Twitter: @MarkusEconomistIntro: MARKUS BRUNNERMEIER

Website: bcf.Princeton.edu

Markus’ intro Previous webinars Pinelopi Goldberg: International trade: Global value chains

Interwoven supply network, COVID transmission, best development aid Hyun Song Shin: International finance: Original Sin Redux

Speakers

Safe Asset Perspective A Safe Asset Perspective on

International Capital Flows and Sudden Stops Brunnermeier-Sannikov (2019) “International Monetary Theory: A Risk Perspective”

Safe Asset (≠ risk-free asset) (see “The I Theory of Money”)

Good friend analogy valuable/liquid when you need it Safe asset tautology multiple equilibria (bubble & no)

Money/Government debt in US, Germany, Japan is safe asset Precautionary savings again (idiosyncratic) risk Private insurance role – hence low yield Bubble/Ponzi scheme: Never paid off, always rolled over Works if 𝑟𝑟 < 𝑔𝑔 (see Blanchard for empirical evidence)

4/20/2020 4

Real risk free rate

Real risk-free rate

𝑟𝑟𝑡𝑡𝑓𝑓 = 𝜌𝜌 +

1𝐼𝐼𝐼𝐼𝐼𝐼

𝐼𝐼 𝑔𝑔𝑡𝑡𝑐𝑐

𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑡𝑡𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑡𝑡𝑠𝑐𝑐𝑐𝑐𝑠𝑠

−12 ⏟𝛾𝛾𝑅𝑅𝑅𝑅

(1 +1𝐼𝐼𝐼𝐼𝐼𝐼

)[ 𝜎𝜎𝑡𝑡𝑐𝑐 2

𝑎𝑎𝑠𝑠𝑠𝑠.𝑟𝑟𝑐𝑐𝑐𝑐𝑟𝑟

+ �𝜎𝜎𝑡𝑡𝑐𝑐 2

𝑐𝑐𝑖𝑖𝑐𝑐 𝑟𝑟𝑐𝑐𝑐𝑐𝑟𝑟

]

𝑐𝑐𝑟𝑟𝑝𝑝𝑐𝑐𝑎𝑎𝑐𝑐𝑡𝑡𝑐𝑐𝑐𝑐𝑐𝑐𝑎𝑎𝑟𝑟𝑝𝑝 𝑐𝑐𝑎𝑎𝑠𝑠𝑐𝑐𝑐𝑐𝑠𝑠𝑐𝑐

𝜎𝜎𝑡𝑡𝑐𝑐 - Consumption risk can be Exogenous shock Endogenous shock due to amplification/runs/sudden stops

Depends on denomination of debt

4/20/2020 5

Risky return/risk premiumUS, Germany, Japan … attractive government funding

Can EME also play the scheme? They are trying at least? When? Challenge 1: Might not be risk-free due to sudden stop 𝑟𝑟𝑡𝑡₱ > 𝑟𝑟𝑡𝑡

$

𝐼𝐼 𝑟𝑟𝑡𝑡₱ = 𝑟𝑟𝑡𝑡𝑓𝑓 + 𝛾𝛾(𝜎𝜎𝑡𝑡𝑐𝑐 + �𝜎𝜎𝑡𝑡𝑐𝑐)

𝑐𝑐𝑟𝑟𝑐𝑐𝑐𝑐𝑝𝑝𝑐𝑐𝑓𝑓 𝑟𝑟𝑐𝑐𝑐𝑐𝑟𝑟

�𝜎𝜎𝑡𝑡₱𝑟𝑟𝑐𝑐𝑐𝑐𝑟𝑟

𝑟𝑟𝑐𝑐𝑐𝑐𝑟𝑟 𝑐𝑐𝑟𝑟𝑝𝑝𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 Challenge 2:

