Carmen M. Reinhart, Harvard University (partly based on ongoing work with Vincent Reinhart,
Standish Mellon Asset Management and
Christoph Trebesch, Kiel Institute,)
San Francisco Federal Reserve Asia Economic Policy Conference
San Francisco, November 16-17, 2017
Capital Flow Cycles and the
Case of the Missing Defaults
Reinhart
Roadmap
Data and approach
Capital flow cycles—a long view
Financial conditions in the global financial
centers
The current cycle and “missing defaults”
Reinhart
What we do
Construct a comprehensive data base on cross border flows
back to 1815
Date turning points in the global capital flow cycle, in the
Burns and Mitchell, Harding and Pagan approach. Features of
the cycles are documented.
Role of external factors financial and through commodity
markets—an expanded version of Calvo, Leiderman, and
Reinhart (1993). Unlike the recent literature, we do not include
the VIX or focus on gross flows (post WWI).
Study the interaction among these global cycles and their
connection to sovereign default and global capital mobility.
Explore time variation in those interactions.
Reinhart
What we do (continued)
Construct (this is not complete) a more comprehensive
(beyond short and long rates) profile of financial center
conditions to incorporate the impacts of regulatory changes
and debt management practices and consider secondary
financial centers (Japanese banks in Kaminsky and Reinhart,
2000 and 2001 an UK and Euro area banks, Cerutti, Claessens.
and Ratnovski, 2017).
Highlight the particulars of individual episodes.
Compare the current capital flow cycle to its historical
counterparts.
Reinhart
Is there a global financial cycle?
There is a global cycle in capital flows
When observed over a long period and many countries, with
identifiable peaks and troughs--we count 14 such cycles from 1815.
The “mega-cycles in capital flows” are connected to global capital
mobility.
There is a global cycle in real commodity prices
Despite considerable variation across individual commodities.
Commodity price cycles occur more often (22 cycles) but large ones
are rarer.
There is a cycle in the stance of policy at the global financial
centers
That are evident in the peaks and troughs of real short-term interest
rates of dominant economies. But the policies also involve
manipulating the central bank balance sheet, managing sovereign debt,
and determining regulatory standards
But there may be multiple centers with uneven regional influence, and
they vary over time
Reinhart
Summary of main findings
Reinhart
Is there a global financial cycle?
These cycles combine to influence finance around the world
The impact of financial center interest rates on capital
flows depends on the extent of capital market integration at
the time (both globally and at the level of the capital
importer).
Comovement: It is suggestive that two factors explain
about ½ the variation in “global” flows (our priors did not
suggest a single global factor) Reducing these global
factors to a single indicator of the “global financial cycle”
and a single “push” factor consistently influencing finance
is expecting too much.
Reinhart
Other highlights of our findings
International capital flow cycles have displayed similar patterns over the past 200
years. The magnitudes of the booms are comparable to the busts while booms last
longer than the often abrupt busts (9 years versus 5 years)
The cross-country “incidence” of capital inflows (and reserve accumulation)
suggests the cycle has become more global or inclusive
Real interest rates were 4-to-10 times as volatile pre-WWII as in the more modern
era and cycles were distinctly differ. Nominal rates were far more stable and
“cyclical” in the 19th century.
Capital flow and commodity flow booms often overlap with lower interest rates in
the financial center. These “triple bonanzas” are often followed by “triple busts” and
rising defaults. All of the six major spikes in new defaults (1800-2016) occurred
after a global capital inflow bonanza ended.
The connection of sovereign defaults with commodity cycles is not as systematic as
with capital flows.
All but 2 (1890s and the present one) of the double busts in commodities and capital
flows overlapped with a spike in “global” interest rates.
