But along came paul Volcker in 1979 and he

showed that its central banks

that determine the rate of inflation that even if there are strong labor unions or uh big firms with market power or whatever or unfavorable demographics, that would be the current version that uh tend to create more

inflation, Other things

equal. Those other things are not equal and particular

central bank

policy is not equal. So I think uh central bankers

views of

what is attainable in terms of inflation and what is desirable in terms of inflation from the

point of view of

maintaining their credibility and therefore the effectiveness of their policies is that

they're going to have to do whatever

it takes to invoke Mario Draghi um inflation back down toward

target that

is within their capacity and that is desirable. Um Regardless of what structural factors demographic or

otherwise might be pushing

in the other direction, how quickly they can achieve that uh is

another issue recalled

the first rule of

forecasting, give them a forecast digested or give them a date. Never give them both. Um You know, I had a question for you, I'm reading through that question. I realized it's a rhetorical question but for the benefit of the viewers of this podcast I'm gonna read it out. But you don't have to answer because I think you've answered the question in the quotation

How great

these three sentences and given what's happening in the last couple of weeks, you've been incredibly present here. I'm not gonna press you on this question. I think you have summed it up very very well here. Um would you like to add anything or we'll move on. Um Yeah, I think that speaks for itself. Indeed. Indeed brilliant.

debt.

We already have in the emerging markets, you know, debt default and making some debt crisis. So what's the way forward for governments which are already heavily indebted? Okay,

I don't think

there's a single way forward.

Certainly

um low low income countries and some middle income countries are going to

have to restructure their

debts. The international

policy

community has

acknowledged that

fact already for a couple of years now.

So they came out with uh

sustainability initiative

Back in 2020

towards the beginning

of the Covid crisis. But there has been very little

progress in

actually implementing that.

And only a

small handful of countries that

have

approached the

authorities and their

private creditors

to restructure

debts that are clearly not sustainable. So we're gonna have to keep crying and try harder to deal with that problem. On the other hand, there are uh advanced economies, the United States,

most of the

economies of the european union Japan, which

don't have an immediate

crisis of debt

sustainability

because

uh

our is

still less than she

because the effective real rate of interest paid on those debts is less than the real growth rate

of their economies. They're

able to grow the denominator

of the debt to GDP ratio faster than

the numerator

unless they continue to add to the numerator rapidly by running

big

primary budget deficits. I do think that we need

to look

forward to uh era when maybe growth is going to be slower because of Charles, good hearts, unfavorable demographics. When the real

interest rate is going to begin

to trend

very

slowly and gradually upward, it tends to move slowly over

historical time

when that relationship will be less favorable. From the point of view of debt sustainability, we're

going to have to think

as well about the next crisis when governments are going to have to do whatever it takes, including on the fiscal front. So we've learned that crisis come more often than we used to think

that

the period of the great moderation is over and there will be another uh global

financial crisis

or pandemic

or climate

change related crisis that will

require deploying

the available fiscal resources. So those are

both

arguments

for

moving in the direction of fiscal consolidation

once or

assuming that

recovery is

secure. So I think that's what the advanced economies are going to have to do. And in the United States for example, we have come a long way in the last year

in terms of

reducing the size of the budget deficit, it's come down from effectively from 14% of GDP to 6% of GDP. How much more fiscal grab do you want to

add in the short

Run one might ask, but we're going to have to stay that course. I think uh in the interest of debt sustainability and in

terms of

enhancing our capacity to borrow in in the event of another crisis of some sort going forward.

So this

problem needs to be attended to uh immediately in the case of low income countries in the medium term, in the case of of advanced economies, you've touched on a critical issue. I think

january april,

I think the Treasury Department's reports suggest that the overall deficit in january april was almost zero or slight surplus. Uh And as a result, Treasury Supply is is substantially lower than anything anybody expected. Uh This has been a through the force. Professor Barry Eichengreen, thank you so much for your time and insights.

Timer. Thank

you. It's a

pleasure.

And thanks to our listeners to for your time, Kobe time was produced by Kendall Rich from Spy studios, daisy Sharma and violently provided additional assistance. All 77 episodes of Coffee Time are available on all

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