More than two years since the onset of the worst recession since the 1930s, advanced economies are starting to revive -- at a snail's pace.
While respectable growth is expected of the global economy -- nearly 5 percent this year and more than 4 percent next year -- demand is still weak in many advanced countries and unemployment still lingers at or near the double digits in both the United States and the Euro zone, according to the International Monetary Fund (IMF)'s World Economic Outlook released on Wednesday.
While a rebound is proceeding, experts fear any number of factors -- from debt consolidation to anti-trade sentiment -- could damage the still fragile recovery.
FISCAL CONSOLIDATION
According to the IMF, the main challenge for advanced economies is fiscal consolidation.
"What is essential here is not to so much to phase out fiscal stimulus now, but to offer a credible medium term plan for debt stabilization, and eventually for debt reduction," said the IMF's chief economist Olivier Blanchard at a press briefing on Wednesday.
Still, many will be reluctant to cut spending if growth is weak, and there are risks in cutting spending too soon.
Dean Baker, co-director of the Center for Economic and Policy Research, said the greatest risk to the recovery is the push to austerity in much of Europe and even in the United States, as the end of the stimulus will be contractionary.
"This could very well upend an extremely weak recovery," he said.
HOUSING
Diane Swonk, chief economist at Mesirow Financial, said weakness in the U.S. housing market will impact the global recovery for some time to come, as the level of activity in this crucial sector of the world's largest economy will be so muted that it will hold down growth.
Indeed, the level of current housing sector activity is more consistent with a recession, she said.
A large chunk of the millions of American jobs lost in this recession have been in the construction industry, and the housing sector continues to be a major factor holding down employment, as it is not reviving enough to create a sufficient number of jobs, she said.
VARIED PACE OF GROWTH
The IMF is also urging more coordination between developed and developing economies, as the two worlds are seeing very different levels of growth.
Blanchard said on Wednesday that demand in developed world nations remains weak, as people are saving more and spending less, while emerging economies are rebounding at a much faster clip.
The IMF forecasts sluggish growth for advanced economies, at 2. 7 percent for 2010 and 2.2 percent for 2011. For the Euro area, a 1.7 percent growth is forecast for this year and 1.5 percent for 2011.
But in emerging economies, consumption and investment are contributing to strong growth, which as a whole is forecast to reach 7.1 percent in 2010 and 6.4 percent for 2011, according to IMF statistics.
"Sustained, healthy recovery rests on two rebalancing acts: internal rebalancing, with a strengthening of private demand in advanced economies, allowing for fiscal consolidation; and external rebalancing, with an increase in net exports in deficit countries, such as the United States, and a decrease in net exports in surplus countries, notably emerging Asia," according to the World Economic Outlook.
Many interpret this to mean that a part of the IMF's push for a "rebalancing" should involve appreciating the Chinese Yuan.
But Chinese Premier Wen Jiabao on Wednesday urged European leaders in Brussels to refrain from pushing for a stronger Chinese currency.
"If the yuan is not stable, it will bring disaster to China and the world," he said in a speech. "I say to Europe's leaders: Don't join the chorus pressing to revalue the yuan."
"If we increase the yuan by 20 percent or 40 percent, as some people are calling for, many of our factories will shut down and society will be in turmoil," he said.
IMF Chief Dominique Strauss-Kahn on Friday urged nations not to succumb to a currency war.
RISING TIDE OF ANTI-TRADE FEELING
Perhaps the greatest threat to recovery in the long run, according to some economists, is growing populist sentiment against international trade, which is on the rise in the United States.
"This issue seems to be unraveling quickly. And we know from history that protectionism shrinks the economy and does not increase the economy," Swonk said.
"We got ourselves into this mess together, and the only way out of it is to coordinate policies across borders and instead we are all starting to throw stones and we all live in glass houses," she said.
Ralph C. Bryant, senior fellow at the Brookings Institution, said such feelings are worrying.
"It's very easy to look at foreigners and say 'you're preventing us from exporting' and there have been times in history when it has had adverse effects," he said.