Reinhart
The Global Capital Flow Database, 1815-2016
1918 - 2016: net flows using current account (CA) and
reserves (gold and FX)
Construct capital account from BOP identity:
CA + KA + ∆RA≡ 0
- Interwar: UN / League of Nations data for 34 countries
- Post-WW2: own constructed series for 61 capital-importing
countries and 7 capital exporters (some series back to 1800s)
- Eurozone post-1999: incorporate Target2 as reserves to
capture within-EZ capital flows
1815-1914: gross flows based on bond issuance
- 1869-1914: UK capital exports to 25 countries Stone (1999)
- 1815-1868: sovereign bond issuance in London, 38 countries,
own data, multiple sources
Reinhart
Other data and ongoing work
o Also constructed the capital account balance for the larger
sample of 145 countries, 1980-2016
o Non-oil primary commodity prices, 1790-2016
o Nominal/real short-/long-term interest rates in financial centers
o Chronologies of regulation/debt management in fin. centers
o New and existing sovereign defaults
o Indices of capital mobility
In progress:
o Integrating gross flows (US, 1920-1930, bank loans 1970-
1980, post-1990 data e.g. Forbes and Warnock)
o Financial conditions in “secondary” financial centers –
expanding role of China
Reinhart
Capital flow cycles: Magnitudes of flows, 1815-2016
Reinhart
Capital flow cycles: Incidence of cross border flows (How “global” is “global”? Capital mobility matters)
Reinhart
0
10
20
30
40
50
60
70
80
18
15
18
21
18
27
18
33
18
39
18
45
18
51
18
57
18
63
18
69
18
75
18
81
18
87
18
93
18
99
19
05
19
11
19
17
19
23
19
29
19
35
19
41
19
47
19
53
19
59
19
65
19
71
19
77
19
83
19
89
19
95
20
01
20
07
20
13
Share of countries issuing
at least one bond
or syndicated loan
(gross flows > 0)
solid line
Share of countries with
net capital inflows,
dashed line
World Wars
are shaded
percent
Co-movement of capital flows across countries Factor Analysis and Principal Components, 1870-2016
Reinhart
Not a WOW…. but two factors explain about
½ of the variation in “global” flows – now and then
Percent
ExplainedTotal
Percent
ExplainedTotal
First Factor 26% 26% 32% 32%
Second 24% 50% 18% 51%
Third 17% 67% 13% 64%
1870 - 1914 1950 - 2016
The interaction of cycles
in capital flows and…
1) interest rates in financial center
and global financial conditions
2) commodity prices (non-oil)
3) sovereign default
Early 19th century: capital flows & long-term rates Debt management matters: Debt conversions in the UK helped
foster the search for yield in the periphery
Reinhart
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
0
5
10
15
20
25
30
35Share of countries issuing
at least one bond
(bars, right axis)
Yield on a UK consol
(dashed line)
Coupon decline in four successful
debt conversions from 5 to 3%
(solid line, left axis)
Interest rates and capital flows: 1870-present
The post-war era of capital
controls stands out for the
absence of boom-bust in
international capital flows.
Reinhart
Reinhart
Share of Developing or Emerging Market Countries with Reserve
Accumulation Greater than 15% over 3 Years (47 countries),
and Real US Federal Funds Rate: Peaks and Troughs, 1960-2016
Real rate, Percent Share of countries
10
20
30
40
50
60
70
80
90
100
-6
-4
-2
0
2
4
6
8
10
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Reseves
solid line
right scale
Interest rates
dashed line
left scale
“Global” interest rates and capital flows
1815-2016 – the role of capital moblity
Time Period 1815 - 1869 1870 - 1914 1918 - 1975 1976 - 2016
Capital Mobility Low High Low High
post-1820
defaults
Gold standard,
financial global.
