Global Imbalances post QE – The Third Pole Advantage Financial Group’s annual conference on “Global Economic Perspectives” - Milan, May 18, 2011 Paulo Vieira da Cunha Tandem Global Management, L.P. 500 Fifth Avenue 37 th Floor 1 private & confidential New York, NY 10110
Global imbalances, post QE? They are back! Same pattern, new twist (already there before but now more visible) • China/US imbalances … now also China/EM (Brazil) • Why? US CHINA ZIRP + Fiscal + QE Accelerated FAI + Global + Wealth Effects Fiscal (9% GDP-2009) liquidity & growth Commodity demand & prices • BRAZIL: Fiscal + Monetary + Credit (Public Banks) = 4-5% GDP (2009/10) • Terms of Trade (external wealth transfer) • RESULT: Expansion in domestic absorption (10-12%pa 2009/10) esp. Consumption FX-appreciation & boom in imports (impact on global demand) 2
Implications? US Trade Balance • US: Trade deficit Mar/11=$522.4bn, Mar/07=$745.0bn (Narrowing during recession, widening (again) in recovery – mainly due to widening deficit with China!) • US/CHINA: Trade deficit Mar/11= $281.6bn, Mar/07= $243.7bn • US/BRAZIL: Trade surplus Mar/11=$12.6bn, Trade deficit Mar/07=$5.9b 600 500 400 112 300 200 100 100 0 2008/IV = 100 -100 88 -200 -300 -400 76 -500 -600 -700 64 -800 -900 52 -1000 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 05 06 07 08 09 10 11 Brazil, Trade Balance, USA (RHS) United States, Trade Balance (LHS) China, Trade Balance, USA, USD (LHS) Source: Tandem Global Partners 3
Implications? BRAZIL Trade Balance • BRAZIL: Trade surplus Mar/11=$22.5bn, Trade surplus Mar/07=$45.9b • CHINA: Imports Mar/11=$32.8bn, Mar/07=$8.8bn Huge ToT effects reverse • CHINA: Exports Mar/11=$37.9bn, Mar/07=$8.7bn surpluses to deficits 500 450 400 350 2006/I = 100 300 250 200 150 100 50 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 05 06 07 08 09 10 11 Exports Value Imports Value Exports Volume Imports Volume Source: Tandem Global Partners 4
Brazil: Large capital inflows • 2007: Strong balances – CAB surplus • 2008: Weakening balances – CAB deficits & collapse in K-flows (loss of reserves) • 2009: Return to strong balances – Widening CAB deficits & recovery in K-flows • 2010: Record strong balances – CAB deficits approaching 3% GDP & booming K-flows 150 Enlarged Basic Balance 79.2G Current Account -50.0G FDI 64.8G 125 Portfolio Investment 64.4G 100 75 USD (billions) 50 25 0 -25 -50 -75 00 01 02 03 04 05 06 07 08 09 10 11 Current Account FDI Portfolio Investment Enlarged Basic Balance Source: Tandem Global Partners 5
Brazil: Accumulating reserves … China speed • CHINA: Reserves Mar/11= $3,044.7bn, Mar/07= $1,202.0bn Growing at app.. 20%pa • BRAZIL: Reserves Mar/11=$317.1bn, Mar/07=$109.5b -- last 2yrs Elasticity (Brazil/China) ≈ 1 • WORLD: Reserves Mar/11=$9,381.5bn, Mar/07=$5,065.4b 175 150 125 2008/IV = 100 100 75 50 25 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 05 06 07 08 09 10 11 Brazil, Foreign currency reserve, total China, Foreign exchange reserves Source: Tandem Global Partners 6
Exchange rates: CNY peg = extreme vol in USD/BRL • CHINA: Appreciating path 2006-07; Re-peg = Q2/08 • BRAZIL: Strong appreciation Q1/07-Q2/08; crash Q3/08-Q1/09 – Recovery Q2/09+ … beyond Q2/08 peak! 190 180 170 160 150 140 2008/IV = 100 130 120 110 100 90 80 70 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 05 06 07 08 09 10 11 Brazil, NEER China, NEER United States, NEER Source: Tandem Global Partners 7
Brazil: Huge gains in Terms-of-Trade (commodities) • CRB and BRAZIL ToT = close parallelism • ToT and FX = close parallelism: Strong appreciation Q3/07-Q2/08; crash Q3/08-Q1/09 Recovery Q2/09+ beyond Q2/08 peak! 200 190 180 170 160 150 2008/IV = 100 140 130 120 110 100 90 80 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 05 06 07 08 09 10 11 Brazil, IC-Br Index World, Reuters/CRB, Continuous Commodity Index (CCI), Close Source: Tandem Global Partners
Brazil: Large rate cuts post-Lehman (Q4/08) • CHINA and BRAZIL: 2007: Accelerated growth & commodity shock and pass-through = Tightening when FED was loosening – Q4/07 to Q1/08! • BRAZIL: Late and slow to normalize post Q4/08 (but given ZIRP, IR diff ≥ 8%! 3.0 14 2.5 13 2.0 12 1.5 11 1.0 Percent Percent 0.5 10 0.0 9 -0.5 8 -1.0 7 -1.5 -2.0 6 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 Q4 05 06 07 08 09 10 11 Brazil, SELIC Target Rate - FED Funds Rate China, 20 Day Reloan Rate - FED Funds Rate Source: Tandem Global Partners 9