UNANSWERED QUESTIONS
Still, the fundamental question at the heart of the global economic recovery remains unanswered: where is demand going to come from?
Ben Carliner, director of research at the Economic Strategy Institute, said the global economy has not yet adjusted to a decrease in demand from the developed world.
The continuing efforts in the United States and Europe to recover from systemic financial crises have left consumers, banks and public sectors struggling to improve their balance sheets, he said.
As these efforts depress aggregate demand, easy monetary policies, in the form of low nominal interest rates and in some cases quantitative easing, are and will continue to be used to offset the demand shock, he said.
For emerging economies that depend on exports of manufactured goods, the principal challenge is how to respond to this external shock, as foreign demand for emerging world exports has dried up, he said.
IS THERE HOPE?
In spite of the many risks that could derail a recovery, there may be some good news on the horizon, some economists said.
The countries that did not experience the drastic slowdown via housing will most likely be able to perform much better, said Andy Busch, a global currency and public policy strategist at BMO Capital Markets.
While unemployment is high in the United States, a new congress will be voted in November, and could move to settle down some of the uncertainties for small business, which some economists say are unable to make hiring decisions because they do not know what legislation will come out of Washington next.
"That will lead to faster growth than many people are anticipating right now," he said. Still, not all economists agree with that assessment, and some observers predict that Congress will continue to be deadlocked along party lines after the elections.
Source: Xinhua
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Saturday, October 9, 2010
Beggaring the world economy
COMMENT
By RAGHURAM RAJAN
GLOBAL capital is on the move. As ultra-low interest rates in industrial countries send capital around the world searching for higher yields, a number of emerging market central banks are intervening heavily, buying foreign capital inflows and re-exporting them to keep their currencies from appreciating.
Others have been imposing capital controls of one stripe or another. In recent weeks, Japan became the first large industrial economy to intervene directly in currency markets.
Why does no one want capital inflows? Which intervention policies are legitimate, and which are not? And where will all this intervention end if it continues unabated?
The portion of capital inflows that is not re-exported represents net capital inflows. This finances domestic spending on foreign goods.
So, one reason countries do not like capital inflows is that it means more domestic demand “leaks” outside. Because capital inflows often cause the domestic exchange rate to appreciate, they encourage further spending on foreign goods as domestic producers become uncompetitive.
Another reason is that some of it might be “hot” (or dumb) money, eager to come in when foreign interest rates are low and local asset prices are rising, and quick to leave at the first sign of trouble or when opportunities back home beckon.
Volatile capital flows induce volatility in the recipient economy, making booms and busts more pronounced than they would otherwise be. But, as the saying goes, it takes two hands to clap.
If countries could maintain discipline and limit spending by their households, firms or governments, foreign capital would not be needed, and could be re-exported easily without much effect on the recipient economy.
Countries can overspend for a variety of reasons. The stereotypical Latin American economies of yesteryear used to get into trouble through populist government spending, while the East Asian economies ran into difficulty because of excessive long-term investment.
In the United States, in the run up to the current crisis, easy credit – especially for housing – induced households to spend too much, while in Greece, the government borrowed its way into trouble.
Unfortunately, though, so long as some countries like China, Germany, Japan, and the oil exporters pump surplus goods into the world economy, not all countries can trim their spending to stay within their means. Since the world does not export to Mars, some countries have to absorb these goods, and accept the capital inflows that finance their consumption.
In the medium term, over-spenders should trim their outlays and habitual exporters should increase theirs. In the short run, though, the world is engaged in a gigantic game of passing the parcel, with no country wanting to take the habitual exporters’ goods and their capital surpluses.
This is what makes today’s beggar-thy-neighbour policies so destructive: though some countries will eventually have to absorb the surpluses and capital, each country is trying to avoid them.
So which policy interventions are legitimate? Any policy of intervening in the exchange rate, or imposing import tariffs or capital controls, tends to force other countries to make greater adjustments. China’s exchange rate intervention probably hurts a number of other emerging market exporters that do not intervene as much and are less competitive as a result.