Wars and capital
controls
Rising to a
new peak
Real interest rate 0.216 -1.317** 0.582* -0.936***
in financial center (0.163) (0.494) (0.305) (0.327)
Observations 53 45 50 41
R2 0.023 0.098 0.114 0.120
Notes: The dependent variable is the value of global capital flows as percent of GDP. The explanatory variable is the
interest rate in the financial center (UK until 1918, US thereafter, see Data Appendix) Robust s.e. in parentheses. *, **, and
***, indicate significance at the 10%, 5% and 1% - level, respectively.
The relationship between capital flows and sovereign
default goes in both directions. Furthermore, defaults can
dampen the role of international interest rates
Reinhart
Commodity cycles: 1790-2016 (real, non-oil prices)
Reinhart
-60
-40
-20
0
20
40
60
80
1795 1815 1835 1855 1875 1895 1915 1935 1955 1975 1995 2015
Per
cen
t ch
an
ge
Trough-to-peak (boom) and peak-to-trough
(bust) changes in real commodity prices
(percent)
Commodity Booms:
Trough-to-peak increase ≥ 15%
Commodity Busts:
Peak-to-trough declines ≥ 15%
Reinhart
Example: Interwar – Capital Flows & Defaults
-4
-2
0
2
4
6
8
10
12
0
5
10
15
20
25
30
35
40
45
50
1922 1924 1926 1928 1930 1932 1934 1936 1938
Per
cent
of
GD
P
Per
cen
t
Net capital inflows
(26 debtor countries)
as a % of UK GDP
(bars, right scale)
Share of
sovereigns
entering
a new default,
(5-year sum)
(line, left scale)
Dangerous liasons: commodity and capital flow
“double busts” and sovereign defaults
Reinhart 21
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
0
5
10
15
20
25
30
35
40
45
50
1815 1830 1845 1860 1875 1890 1905 1920 1935 1950 1965 1980 1995 2010
Per
cent
of
countr
ies
ente
ring a
new
def
ault
Share of
sovereigns
entering a
new default
3-year sum
solid line
“Double Busts”
joint declines in
capital flows and
commodity prices
(>1 year)
red shading
The current cycle
in historical perspective
Reinhart
Reinhart
Share of New Defaults before and after capital flow
surges, 1815-2016
Despite the magnitude of the recent boom and
reversal, the increase in defaults is modest.
0
5
10
15
20
25
1824 1834 1843 1852 1865 1873 1890 1897 1914 1929 1938 1979 1991 2011
Per
cen
t
Peak 1-2 years later Size of boom
Share of new defaults at
peak capital inflows (stripe)
Share of defaults
1-2 years post-peak (pale)
Magnitude of capital
inflow boom (dark)
Double and Triple Busts
and the “missing” defaults since 2011
Double bust Capital flow Commodity Interest Rate Share of Countries
episodes Bust Bust Spike (real)? in Default
(in peak year)
1824 - 1828 yes yes yes 43.75
1890 - 1894 yes yes no 18.60
1914 - 1918 yes yes yes 17.65
1929 - 1933 yes yes yes 46.43
1981 - 1986 yes yes yes 42.74
1991 - 1999 yes yes yes 46.34
2011 - 2016 yes yes no 13.82
About 15-20 new defaults “missing” since 2011 (in hist. comparison)
• Lower rates (post inflation stabilization in US)?
• Better macroeconomic management? Mismeasurement?
• China’s emergence as a push factor (both real and in finance)?
Reinhart
Some (not necessarily) mutually exclusive
hypotheses for the missing defaults
Better macroeconomic management, including macroprudential
and more hedging. Frankel and Vegh (2013), McGettigan et al.
(2015) on fiscal and monetary policy. Ostry, Ghosh and Qureshi
(2012 and 2016) and Cerutti, Claessens and Laeven (2016) on
macroprudential and Donders et al (2017) on private
commodity hedging, among others.
Better luck, external factors have remained more favorable than
in past cycles
low interest rates in US and other advanced economies
high growth in China (the newest push factor)?
Mismeasured (under-reported) defaults (Reinhart and Trebesch,
2016, arrears on official creditors. Arrears on Chinese lending
to low income commodity producers?
