Soaring debt levels in advanced economies, overheating emerging markets and strict capital controls are among the global economic and financial challenges faced by financial planners, according to Thomas Hockin, executive director, International Monetary Fund, speaking at the CIFPs 9th Annual National Conference-2011, in Ottawa.
“We’ve had 22 financial crises since 1945; financial crisis is the new normal, what’s abnormal is to go a decade without one,” said Hockin. “But if anyone can track this all intelligently and have a chance to help clients through it, it’s the disciplined CIFPs.”
Hockin identified five unique and powerful forces that are affecting the current uneven global economic recovery. These forces are not necessarily ones that investors and planners read about in the mainstream media.
The G-20 matters because it makes up 85% of the worldwide output and provided a forum to co-ordinate a response to the global financial crisis.
“That is worth watching, worth monitoring and worth knowing when you talk to your clients. It’s a good sign [and] it’s an important force that’s too often overlooked.”
Tsunami of capital
Capital flows by 2008 had reached levels never before seen in the global economy. They remain very high today, but Hockin advises caution. “You’ve got to be careful; there’s some good news and bad news,” he said.
Commercial lending in emerging markets, record foreign direct investment into emerging markets, monetary and quantitative easing in the U.S., and portfolio investments from individuals are all factors significantly contributed to global capital flows. But, says Hockin, all that has also led to some idiosyncratic results.
“We now have spreads between high yield bonds and investment grade bonds at the lowest level ever,” he said. “Is that realistic? You have to watch that very carefully. Advanced economy portfolio flows into higher yield products in emerging markets are very fickle.”
Fund flow patterns in emerging markets can quickly move from an flood of investment to a trickle. “This means we could create huge asset bubbles,” he said. “Foreign direct investment is more sticky, but portfolio investment is very choppy and that has implications for the kind of advice you give.”
Hockin warns that the tsunami of capital flows has raised new challenges. Major emerging markets such as China, India and Brazil have capital controls in place, restricting investors’ ability to pull money out of the economy. “They can be dealt with, but they must be recognized.”
Canada’s net debt to GDP is 35%, one of the best in the industrialized world. “We are unique because we have funded pension plans in this country,” he said. “This is not true in Europe – France, Germany, Belgium, Italy – all those pensions are pay as you go.”
This has resulted in a tremendous debt bubble that has to be funded somehow, and 50% of the advanced economy debt is held by China and emerging economies, he added.
The 2008 crisis showed us that “we had far too much leverage in the system and far less capital than was needed.”
There is no doubt that deleveraging is underway. To some extent, this will slow the economy, but it also removes some vulnerability.
“The big story here is that we’re starting to set the stage for more capital and less dangerous leveraging in this system.”
“Banking credits are flowing big time in merging markets,” said Hockin. “Major banks in China and Brazil have expanded their balance sheets by more than a 100% in the last three years so we have a tremendous amount of new credit flowing in the emerging markets.”
While Canada has managed to skate through the global recession virtually unscathed, Hockin warns that we remain vulnerable to U.S. slow down.
Finally, according to the IMF, Canada must have in Ottawa, a federal securities commission that can deal with systemic crises. “Canada needs a focus at the federal level on securities regulation,” said Hockin. “The next crisis that hits us, we must be centrally prepared for it.”