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The Shift Of Two Big Circulations In Global Finance And Trade

Jul 11 , 2016
  • Zhang Monan

    Senior Fellow, China Int'l Economic Exchanges Center

Whether the Fed will start its interest-rate hike in June has been an uncertain factor harassing the global financial market. However, no matter whether the anticipated hike happens or not, the global cross-border capital structure and flow will change in turning point and direction.

Fundamentally, the total outflow and inflow of cross-border capital follow the basic law of the global financial cyclical change as capital flow, credit increase and leverage ratio all have a global financial cycle. The counter cyclicality in the global capital flow supervision is a big issue facing the decision makers.

After the international financial crisis, the US implemented four rounds of quantitative easing policies, quadrupling the US base currency over the past 6 years. The capital structure shows that the Fed holds $4.5 trillion in assets. To break this down, $1.76 trillion is in MBS and $2.46 trillion is treasuries. Of that, 55% and 8% of the treasuries will be due within five years and one year respectively. If the Fed stops treasury reinvestment, the balance sheet can be narrowed by $1.35 trillion over the next five years. The narrowed balance sheet will have a more direct impact on dollar liquidity and the global capital flow than an interest-rate hike.

The dollar liquidity is edging from “quantitative easing” to a new cycle of “quantitative tightening”, which mainly influences global capital and liquidity as follows: First, the US cross-border capital flow turns its direction. The Institute of International Finance released determined that the emerging economies on the whole witnessed an outflow of its capital in 2015. The total inflow of non-residential capital fell to $41 billion, much lower than the average level of 285 billion dollars in 2010 – 2014; of the total inflow, $13 billion and $28 billion went to the stock market and the debt market respectively, Recently, there was a sign of capital return to the emerging markets on the back of the restoration of the financial market risk preference.

The shrinkage of petro dollars also impacted the capital flow. The fluctuation of the global commodity prices triggered by the world’s fallen oil price, along with the volatility of the global financial asset prices caused by the significantly shrinking petrol dollars, has an withdrawing effect on the capital inflow in the emerging economies.

In essence, the global capital and liquidity rely on financial (monetary) and trade circulations for two factors. First, the trade deficit country makes payment to the trade surplus country, causing the capital flow of the current account; second, the trade surplus country reinvests the accumulated reserve assets in the financial products of the trade deficit country, producing the capital flow of the financial account. These two factors form a complete monetary and economic circulation, meaning the more serious the imbalance of the global trade is, the more derived liquidity there will be.

However, since the financial crisis, the rebalance of the global economy has gradually changed the world financial and monetary circulation. In fact, in July of 2015, apart from China, Russian official reserve assets reduced by $3.945 billion to $357.626 billion; Brazilian reserve assets fell by 416 million dollars to $368.252 billion; South African reserve assets dropped by $1.006 billion to $45.823 billion; Indian official reserves declined by $1.761 billion to $353.46 billion compared with June 2015. So, the emerging countries and BRICS show a turning point in reserves.

On the other hand, according to the IMF World Economic Outlook, 50% of the global capital still flew into such countries as the US and the UK. The US stable recovery drew a large amount of global capital to the dollar-denominated assets. In 2015, the US net capital inflow was estimated to reach $460 billion, up by 18.3% year on year; the capital inflow grew 14.8% faster than last year and accounted for 38% of the world’s total capital inflow.

From 2000 to 2014, China saw a considerable reserve asset increase every year. But this situation is significantly changing with its official reserve assets continuing to decline. In the future, China’s international balance of payments will not enjoy the huge surplus in both the current account and the capital account, and will be taken over by a new normality of a surplus in the current account and fluctuation (or deficit) in the capital account. The general pattern and the internal mechanism have changed fundamentally.

On the one hand, the original large global trade circulation is not sustainable. China is approaching the turning point of demographic dividend as more people are aging and the labor cost will be reflected in the enterprises cost that will cut down the savings of the enterprises. Also, Chinese manufacturing will accelerate its restructuring and the enterprises will have less ability to create surplus. The global aggregate demand led by the developed countries shrinks continuously and the world continues to face the constraint of inadequate aggregate demand. The golden period of the hyper growth of China’s export sectors has gone and the labor-intensive export sectors under a heavy allocation of labor resource begin to have lower efficiency.

In the medium and long term, the direction of the global capital flow and allocation structure will change. The emerging markets have formed a capital outflow scale in the developed countries like the US through official purchase of foreign exchange. Since the turning point occurs in the reserve assets, this scale will become smaller.

On the other hand, the original large global financial circulation is not sustainable. The existing large-scale capital flow amid the global economic imbalance is attributed to the following factors: first, the developed dollar-denominated capital markets and dollar assets have a low supply; second, the excessive reserves of the Asian emerging countries flow to the US to make up for the imbalanced current account with the US; third, the long-term interest rate is low against the backdrop of the balanced global savings and planned investments. With the global imbalance being corrected and the real interest rate rising, the cost of bond financing such as the US treasuries will also increase, pushing up the global real interest rate.

Therefore, “dollar liquidity shortage” is inevitable in the future. How to improve the liquidity management including cross-border capital flow and monetary reserves and so on is the key to systematic risk control and crisis management. A global macro-prudential supervision frame should be established to supervise the cross-border capital liquidity as the core target and measure for capital management.

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