But industrial countries, too, intervene substantially in markets. For example, while US monetary policy intervention (yes, monetary policy is also intervention) has done little to boost domestic demand, it has spurred domestic capital to search for yield around the world.
The US dollar would fall substantially – encouraging greater exports – were it not for the fact that foreign central banks are pushing much of that capital right back by buying US government securities.
All this creates distortions that delay adjustment – exchange rates are too low in emerging markets, slowing their move away from exports, while the ease with which the US government is being financed creates little incentive for US politicians to reduce spending over the medium term.
Rather than intervening to obtain a short-term increase in their share of slow-growing global demand, it makes sense for countries to make their economies more balanced and efficient over the medium term.
That will allow them to contribute in a sustainable way to increasing global demand. China, for example, must move more income to households and away from its firms, so that private consumption can increase.
The United States must improve the education and skills of significant parts of its labour force so that they can produce more of the high-quality knowledge and service-sector exports in which the United States specialises. Higher incomes would boost US savings, reducing households’ dependence on debt, even as they maintained consumption levels.
Unfortunately, all this will take time, and citizens impatient for jobs and growth are pressing their politicians. Countries around the world are embracing shortsighted policies that cater to the immediate needs of domestic constituencies.
There are exceptions. India, for example, has eschewed currency intervention thus far, even while opening up to long-term rupee debt inflows, in an attempt to finance much-needed infrastructure projects.
India’s willingness to spend when everyone else is attempting to sell and save entails risks that need to be carefully managed. But India’s example also provides a glimpse of what the world could achieve collectively.
After all, beggar-thy-neighbour policies will succeed only in making us all beggars. — © Project Syndicate
Raghuram Rajan, a former chief economist of the IMF, is professor of finance at the Booth School of Business, University of Chicago, and author of Fault Lines: How Hidden Fractures Still Threaten the World Economy.
Others have been imposing capital controls of one stripe or another. In recent weeks, Japan became the first large industrial economy to intervene directly in currency markets.
Why does no one want capital inflows? Which intervention policies are legitimate, and which are not? And where will all this intervention end if it continues unabated?
The portion of capital inflows that is not re-exported represents net capital inflows. This finances domestic spending on foreign goods.
So, one reason countries do not like capital inflows is that it means more domestic demand “leaks” outside. Because capital inflows often cause the domestic exchange rate to appreciate, they encourage further spending on foreign goods as domestic producers become uncompetitive.
Another reason is that some of it might be “hot” (or dumb) money, eager to come in when foreign interest rates are low and local asset prices are rising, and quick to leave at the first sign of trouble or when opportunities back home beckon.
Volatile capital flows induce volatility in the recipient economy, making booms and busts more pronounced than they would otherwise be. But, as the saying goes, it takes two hands to clap.
If countries could maintain discipline and limit spending by their households, firms or governments, foreign capital would not be needed, and could be re-exported easily without much effect on the recipient economy.
Countries can overspend for a variety of reasons. The stereotypical Latin American economies of yesteryear used to get into trouble through populist government spending, while the East Asian economies ran into difficulty because of excessive long-term investment.
In the United States, in the run up to the current crisis, easy credit – especially for housing – induced households to spend too much, while in Greece, the government borrowed its way into trouble.
Unfortunately, though, so long as some countries like China, Germany, Japan, and the oil exporters pump surplus goods into the world economy, not all countries can trim their spending to stay within their means. Since the world does not export to Mars, some countries have to absorb these goods, and accept the capital inflows that finance their consumption.
In the medium term, over-spenders should trim their outlays and habitual exporters should increase theirs. In the short run, though, the world is engaged in a gigantic game of passing the parcel, with no country wanting to take the habitual exporters’ goods and their capital surpluses.
This is what makes today’s beggar-thy-neighbour policies so destructive: though some countries will eventually have to absorb the surpluses and capital, each country is trying to avoid them.
