Month: June 2004

Yesterday, I test drove a Toyota Prius, the high-tech gas-electric vehicle that gets up to 60 mpg. After the test drive, the salesperson told me that demand was so high there was a 6 month wait.

Every time I go to Europe I wonder what kind of future the place has:

1. The average American consumes 77 percent more than the average citizen of EU-15, read here.

2. Germany has recently failed in its attempt to reform the country’s antiquated store closing laws. German shops, with some exceptions, cannot stay open later than eight at night or on Sundays or major holidays. The German public strongly opposes these laws, but the small shop lobby dominates.

3. A recent survey in France suggests that 70 percent of French schoolchildren aspire to become bureaucrats rather than captains of industry. (See the IHT, June 9, “Divided We Graumble,” by Roger Cohen, p.2.)

4. The beauty of European cities typically stems from 1920 or earlier, when much of Europe was economically freer than the United States. How would U.S./Europe comparisons feel to us if all of Europe had been built after the second World War? How many people would then think that the “European way of life” is superior.

5. Guido Tabellini (FT, June 3) tells us that Europeans consume more leisure because they find it harder to get good jobs, not because of a cultural preference for the finer things in life.

6. The major European economies face serious demographic problems and have a hard time pushing much above a one percent growth rate. Americans call it a recession when our rate of growth falls to a mere two percent.

Hey, wait a minute:

American investment in the European Union is at an all-time high. So how bad can things be?

This is what makes economics an interesting science. My best guess is that it is easier than ever before to free-ride on the productivity and ingenuity of your neighbors. This is a great benefit of globalization, but it also makes it too easy for economies to postpone needed reforms.

That being said, here are further grounds for hope.

Mr [Barry] Eichengreen spells out…an ingenious plan…he proposes the creation of a market for lending and borrowing in a synthetic unit of account, a weighted basket of emerging-market currencies. Such bonds would be popular with investors, since the currency would be more stable than the sum of its parts and, at first at least, carry attractive yields. Importantly, such a market, if it could be established, would eventually let emerging-market economies tap foreign capital without currency mismatches. This is because those, such as the World Bank, that issued such bonds would be keen to reduce their exposure to the basket by lending to the countries in that basket in their own currencies.

The idea is to prevent a mismatch between assets and liabilities:

…some countries’ financial fragility results simply from their need for foreign investment. In the most susceptible countries, firms and banks borrow heavily in dollars, while lending in local currencies. If the value of the local currency wobbles, this mismatch between domestic assets and foreign liabilities is cruelly exposed.

Why are the assets and liabilities of emerging markets so ill matched?…International investors are very choosy about currencies. Most consider only bonds denominated in dollars, yen, euros, pounds or Swiss francs. This select club of international currencies is locked in for deep historical and structural reasons. Thus, poor countries that want to borrow abroad must bear currency mismatches through no fault of their own.

I have no problem with trying the idea, but what can we expect?

First, it remains a puzzle why lenders are reluctant to denominate international loans in anything but the five major currencies (dollar, Euro, yen, sterling, and Swiss franc). So it is hard to know whether another unit of account could join this exclusive club. Perhaps investors would find the basket hard to evaluate or simply unwieldy. They might not want the basket any more than they would lend in Brazilian real, which is the original source of the problem.

Second, say that the basket did become widely used and relatively stable. Underdeveloped countries would then have their liabilities in a stable unit of account but their assets would still fluctuate in value. We would return to a version of the original problem. Now one might hope that the basket-denominated debts would be swapped back into the local currency. But I don’t see any particular reason why such swaps would increase in ease.

Third, if the basket becomes more liquid than its underlying components, the system may be vulnerable to arbitrage and speculation opportunities. Whether these would be stabilizing remains an open question. In essence the price of the basket would tell you where the underlying components are headed. We would have a new version of the “stale pricing” problem.

The Eichengreen proposal represents an old dream, and one that I have been taken with myself: improve risk-sharing simply by creating a new nominal value. This may sound like economic alchemy, but hey, it worked with stock index futures. That being said, in this arena the number of failures far outweighs the number of successes.

Here is one summary of the plan. Here is a useful summary by Eichengreen and Haussman.

Thanks to Chris Danford for the pointer.

1. Chinese per capita income in 2003 is roughly seven times higher than in 1978.

2. In 2002, in purchasing power parity terms, China accounted for twelve percent of global gdp.

3. The figure drops to only four percent, if we calculate real gdp by exchange rates rather than purchasing power parity.

4. In 1952, Communist China claimed to comprise five percent of global gdp.

2. China accounted for one-third of world economic product in 1820. The figure is from work by Angus Maddison.

These facts are drawn from Tuesday’s Financial Times, an Op-Ed entitled “China is Not Racing Ahead, Just Catching Up.”

Addendum: Bruce Bartlett refers me to Maddison’s data.