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The Global Economy – No. 8/2010
1. The Global Economy
Monthly letter from Swedbank’s Economic Research Department
by Cecilia Hermansson No.8 • 11 November, 2010
Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46-8-5859 7740
E-mail: ek.sekr@swedbank.se Internet: www.swedbank.com Responsible publisher: Cecilia Hermansson, +46-8-
5859 7720, Magnus Alvesson, +46-8-5859 3341, Jörgen Kennemar, +46-8-5859 7730, ISSN 1103-4897
The G20 countries have to put an end to the
world economy’s destructive behaviour
• The global recovery is continuing, with signs of both positive and negative data.
The bright spots in the US include small businesses and the labour market. In
Europe, financial concerns are growing at the same time that budget consolidation
and the stronger euro are hurting growth prospects.
• In many cases, expectations going into to the G20 summit are low. Rhetorically
correct statements, but a lack of practical action, are pretty much what can be
expected. The US has toned down its demands to cap current account surpluses
and deficits, probably to mollify criticism about its new round of quantitative easing.
There is still a risk for a negative spiral of easing, carry trade, capital flows to
emerging countries, capital controls and taxes on derivatives trading, currency
interventions and in the long run potentially protectionism as well. It is vital that the
G20 breaks this destructive pattern and finds a framework that gradually reduces
imbalances.
Global demand: Mixed signals
Data released since our last monthly global letter
have been both positive and negative. Purchasing
managers’ indexes in most large countries – except
Japan – still point to good growth in manufacturing.
Purchasing Managers’ Index (PMI)
Source: Reuters EcoWin
06 07 08 09 10
25
30
35
40
45
50
55
60
65
70
USA
UK
Japan
Euroland
China
India
Sweden
Purchasing Managers Index (PMI) for Industrial Production
In terms of GDP, Western economies are muddling
along, while emerging economies continue their
strong growth, though at a slightly slower rate than
before.
In the third quarter China's GDP grew by 9.6% on
an annual basis, which is not an entirely
undesirable slowdown from just over 11% in the first
half of the year. This could make it hard to maintain
our full-year forecast of 9.8%. It's more likely that
growth this year will exceed 10%. China is
becoming more important as an importer, which
certainly helps export-dependent Western nations.
For the US, it is positive is that confidence among
small businesses rose slightly in October, though
from depressed levels, and even more importantly
that employment rose more than expected, with
159 000 new jobs in the private sector. Even though
unemployment hasn’t yet begun to fall, this is a step
in the right direction. In our recently published US
analysis we stated that GDP growth will probably
have to be revised downward slightly this year and
next, despite relatively positive growth data.
In Germany, exports remained strong, but new
orders and production have swung back and forth
between months, which have created some
uncertainty going forward. The stronger euro could
make it more difficult for the Eurozone’s export
sector, mainly the PIIGS countries, but a more
important reason for the slowdown is that the
previous growth rate was built on temporary
2. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 8 • 11 November 2010
2 (5)
stimulus measures and an inventory recovery,
which are hard to maintain.
Third-quarter GDP growth in the UK exceeded that
of the second quarter by 0.8%. Moreover, the gains
were broader than the second quarter’s 1.2%,
which largely consisted of inventory restocking.
Although the construction industry contributed to the
unexpectedly strong growth, the government’s
austerity package is likely to dampen sentiment
going forward. The strong results may force us to
revise GDP growth for 2010 upward from the
current 1.1% to about 1.5%.
The big, though expected, news in the last month
was the Federal Reserve's new round of USD 600
billion in Treasuries purchases through the second
quarter of next year.
Since this was expected, the US dollar had already
weakened, long-term interest rates had retreated
and stock prices had risen. We are also seeing
higher commodity prices – especially for precious
metals and grain – and rising inflation in countries
where food accounts for a relatively large portion of
household spending, e.g., in Eastern Europe.
Increased tensions at G20- summit
Today, November 11, marks the start of the G20
summit in South Korea's capital, Seoul. The finance
ministers of the 20 countries met on October 22-23,
and the countries of the Asia Pacific Economic
Cooperation (APEC) held a meeting of their finance
ministers on November 6. The latter meeting
provided a foreshadowing of the issues that will
command attention at the current meeting.
Even before the meeting the countries had reached
agreement how to more evenly divide the IMF’s
votes between Western countries and emerging
countries. Despite the need to discuss how the
world can combat climate change and strengthen
financial regulation, currency tensions and trade
imbalances will dominate the agenda.
Countries with large current account deficits and
deleveraging need a nominal and real currency
depreciation. This is especially true of the US.
