Lawrence Summers delivered today at the World Bank his presentation “Almost a Free Lunch: Investing Foreign Exchange Reserves in Global Equity Markets”, following similar presentations at the Reserve Bank of India in Mumbai or at the Center for Global Development in Washington DC.
Mr. Summers claims that the flow of capital today is exactly the opposite of what the “International Financial Architecture” had in mind after the World War. Today we see a net flow of capital from the poorer to the richer countries. In particular, large amounts from developing countries are being accumulated as reserves in US Treasury Bonds.
He sees two main problems here:
The amounts that are being kept as reserves in developing countries are too big.
These reserves in US Treasury Bonds have a very low real rate of return, close to zero.
The gap between the return obtained at a typical central bank or what could be obtained with a typical pension portfolio or in stock is around 4 % or 5 % respectively (this gap would be of around 10 % if compared to the return of Harvard’s endowment while he was President).
Therefore, we have some of the most rapidly growing economies in the world, with high percentages of their populations living in poverty, with a “fair amount of money deployed in clearly suboptimal investment”.
And what is the cost of this excess of reserves invested in low yielding US Treasury Bonds? The excess of reserves for the 121 developing countries is, according to Mr. Summers, around $ 2 trillion, or 19 % of their combined GDP. If developing countries where able to deploy 10 % of their GDP in global equity markets that produced a 5 % extra return, the amount earned would clearly exceed the amount spent in foreign aid worldwide.
Food for thought …