The economy: digging into our ‘external imbalance’

  • Figure 1
  • Robert Stubbs

So, where were we? Ah, yes, our “fundamental macroeconomic external imbalance”.

If a nation’s savings exceeds its investment, as ours obviously does, the country has “excess savings”, which it then exports to other countries to fund their investment needs. Other countries will have investment requirements exceeding their savings, and their savings shortfall will be met by importing capital from overseas.

As a planet, we don’t send money to the moon, so some countries are net “capital exporters”, while others are net “capital importers” — and in total their sums must equal.

So now we have introduced a third kind of capital and, for our non-financial readers, we will take a moment to describe this new kind of capital. Last week, we spoke of “physical capital” and “human capital”. This week we’re talking about “investment capital” — and, I promise, this will be the very last kind of capital I introduce.

You can think of “investment capital” as wealth. Wealth includes financial assets such as stocks, bonds and savings deposits, but it also includes assets such as real estate, land, gold bullion, fine art, rare bottles of wine and the numerous other investments acquired by those fortunate enough to require a store of value.

The acquisition of any of these assets in a foreign country is classified as a capital export. If a resident of Bermuda were to use the proceeds of their savings earned on the island to buy shares of an American company traded on the New York Stock Exchange, place a deposit with a bank in Zurich or purchase a house in Dublin, she would be exporting capital from Bermuda to the US, Switzerland or Ireland.

A key distinction to keep in mind is that “investment capital” is title to a financial asset, or to any of the various other assets generally classified as wealth, while “physical capital” is a tangible asset such as a computer, office building, school or airport used by either a household, government or business in the provision of goods and services, and “human capital” are the intangible assets of education and training needed to develop skills And capabilities, and to foster human creativity. Three very different kinds of capital.

And just as Bermuda has the world’s greatest excess of savings over investment, so, too, are our exports of excess savings the very largest in the world. Bermuda’s “fundamental macroeconomic external imbalance” refers to our capital exports, and our external imbalance happens to be the world’s very largest by a long shot (Figure 1).

No other country exports capital in quantities remotely close to Bermuda. In fact, at 20 per cent of GDP, our capital exports are fully five times greater than the level considered excessive by the International Monetary Fund. For a few years before the global financial crisis of 2008, capital exports from the mega-saving China increased alarmingly, rising to as high as 10 per cent of GDP, but Bermuda exports twice as much capital as China ever did at her peak.

And our capital exports are not only of staggering size, they have been sustained for a long period. Just as our savings/investment imbalance widened appreciably in the mid-1990s, so, too, did our export of investment capital. Today, we export capital at these staggering levels year in and year out.

In dollar terms, our capital exports are roughly $1.2 billion annually. Even more astoundingly, this figure is actually “net”. Bermuda’s “net” capital exports are $1.2 billion. Or total capital outflows minus total capital inflows — that is, the total annual foreign investments made by residents of Bermuda in other countries minus the total annual investments of the rest of the world in Bermuda. Our gross capital exports are even larger than $1.2 billion.

At this juncture, we should probably acknowledge Bermuda’s policymakers certainly are not alone in failing to recognise their mistakes. As just about everyone is aware, these are turbulent economic times globally, to say the least, and in recent years many an international policymaker has been forced to fall on their proverbial economic policymaking sword.

Most notably, in the midst of the global financial crisis, the world’s leading economic policymakers at the IMF and World Bank were forced to concede that, rather than promoting their touted aims of economic growth and financial stability, many of their previous policy recommendations were significant contributing factors in precipitating the crisis itself.

Much to the chagrin of its senior leadership, the IMF, in particular, was forced to climb down, backtrack, reverse course and eat crow regarding a number of economic policies it used to push on countries.

Indeed, the events of 2008 set off a series of waves of fundamental, economic policymaking reform worldwide, and perhaps no more so than in the oversight and management of the very external and internal macroeconomic imbalances Bermuda suffers from today.

Originally exacerbated by IMF-sponsored reforms, China’s massive capital exports before 2008 were viewed subsequently as fuelling the US housing bubble at the heart of the crisis. Post-2008, Chinese policymakers implemented a range of policy adjustments, including the imposition of capital controls previously opposed by the IMF, which proved highly successful in reducing China’s capital exports to more prudent levels.

Since 2008, substantial international policymaking resources have been devoted to extensive monitoring and oversight of macroeconomic imbalances. And today, the IMF places far greater importance on the policy reforms and adjustments necessary to prevent imbalances reaching unsustainable levels¹.

Bermuda is hardly immune to these international economic policymaking reforms, with the most visible evidence of their influence to date being the formation of our Financial Policy Council in 2015.

Convening a panel of external experts, Bermuda’s Financial Policy Council meets periodically throughout the year and is charged with recommending policy reforms promoting the island’s economic wellbeing and assessing potential threats to our financial stability.

If Bermuda is to benefit from any of the international policymaking reforms sweeping the world, this is where you would most expect to find it, and indeed you can because our Financial Policy Council has rendered an opinion in no uncertain terms regarding the very internal and external macroeconomic imbalances ailing Bermuda.

More specifically, when asked about attracting additional foreign investment to the island, our panel of experts noted Bermuda’s vast capital exports and advised that we must be able to adopt additional measures encouraging the investment of more of these savings right here at home.

So, there you have it. This advice was communicated to the Bermuda Government as long ago as 2017, so now the question becomes, why has our government failed to act on it?

That’s about all we have time for this week, but before we go, perhaps to calm the nerves of some of the island’s higher-income residents, we should disclose in advance that nowhere in the this series do we broach the vexed subject of exchange controls. Rather, the focus is on those macroeconomic policy adjustments deemed appropriate by international policymaking authorities in obviating the need for exchange controls.

Before considering such policy adjustments, however, next week we will examine our Bermuda policymakers’ response to the Financial Policy Council’s advice regarding our exorbitant capital exports. And, should time permit, we may even get to delve into a few of those mental missteps.

¹International Monetary Fund, 2018 External Sector Report https://www.imf.org/en/Publications/ESR/Issues/2018/07/19/2018-external-sector-report. This is part of a series examining not just the principle causes, but, even more importantly, the appropriate solutions to the island’s economic crisis. Robert Stubbs is an economist, CFA, holds an International Bond Dealer Diploma and has completed the ACAS actuarial exams. He was formerly Head of Research for Bank of Bermuda and his professional interests at present lie in enterprise risk management