Compete with safe US Treasuries, German Bund, …offers return of 𝑟𝑟𝑡𝑡

$

4/20/2020 6

Risk-on vs. Risk-off region 𝜌𝜌 + 1

𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝑔𝑔𝑡𝑡𝑐𝑐 − 1

2𝛾𝛾(1 + 1

𝐼𝐼𝐼𝐼𝐼𝐼)[ 𝜎𝜎𝑡𝑡𝑐𝑐 2 + �𝜎𝜎𝑡𝑡𝑐𝑐 2] +

=𝑟𝑟𝑡𝑡𝑓𝑓

𝛾𝛾(𝜎𝜎𝑡𝑡𝑐𝑐 + �𝜎𝜎𝑡𝑡𝑐𝑐)𝑐𝑐𝑟𝑟𝑐𝑐𝑐𝑐𝑝𝑝𝑐𝑐𝑓𝑓 𝑟𝑟𝑐𝑐𝑐𝑐𝑟𝑟

�𝜎𝜎𝑡𝑡₱𝑟𝑟𝑐𝑐𝑐𝑐𝑟𝑟

𝑟𝑟𝑐𝑐𝑐𝑐𝑟𝑟 𝑐𝑐𝑟𝑟𝑝𝑝𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 As (idio) risk �𝜎𝜎𝑡𝑡𝑐𝑐 increases,

Required 𝑟𝑟𝑡𝑡𝑓𝑓 declines

Investment rate and growth rate 𝑔𝑔𝐼𝐼𝐸𝐸𝐼𝐼 declines ⇒ lowers 𝑟𝑟𝑓𝑓 again, but ₱-government debt bubble less sustainable.

… but currency competition with $-treasuries Risk-on/low risk �𝜎𝜎𝑡𝑡𝑐𝑐 -region with $-borrowing since 𝑟𝑟𝑡𝑡

𝑓𝑓 > 𝑟𝑟$

Domestic ₱-government debt serves as safe asset High investment rate funded with $-debt ⇒ boosts 𝑔𝑔𝐼𝐼𝐸𝐸𝐼𝐼

Risk-off/high �𝜎𝜎𝑡𝑡𝑐𝑐 -region with $-saving when 𝑟𝑟𝑡𝑡𝑓𝑓 > 𝑟𝑟$ - Sudden reversal

Low investment rate ⇒ low 𝑔𝑔𝐼𝐼𝐸𝐸𝐼𝐼 Ponzi scheme not possible ⇒ standard DSA with intertemporal gov. budget constraint

₱- Currency collapses and risk premium (including term premia) rise 7

Risk & debt denomination

Risk 𝜎𝜎𝑡𝑡𝑐𝑐 + �𝜎𝜎𝑡𝑡𝑐𝑐 allocation:depends on denomination of debt & maturity mismatch Well allocated, risk is lower Not well allocated, risk is amplified ⇒ endogenous risk

Risk can be on End-borrowers side Domestic banks Foreign banks Foreign investor

Problem: individual end-borrower and foreign takes exchange rate moves and GE price shifts as given – misallocations

4/20/2020 8

Original Sin

Global Financial Architecture

Can EME provide their own safe asset Reduce risk premium Only possible if one reduces endogenous risk

Rechannel capital outflows with GlosBies

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Brunnermeier-Huang (2019)“A global safe asset from and for Emerging Economies”

A L

Pool of Sovereign

Bonds

Senior Bond

Junior Bond

TranchingPool

ing

Poll 01

1. Do you prefer an international financial architecturea. In which the IMF and US Federal Reserve actively intervenes to

channel back funds to other economies, e.g. with swap linesb. Autonomous system which is self-stabilizing

2. Which region are ina. US/Canadab. Latin Americac. Europed. Asiae. Australiaf. Africa

4/20/2020 10

Twitter: @MarkusEconomistIntro: MARKUS BRUNNERMEIER

Website: bcf.Princeton.edu

Capital flows and “Original Sin Redux”Princeton University, Bendheim Center for Finance webinar series

Hyun Song Shin*, Economic Adviser and Head of Research, BIS20 April 2020*The views expressed here are mine and not necessarily those of the Bank for International Settlements

2

Borrowers Investors

A LA L

Country AA’s currency

3

Finding 1: lenders tend to lend in their own currency

Borrowers

A LInvestors

A LA LA’s currencyCountry A

Maggiori, Neiman and Schreger (2018) “The rise of the dollar and fall of the euro as international currencies”

4

Finding 2: private sector borrowers are subject to “original sin”; when borrowing from abroad, they do so in foreign currency

Borrowers

A LInvestors

A LA LA’s currencyCountry A

A L

5

Canadian corporate bond issuance

Maggiori, Neiman and Schreger (2018) “The rise of the dollar and fall of the euro as international currencies”