Reinhart
Vulnerability to Changes in International Interest
Rates, 1970-2016
Reinhart
20
25
30
35
40
45
50
55
197
0
197
1
197
2
197
3
197
4
197
5
197
6
197
7
197
8
197
9
198
0
198
1
198
2
198
3
198
4
198
5
198
6
198
7
198
8
198
9
199
0
199
1
199
2
199
3
199
4
199
5
199
6
199
7
199
8
199
9
200
0
200
1
200
2
200
3
200
4
200
5
200
6
200
7
200
8
200
9
201
0
201
1
201
2
201
3
201
4
201
5
201
6
Perc
ent
Share of variable rate
external debt, 137
developing and EMs
Reinhart
China’s inroads in
world trade are widely
recognized and cuts
across advanced and
emerging economies
and nearly all regions.
Shares of China in BIS
broad effective
exchange rate indexes
based on bilateral trade
shares.
0 10 20 30 40
AlgeriaArgentinaAustralia
AustriaBelgium
BrazilBulgariaCanada
ChileChina
Chinese TaipeiColombia
CroatiaCyprus
Czech RepublicDenmark
EstoniaEuro area
FinlandFrance
GermanyGreece
Hong Kong SARHungary
IcelandIndia
IndonesiaIreland
IsraelItaly
JapanKoreaLatvia
LithuaniaLuxembourg
MalaysiaMalta
MexicoNetherlands
New ZealandNorway
PeruPhilippines
PolandPortugalRomania
RussiaSaudi Arabia
SingaporeSlovakiaSlovenia
South AfricaSpain
SwedenSwitzerland
ThailandTurkey
United Arab EmiratesUnited Kingdom
United StatesVenezuela
2011-13
1993-95
Percent
Shares in the FRB broad exchange rate index for
the US based on bilateral trade shares, percent
Reinhart
57
26 22
1 0
10
20
30
40
50
60
70
2018201320082003199819931988198319781973
Other important trading partners of which China
Trade inroads have their counterpart in China’s
International Lending—especially low income countries: Estimated Share of Total Cross-Border Claims as of 2016:Q1
Reinhart
0 20 40 60 80 100
AlgeriaAngola
BeninBotswana
Burkina FasoBurundi
CameroonCape Verde
ChadCongo
CongoDRCote D'Ivoire
DjboutiEgypt
EthiopiaGabon
GambiaGhana
GuineaKenya
LesothoLiberia
MadagascarMalawi
MaliMauritania
MoroccoMozambique
NamibiaNiger
NigeriaRwanda
SeychellesSierra Leone
So AfricaSudan
TanzaniaTogo
TunisiaUgandaZambia
ZimbabweAverage
Percent of all external claims
0 10 20 30 40 50 60 70 80 90
Bangladesh
Cambodia
China
India
Indonesia
Korea
Laos
Malaysia
Mongolia
Myanmar
Nepal
Pakistan
Philippines
Sri Lanka
Thailand
Vietnam
Average
Percent of all external claims
Africa
Asia
Are some of these official Chinese
loans in arrears?
Currency Composition of Public and Publicly
Guaranteed Debt: All Other Currencies:
Renminbi’s Growing Share?
Reinhart
8
9
10
11
12
13
14
15
16
17
Percent
The Incidence of Default With and Without Official Creditors:
1952-2016
Defaults and arrears to non-China official creditors are much higher
than commonly reported—but still no recent upturn
Reinhart
There is evidence to suggest that the macroeconomic
management of capital inflow surges has been improving in
emerging markets as a whole.
Yet, one has to recall that prior to the Global Financial Crisis
of 2007-2009, a widely accepted view was that the advanced
economies had tamed the business cycle. This was the short-
lived era of the so-called “Great Moderation.”
Perhaps, the change is structural but a cautious interpretation
the missing defaults is that the protracted nature of the
downturn in international conditions has yet to take its
cumulative toll or lingering weaknesses will only become
evidence once the major central banks move further along in
renormalizing the stances of their policies.
Reinhart