Economists are not known for their star turns. Yet the interplay of global events and timely research can conspire to drag a tweed-jacketed dismal scientist blinking into the public eye. In 2014 Thomas Piketty became an unlikely celebrity when his weighty book on global inequality, “Capital in the Twenty-First Century”, made bestseller lists. In 2016 another French economist might have just the right message for the times. The research of Hélène Rey, of London Business School, on the massive flows of money sloshing around the global economy is well suited to a moment when the tide of global capital is turning once again.
Ms Rey is a chronicler of the “global financial cycle”. It is a relatively new phenomenon. Over the past three decades capital-market liberalisation and globalisation combined to link up markets around the world and allow an ocean of money to swirl between them. Trade in goods was once far larger than trade in financial assets, but no longer. In emerging economies the gross foreign financial position can be as large as GDP. In rich economies, the ratio can rise much higher. Given the size of the flows, a change in their movement can have enormous effects on local economic conditions.
The movement of capital across borders is a good thing. Openness often allows investors in mature rich countries to seek out large returns in capital-starved emerging economies, nurturing the process of development there. Yet Ms Rey argues that flows do not always follow this pattern. Money can in fact flow in the other direction. Nervous emerging economies often save to protect themselves against fickle global markets, amassing large quantities of foreign-exchange reserves. That hoarding helps build up a “global savings glut”: a sea of money that can swamp individual economies.
The turn of the tide, Ms Rey reckons, is determined largely, if not entirely, by the Federal Reserve. American monetary policy shapes the global appetite for risk because of the dollar’s privileged position in global finance. When the Fed changes course, asset prices, the return on risk and volatility all move in its wake, with all sorts of effects for other countries.
The tide can shift with sudden violence, as in 2008, when the American financial system faced a panicked pivot in capital flows from risky private assets to safe government ones. As the Fed moved to boost the American economy, by cutting interest rates and printing money to buy bonds, yield-hungry investors sought better returns abroad, sending a sea of capital towards countries that were already growing rapidly. Many complained loudly. In 2010 Guido Mantega, then Brazil’s finance minister, accused the Fed of waging “currency war”.
Yet the howls were nearly as loud when the Fed moved to tighten its policy. In 2015, as it prepared markets for the first interest-rate increase in nearly a decade, emerging-market currencies tumbled. Foreign money dried up just as many emerging markets were slumping, thanks to falling commodity prices and weaker growth in China. Some central banks, including Brazil’s, have raised interest rates even as the economy has sunk into recession, to slow the leakage of capital and hold down inflation, which has surged as the currency falls.
Ms Rey argues that most economies face a fundamental dilemma: they can choose open capital markets, allowing in the foreign investment that emerging markets need to fuel their growing economy, but only if they accept losing domestic control over the business cycle. For many economies, that’s a fair price to pay. But when the Fed eventually raises its interest rate, as it almost certainly will in 2016, the trade-off will look less appealing, and Ms Rey’s work will resonate.