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Fed's dilemma, Chinese exports & more...

Apr 11, 2008

  • The US central bank, Federal Reserve having opened up its purse for the distressed Wall Street firm Bear Stearns is now finding the hole in it growing bigger. Venerable Wall Street investment companies are now stepping up their borrowing from the Fed's unprecedented emergency lending program. The Fed reported last week that firms borrowed an average US$ 38 bn daily over the week from the new lending program as compared to US$ 33 bn in the previous week and US$ 13 bn in the first week the lending facility opened. The central bank, for the first time, has agreed to let big investment houses temporarily get emergency loans directly from it. This mechanism, similar to one available for commercial banks for years, will continue for at least six months. It was the broadest use of the Fed's lending authority since the 1930s. While on one hand the Fed has defended this move as being necessary to avert a global financial crisis, on the other economists have warned of severe inflationary pressures going forward, which may require the Fed to increase the interest rates faster than it lowered them.

  • China's exports surged from 20% of GDP in 2001 to almost 40% in 2007, which seems to suggest not only that exports are the main driver of growth, but also that China's economy would be hit much harder by an American downturn than it was during the previous recession in 2001. However, a study conducted by the 'Economist' suggests that if exports are measured correctly, they account for a surprisingly modest share of China's economic growth. The team has tried to estimate exports in value-added terms by stripping out imported components, and then converting the remaining domestic content into value-added terms by subtracting inputs purchased from other domestic sectors. Once these adjustments are made, it is reckoned that the true export share is just under 10% of GDP.

    It is also argued that China's massive current-account surplus (estimated at 11% of GDP in 2007) proves that it produces far more than it consumes and relies on foreign demand to buy the excess. In the six years upto 2004, net exports accounted for only 5% of China's GDP growth while 95% came from domestic demand. But since 2005, the net exports have contributed more than 20% of growth. This is, however, not due to faster export growth, but to a sharp slowdown in imports. The 'Economist' also estimates that even if the contribution from net exports for China fell to zero, China's GDP growth would still be close to 9% per annum thanks to strong domestic demand.

  • The International Monetary Fund (IMF) is contemplating a broad financial overhaul plan that could lead to the eventual sale of a little over 400 tonnes of its substantial gold supplies. The proposed new framework for the fund, designed to close a projected US$ 400 m budget deficit over the next few years, includes sharp spending cuts of US$ 100 m over the next three years as well.

    The IMF is taking this step to revamp the fund's income model from one that primarily relies on lending to one that generates money from various sources. During the 1990s, the IMF lent billions to countries in Asia and Latin America that were facing financial crises and financed its operations on interest from those loans. In the recent years, IMF's lending operations have dried up as many of those countries have built up reserves to prevent them from having to borrow again from the IMF. The declining interest payments have led to the IMF's budget gap.

    Under the plan, the IMF would sell the 403 tonnes or nearly 13 m ounces of gold for about US$ 11 bn over several years. The IMF would keep US$ 4.4 bn on its books, and the remaining US$ 6.6 bn would go into an investment account. The sales would be coordinated with central banks across the world in an effort to prevent market disruptions.


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