The chief economist to the IIF, a bankers’ lobby group, knows a thing or two about international financial diplomacy, as a former deputy director of the IMF research department and in his capacity, until July, as assistant secretary for international finance at the US Treasury, where he played a role in shaping the US response to European bailout packages and the Arab Spring.
In an interview with Euromoney on the occasion of the annual meetings of the World Bank and IMF in Washington DC, Charles Collyns discusses the US’s fiscal health, tapering and international financial diplomacy.
As an economist to a lobby group that has consistently warned about the negative unintended consequences of tighter financial regulation, you are presumably a staunch free-market economist. How would you characterize your economic school of thought?
I am in the mainstream school of economic thought, as it has evolved in the past 20 years. We need in-depth analysis rather than a pre-existing ideological perspective.
For example, with respect to the austerity debate, I am sympathetic that you need to care about short term as much as the long term. So I am a Keynesian. You need to create a balance between giving necessary support to economies to recover while putting in place the underlying structures to reassure markets about fiscal sustainability.
How would you characterize the US’s fiscal health?
In the US this year we are going through a consolidation that is much more rapid than intended because of the political cycle. But good news is that the US private sector has healed sufficiently so the economy did not tank despite the equivalent of 3% of GDP fiscal contraction.
By contrast, in Europe, they got the balance wrong. They put all the pressure on reducing the deficit rather than putting in place a structure to reduce the deficit over time. That put a lot of pressure on the financial sector and caused major problems in the European periphery. The European trajectory would have been much less devastating if they had a more moderate and calibrated approach.
Markets seem to be sanguine about US sovereign-debt sustainability, but influential characters, such as Niall Ferguson, the Harvard professor, continue to sound the alarm. What’s your view?
The Europeans don’t really appreciate the underlying strength of the US fiscal position. They say you should have a balanced budget framework in place. But the US has its own approach: legislation that sets clear rules on spending, based on a dispassionate analysis by the CBO, which reassures markets. Even without the sequestration, fiscal consolidation was on track.
What about the debt-ceiling debate?
A deal will be cut last-minute. We have seen this through a couple of times before and it’s scary. Defaulting would clearly be catastrophic. The key uncertainty is whether the fiscal outlook will be resolved or whether we will be replaying this episode. In the event of continued fiscal uncertainty, it will be damaging for financial markets and further reduce business investment. So, instead of getting a nice rebound in investment next year, you could see continued weakness.
The US prides itself in its intellectual leadership. Do you think its moral authority has been damaged by the partisan gridlock in Washington?
US officials take strong intellectual positions on international forums. But it does undermine our soft power whenever the US does not deliver a smooth fiscal trajectory and has difficulties in passing reforms. For example, the US led the charge to advance IMF reforms and now we [Congress] are blocking these reforms.
If there is a nuclear accident [a US sovereign default] then clearly Chinese or Japanese reserve managers will be re-thinking their Treasury investments.
The IIF has warned about negative unintended consequences from prolonged central-bank stimulus, given the prospect for asset market bubbles. What’s your view?
We don’t want to kill the goose that lays the golden egg.
It’s hard to pre-judge the point in which the Fed will take a view on winding down its monthly asset-purchase programme, but we are getting to the point where, in theory, the Fed is right about considering that option.
And if we go over this fiscal uncertainty, then pretty soon it will be appropriate to take the tapering decision, but the key is to do this in a transparent way to give markets confidence.
The IIF projects that capital inflows will drop to $1.062 trillion in 2013 and to $1.029 trillion in 2014, from $1.145 trillion in 2012, in part due to the prospect of tighter US monetary conditions. Sentiment towards China’s economy will also be a factor in shaping the capital-flow cycle in emerging markets. What’s your view on Beijing’s reform agenda?
In the short term, China is doing okay, will benefit from the US rebound and policymakers have tools to keep the economy going. We are worried, however, about the moral-hazard problem and the pace of credit growth in the shadow banking system. The Chinese need to reform the financial system to ensure credit is invested in productive sectors.
The Chinese need to embark on a series of major reforms and open up sectors. So the real question is what will happen in November [the plenary session of the 18th Party Congress in China]. When we were in Beijing recently, we received signals that they might not get to grips with some major reforms given political risks, such as opening up SOE monopolies and reforming the hukou system [the household-registration system].