6

Finding 3: exception is the US and the US dollar

Borrowers

A LInvestors

A LA LUS dollar

USA

A L

7

US corporate bonds issuance

Maggiori, Neiman and Schreger (2018) “The rise of the dollar and fall of the euro as international currencies”

8

Liabilities side of lender’s balance sheet looms into view

Borrowers

A LInvestors

A LA LA’s currencyCountry A

A L

Pension funds and lifeinsurers have bond-likeobligations; they want

assets that back them up

9

Lessons from 1990s EME financial crises

Avoid currency mismatch

Avoid maturity mismatch

10

Overcoming original sin: non-resident holdings of EME local currency sovereign bonds

40

30

20

10

0

Peru

So

uth

Afr

ica

Ind

on

esi

a

Mexi

co

Po

lan

d

Ru

ssia

Mala

ysia

Co

lom

bia

Eg

ypt

Tu

rkey

Ro

man

ia

Hu

ng

ary

Th

aila

nd

Bra

zil

Ch

ile

Lith

uan

ia

Latv

ia

Ph

ilip

pin

es

Ind

ia

Ch

ina

Bu

lgari

a

Ukr

ain

e

2016 Q4 2017 Q4

Source: World Bank

%

11

Two duration measures

Duration = −𝑑𝑃/𝑃𝑑𝑟 Compare duration measures with:

Percentage return in local currency terms Percentage return in dollar terms

12

Percentagereturn

Yield change0

13

EMEs local currency sovereign bond returns1, January 2013 – October 2018

1Total return on bonds denominated in local currency as weekly change in JPMorgan GBI-EM principal return index in local currency and US dollar. Sources: JPMorgan Chase; BIS calculations.

Mexico South Africa

y = -0.06 -12.4xwhere R2 = 0.58

y = -0.01 -5.05xwhere R2 = 0.88

–10

–5

0

5

–0.5 0.0 0.5 1.0

Local currency returnChange in yield, in percentage points

Retu

rn, in

per

cent

y = -0.02 -12.8xwhere R2 = 0.70

y = 0.03 -4.59xwhere R2 = 0.94

–10

–5

0

5

–0.5 0.0 0.5 1.0

US dollar returnChange in yield, in percentage points

Retu

rn, in

per

cent

14

EMEs local currency sovereign bond returns1, January 2013 – October 2018

1Total return on bonds denominated in local currency as weekly change in JPMorgan GBI-EM principal return index in local currency and US dollar. Sources: JPMorgan Chase; BIS calculations.

Indonesia Brazil

y = -0.09 -6.6xwhere R2 = 0.60

y = -0.01 -4.52xwhere R2 = 0.88

–10

–5

0

5

–0.5 0.0 0.5 1.0

US dollar returnChange in yield, in percentage points

Retu

rn, in

per

cent

y = -0.11 -8.52xwhere R2 = 0.66

y = 0.04 -4.34xwhere R2 = 0.93

–10

–5

0

5

–0.5 0.0 0.5 1.0

US dollar returnChange in yield, in percentage points

Retu

rn, in

per

cent

15

Advanced economies sovereign bond returns1, January 2013 – October 2018

1 GBI Global Country 5 to 7 year maturity indices for the selected economies.

Sources: JPMorgan Chase; BIS calculations.

France Sweden

y = -0.06 -2.67xwhere R2 = 0.02

y = -0.03 -5.41xwhere R2 = 0.96

–4

–2

0

2

–0.2 –0.1 0.0 0.1 0.2 0.3

Local currency returnChange in yield, in percentage points

Retu

rn, in

per

cent

y = -0.12 -1.91xwhere R2 = 0.01

y = -0.03 -5.09xwhere R2 = 0.94

–6

–4

–2

0

2

–0.2 –0.1 0.0 0.1 0.2 0.3

US dollar returnChange in yield, in percentage points

Retu

rn, in

per

cent

16

17

Covid-19 shock

18

Foreign ownership in EME local currency bond markets

19

US dollar and local currency returns vis-à-vis yield changes

20

US dollar and local currency returns vis-à-vis yield changes (cont)

21

Exchange rates co-move with bond yields in EMEs

22

EME FX reserve buffers

Monetary policy frameworks in EMEs: BIS Annual Economic Report 2019, Chapter II

23