Countries with large current account deficits instead
will have to watch their currencies appreciate, their
savings decline and domestic demand take over as
more of a growth engine.
At a time when the global economic outlook feels
uncertain and fiscal and monetary policy don't have
enough ammunition left, countries are too easily
taking flight to weaker currencies (or trying to fight
the appreciation of their own currencies, like China).
Various currencies against the US-dollar
(Index 2007-08-09 = 100)
Source: Reuters EcoWin
03 04 05 06 07 08 09 10
60
70
80
90
100
110
120
130
140
150
160
170
180
190
Yen
Euro
Korean Won
Brazilean Real
Swedish Krona
Yuan
Swiss Franc
When the US starts cranking up the printing
presses to buy Treasuries, and depreciating the
value of the dollar, it will launch a wave of activity in
emerging countries. Low interest rates in the West
increase the carry trade, and capital seeks out
countries with higher returns. Emerging countries,
which are seeing their currencies rise and capital
inflows grow more volatile, are resorting to capital
controls and taxes on the derivatives trading. Brazil,
for example, has tightened controls, and Thailand
and other Asian countries are close behind.
China is seeing its currency portfolio, now valued at
USD 2.65 trillion, shrink in value, since two thirds of
it is in US dollars, creating a need for diversification.
China is buying Korean won and Japanese yen.
These countries feel forced to intervene to avoid
volatility (read: to stop their currencies from rising,
which could threaten their export sectors).
The quantitative easing (QE2) that has started in
the US and which will invest USD 600 billion in
Treasuries of various maturities (mainly in the
segment 2.5-10 years) has already been interpreted
as insufficient by the financial markets. Now QE3
and QE4 await. Expectations like these weaken the
dollar and could launch a new negative spiral of
capital controls, currency interventions and
eventually the possibility of a trade war.
Various proposals are being offered to undo the
knots chaining the global financial system. A few
are discussed below:
3. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 8 • 11 November 2010
3 (5)
1. Instead of focusing on currency policy for
countries that peg their currencies to the dollar,
the US proposed a cap on current account
surpluses/deficits. It suggested a limit of 4% of
GDP. Critics were quick to respond, saying that
such a proposal doesn't account for
demographics, savings and whether currencies
are already market-based or not. The risk is that
it would restrict trade and sabotage global
growth. The US withdrew the proposal at the
recent APEC summit and will instead focus on
“how to build a framework for cooperation that
will reduce the risk that future growth is imperiled
by the reemergence of large external
imbalances.”
Current account balance as a share of world GDP
in some countries / groups of countries
2. A couple of days after the APEC summit World
Bank President Robert Zoellick suggested that a
new international monetary system was needed
to replace Bretton Woods. This new system
would include the major currencies as well as
gold, as an “international reference point of
market expectations about inflation, deflation
and future currency values.” Criticism was
severe. The supply of gold falls far short of the
supply of money. A few large central banks own
a disproportionately large share. Switching to the
gold standard would create deflation. Global
trade wouldn’t grow as hoped, since the gold
supply would keep it in check. The price of gold
poorly reflects inflation as a whole in the
economy.
3. A continued appreciation of the Chinese
currency, the renminbi, against the dollar and a
gradual internationalisation, where the renminbi
is increasingly used outside China’s borders.
This process will take time, but is becoming
unavoidable. Europe dropped its peg to the
dollar in the early 1970s, when inflation jumped
in the US. The next step is for China's currency
to drop the peg to the dollar, no longer giving the
US the benefit of the dollar as a reserve
currency.
It is not likely that the G20 countries will reach
agreements at the summit in Seoul that go beyond
their previous statement that “we will move towards
more market-determined exchange rate systems
that reflect underlying economic fundamentals
without competing to force down currencies.” The
US will continue to cite a “strong dollar policy”, but
in practice QE2 weakens the dollar. Countries will
also talk about “avoiding beggar-thy-neighbor
currency policies to spur growth.”
While politically correct, these statements aren’t
being followed by actions that live up to the rhetoric.
Europe – third wheel under the wagon
Germany feels that the EU’s current account
surplus or deficit should be seen from the
perspective of the Union as a whole, not by
individual EU country. In other words, problems in
the Eurozone should “stay within the family.”
The thing is that a stronger euro is not as big a
problem for Germany as for the PIIGS countries.
Germany will begin a period of fiscal austerity as
early as next year despite that it could wait another
year or so. Representatives of the German central
bank may soon consider raising interest rates and
want to cancel the bond purchases that the ECB,
despite German objections, is making.