So which policy interventions are legitimate? Any policy of intervening in the exchange rate, or imposing import tariffs or capital controls, tends to force other countries to make greater adjustments. China’s exchange rate intervention probably hurts a number of other emerging market exporters that do not intervene as much and are less competitive as a result.
But industrial countries, too, intervene substantially in markets. For example, while US monetary policy intervention (yes, monetary policy is also intervention) has done little to boost domestic demand, it has spurred domestic capital to search for yield around the world.
The US dollar would fall substantially – encouraging greater exports – were it not for the fact that foreign central banks are pushing much of that capital right back by buying US government securities.
All this creates distortions that delay adjustment – exchange rates are too low in emerging markets, slowing their move away from exports, while the ease with which the US government is being financed creates little incentive for US politicians to reduce spending over the medium term.
Rather than intervening to obtain a short-term increase in their share of slow-growing global demand, it makes sense for countries to make their economies more balanced and efficient over the medium term.
That will allow them to contribute in a sustainable way to increasing global demand. China, for example, must move more income to households and away from its firms, so that private consumption can increase.
The United States must improve the education and skills of significant parts of its labour force so that they can produce more of the high-quality knowledge and service-sector exports in which the United States specialises. Higher incomes would boost US savings, reducing households’ dependence on debt, even as they maintained consumption levels.
Unfortunately, all this will take time, and citizens impatient for jobs and growth are pressing their politicians. Countries around the world are embracing shortsighted policies that cater to the immediate needs of domestic constituencies.
There are exceptions. India, for example, has eschewed currency intervention thus far, even while opening up to long-term rupee debt inflows, in an attempt to finance much-needed infrastructure projects.
India’s willingness to spend when everyone else is attempting to sell and save entails risks that need to be carefully managed. But India’s example also provides a glimpse of what the world could achieve collectively.
After all, beggar-thy-neighbour policies will succeed only in making us all beggars. — © Project Syndicate
Raghuram Rajan, a former chief economist of the IMF, is professor of finance at the Booth School of Business, University of Chicago, and author of Fault Lines: How Hidden Fractures Still Threaten the World Economy.
Currency wars at a time of deficient demand
WHAT ARE WE TO DO
By TAN SRI LIN SEE-YAN
LAST week, Brazil’s finance minister said: “We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness.”This says it all. The International Monetary Fund has since warned of widespread currency interventions which could derail the fragile recovery. Many nations are engaged in policies to weaken their currencies. Further competitive devaluation will inflame global tensions.
At a time of continuing deficient demand, this is not the time for the world’s major currencies to face off in what can only be described as an “ugly contest”.
By the third quarter of this year (Q3), attention had shifted from the deep woes engaging the eurozone to re-emerging economic and fiscal fissures in the United States.
This sudden re-orientation of focus helped the euro reverse most of its springtime collapse, and saw the US dollar lose more lustre.
Then there is the ever-strong yen. Japan is faced with a deep economic malaise and is anxious to ease exporters’ burden. It is not surprising that Q3 highlighted the standoff over which of the three most actively traded currencies has the lousiest outlook.
The euro hit a new low against the US dollar (1.1917) on June 7 and for the first half of 2010, it was 15% from where it started the year.
But the euro rose 11.5% in Q3. Against the yen, the US dollar fell to a 15-year low (83.10 yen) in mid-September. That prompted the unleashing of a US$20bil blitz of yen selling, driving it off its high.
The yen has since returned to its pre-intervention rate. The end result: the US dollar not only slid against the euro and the yen, but also fared worse against most emerging market currencies.
When measured against a basket of major currencies, the US dollar sank to its lowest level since January. By Oct 5, the ICE Dollar Index was below 78, against 88 in June.
The grass gets crumpled
This is not the first time we see a currency conflict. In August 1971, the “Nixon shock” ended US dollar convertibility to gold. In September 1985, the Plaza Accord devalued the US dollar, notably against the yen. This time around, the target is the Chinese yuan.
The East has a saying – when tigers fight or make love, the grass gets crumpled. The United States has pressed hard on China to revalue faster; the European Union (EU) and Australia have since raised the volume of their rhetoric on China. Meanwhile, others have been intervening to hold their currencies down.