What is the effect of the "wall of liquidity" – QE2? • World produces two assets: A="safe" assets (low yield); B="risky" asset (higher yield) • EM grows faster, saves more and buys reserves = A assets • DM supplies A assets and has greater capacity to "select" B assets (venture capital) US CHINA FDI US-China Supplies "safe" Supplies savings, buys assets and VS. "safe" assets and recycles capital to TSY China-US develops "risky" "risky" projects projects • QE: Reduces price of B assets & post-risk aversion transfers wealth back to B assets (stock market) → restores consumption & income; investment (lower asset prices) • QE1 = direct impact on B assets (purchases of MBS) • QE2 = "leak in demand" for B assets (purchases of A assets) → "search for yield" QE2 EM Lowers r A (return Lower relative risk on "safe" assets) Portfolio flows (post crisis) and induces flows Solid supply of good to B ("risky" assets) but riskier projects (B) 10
Is this the case with Brazil? • Model: structural VER – Jan/07-Feb/11 • Cointegrated variables (endogenous) – BRLUSD – Terms of Trade – Interest rate differential (Brazil-US policy rates) – Non-tradable inflation differential (Brazil-US CPI-services) • Effect variables (exogenous) – Portfolio flows – FDI – FIXED EFFECTS • Recession (NBER): Dec/07-Jun/09 • QE1: Dec/08-May/10 • QE2: Sep/10+ 11
Results: Impact of Terms of Trade, Interest Rate and Inflation Differentials on USD/BRL, as expected Response to Cholesky One S.D. Innovations Response of LFX_BRLUSD_12 to LTOT_IND_12 Cointegrated variables ≈ 80% of variance .010 .010 .005 .005 Shock to Terms of Trade ► appreciation, .000 .000 building up in the first 10mo, attenuating -.005 -.005 thereafter -.010 -.010 5 10 15 20 25 30 35 Response of LFX_BRLUSD_12 to LIRD_BRA_USA_12 .010 .010 Shock to interest rate differential (higher rate .005 .005 in Brazil) ► initial strong appreciation .000 .000 with reversal after 10mo -.005 -.005 -.010 -.010 5 10 15 20 25 30 35 Response of LFX_BRLUSD_12 to LCPI_BRA_USA_SRV_12 .010 .010 .005 .005 Shock to relative non-tradable inflation (higher inflation in Brazil) ► appreciation .000 .000 with long persistency (peak in 30mo) -.005 -.005 -.010 -.010 5 10 15 20 25 30 35 12
Capital flows: What about QE2? • Effects variables (K-flows) ≈ 20% of variance • Complicated interaction between FDI and Portfolio. Portfolio clearly dominant FED easing (cut rates in Oct/08 to 1% and in Mar-11 Dec/08 to 0.25%) vs. the late cycle in Brazil QE-2 Dec-10 (BACEN was hiking rates through Sep/08 Sep-10 +75bp to 13.75% and kept it there with a cut Jun-10 only in Jan/09 to 12.75%) → additional Mar-10 appreciation pressure (about 12% additional) Dec-09 Sep-09 QE-1 QE1 in directly reducing the yield of risky assets in Jun-09 the US (MBS + S&P) and making EM risky Mar-09 assets more attractive contributed to this Dec-08 additional appreciation pressure (joint effect of Recession Sep-08 about 20%) Jun-08 Mar-08 Dec-07 QE2 targeted at safe assets in the US (TSY) but Sep-07 with huge spillover effects in the US (S&P) Jun-07 Did NOT contribute to additional appreciation Mar-07 In fact, the opposite (effect app -18%) Dec-06 13
A currency model: Capital flows and QE* Structural Error Correction: D(LFX_BRLUSD_12) Dependent Variable: COINTEQ01 Sample (adjusted): 2007M01 2011M 02 Sample (adjusted): 2007M 02 2011M 02 Included observations: 50 after adjustments Included observations: 49 after adjustments t-statistics in italics (*=1%level) White heteroskedasticity-consistent standard errors & covariance t-statistics in italics (*=1%level **=5%level) CointEq1 -0.099 -7.721* Standardized D(LFX_BRLUSD_12) 0.661 7.759* Coefficient D(LTOT_IND_12) -0.018 -0.111 C 0.000 -2.698* Endogenous D(LIRD_BRA_USA_12) 0.102 5.600* COINTEQ01(-1) 0.896 31.082* D(LCPI_BRA_USA_SRV_12) 0.090 0.127 BOP_PORT_12 0.211 6.140* BOP_FDI_12 -0.044 -1.650** BOP_PORT_12 0.000 4.614* DUM _REC 0.122 5.301* BOP_FDI_12 0.000 -2.259* DUM _QE1 0.082 1.929* Exogenous DUM _REC 0.004 2.447* DUM _QE2 -0.175 -7.236* DUM _QE1 0.001 0.373 DUM _QE2 -0.006 -1.948* R-squared 0.985 Adjusted R-squared 0.983 R-squared 0.958 F-statistic 455.855 Akaike AIC -8.449 Durbin-Watson stat 1.136 Schwarz SC -8.067 Akaike info criterion -6.366042 F-statistic 101.187 Schwarz criterion -6.095782 Log likelihood 221.236 * All variables, except "dummies" for time-effects are 12 month moving averages 14
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