The EU Council’s approval of the German-French
proposal that any crisis management mechanism
should include a greater commitment from the
private sector has again raised interest rate
spreads. Concerns mainly focus on Portugal and
Ireland, each of which has to borrow about 55 billion
euros during the period 2011-2013. If Spain is also
included, that figure exceeds the current
stabilisation fund of 440 million euros. This worries
the financial markets, as do individual events such
as political uncertainty about local elections in
Greece and Ireland's growing mortgage crisis.
-3
-2
-1
0
1
2
3
4
1970 1975 1980 1985 1990 1995 2000 2005 2010
Oil producers USA
Japan Germany
China Rest of Asia
Rest of world
4. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 8 • 11 November 2010
4 (5)
Interest spreads between German 10 years government
bonds and ditto for other European countries
(percentage points)
Source: Reuters EcoWin
jan
07
maj sep jan
08
maj sep jan
09
maj sep jan
10
maj sep
Percent
-1
0
1
2
3
4
5
6
7
8
9
10
Greece
Italy
BelgiumFrance
Spain
Portugal
Ireland
UK
Because the ECB now has to delay its exit strategy
for purchasing bonds, since the banking system
could again be at risk, tensions are growing
between Germany on the one hand and the PIIGS
countries on the other. In the past week the ECB
has bought 711 million euro in government bonds, a
relatively small sum compared with how much it has
bought since May – 64 billion.
In other words, the crisis extends beyond Europe
and is growing. In 2011 the debt ratio in the
Eurozone as a whole will pass 90%. Among the
larger countries, only Germany and Spain will have
a debt ratio below the average. Loan requirements
are huge.
Growth prospects are being hurt by the need for
budget consolidation and the relatively strong euro
(in PPP terms, the long-term rate should be around
1.1, according to the OECD, i.e., a far cry from
today's 1.38). The Conference Board expects the
Eurozone to slow by 0.5-1 bp in 2011 due to lower
government spending and private consumption. In
the longer term it is important to improve growth
prospects for the Eurozone, which does not have
the same opportunities as the US, for example, with
its more active monetary policy, reserve currency,
ability to utilise transfers between states and more
flexible workforce.
A few closing words
To date the IMF has been able to place conditions
on countries with current account deficits that have
programmes with the IMF. On the other hand, it
lacks the means to pressure countries with
surpluses that don't have programmes with the IMF,
i.e., Japan, China, Germany and even Sweden,
where the current account surplus exceeds 6-7% of
GDP.
Although it may seem that countries with deficits are
the ones that have erred, i.e., that they have
maintained exceptionally expansive economic
policies and encouraged imbalances in household
purchasing, consumer loans, etc., it is not enough
to correct only these countries and leave the others
with surpluses alone.
The problem is that the world would find itself in a
deflationary and depressive cycle. If there are no
currency corrections in that direction to ease the
adjustment in the US, and in part of the Eurozone,
these countries will have to resort to internal
devaluations in the form of lower salaries and
prices, which is something that is already
happening in the PIIGS countries in the absence of
other available means.
The currency policies of emerging countries are
also contributing to the US having to resort to QE2,
and possibly even QE3 and QE4. This in turn will
create new spirals, making it vital that the G20
summit introduce a process that breaks this pattern.
The weakening of the US dollar against the
currencies of emerging countries and oil producers,
as well as against developed countries such as
Sweden and Norway, where market adjustments
can be made, would be a good thing. It is also
important that the Eurozone find an arrangement so
that Germany and the PIIGS countries can better
share the burden of adjustment.
We eagerly await the outcome of the G20 summit.
Perhaps it is reasonable to hope for the best, but it
is even more reasonable to prepare for the worst …
Cecilia Hermansson
Swedbank
Economic Research Department
SE-105 34 Stockholm, Sweden
Phone +46-8-5859 7740
ek.sekr@swedbank.se
www.swedbank.se
Legally responsible publisher
Cecilia Hermansson, +46-88-5859 7720.
Magnus Alvesson, +46-8-5859 3341
Jörgen Kennemar, +46-8-5859 7730
Swedbank’s monthly The Global Economy newsletter is published as a service to our
customers. We believe that we have used reliable sources and methods in the preparation
of the analyses reported in this publication. However, we cannot guarantee the accuracy or
completeness of the report and cannot be held responsible for any error or omission in the
underlying material or its use. Readers are encouraged to base any (investment) decisions
on other material as well. Neither Swedbank nor its employees may be held responsible for
losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’s
monthly The Global Economy newsletter.