Australia warned Europe against reviving protectionism masquerading as environmentalism. The situation can only get worse. Already, the Institute of International Finance (IIF), representing 420 leading financial institutions, just revised upwards its latest forecast for net inflows of capital into emerging markets, showing a sharp increase to US$825bil for 2010. All in search of higher yields, thereby risking instability.
Of course, the United States and EU blames all this on China. But many emerging economies blame ultra-low interest rates in rich countries (reflecting aggressive quantitative easing, or QE) for diverting vast amounts of cheap funds to their domestic markets, creating a policy dilemma for most.
Their economies are growing nicely in the face of rising inflation. This limits the use of interest rates to curb these funds inflow.
On Oct 4, Brazil doubled a tax on foreigners’ purchases of local bonds. Australia and Indonesia kept their benchmark rates unchanged to ward off further inflows. The Philippines is expected to hold their rates. India and Thailand are considering new steps of protection.
The big problem remains. Globally, ad hoc currency interventions don’t work. At its heart is the US dollar, trapped in a downward spiral as expectations of further monetary easing by the Federal Reserve Bank (Fed) drags it lower.
The global architecture is broken. But how best to move away from a system where the US dollar plays the role of a major reserve currency and the United States sets global interest rates?
It looks like the entire Asian sovereign community is suddenly buying euro and yen – so much so the Japanese on Oct 6 lowered the target for its key overnight rate to 0.0% and 0.1%.
John Connally (Nixon’s Treasury Secretary) says it best when he famously told Europeans that the “US dollar is our currency, but your problem.”
In the absence of currency adjustments, the Chinese response appears to be, in the words of Financial Times’ Martin Wolf: “In effect, the United States is seeking to inflate China and China, to deflate the United States.” It’s a stalemate. The grass continues to get crumpled.
There is now, according to the IIF, “an environment of unilateralism and bilateralism laced with isolation and parochialism.” Somewhat exaggerated, but in essence, correct as I see it.
The yuan scapegoat
Reality check: The developed world suffers from chronic deficient demand. The IMF just cut its growth forecast. The six biggest high-income nations’ gross domestic product (GDP) in Q2 is nowhere near what it was in Q1 of 2008.
They are operating up to 10% below potential. In the United States and eurozone, core inflation is only 1%. Deflation beckons.
Those with trade deficits and surpluses alike all love to have export-led growth. In a zero-sum world, this can only happen if emerging nations shift to run huge current deficits. That’s not about to happen.
Also, the vast accumulation of foreign reserves complicates any meaningful adjustment. Between January 1999 and May 2010, reserves went up by US$6.8 trillion to reach US$8.4 trillion. China accounted for 30% of the world total, or equivalent to 50% of its own GDP. That’s the big picture.
Until the early 1970s, currency rates were fixed under the Bretton Woods monetary system. It fell apart with the US-inspired inflation of the 1970s. So the world moved to floating rates.
But most nations still chose to peg to the US dollar. With the euro, most of Europe moved to fixed exchange rates. Pegging offered the benefits of exchange rate stability, eliminating a source of uncertainty for investment and trade to flourish.
One catch though: pegged nations give up monetary independence. In the US dollar-bloc, they yield to the Fed and in the euro-bloc, the European Central Bank (ECB).
This is what China did when its yuan was pegged to the US dollar. In exchange for the benefits of exchange rate stability, it subcontracted much of its monetary discretion to the Fed.
For more than a decade, this served the world economy well; Americans raised their living standards and millions of Chinese enjoyed prosperity.
For years, the United States had pressed the yuan to revalue in the name of reducing the US trade deficit. What’s not so obvious is that much of this deficit is intra-company trade, that is, US firms outsourcing production to China to stay globally competitive.
Beijing bent for a while in the middle of last decade and adopted a crawling peg, allowing the yuan to revalue by 18% with little impact on US trade deficit. China re-pegged amid the financial panic in 2008. American clamour to revalue revived and the yuan relented and moved to greater “flexibility” last June. Recently, the yuan reached its strongest since 1993 – up 2% to 6.69 per US dollar but fell 10% against the euro. That’s far too slow for the United States and Europeans.
The US trade deficit with China surged to US$268bil in 2008, up from US$202bil in 2005. Currency is but one factor influencing where firms manufacture.
Furthermore, the United States no longer make many of the goods China exports. So a shift in business out of China would more likely mean relocation to other low-cost Asian nations, rather than rebuild US capacity.
The yuan has appreciated 55% against the dollar since 1994, when Beijing begun to overhaul its forex system. That bilateral imbalance is structural. As I see it, the only way the United States can fight off Chinese competitive challenges is to innovate and boost productivity at home.
Both the United States and EU now urge China to allow “an orderly, significant and broad-based appreciation” of the yuan. I think China is right to resist these calls, not least because a large revaluation is likely to damage China’s growth and basic restructuring plans.
China’s continuing expansionary “train” is pulling along growth in East Asia nicely, and to a lesser extent, that of the developed world as well.
“The world has already become partially de-coupled” says Nobel laureate Joseph Stigliz. China has learned from past experience, including that of Japan, which bowed to similar US pressures in the 1980s and 1990s, revaluing the yen from 360 per US dollar to a high 80 in 1995.
According to Stanford’s Prof R. McKinnon, one result was domestic deflation and its lost decades in growth. Meanwhile, Japan continues to run a trade surplus as imports fell with slower growth and cross-border prices adjusted. China helped lead the world out of recession and the world needs that to continue.
What’s China to do?
The media wants us to believe the biggest sinner in this game of beggar-thy-neighbour is China. But, in their own way, the United States, Britain and EU are engaged in much the same thing.
Massive QE has effectively created negative interest rates and debauched their currencies to boot with floods of liquidity. QE proved a highly effective way to devalue the dollar.
Indeed, it is a much more powerful form of persuasion than the threat of tariffs. The very prospect of more QE can rattle China and most of Asia to submission.
But the global imbalances that created the crisis have yet to be addressed by centring criticism on China. Reform of the international monetary architecture is needed to resolve the problem, with a global “clearing” organisation acting independently among nations to manage “surpluses” and “deficits”. This institution is intended to keep the world in balance. This won’t happen.
Maybe, the approach is wrong. I think the real problem is not the yuan’s exchange rate but its inconvertibility and capital controls. As a result, the yuan’s development has been stunted since private markets can’t recycle the flow of dollars arising from continuing large surpluses.
China’s huge reserves represent a significant misallocation of global resources. Instead of letting these reserves find their optimum private investment use, China uses them to buy US Treasuries and bonds.
Once made convertible, capital and trade flows will adjust through private markets rather than the Peoples’ Bank. That’s how Germany recycles its surpluses. In this way, a one-time modest revaluation accompanied by convertibility can assist in the global adjustment process, while avoiding the perils of Japan-like deflation.
Whether China is ready for convertibility of its yuan is a key question. All I can say is that stage-by-stage convertibility increases domestic pressures for China to further liberalise to develop its financial system, which in turn, helps in global rebalancing.
What’s important is for China and the other surplus nations (Germany and Japan) to understand that their policies are not helping the United States to rebalance.
Similarly, the United States and EU need to understand that the surplus nations simply can’t adjust fast enough to suit them.
Resolution requires realistic “grown-up” behaviour on the part of core parties in this dispute to agree to global rebalancing with care and with determination.
For a start, I see merit in the IIF’s call for a new coordinated currency pact by the core parties to hammer out with haste, an understanding to help rebalance the global economy.
It needs a more sophisticated version of the Plaza Accord to include “stronger commitments to medium-term fiscal stringency in the United States and structural reform in Europe.” The world deserves more, not less.
Former banker Dr Lin is a Harvard-educated economist and a British Chartered Scientist who now spends time teaching and promoting the public interest. Feedback is most welcome at
starbiz@thestar.com.my.
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